Let me welcome you to your new responsibilities. You have a very important job. There are a significant number of people in the financial world who lie awake at night worrying about the mortgage lenders you are responsible for. Fannie Mae, Freddie Mac and the FHLBs hold or guaranty $6.3 Trillion in residential mortgages. It is simply not possible for the US to get out of the mess we are in unless these Agencies are stabilized. Should those Agencies fail, all that has been done to heal the US financial sector will have been wasted. In a significant manner, your success or failure will determine the medium term course of the US economy. Given that the USA is still the driver of global economic activity I would extend that albatross on you as well. If you do not succeed the rest of the global economy will suffer.
You need to do things differently than your predecessor. You need to be aggressive in addressing the Agencies problems. You need to find new solutions, you need to be creative.
Would you like to sell up to $60 billion of your Real Estate Owned (“REO” )? This would be a critical step. If you were able to sell these properties at a reasonable price it would reduce the problem significantly. If you sold the properties rather than auction them off you would be helping to protect the value of homes in neighborhoods across the country. The auction process just devalues the nearby homes and results in more defaults. We need a plan to address this negative cycle.
Would you like to address and resolve the problem you face with the Preferred Shares that both Fannie and Freddie have outstanding? These shares are an impediment to a restructuring of the Agencies. While you may be able to let the common shareholders blow in the wind it is not likely that you can take this attitude regarding the Preferred holders. The action to buy in the Subordinated debt of FRE puts this issue on the table. You can’t make one group of creditors money good while another is out in the cold. My proposal:
Agency Preferred Stock Swap for REO
(discussion draft)
Parties to the Transaction:
(A) Fannie Mae and Freddie Mac as the “Sellers”or the “Agencies”.
(B) Private sector individuals and Corporations who are owners of the Preferred Shares of the Agencies (the “Purchasers”).
Sale Pricing:
Individual properties will be made available to Purchaser at a price equal to the sum of (i) The outstanding principal loan balance plus (ii) 100% of past due and accrued interest on the loan plus (iii) 10% of the outstanding loan principal balance (the “Purchase Price”).
Treatment of Unpaid and Outstanding Property Taxes:
The Purchasers must come to the closing with cash in an amount equal to 100% of the outstanding property taxes. These funds will be remitted directly to the appropriate municipal tax authorities.
Purchase Terms:
The Purchasers can satisfy the Purchase Price by tendering Preferred Shares of the Agencies. The par value of the Preferred Shares will be the basis of determining the number of shares required to consummate the purchase. Example: If the Purchase Price is $250,000, then 10,000 shares of $25 par value Preferreds are required. Alternatively 5,000 of $50 Preferreds are required. (the “Tendered Preferred”).
Treatment of Cumulative Dividends on the Tendered Preferred:
Any unpaid or accumulated dividends on the Tendered Preferred will be forgiven.
Minimum Holding Period of the Purchased Properties:
The Purchasers will agree to retain ownership in the Purchased properties for a period of 24 months commencing from the date of closing.
Penalty for Early Sale:
If a sale of a Property is consummated prior to the 24-month restriction a penalty of 20% of the sale price will be assessed at the closing (the “Early Sale Penalty”). This penalty amount will be paid to the Municipality in which the property is located.
This type of transaction would solve the Agency Preferred share problem, it would result in the sale of a very substantial amount of the REO on your books. It would do it without loss to the Agencies. It would resolve the back tax problem that is hurting communities and ultimately will hurt the Agencies. It would recycle these properties back into the private sector where they belong. The lockup provisions would insure that the properties are not back on the market for an extended period of time. This proposal would create liquidity and increased value for the outstanding Preferred shares. As you know, the Nations regional banks hold a significant amount of these shares. Creating liquidity and enhanced value would help restore bank balance sheets.
I wish you well in your new job. We are all rooting for your success. Market based solutions are the only approaches that will work. Please give market based thinking some consideration. That would be well received. It would be a refreshing departure from all of the non-market solutions that D.C. is pursuing.
Bruce Krasting
Disclosure: I own Agency Pref. Some I acquired before they went into conservatorship last year. These shares are trading at 10-15% of their original issue price. I am deep under water on those buys. I bought some more a few months ago in a double down desperado move. If something happened along the lines I describe above I might break even. That would suit me fine. It is not material. I think that this transaction concept could make everyone a winner. Comments more than welcome on this one.
Monday, August 31, 2009
Sunday, August 30, 2009
Swiss "Black" Accounts – A Trillion Dollar Problem
The case against UBS is over. The Justice Department appears to have won this one. A total of 4,450 out of a total of 52,000 names will be divulged to either DOJ or IRS. Based on what has been presented it would appear that the other 48,000 names that were not disclosed either had the money sent back to a bank in the Sates (equivalent of full disclosure) or they had hired a lawyer and confessed their sins to the IRS.
According to the DOJ the 52,000 names had a total of $15 billion in their black accounts. A sizable amount of money. The question that has been hanging in the air is how much money is still in Swiss black accounts that has not been flushed out at this point? How many other Americans have accounts that were not with UBS? How many accounts are there from non-US names? What is an estimate as to the size of this problem?
The August edition of Swiss Review provides some insight. While Swiss Review is not the end all source of information on this topic their writing is not independent of the Swiss Government who provides a portion of the operating budget. With that in mind I was shocked to find the following in the August edition of SR:
“Switzerland has become a paradise for foreign capital on which tax is not paid. The uproar from foreign governments is understandable.” These are not the words of a critic of the banks, but of private banker Konrad Hummler. He says that around 30%, or CHF 1,000 billion, of the CHF 2,800 billion or so of foreign assets in Swiss banks is untaxed “black money”.
Mr. Hummler probably knows as much about the topic of black accounts in Switzerland as anyone. His Bio:
Konrad Hummler is managing partner of Wegelin & Co., private bankers, and has acted for many years as personal advisor to the chairman of the board of directors of the Union Bank of Switzerland (UBS). He serves as a colonel in the general staff of the Swiss Army.
Mr. Hummler has put a number of nearly 1 Trillion dollars on the problem. This is much higher than any estimate that I have seen before. I thought it could be as high as $500b. It appears that I was understating things by a factor of 2. Some perspective based on the comments by Mr. Hummler:
-The $15 billion owned by the 52,000 American names represents 1.5% of the total.
-The average US account balance at UBS was $300,000. ($15b/52k). Extrapolating from that number one gets an estimate on the total number of black accounts at 3.3 million. Based on this calculation a range of estimates on the total number would be between 2 and 4 million.
Mr. Hummler’s comments are unlikely to go unnoticed by the global taxing authorities. The idea that there is this much money waiting to be claimed by the host countries makes it certain that the attacks against Swiss banks will continue far into the future. Everyone will want their share of $1 Trillion.
I believe that the trees are shaking and the leaves falling on this issue as I write. I recently reviewed a letter from a large Swiss private bank (not Wegelin & Co) that was sent to a US client it reads, in part, as follows:
“To ensure transparency toward the IRS, we would ask you to sign the enclosed form W-9 and return it to us by 30 September 2009. We will then forward form W-9 to our US depository, which will in turn disclose your holdings to the IRS.”
While this letter may not represent the thinking and action of other Swiss banks it is likely that they will be forced to follow suit in the not too distant future. Mr. Rolf Ribi the author of the story in Swiss Review states in his lead in, Banking confidentiality is facing, “the beginning of the end”. I would disagree with Mr. Ribi. We are far from the beginning of this process. The end will come much sooner than is expected. Black accounts in Switzerland are a thing of the past.
A Hat Tip to Mr. Hummler for providing this insight.
According to the DOJ the 52,000 names had a total of $15 billion in their black accounts. A sizable amount of money. The question that has been hanging in the air is how much money is still in Swiss black accounts that has not been flushed out at this point? How many other Americans have accounts that were not with UBS? How many accounts are there from non-US names? What is an estimate as to the size of this problem?
The August edition of Swiss Review provides some insight. While Swiss Review is not the end all source of information on this topic their writing is not independent of the Swiss Government who provides a portion of the operating budget. With that in mind I was shocked to find the following in the August edition of SR:
“Switzerland has become a paradise for foreign capital on which tax is not paid. The uproar from foreign governments is understandable.” These are not the words of a critic of the banks, but of private banker Konrad Hummler. He says that around 30%, or CHF 1,000 billion, of the CHF 2,800 billion or so of foreign assets in Swiss banks is untaxed “black money”.
Mr. Hummler probably knows as much about the topic of black accounts in Switzerland as anyone. His Bio:
Konrad Hummler is managing partner of Wegelin & Co., private bankers, and has acted for many years as personal advisor to the chairman of the board of directors of the Union Bank of Switzerland (UBS). He serves as a colonel in the general staff of the Swiss Army.
Mr. Hummler has put a number of nearly 1 Trillion dollars on the problem. This is much higher than any estimate that I have seen before. I thought it could be as high as $500b. It appears that I was understating things by a factor of 2. Some perspective based on the comments by Mr. Hummler:
-The $15 billion owned by the 52,000 American names represents 1.5% of the total.
-The average US account balance at UBS was $300,000. ($15b/52k). Extrapolating from that number one gets an estimate on the total number of black accounts at 3.3 million. Based on this calculation a range of estimates on the total number would be between 2 and 4 million.
Mr. Hummler’s comments are unlikely to go unnoticed by the global taxing authorities. The idea that there is this much money waiting to be claimed by the host countries makes it certain that the attacks against Swiss banks will continue far into the future. Everyone will want their share of $1 Trillion.
I believe that the trees are shaking and the leaves falling on this issue as I write. I recently reviewed a letter from a large Swiss private bank (not Wegelin & Co) that was sent to a US client it reads, in part, as follows:
“To ensure transparency toward the IRS, we would ask you to sign the enclosed form W-9 and return it to us by 30 September 2009. We will then forward form W-9 to our US depository, which will in turn disclose your holdings to the IRS.”
While this letter may not represent the thinking and action of other Swiss banks it is likely that they will be forced to follow suit in the not too distant future. Mr. Rolf Ribi the author of the story in Swiss Review states in his lead in, Banking confidentiality is facing, “the beginning of the end”. I would disagree with Mr. Ribi. We are far from the beginning of this process. The end will come much sooner than is expected. Black accounts in Switzerland are a thing of the past.
A Hat Tip to Mr. Hummler for providing this insight.
Saturday, August 29, 2009
Big Deals and Big Balls on Wall Street - The "Pony" Trade
I have access to the super secret technology (made in China) that allows one to listen in on selected cell phone conversations. I pulled this one out of the air yesterday. Using names would be unfair, so I will just use initials. PD is Prop Desk. BB is Big Boss.
PD: Hi BB, sorry to bother you, but there is something that I wanted to discuss and it has a short fuse. Where are you?
BB: I am down in Argentina. Muffy and I are here doing a little shopping.
PD: Well, that sounds like fun. What are you shopping for?
BB: Polo ponies, lots of them. The recession killed the market for these horses. You can buy a decent pony now for under $500,000. I am buying all of them that I can find.
PD: Corner the market on ponies huh? Sounds like a good plan. What are you going to do with them?
BB: There are several big shopping malls in NJ that are going belly up this fall. My intention is to buy one, gut it and convert it into the first ever completely indoor polo field. I have always wanted one of those.
PD: Well good for you. That sounds like a swell idea. I have an idea that will pay for the horses and mall and a bunch left over. I wanted to run it by you.
BB: I am all ears when it comes to making money. What’s the play this time?
PD: Our guys in D.C. have been speaking with Timmy G. about their position in Citi. As you know Treasury owns 7.7 billion shares of common. Their cost basis is $3.25 and it closed Friday at 5.23. Apparently the FDIC is just about broke and needs more cash so they are looking to raise $14- 15 billion to plug what is being called the ‘Sheila Gap’. We are in discussion with them about a secondary for 4 billion shares. It would be the biggest deal ever.
BB: A secondary that would float 40% more shares sounds like a lotta risk. Who are you going to do that with? Merrill has no buying power, Morgan Stanley has no balls. Who is going to take that much stock?
PD: Well that is why I am calling. The plan is to do it all alone. A "bought deal" for the whole thing. Timmy is concerned that a transaction of this size would cause market disruptions so they have put the condition on the deal that we have to do a buy and hold for three months. That works to our advantage. Because they insist on our keeping the stock they have agreed to sell it to us deep in the hole. They are willing to sell the 4b shares at $3.75.
BB: Well that sounds interesting, but it is still a lot of risk. Three months is a long time. This will impact our VAR, and we will get more flack from that. Let’s face it, C is a piece of crap and the stock does not belong above $2. So what is the plan to manage the risk?
PD: We think we have that covered. The whole firm is involved at this point. Here is the plan:
The stock loan department has 2.5b shares available for lending. They have withheld these shares for the last ten days. We did that to get a better bid under the stock by making shorting harder. With the 2.5b shares available to us we can sell short the borrowed stock at the current level. We think we can get at least 2.5b shares out the door before the deal is announced. So that way we can eliminate more than half the risk and realize a gain on the 2.5b of $5billion. If we apply that to the remaining unsold shares our average cost goes down to 40 cents. We can’t lose money at that price.
BB: Well it’s getting interesting, but how are you going to get 2.5b shares out the door by midweek?
PD: That is where it gets interesting. We have been working with the quant guys on the HFT desk. They have an interesting plan that I think will work:
The HFT guys are going to run their programs in reverse for a few days. The plan is to put bids and offers in the market for C stock that will cause the other HFT traders to execute transactions and automatically make money in the process. We think that if we put $20 mm of gains in their pocket over a few days they will ramp up their activity and take ever bigger position. Between 1pm and 3 pm on the third day the Algo boys reverse the programming and start selling. The rest of the HFT world will have no clue what is going on and will take the paper assuming the high bids will be there. We think we can push out 1.5b shares before they even know what is going on.
As for the other 1b shares the guys on the trading desk have come up with a idea. Apparently there are over 1mm day traders out there taking positions in C stock. These guys are lining ups bids and offers on the SOES System. The plan is to feed blocks to the day traders below market. The trading desk will be bidding above those levels for smaller amounts so the greed factor of the day traders will allow them to keep buying big while they are selling small. All that is required is to get 100,000 day traders to take 10,000 shares each. This could cost us $10mm but we think we can push out the 1b shares in the morning of the third day. The trading desk is in touch with most of the idiot day traders, so there does not appear to be much of a problem there as well.
So by 3 pm we have pushed out 2.5b shares on to the street.
BB: Isn’t this going to cause a large order imbalance by the end of the day? When the stock collapses by 4 pm there will be hell to pay.
PD: We have that covered too. The research guys are going to issue a report on C at 3pm. They will come out with a ‘Trading buy’ recommendation for C. That will bring in a bunch of others from the buy side. We think that FIDO and the other big guys will buy like crazy from 3- 4. The price might even move up in the last hour. At 4 pm The Treasury announces that the shares have been placed and locked up for two months. We can put out a statement, “We believe in Citi”.
BB: But all of this will result in an explosion of volume. To get this done like you describe it would require back-to-back days of over 5b shares trading hands. Won’t that get the SEC looking into all of this? We would not want that.
PD: We have that covered too. Timmy has leaned on the SEC and they have folded. Mary Schapiro will make a statement after the close, “The transaction is a reflection of the strength and durability of our capital markets. America can be proud of its financial institutions.”
BB: Jesus, it sounds like you have all the bases covered. How much money do you think we can make on this?
PD: We are thinking $6-8 billion. It could go higher.
BB: Well that is a lot of ponies. So giddy up and get that deal printed!
PD: Hi BB, sorry to bother you, but there is something that I wanted to discuss and it has a short fuse. Where are you?
BB: I am down in Argentina. Muffy and I are here doing a little shopping.
PD: Well, that sounds like fun. What are you shopping for?
BB: Polo ponies, lots of them. The recession killed the market for these horses. You can buy a decent pony now for under $500,000. I am buying all of them that I can find.
PD: Corner the market on ponies huh? Sounds like a good plan. What are you going to do with them?
BB: There are several big shopping malls in NJ that are going belly up this fall. My intention is to buy one, gut it and convert it into the first ever completely indoor polo field. I have always wanted one of those.
PD: Well good for you. That sounds like a swell idea. I have an idea that will pay for the horses and mall and a bunch left over. I wanted to run it by you.
BB: I am all ears when it comes to making money. What’s the play this time?
PD: Our guys in D.C. have been speaking with Timmy G. about their position in Citi. As you know Treasury owns 7.7 billion shares of common. Their cost basis is $3.25 and it closed Friday at 5.23. Apparently the FDIC is just about broke and needs more cash so they are looking to raise $14- 15 billion to plug what is being called the ‘Sheila Gap’. We are in discussion with them about a secondary for 4 billion shares. It would be the biggest deal ever.
BB: A secondary that would float 40% more shares sounds like a lotta risk. Who are you going to do that with? Merrill has no buying power, Morgan Stanley has no balls. Who is going to take that much stock?
PD: Well that is why I am calling. The plan is to do it all alone. A "bought deal" for the whole thing. Timmy is concerned that a transaction of this size would cause market disruptions so they have put the condition on the deal that we have to do a buy and hold for three months. That works to our advantage. Because they insist on our keeping the stock they have agreed to sell it to us deep in the hole. They are willing to sell the 4b shares at $3.75.
BB: Well that sounds interesting, but it is still a lot of risk. Three months is a long time. This will impact our VAR, and we will get more flack from that. Let’s face it, C is a piece of crap and the stock does not belong above $2. So what is the plan to manage the risk?
PD: We think we have that covered. The whole firm is involved at this point. Here is the plan:
The stock loan department has 2.5b shares available for lending. They have withheld these shares for the last ten days. We did that to get a better bid under the stock by making shorting harder. With the 2.5b shares available to us we can sell short the borrowed stock at the current level. We think we can get at least 2.5b shares out the door before the deal is announced. So that way we can eliminate more than half the risk and realize a gain on the 2.5b of $5billion. If we apply that to the remaining unsold shares our average cost goes down to 40 cents. We can’t lose money at that price.
BB: Well it’s getting interesting, but how are you going to get 2.5b shares out the door by midweek?
PD: That is where it gets interesting. We have been working with the quant guys on the HFT desk. They have an interesting plan that I think will work:
The HFT guys are going to run their programs in reverse for a few days. The plan is to put bids and offers in the market for C stock that will cause the other HFT traders to execute transactions and automatically make money in the process. We think that if we put $20 mm of gains in their pocket over a few days they will ramp up their activity and take ever bigger position. Between 1pm and 3 pm on the third day the Algo boys reverse the programming and start selling. The rest of the HFT world will have no clue what is going on and will take the paper assuming the high bids will be there. We think we can push out 1.5b shares before they even know what is going on.
As for the other 1b shares the guys on the trading desk have come up with a idea. Apparently there are over 1mm day traders out there taking positions in C stock. These guys are lining ups bids and offers on the SOES System. The plan is to feed blocks to the day traders below market. The trading desk will be bidding above those levels for smaller amounts so the greed factor of the day traders will allow them to keep buying big while they are selling small. All that is required is to get 100,000 day traders to take 10,000 shares each. This could cost us $10mm but we think we can push out the 1b shares in the morning of the third day. The trading desk is in touch with most of the idiot day traders, so there does not appear to be much of a problem there as well.
So by 3 pm we have pushed out 2.5b shares on to the street.
BB: Isn’t this going to cause a large order imbalance by the end of the day? When the stock collapses by 4 pm there will be hell to pay.
PD: We have that covered too. The research guys are going to issue a report on C at 3pm. They will come out with a ‘Trading buy’ recommendation for C. That will bring in a bunch of others from the buy side. We think that FIDO and the other big guys will buy like crazy from 3- 4. The price might even move up in the last hour. At 4 pm The Treasury announces that the shares have been placed and locked up for two months. We can put out a statement, “We believe in Citi”.
BB: But all of this will result in an explosion of volume. To get this done like you describe it would require back-to-back days of over 5b shares trading hands. Won’t that get the SEC looking into all of this? We would not want that.
PD: We have that covered too. Timmy has leaned on the SEC and they have folded. Mary Schapiro will make a statement after the close, “The transaction is a reflection of the strength and durability of our capital markets. America can be proud of its financial institutions.”
BB: Jesus, it sounds like you have all the bases covered. How much money do you think we can make on this?
PD: We are thinking $6-8 billion. It could go higher.
BB: Well that is a lot of ponies. So giddy up and get that deal printed!
Thursday, August 27, 2009
What's C Worth?
I have no clue where C will open tomorrow, forget about a week or a month from now. All I know is that it closed today at fairly miraculous price of $5.05. I am not sure what this price represents. It is somewhat comforting that neither Yahoo nor Bloomberg can figure out what this price means either. Note on the following two slides their respective calculations on the market capitalization of C at the closing level. There is a $30b difference in the calculation. I think they are both wrong.
The calculation by Yahoo assumes that there are 5.5b shares outstanding. That is not correct. I believe that this number comes from C’s 2nd Q 10-Q. In that report C shows 5.9b shares outstanding. This number would be reduced by treasury stock buy backs and therefore comes close to that 5.5b number. On July 23rd and 29th C swapped a boatload of preferred into newly issued common. The Yahoo calculation does not take this transaction into effect when deriving the MC for C.
Bloomberg is very precise on the number of shares used in its calculation. They are using 11,341,826,000 (11.3b). It is not clear where this number comes from. It represents an increase of 5.4b shares from the net 5.9b that were recorded at the end of March. The following chart describes who did what to whom in the C deal.
From this one would have assumed that the 3.846b, 823mm, 3.351, and 1.660b (the non Government Pref.) are now part of the public float. That total of new shares comes to 9.7b. This number does not square well with the number that Bloomberg uses. It would appear that some of the Private stock is not included in the public float calculation. For the sake of discussion assume that the Bloomberg share number is correct. If anything it understates the public float.
That number does not reflect the shares that are held by the USG (aka the taxpayer). The USG holds an additional 7.7b shares. These shares are not now part of the public float and therefore their exclusion in determining public market cap is correct. But at a $5.05 price the taxpayer has a gain in the common that it owns, and I doubt many of the citizens want to be long-term holders. When considering what the pro-form market cap is, the USG shares should be included. At a minimum there should be an asterisk on this number.
If you take Bloomberg’s 11.3b and add to it the 7.7b USG shares you get 19b total shares. At $5.05 that comes to $96b. By way of comparison the de-TARPed GS has a market cap of only $84b. I’m not sure if anyone knows the fair value of C.
Note:
At a price above $5 the opportunity for Treasury to do a secondary to offload some of its stock must be very tempting (there is a $14b mark to market gain). This is the taxpayer’s money. It makes perfect sense to take some ‘off the table’ given the market conditions. News of that transaction would read very well for Mr. Geithner and the Administration. They have an obligation to protect all of our interests. In this case getting some of the eggs safely back into the nest would seem wise.
I don’t know the provisions for a lock up of the USG shares. It might require a vote. Those shares are in effect owned by 300 million people. I think they would all vote to do a secondary offering. It would be an interesting Proxy fight.
The calculation by Yahoo assumes that there are 5.5b shares outstanding. That is not correct. I believe that this number comes from C’s 2nd Q 10-Q. In that report C shows 5.9b shares outstanding. This number would be reduced by treasury stock buy backs and therefore comes close to that 5.5b number. On July 23rd and 29th C swapped a boatload of preferred into newly issued common. The Yahoo calculation does not take this transaction into effect when deriving the MC for C.
Bloomberg is very precise on the number of shares used in its calculation. They are using 11,341,826,000 (11.3b). It is not clear where this number comes from. It represents an increase of 5.4b shares from the net 5.9b that were recorded at the end of March. The following chart describes who did what to whom in the C deal.
From this one would have assumed that the 3.846b, 823mm, 3.351, and 1.660b (the non Government Pref.) are now part of the public float. That total of new shares comes to 9.7b. This number does not square well with the number that Bloomberg uses. It would appear that some of the Private stock is not included in the public float calculation. For the sake of discussion assume that the Bloomberg share number is correct. If anything it understates the public float.
That number does not reflect the shares that are held by the USG (aka the taxpayer). The USG holds an additional 7.7b shares. These shares are not now part of the public float and therefore their exclusion in determining public market cap is correct. But at a $5.05 price the taxpayer has a gain in the common that it owns, and I doubt many of the citizens want to be long-term holders. When considering what the pro-form market cap is, the USG shares should be included. At a minimum there should be an asterisk on this number.
If you take Bloomberg’s 11.3b and add to it the 7.7b USG shares you get 19b total shares. At $5.05 that comes to $96b. By way of comparison the de-TARPed GS has a market cap of only $84b. I’m not sure if anyone knows the fair value of C.
Note:
At a price above $5 the opportunity for Treasury to do a secondary to offload some of its stock must be very tempting (there is a $14b mark to market gain). This is the taxpayer’s money. It makes perfect sense to take some ‘off the table’ given the market conditions. News of that transaction would read very well for Mr. Geithner and the Administration. They have an obligation to protect all of our interests. In this case getting some of the eggs safely back into the nest would seem wise.
I don’t know the provisions for a lock up of the USG shares. It might require a vote. Those shares are in effect owned by 300 million people. I think they would all vote to do a secondary offering. It would be an interesting Proxy fight.
US Treasury on Agency MBS – Don’t Buy It!
The office of Inspector General, Department of Treasury released a report on 8/6/09 on the failure of the National Bank of Commerce. NBC went toast on 1/16/2009. The principal source of its collapse was its investments in Fannie Mae Preferred Stock. They owned $98mm of that swill. When they wrote it off they had no tier-one equity left and had to be shuttered.
The report exonerated both the banks management and the supervisory effort by OCC. From the report:
“All things considered, we believe that NBC acted in good faith when it invested in the GSE securities. Additionally, we have no reason to fault OCC’s supervision of the institution as it relates to NBC’s investment practices. Current law and regulatory standards permit banks to purchase GSE securities without limitation.”
Is the Treasury IG suggesting that there should be a limit on banks investing in GSE securities? You betcha they are:
"The lesson to be taken from the NBC material loss is that banks and regulators need to be cognizant that securities that are not backed by the full faith and credit of the U.S. government do entail risk, and high concentrations of such holdings elevate that risk."
Hello there! Fannie Mae and Freddie Mac have $3.5 Trillion of MBS outstanding. Not one penny of it is expressly guaranteed by Treasury or the Fed.
“We are recommending that OCC (1) conduct a review of investments held by national banks for any potential high risk concentrations and take appropriate supervisory action, and (2) reassess examination guidance regarding investment securities, including GSE securities.”
This report is a kick in the head for everyone involved. Fannie and Freddie look bad. Who would want to own the GSE paper with this warning from Treasury? It makes Treasury look silly. They hold the Government Pref. issued by the Agencies. If they guy down the hall is saying don’t buy the debt he is certainly saying don’t buy the equity. The Fed looks the worst of the lot in light of this. They are in the process of buying $1.25 Trillion of Agency MBS. I wonder what the Treasury IG would have to say about that level of concentration.
The only one looking good on this are the Chinese. They have sold their Agency MBS back to the Fed. Take a guess who will be the loser on that trade.
Link to the OIG report:http://www.treas.gov/inspector-general/audit-reports/2009/oig09042.pdf
The report exonerated both the banks management and the supervisory effort by OCC. From the report:
“All things considered, we believe that NBC acted in good faith when it invested in the GSE securities. Additionally, we have no reason to fault OCC’s supervision of the institution as it relates to NBC’s investment practices. Current law and regulatory standards permit banks to purchase GSE securities without limitation.”
Is the Treasury IG suggesting that there should be a limit on banks investing in GSE securities? You betcha they are:
"The lesson to be taken from the NBC material loss is that banks and regulators need to be cognizant that securities that are not backed by the full faith and credit of the U.S. government do entail risk, and high concentrations of such holdings elevate that risk."
Hello there! Fannie Mae and Freddie Mac have $3.5 Trillion of MBS outstanding. Not one penny of it is expressly guaranteed by Treasury or the Fed.
“We are recommending that OCC (1) conduct a review of investments held by national banks for any potential high risk concentrations and take appropriate supervisory action, and (2) reassess examination guidance regarding investment securities, including GSE securities.”
This report is a kick in the head for everyone involved. Fannie and Freddie look bad. Who would want to own the GSE paper with this warning from Treasury? It makes Treasury look silly. They hold the Government Pref. issued by the Agencies. If they guy down the hall is saying don’t buy the debt he is certainly saying don’t buy the equity. The Fed looks the worst of the lot in light of this. They are in the process of buying $1.25 Trillion of Agency MBS. I wonder what the Treasury IG would have to say about that level of concentration.
The only one looking good on this are the Chinese. They have sold their Agency MBS back to the Fed. Take a guess who will be the loser on that trade.
Link to the OIG report:http://www.treas.gov/inspector-general/audit-reports/2009/oig09042.pdf
Wednesday, August 26, 2009
Clunkers and Home Sales – It’s All the Same Thing
The car clunker program was a huge success. Close to 700,000 cars were sold as a result of the program. The cash rebate was the down payment that was necessary for consumers to borrow more money and buy a car. The clunker concept has now been extended to washing machines. No doubt that the availability of government rebate checks will stimulate demand for these products as well.
It will be very interesting to follow car sales over the next few months. The sales volume will fall, as the stimulus to buy is no longer there. The question will be: “ Did the clunker program just steal from future consumption, or has there been a permanent increase in demand that reflects a stronger economy? My bet is that the demand is going to fall flat. I visited a car dealer on Tuesday and they had not seen a customer. Without the rebate there are no buyers.
There is another clunker like program that is out there stimulating demand. It is focused on the low end housing market. Given the huge success of car clunkers it is reasonable to assume that this segment of the housing market is being positively influenced by the subsidy. The question here will be whether that stimulus is responsible for the improved housing numbers that have surfaced over the past few months.
The American Recovery and Reinvestment Act (ARRA) of 2/17/2009 created an $8,000 tax credit for first time home buyers. The number of homes that have been sold as a result of this program is not clear at this time. As I drive around my neighborhood I see many For Sale signs that highlight the $8,000 credit. Until the success of the car clunker program I thought that this incentive was not a significant factor. I have revised my own view regarding its impact on the housing market.
The ARRA established an estimate of $3b as the cost of the housing subsidy. The actual results could vary significantly from that estimate. It depends on how many buyers take advantage of the program. The full $8,000 is available to only a defined group of buyers. The rebate is limited to not more than 10% of the home to be purchased. Therefore one has to buy a home equal to not less than $80,000 to get the max. Another restriction is on individual/family income. Above $150,000 of household income the tax credit is phased out.
These variables make it difficult to predict how significant the stimulus results are. We will not know the exact answer until the IRS reports on this. That is a next year event. For the sake of discussion assume that this program is working as planned and that the number of homes sold as a result of the incentive is prorated equally over the life of the program. $3b divided by $8,000 comes to 375,000 homes. The program will expire at the end of November; therefore an estimate of the number of homes sold under the program from inception to date would be 250,000.
How significant is this in the home sales rebound that we seem to be witnessing? My answer is that it is a big factor. Housing sales are running at a rate close to 5mm per year. During the six months that the housing rebate program has been in place approximately 10% of the homes sold were a result of the program.
It is likely that the full benefits of the program were not felt until May 19th of this year. At that time HUD created the opportunity for a buyer to use the $8,000 as a down payment provided that the borrower obtained an FHA insured mortgage. FHA can insure up to 97.5% of a purchase price. This means that the equity of $8,000 could have been used to finance a 100% purchase. If one was wondering why there are the endless ads for FHA mortgages on cable TV, this is your answer. The cash that can be created along with the high LTV FHA loans makes it possible once again to buy a home with no money down. The three months that this 100% financing window has been open are the same three months where housing has turned around. That is not a coincidence. We’ve seen this before. It sells homes. It raises values. It looks good. But it creates a tremendous headache.
Given that the bulk of the stimulus was felt post 5/19 it is possible that as much as 20% of the sales over the last three months were tied to the rebate. Without that contribution we would not have seen any recovery in home values over the past three months.
These stimulus measures work. That has been proven. But these programs are not sustainable. The budget deficit is already too large. At some point the music has to stop with all of the economic intervention. When that happens the economy will have no boost. Economic activity will suffer. We have bought some time with all of the subsidies for consumption. That time is running out.
1%+ real economic growth for 2010 will be difficult to achieve unless Congress passes a second stimulus program. The question will be whether the money to fund these stimulus measures can be borrowed at a cost we can afford. The other question will be if the dollar can hold up in the face of America’s continued dependence on debt as the only driver of consumption.
The ability to expand the stimulus programs will be dependent on the will of the Markets as much as the will of the Administration/Congress. At the end of August there is no evidence of unfriendly markets. September and October are not likely to be as friendly.
It will be very interesting to follow car sales over the next few months. The sales volume will fall, as the stimulus to buy is no longer there. The question will be: “ Did the clunker program just steal from future consumption, or has there been a permanent increase in demand that reflects a stronger economy? My bet is that the demand is going to fall flat. I visited a car dealer on Tuesday and they had not seen a customer. Without the rebate there are no buyers.
There is another clunker like program that is out there stimulating demand. It is focused on the low end housing market. Given the huge success of car clunkers it is reasonable to assume that this segment of the housing market is being positively influenced by the subsidy. The question here will be whether that stimulus is responsible for the improved housing numbers that have surfaced over the past few months.
The American Recovery and Reinvestment Act (ARRA) of 2/17/2009 created an $8,000 tax credit for first time home buyers. The number of homes that have been sold as a result of this program is not clear at this time. As I drive around my neighborhood I see many For Sale signs that highlight the $8,000 credit. Until the success of the car clunker program I thought that this incentive was not a significant factor. I have revised my own view regarding its impact on the housing market.
The ARRA established an estimate of $3b as the cost of the housing subsidy. The actual results could vary significantly from that estimate. It depends on how many buyers take advantage of the program. The full $8,000 is available to only a defined group of buyers. The rebate is limited to not more than 10% of the home to be purchased. Therefore one has to buy a home equal to not less than $80,000 to get the max. Another restriction is on individual/family income. Above $150,000 of household income the tax credit is phased out.
These variables make it difficult to predict how significant the stimulus results are. We will not know the exact answer until the IRS reports on this. That is a next year event. For the sake of discussion assume that this program is working as planned and that the number of homes sold as a result of the incentive is prorated equally over the life of the program. $3b divided by $8,000 comes to 375,000 homes. The program will expire at the end of November; therefore an estimate of the number of homes sold under the program from inception to date would be 250,000.
How significant is this in the home sales rebound that we seem to be witnessing? My answer is that it is a big factor. Housing sales are running at a rate close to 5mm per year. During the six months that the housing rebate program has been in place approximately 10% of the homes sold were a result of the program.
It is likely that the full benefits of the program were not felt until May 19th of this year. At that time HUD created the opportunity for a buyer to use the $8,000 as a down payment provided that the borrower obtained an FHA insured mortgage. FHA can insure up to 97.5% of a purchase price. This means that the equity of $8,000 could have been used to finance a 100% purchase. If one was wondering why there are the endless ads for FHA mortgages on cable TV, this is your answer. The cash that can be created along with the high LTV FHA loans makes it possible once again to buy a home with no money down. The three months that this 100% financing window has been open are the same three months where housing has turned around. That is not a coincidence. We’ve seen this before. It sells homes. It raises values. It looks good. But it creates a tremendous headache.
Given that the bulk of the stimulus was felt post 5/19 it is possible that as much as 20% of the sales over the last three months were tied to the rebate. Without that contribution we would not have seen any recovery in home values over the past three months.
These stimulus measures work. That has been proven. But these programs are not sustainable. The budget deficit is already too large. At some point the music has to stop with all of the economic intervention. When that happens the economy will have no boost. Economic activity will suffer. We have bought some time with all of the subsidies for consumption. That time is running out.
1%+ real economic growth for 2010 will be difficult to achieve unless Congress passes a second stimulus program. The question will be whether the money to fund these stimulus measures can be borrowed at a cost we can afford. The other question will be if the dollar can hold up in the face of America’s continued dependence on debt as the only driver of consumption.
The ability to expand the stimulus programs will be dependent on the will of the Markets as much as the will of the Administration/Congress. At the end of August there is no evidence of unfriendly markets. September and October are not likely to be as friendly.
Sunday, August 23, 2009
Blog Wars- AC VS BK
Across the Curve
Attn: Mr. Jansen,
You choose to rip up a small portion of my post at Zero Hedge. You take me to task because I stated that the Fed QE buys were $1.5 trillion. You point to a Fed report that states that the FED POMO purchases will total $1.75 trillion. They will buy $200B of Agency debt, 1.25T of Agency MBS and $300B of Treasury Coupons. That total is clearly $1.75 Trillion so score one for you.
In my post I stated $1.5 trillion because this is the rounded total of MBS and Treasury purchases. I excluded the $200b of Agency debt from my calculation. I did this as I am not certain that the Agency debt buys are actually a part of the QE program.
A question for you. When the Fed lent money to AIG was that QE? I don’t think so, but I look forward to your input on that. If AIG was not QE then it might be fair to say that money lent directly to the Agencies might also be excluded. If that were to be the case then my number on QE would be correct.No?
If you can’t answer this then maybe we can pose the question to Mr. Bernanke.
In my writing I try hard not to exaggerate or understate facts. If I had stated that QE was $3t then you could have legitimately ripped me up. But that was not the case.
We disagree on whether the Agency loans are QE or whether they are something else. That is a good discussion to have in the blogs. I admit that I do not know the answer to this.
Your objective in this piece was simple. You’re continuing your effort to marginalize Zero Hedge. And you're using me to achieve that end. It will not work. Read the comments on your post.
John,the word is hubris. Look it up.
Attn: Mr. Jansen,
You choose to rip up a small portion of my post at Zero Hedge. You take me to task because I stated that the Fed QE buys were $1.5 trillion. You point to a Fed report that states that the FED POMO purchases will total $1.75 trillion. They will buy $200B of Agency debt, 1.25T of Agency MBS and $300B of Treasury Coupons. That total is clearly $1.75 Trillion so score one for you.
In my post I stated $1.5 trillion because this is the rounded total of MBS and Treasury purchases. I excluded the $200b of Agency debt from my calculation. I did this as I am not certain that the Agency debt buys are actually a part of the QE program.
A question for you. When the Fed lent money to AIG was that QE? I don’t think so, but I look forward to your input on that. If AIG was not QE then it might be fair to say that money lent directly to the Agencies might also be excluded. If that were to be the case then my number on QE would be correct.No?
If you can’t answer this then maybe we can pose the question to Mr. Bernanke.
In my writing I try hard not to exaggerate or understate facts. If I had stated that QE was $3t then you could have legitimately ripped me up. But that was not the case.
We disagree on whether the Agency loans are QE or whether they are something else. That is a good discussion to have in the blogs. I admit that I do not know the answer to this.
Your objective in this piece was simple. You’re continuing your effort to marginalize Zero Hedge. And you're using me to achieve that end. It will not work. Read the comments on your post.
John,the word is hubris. Look it up.
Thursday, August 20, 2009
Freddie's ESOP - A Conflict?
Mr. Lockhart’s decision to leave FHFA at the end of the month took me by surprise. It’s only the 20th and he already has a new job. Distressed debt at WL Ross & Co. LLC. Funny how these things work out.
There were a few rumors regarding the Agency's future a few weeks ago. At the time I thought the reports were deliberate leaks. They seemed to be too coincidental with Lockhart’s announcement. That talk probably came from Treasury. That would be logical given that $6.3 trillion is at stake. It looks like Treasury is lining up to take an active role in the Agencies. Mr. Geithner dodged this issue early this year in a Q&A re: the stress test process. He did make it clear that the Agencies were on his, “to do” list.
If the Agencies get folded into Treasury, or come under Treasury’s direct control it will likely result in an end to the debate, “Should there be a GSE in our future?” If Treasury is going to assume direct responsibility, the obvious answer to that question is an emphatic, “No”. Consider the issue of stock ownership by employees of Freddie Mac.
Ownership of stock by senior management of a corporation is a positive. An investor should ‘feel better’ when common shares are widely owned by officers. There are, no doubt, a few thousand exceptions to that rule; Freddie Mac is one of the exceptions.
Follow that logic (if you agree) and consider the implications of common stock ownership of Freddie Mac management. Based on the foregoing thought it would be very reasonable to have significant equity ownership by management at FRE. But now think of this as a taxpayer, politician, or a regulator. There is an obvious conflict of interest for management to have an upside when taxpayers have the downside. Heads I win. Tails you lose.
FRE was very much a public company. They have 650mm share outstanding. Two years ago the stock was trading hands at $64. They had a market cap of $40b. And like most other publicly traded companies they had a significant amount of equity ownership by senior management. As of 3/31/08, just five months before the implosion, there were 12mm shares in the hands of employees. Fannie’ stock had been cut in half by March 2008. Those employee owned shares were still worth $400mm.
A list of the SEC Form-4 transaction by FRE management shows that a number of officers have sold stock in the last year. These sales were done at distressed values and the amounts are not significant. What is of interest is the amount of shares these officers held.
This very limited list of management (15) shows that these folks owned a total of 1.1mm shares of FRE. In March of last year that was worth $35mm. They had a lot riding on the outcome. The SVP in Charge of Investments and Capital Markets held shares that had a value of $4mm. The Chief Compliance Officer had $3mm. The Chief Business Officer had a stake of $7mm. The SVP for Regulatory Affairs had a modest $1.5mm, the more optimistic EVP and General Council had $3mm. These holdings were worth twice that in 2007.
In my opinion, this ownership is perfectly appropriate for a publicly owned corporation. I am sorry for the people who lost money whether they be employees or regular shareholders. However, this kind of compensation plan is not in the future. It is inappropriate for a government run operation that is responsible to the taxpayers. The bastard status of the GSE’s created the ambiguity. We can’t allow that to happen again. Hopefully, Mr. Geithner will see the GSE structure for what it is. Dead.
Note: An impossible suggestion. Paul Volker. He does not have to run FHFA, or have any responsibility for the Agencies activities. But if he put his thumbprint on plan that could be implemented over a few years it would be one hell of jolt to the system. I might even get bullish.
The more probable outcome of a significant Treasury role will prove to be a political mess. At least I will have something to write about for a few more years….
From Fannie's 2008 Proxy
List of the FRE Form 4 filings.
There were a few rumors regarding the Agency's future a few weeks ago. At the time I thought the reports were deliberate leaks. They seemed to be too coincidental with Lockhart’s announcement. That talk probably came from Treasury. That would be logical given that $6.3 trillion is at stake. It looks like Treasury is lining up to take an active role in the Agencies. Mr. Geithner dodged this issue early this year in a Q&A re: the stress test process. He did make it clear that the Agencies were on his, “to do” list.
If the Agencies get folded into Treasury, or come under Treasury’s direct control it will likely result in an end to the debate, “Should there be a GSE in our future?” If Treasury is going to assume direct responsibility, the obvious answer to that question is an emphatic, “No”. Consider the issue of stock ownership by employees of Freddie Mac.
Ownership of stock by senior management of a corporation is a positive. An investor should ‘feel better’ when common shares are widely owned by officers. There are, no doubt, a few thousand exceptions to that rule; Freddie Mac is one of the exceptions.
Follow that logic (if you agree) and consider the implications of common stock ownership of Freddie Mac management. Based on the foregoing thought it would be very reasonable to have significant equity ownership by management at FRE. But now think of this as a taxpayer, politician, or a regulator. There is an obvious conflict of interest for management to have an upside when taxpayers have the downside. Heads I win. Tails you lose.
FRE was very much a public company. They have 650mm share outstanding. Two years ago the stock was trading hands at $64. They had a market cap of $40b. And like most other publicly traded companies they had a significant amount of equity ownership by senior management. As of 3/31/08, just five months before the implosion, there were 12mm shares in the hands of employees. Fannie’ stock had been cut in half by March 2008. Those employee owned shares were still worth $400mm.
A list of the SEC Form-4 transaction by FRE management shows that a number of officers have sold stock in the last year. These sales were done at distressed values and the amounts are not significant. What is of interest is the amount of shares these officers held.
This very limited list of management (15) shows that these folks owned a total of 1.1mm shares of FRE. In March of last year that was worth $35mm. They had a lot riding on the outcome. The SVP in Charge of Investments and Capital Markets held shares that had a value of $4mm. The Chief Compliance Officer had $3mm. The Chief Business Officer had a stake of $7mm. The SVP for Regulatory Affairs had a modest $1.5mm, the more optimistic EVP and General Council had $3mm. These holdings were worth twice that in 2007.
In my opinion, this ownership is perfectly appropriate for a publicly owned corporation. I am sorry for the people who lost money whether they be employees or regular shareholders. However, this kind of compensation plan is not in the future. It is inappropriate for a government run operation that is responsible to the taxpayers. The bastard status of the GSE’s created the ambiguity. We can’t allow that to happen again. Hopefully, Mr. Geithner will see the GSE structure for what it is. Dead.
Note: An impossible suggestion. Paul Volker. He does not have to run FHFA, or have any responsibility for the Agencies activities. But if he put his thumbprint on plan that could be implemented over a few years it would be one hell of jolt to the system. I might even get bullish.
The more probable outcome of a significant Treasury role will prove to be a political mess. At least I will have something to write about for a few more years….
From Fannie's 2008 Proxy
List of the FRE Form 4 filings.
Tuesday, August 18, 2009
Social Security - Some Fun Facts
In a recent Fortune article Mr. Steven Goss the Chief Actuary of the Social Security Trust Fund said, “Health care must be addressed before SS is reformed”. Given the absolute lack of progress on health care it looks like any resolution of the problems at SS will be put off until next year. The Fund is already past a tipping point. Another year lost before the issues are addressed will just make the problems more difficult to solve. Some odds and ends on the Fund:
-Total expenses and disbursements of the SSTF in 2009 are anticipated to be $675 billion or 5% of GDP. Total military expenditures for 2009 including supplemental costs for Iraq/Afghanistan will be near $600 billion. The Trust Fund has the clout of the Military.
-In 2009 the Fund recorded a gain of $92mm from “Uncashed Checks”. If nearly $100mm of checks were not cashed one has to wonder how many checks were cashed that should not have been?
-The combined cost of running the fund is $4.9 billion. Of that amount $849mm is paid to the US Treasury. Nearly a billion paid to Treasury for "services"? What services?
-In 2008 the Fund reported an income of “less than $500k” from a gift. Someone died and left the SSTF an inheritance. Congress passed a bill that permitted the Fund to accept these gifts. With all of the good things out there that are in need of money one has to wonder about the mindset of these donors. The mindset of Congress to pass the enabling legislation is also in question.
-A significant factor in the long run health of the Fund is the mortality rate. If the mortality rate for beneficiaries were to rise (versus a projected drop) it would solve the financial imbalance. These Town Hall meetings today where folks are screaming at ‘End of Life Counseling’ are nothing. Wait till these people understand that economics will drive the availability of heath care and result in an increase in mortality.
-There are three significant milestones for the Fund.
(I) The year that the number of workers per beneficiary peaked. That happened in 2006.
(II) The year that total outflows exceed tax income. It looks increasingly likely that this will occur in 2010 unless there is a significant increase in employment very quickly.
(III) The year that total outflows exceed tax income and interest income. The Fund projects this to be 2017. It is could come as early as 2011.
-In 2009 there was an error adjustment of $339 million between the DI and OASI fund. “To correct an allocation error” was the explanation. The numbers are so large that this is a rounding error.
-In the past 12 months there have been 6 ‘deficit’ months at the Fund. These are months were income is less than out go. That has never happened before. It is an indication of the deterioration in the footings of the Fund. The primary problem is a lack of income from payrolls. A turnaround in the direction of the TF would require a rapid return to 6% unemployment. This implies a complete reversal of the monthly declines and an increase in the work force of 2mm. An improbable outlook for the next 24 months. Additional deficit months are likely in August, October and November of 2009. These deficit months are rapidly changing the calculation for the Net Future Value of the Fund.
-In 08 the Fund forecast that its assets would grow from $2.238 T to $4.273 T in ten years. In 09 the Fund predicted that its assets would grow to only $3.874 T in the next decade. That is a tremendous revision of the projected size of the Fund. The internal growth rate was revised from 6.68% to 4.83% in just one year. That is a 30% reduction in expected growth. The adjusted 2008 forecast for the year 2018 would have brought the fund to a balance of $4.558 T. The revised 2009 forecast is therefore $680 billion less than just one year ago. This constitutes a 15% drop in the projected size of the surplus. A gigantic miss.
-In its 2009 report the Fund urged an immediate increase of 2% in total payroll taxes or a 13% drop in benefits (or some combination of the two). By the time America is done with the health care debate and the higher taxes that it will surely bring there will be no discussion for additional increases in taxes on 100mm workers to fix SS. To do so would be economic suicide. Therefore, the solution will be heavily skewed to cuts in benefits. If the proposal to ‘fix’ the problem is for a 10% cut there will be a social explosion. There are 52mm covered beneficiaries today. If you think America is mad over health care wait until this reality is made public.
-The population 65+ today is 40mm. In 2020 it will be 54mm. A 36% increase. This is the boomers. They are the problem.
-Disable workers represent 9.5mm of the 52mm current beneficiaries. It is good that America has a safety net for workers who become disabled. However, this is about retirement benefits, not social costs for workers. Including the DI fund in the retirement fund mixes two different things. They should be separate.
-The Secretary of the Treasury, Mr. Timothy Geithner is a Managing Trustee for the Fund. I can’t imagine that he has the time to look at 10% of the issues the Fund faces.
-In the June 2009 annual report the Fund forecast revenues of $708b and expenses of $562B. These numbers produce an estimate for the full year 2009 surplus of $146 billion. So far through May of this year they are well behind on that projection. Through May of 09 the surplus was $36.7b versus the same period in 08 of 57.4 b A full year surplus of only $80b looks more likely. In 2005 the TF surplus funded half of the public deficit. By 2011 those surpluses will be gone. Another big buyer of our debt will no longer be there.
-As part of its July 2009 cash management activities the Fund bought and sold Treasury IOUs totaling $115 billion. They acquired an eleven-month piece of paper for $56.35b at an interest rate of 3.25%. A market rate would have been .75%. That difference comes to $1.3 billion. Just another of those rounding errors.
-Total expenses and disbursements of the SSTF in 2009 are anticipated to be $675 billion or 5% of GDP. Total military expenditures for 2009 including supplemental costs for Iraq/Afghanistan will be near $600 billion. The Trust Fund has the clout of the Military.
-In 2009 the Fund recorded a gain of $92mm from “Uncashed Checks”. If nearly $100mm of checks were not cashed one has to wonder how many checks were cashed that should not have been?
-The combined cost of running the fund is $4.9 billion. Of that amount $849mm is paid to the US Treasury. Nearly a billion paid to Treasury for "services"? What services?
-In 2008 the Fund reported an income of “less than $500k” from a gift. Someone died and left the SSTF an inheritance. Congress passed a bill that permitted the Fund to accept these gifts. With all of the good things out there that are in need of money one has to wonder about the mindset of these donors. The mindset of Congress to pass the enabling legislation is also in question.
-A significant factor in the long run health of the Fund is the mortality rate. If the mortality rate for beneficiaries were to rise (versus a projected drop) it would solve the financial imbalance. These Town Hall meetings today where folks are screaming at ‘End of Life Counseling’ are nothing. Wait till these people understand that economics will drive the availability of heath care and result in an increase in mortality.
-There are three significant milestones for the Fund.
(I) The year that the number of workers per beneficiary peaked. That happened in 2006.
(II) The year that total outflows exceed tax income. It looks increasingly likely that this will occur in 2010 unless there is a significant increase in employment very quickly.
(III) The year that total outflows exceed tax income and interest income. The Fund projects this to be 2017. It is could come as early as 2011.
-In 2009 there was an error adjustment of $339 million between the DI and OASI fund. “To correct an allocation error” was the explanation. The numbers are so large that this is a rounding error.
-In the past 12 months there have been 6 ‘deficit’ months at the Fund. These are months were income is less than out go. That has never happened before. It is an indication of the deterioration in the footings of the Fund. The primary problem is a lack of income from payrolls. A turnaround in the direction of the TF would require a rapid return to 6% unemployment. This implies a complete reversal of the monthly declines and an increase in the work force of 2mm. An improbable outlook for the next 24 months. Additional deficit months are likely in August, October and November of 2009. These deficit months are rapidly changing the calculation for the Net Future Value of the Fund.
-In 08 the Fund forecast that its assets would grow from $2.238 T to $4.273 T in ten years. In 09 the Fund predicted that its assets would grow to only $3.874 T in the next decade. That is a tremendous revision of the projected size of the Fund. The internal growth rate was revised from 6.68% to 4.83% in just one year. That is a 30% reduction in expected growth. The adjusted 2008 forecast for the year 2018 would have brought the fund to a balance of $4.558 T. The revised 2009 forecast is therefore $680 billion less than just one year ago. This constitutes a 15% drop in the projected size of the surplus. A gigantic miss.
-In its 2009 report the Fund urged an immediate increase of 2% in total payroll taxes or a 13% drop in benefits (or some combination of the two). By the time America is done with the health care debate and the higher taxes that it will surely bring there will be no discussion for additional increases in taxes on 100mm workers to fix SS. To do so would be economic suicide. Therefore, the solution will be heavily skewed to cuts in benefits. If the proposal to ‘fix’ the problem is for a 10% cut there will be a social explosion. There are 52mm covered beneficiaries today. If you think America is mad over health care wait until this reality is made public.
-The population 65+ today is 40mm. In 2020 it will be 54mm. A 36% increase. This is the boomers. They are the problem.
-Disable workers represent 9.5mm of the 52mm current beneficiaries. It is good that America has a safety net for workers who become disabled. However, this is about retirement benefits, not social costs for workers. Including the DI fund in the retirement fund mixes two different things. They should be separate.
-The Secretary of the Treasury, Mr. Timothy Geithner is a Managing Trustee for the Fund. I can’t imagine that he has the time to look at 10% of the issues the Fund faces.
-In the June 2009 annual report the Fund forecast revenues of $708b and expenses of $562B. These numbers produce an estimate for the full year 2009 surplus of $146 billion. So far through May of this year they are well behind on that projection. Through May of 09 the surplus was $36.7b versus the same period in 08 of 57.4 b A full year surplus of only $80b looks more likely. In 2005 the TF surplus funded half of the public deficit. By 2011 those surpluses will be gone. Another big buyer of our debt will no longer be there.
-As part of its July 2009 cash management activities the Fund bought and sold Treasury IOUs totaling $115 billion. They acquired an eleven-month piece of paper for $56.35b at an interest rate of 3.25%. A market rate would have been .75%. That difference comes to $1.3 billion. Just another of those rounding errors.
Thursday, August 13, 2009
On Fed Intervention and the Blogs
A week ago a great debate was stirred in the financial blog world. As is often the case Zero Hedge was in the middle of the fracas. Mr. Durden penned a piece that suggested that the Fed was manipulating the auctions in such a way as to benefit the primary dealers. It got to be a very sophisticated discussion that brought in some thinking from Yves Smith at Naked Capitalism and John Jansen at Across the Curve.
The debate is over is far as I am concerned. The Treasury had another successful auction today of the 30 year. But in order to make it a success the Fed bought $27 billion of 15-30 year mortgage paper. The curve is the curve. If Treasury sells duration while at the same time the Fed buys duration the net impact to the market is negligible. The near simultaneous supply and demand is expressed in the Agency MBS/Treasury swap market. The numbers are so large that only pros are allowed to play. A $27 billion swap trade only benefits the dealers.
This is timed intervention. That is a polite way to say manipulation.
The debate is over is far as I am concerned. The Treasury had another successful auction today of the 30 year. But in order to make it a success the Fed bought $27 billion of 15-30 year mortgage paper. The curve is the curve. If Treasury sells duration while at the same time the Fed buys duration the net impact to the market is negligible. The near simultaneous supply and demand is expressed in the Agency MBS/Treasury swap market. The numbers are so large that only pros are allowed to play. A $27 billion swap trade only benefits the dealers.
This is timed intervention. That is a polite way to say manipulation.
FHFA Report on Restructurings – Everything is Going Fine
The FHFA released a report on their refinancing activity for the year to date. As usual it was cast in glowing terms. It is clear that FHFA is doing something. In my view that ‘something’ is consistently the wrong thing. From the report:
Washington, DC – Fannie Mae and Freddie Mac refinanced more than 2.9 million mortgage loans in 2009 through July of this year. Since the inception of the Making Home Affordable Refinance Program (HARP) in April, Fannie Mae and Freddie Mac refinanced almost 1.9 million mortgage loans through July.
A little clarity. This first paragraph reads as if the Agencies have addressed and restructured 2.9mm loans under the Harp program. That is not correct. Of the total of 2.9mm only 190k were under the HARP program. The balance were ReFi’s where the borrower got a lower rate and likely took some additional money in a cash out.
In the first seven months of the year Fannie and Freddie did all the ReFi's that they could at lower interest rates. During this period the D.C. lenders were 90% of the mortgage market. The opportunity to lower a mortgage interest rate had a very beneficial impact on those lucky borrowers. The claimed ‘savings’ of 1.3% on 2.7mm mortgages with an average balance of $200k comes to $7 billion a year. An effective stimulus for sure. But now the rates for mortgages have risen. On a mark to market basis those new mortgages are underwater. Because the folks at F/F do not have to bother with trivialities like mark to market there is no reported loss from this activity. But it will be a drag on future income for the next decade. We again follow a policy that steals from the future to pay for current excesses.
Anyone can make cheap loans. That is not success. This is a policy decision by the federal government to stimulate consumer demand. If F/F are tools of government policy their status should be resolved so that role can be debated. Making low interest rate loans and then having the Fed buy $1.25 trillion of these loans is a subsidy. It has a current and future expense. This needs to be understood and accounted for.
Mr. Lockhart said. “Importantly, over 60,000 borrowers with mortgage loans that exceed 80 percent of the house value up to 105 percent have been refinanced. We are now seeing significant results from the HARP and the Home Affordable Modification Program (HAMP), but much more work needs to be done. I commend the Fannie Mae and Freddie Mac teams for helping drive this effort.”
Historical data shows that the bulk of mortgage defaults occur when the borrower has a change of circumstance (illness, death of spouse, loss of job) and not high LTV loans. The Agencies are relying on this with these new high LTV loans. That is terrible policy. Up until 2007 there had never been a year where there were nationwide declines in RE values greater than 5%. So relying on old reasoning does not apply when prices can decline by 25% in just one year. The most significant cause for default today is that borrowers are ‘upside down’. When the Agencies make high LTV loans they put all of us at risk. High LTV loans have default rates in the 20%+ range. We need to stop policies that encourage defaults. Mr. Lockhart lauds these results. He is just writing a taxpayer check.
Under HARP, borrowers whose loan-to-value (LTV) ratio is above 80 percent up to 105 percent are able to refinance without added mortgage insurance requirements, a previous key barrier to refinancing.
The Charter of both Fannie and Freddie spell this out in their definition of Conforming Loans. It is simple. 80% LTV to a borrower who can demonstrate they can make the payments. Insurance industry lobbyists created a carve-out to this rule with Mortgage Insurance. This allowed F/F to buy 103% LTV loans and avoid their own restrictions. It has proven to be a disaster. The ‘enhanced’ loans are one of the largest contributors to the pool of busted mortgages. Now they are just waiving those Charter restrictions away. By what authority do they do that? Congress is supposed to be looking after this mess. Who is minding the store here? Is Barney Frank still involved with this? Is he writing taxpayer checks too?
Through July, Fannie Mae had refinanced 1.7 million loans. Of that total, approximately 138,000 loans were refinanced under the company’s DU Refi Plus and Refi Plus flexibilities that were put in place to support the HARP. Freddie Mac refinanced 1.2 million loans through July. Of that total, approximately 53,000 loans were refinanced under the company’s Relief Refinance program that was put in place to support HARP.
The 190k loans restructured under HARP guidelines are the problem loans. While FHFA crows about this success they fail to mention that they have a backlog of more than one million borrowers that are seriously delinquent. Nor do they mention that as many as 50% of these ReFi's will go back into default in less than six months.
The Federal Housing Finance Agency recently announced the expansion of HARP to allow borrowers with LTVs up to 125 percent to participate. Fannie Mae will begin accepting deliveries of refinanced loans with LTVs over 105 percent up to 125 percent as of September 1. Freddie Mac will begin accepting deliveries of these loans on October 1.
This is insane. No private lender in their right mind would make a 125% loan. These are just losses to be. The FHFA is perpetuating the cycle of default. They are making things worse, not better.
###
The Federal Housing Finance Agency regulates Fannie Mae, Freddie Mac and the 12 Federal Home Loan Banks. These government-sponsored enterprises provide more than $6.3 trillion in funding for the U.S. mortgage markets and financial institutions.
The FHFA always ends its communications with this sentence. I do not know if they are proud of this number or whether they point this out to remind us of how powerful they are. No single entity should have this much exposure to the credit market. It defines systemic risk.
Washington, DC – Fannie Mae and Freddie Mac refinanced more than 2.9 million mortgage loans in 2009 through July of this year. Since the inception of the Making Home Affordable Refinance Program (HARP) in April, Fannie Mae and Freddie Mac refinanced almost 1.9 million mortgage loans through July.
A little clarity. This first paragraph reads as if the Agencies have addressed and restructured 2.9mm loans under the Harp program. That is not correct. Of the total of 2.9mm only 190k were under the HARP program. The balance were ReFi’s where the borrower got a lower rate and likely took some additional money in a cash out.
In the first seven months of the year Fannie and Freddie did all the ReFi's that they could at lower interest rates. During this period the D.C. lenders were 90% of the mortgage market. The opportunity to lower a mortgage interest rate had a very beneficial impact on those lucky borrowers. The claimed ‘savings’ of 1.3% on 2.7mm mortgages with an average balance of $200k comes to $7 billion a year. An effective stimulus for sure. But now the rates for mortgages have risen. On a mark to market basis those new mortgages are underwater. Because the folks at F/F do not have to bother with trivialities like mark to market there is no reported loss from this activity. But it will be a drag on future income for the next decade. We again follow a policy that steals from the future to pay for current excesses.
Anyone can make cheap loans. That is not success. This is a policy decision by the federal government to stimulate consumer demand. If F/F are tools of government policy their status should be resolved so that role can be debated. Making low interest rate loans and then having the Fed buy $1.25 trillion of these loans is a subsidy. It has a current and future expense. This needs to be understood and accounted for.
Mr. Lockhart said. “Importantly, over 60,000 borrowers with mortgage loans that exceed 80 percent of the house value up to 105 percent have been refinanced. We are now seeing significant results from the HARP and the Home Affordable Modification Program (HAMP), but much more work needs to be done. I commend the Fannie Mae and Freddie Mac teams for helping drive this effort.”
Historical data shows that the bulk of mortgage defaults occur when the borrower has a change of circumstance (illness, death of spouse, loss of job) and not high LTV loans. The Agencies are relying on this with these new high LTV loans. That is terrible policy. Up until 2007 there had never been a year where there were nationwide declines in RE values greater than 5%. So relying on old reasoning does not apply when prices can decline by 25% in just one year. The most significant cause for default today is that borrowers are ‘upside down’. When the Agencies make high LTV loans they put all of us at risk. High LTV loans have default rates in the 20%+ range. We need to stop policies that encourage defaults. Mr. Lockhart lauds these results. He is just writing a taxpayer check.
Under HARP, borrowers whose loan-to-value (LTV) ratio is above 80 percent up to 105 percent are able to refinance without added mortgage insurance requirements, a previous key barrier to refinancing.
The Charter of both Fannie and Freddie spell this out in their definition of Conforming Loans. It is simple. 80% LTV to a borrower who can demonstrate they can make the payments. Insurance industry lobbyists created a carve-out to this rule with Mortgage Insurance. This allowed F/F to buy 103% LTV loans and avoid their own restrictions. It has proven to be a disaster. The ‘enhanced’ loans are one of the largest contributors to the pool of busted mortgages. Now they are just waiving those Charter restrictions away. By what authority do they do that? Congress is supposed to be looking after this mess. Who is minding the store here? Is Barney Frank still involved with this? Is he writing taxpayer checks too?
Through July, Fannie Mae had refinanced 1.7 million loans. Of that total, approximately 138,000 loans were refinanced under the company’s DU Refi Plus and Refi Plus flexibilities that were put in place to support the HARP. Freddie Mac refinanced 1.2 million loans through July. Of that total, approximately 53,000 loans were refinanced under the company’s Relief Refinance program that was put in place to support HARP.
The 190k loans restructured under HARP guidelines are the problem loans. While FHFA crows about this success they fail to mention that they have a backlog of more than one million borrowers that are seriously delinquent. Nor do they mention that as many as 50% of these ReFi's will go back into default in less than six months.
The Federal Housing Finance Agency recently announced the expansion of HARP to allow borrowers with LTVs up to 125 percent to participate. Fannie Mae will begin accepting deliveries of refinanced loans with LTVs over 105 percent up to 125 percent as of September 1. Freddie Mac will begin accepting deliveries of these loans on October 1.
This is insane. No private lender in their right mind would make a 125% loan. These are just losses to be. The FHFA is perpetuating the cycle of default. They are making things worse, not better.
###
The Federal Housing Finance Agency regulates Fannie Mae, Freddie Mac and the 12 Federal Home Loan Banks. These government-sponsored enterprises provide more than $6.3 trillion in funding for the U.S. mortgage markets and financial institutions.
The FHFA always ends its communications with this sentence. I do not know if they are proud of this number or whether they point this out to remind us of how powerful they are. No single entity should have this much exposure to the credit market. It defines systemic risk.
Monday, August 10, 2009
Fannie and Freddie - $1.4T In Troubled Loans, Stock Up 100%
Freddie Mac (FRE) had a good day. Up 130%. It’s poor sister Fannie Mae was up a more modest 50%. This big up moves comes on the heels of an after the market release on Friday of 2nd quarter earning at FRE. These numbers actually showed a gain. After taking into account the Senior Preferred dividend that is owed to Uncle Sam, Freddie of course showed a loss. That loss would have been much larger if it had been current on the other preferred shares outstanding (the public Pref.) The losses at Freddie would have been staggering if they had taken adequate reserves on their troubled loan portfolio.
Both Fannie and Freddie have now posted their second quarter statements. Two numbers jump out:
-The total of troubled loans at the agencies is now $1.4 trillion or 30% of all loans.
-The notional value of derivatives outstanding is equal to $2.9 Trillion.
The following slides are from F/F. They show their holdings of troubled loans. Those numbers include:
Negative amortization……….12b
Interest Only…………………… 30
Low FICO < 660………………585
LTV>90%............................394
Alt-A………………………………400
Sub Prime…………………………..8
Totals:…………………………...$1.4 Trillion
The Agencies have very large interest rate derivatives outstanding. The combined book is $2.85 Trillion. Most of this activity is concentrated on just a few days of any given month. When they come to the market with these big trades, it adds to volatility. This is increasing the cost that the taxpayers are paying to fund our $2 trillion deficit. A fair question to ask is, “Who are they doing these trades with and how much are those counter-parties making while executing this big order flow?”
The fist two slides show FNM's derivative book and their losses ($2b). The third and fourth look at FRE. They had a gain of 2.4b. Without that gain they would have had an operating loss. Does this mean FRE made a big ‘rate bet’ and won? Or did FNM make a losing trade?
FNM
Fannie Losses
Freddies Derivative Book
Freddie's Gain. Were they gambling or was this just a mis-hedged situation that they lucked out on?
The timing of the departure by Mr. Lockhart and the whispers from the Administration regarding ‘a new plan for the Agencies’ were certainly influenced by the reports that were released to the public last week. We have a systemic problem. When the other D.C. mortgage lenders (Ginnie Mae, FHA and the Federal Home Loan Banks) are included, the grand total of the government’s involvement in the mortgage market is now in excess of $7 trillion or 60% of all mortgages.
How big could the losses be at the Agencies? If half of the trouble loans were to go into default and of those 50% of the loan balance is lost, then the cost over time could exceed $400 billion. That estimate does not include any losses from the $3.2 trillion of Prime loans in their portfolio. The potential for losses in excess of $500billion is there.
The Agency public preferred stock also traded higher on the day. There are still pricing anomalies but there is a level of convergence of pricing in the $2 range. The exceptions include the FRE-K that closed at $2.94 while the FRE-V and W are only worth $1.50. Go figure?
The FNM-S is consistently the most liquid issue. There were 1.6mm shares changing hands today, about 6X’s average. It closed at $1.90. Of note was a 300k trade of the FRE-Z and 490K trade of the FNM-S. These larger amounts seem to disappear. Those two trades are worth $1.6mm, but the securities have a face value claim of $20mm. It is not clear if there is any value in the Agency common. If there is, the evidence will be in the pref. stock.
Both Fannie and Freddie have now posted their second quarter statements. Two numbers jump out:
-The total of troubled loans at the agencies is now $1.4 trillion or 30% of all loans.
-The notional value of derivatives outstanding is equal to $2.9 Trillion.
The following slides are from F/F. They show their holdings of troubled loans. Those numbers include:
Negative amortization……….12b
Interest Only…………………… 30
Low FICO < 660………………585
LTV>90%............................394
Alt-A………………………………400
Sub Prime…………………………..8
Totals:…………………………...$1.4 Trillion
The Agencies have very large interest rate derivatives outstanding. The combined book is $2.85 Trillion. Most of this activity is concentrated on just a few days of any given month. When they come to the market with these big trades, it adds to volatility. This is increasing the cost that the taxpayers are paying to fund our $2 trillion deficit. A fair question to ask is, “Who are they doing these trades with and how much are those counter-parties making while executing this big order flow?”
The fist two slides show FNM's derivative book and their losses ($2b). The third and fourth look at FRE. They had a gain of 2.4b. Without that gain they would have had an operating loss. Does this mean FRE made a big ‘rate bet’ and won? Or did FNM make a losing trade?
FNM
Fannie Losses
Freddies Derivative Book
Freddie's Gain. Were they gambling or was this just a mis-hedged situation that they lucked out on?
The timing of the departure by Mr. Lockhart and the whispers from the Administration regarding ‘a new plan for the Agencies’ were certainly influenced by the reports that were released to the public last week. We have a systemic problem. When the other D.C. mortgage lenders (Ginnie Mae, FHA and the Federal Home Loan Banks) are included, the grand total of the government’s involvement in the mortgage market is now in excess of $7 trillion or 60% of all mortgages.
How big could the losses be at the Agencies? If half of the trouble loans were to go into default and of those 50% of the loan balance is lost, then the cost over time could exceed $400 billion. That estimate does not include any losses from the $3.2 trillion of Prime loans in their portfolio. The potential for losses in excess of $500billion is there.
The Agency public preferred stock also traded higher on the day. There are still pricing anomalies but there is a level of convergence of pricing in the $2 range. The exceptions include the FRE-K that closed at $2.94 while the FRE-V and W are only worth $1.50. Go figure?
The FNM-S is consistently the most liquid issue. There were 1.6mm shares changing hands today, about 6X’s average. It closed at $1.90. Of note was a 300k trade of the FRE-Z and 490K trade of the FNM-S. These larger amounts seem to disappear. Those two trades are worth $1.6mm, but the securities have a face value claim of $20mm. It is not clear if there is any value in the Agency common. If there is, the evidence will be in the pref. stock.
Sunday, August 9, 2009
Keynes on Clunkers: “I Hate It”
I went to see friend who runs a local car dealer. It went like this:
Q: How’s business?
A: Best in two years.
Q: All clunker related?
A: All clunker.
Q: What’s your average vehicle sale price?
A: $28,000.
Q: What is the average rebate?
A: $4,000.
Q: How many of the sales are financed?
A: All of them.
Q: What is the average foreign content in the cars you’re selling?
A: Half.
Assume that this information is representative of what is going on at car dealers across the country. I believe it is. Some implications:
If the average rebate is $4,000 and the money behind it is $3 billion it means that a total of 750,000 cars will be sold as a result of the clunker program.
The $28,000 average price per car translates into a total sale value of $21 billion. Of that amount $3b will be borrowed by Treasury, the balance of $18b will be financed by the new owners.
A month from now the new payments will hit both households and Treasury. For Treasury the cost is $90 million a year. Just $7.5mm per month. Think of it as $7.5mm a month forever. For the households who are driving nice new cars the numbers are much worse.
If buyers finance their purchase with 8% money and a five-year payback the monthly nut for these cars is $375 million. Nearly $5b a year. The owners will have a fully paid asset at the end of the five years, but they have to pay for it in full. It comes to $500 per person each month on a fully loaded basis.
Maynard Keynes was an advocate of government intervention in the economy. He believed that it was the job of the public sector to provide stimulus when necessary. He legitimized the concept of deficit financing as an economic tool to increase total demand. He believed that stimulus/deficit financing should be used to offset a shortage of demand (recession) in the public sector. He maintained that if these steps were not taken the propensity of an economy to fall would accelerate.
Virtually every step that has been taken in the past 18 months has been done in the name of Maynard Keynes and his theories. Mr. Keynes is rolling in his grave over the Clunker program. He would never have advocated this approach. This stimulus works. But it is being paid for by the private sector. The end result of this will be that 750,000 households will have $500 per month less to spend for many years to come This very short term stimulus will quickly turn into an economic drag. A stimulus plan that depends on the private sector for financing and payment is not a stimulus. It is just a reallocation of income within the private sector. The plus today will be a negative tomorrow, the net is zero.
Over indebted consumers nearly killed us last year. CC’s, crazy mortgages, store cards, car loans you name it. We are not out of trouble yet from our debt binge. For the government to be crafting ‘solutions’ that just put another $18 billion of debt onto consumers is bad policy.
The Fed announced details of a TALF transaction this past week. This is the Term Asset Loan Facility where the Fed provides cheap (2.5%) non-recourse debt to finance a pool of newly issued consumer receivables. The amount of auto loans that were financed on August 6th was $550mm. That number will surely rise in the coming months as the Fed finances the ‘clunker’ auto loans. If it were not for this cheap funding (and a lot of arm twisting) the private lenders would not have made the car loans. It would seem that very little is being accomplished by all of this. We are still buying cars we can’t afford. We are still living beyond our means in both the private and public sector. Every step that is taken piles on more debt.
It is as if we are in a race to reflate. The long-term cost of the effort to return to ‘trend line’ growth could overwhelm us. More debt in the private sector is a bad trade off for short-term results. There are a lot of people in Washington who understand Keynesian economics. It would appear that they are more interested in selling cars than solving problems.
Lord Maynard Keynes would not be dancing if he knew his theories on economics would result in the Clunker program.
Q: How’s business?
A: Best in two years.
Q: All clunker related?
A: All clunker.
Q: What’s your average vehicle sale price?
A: $28,000.
Q: What is the average rebate?
A: $4,000.
Q: How many of the sales are financed?
A: All of them.
Q: What is the average foreign content in the cars you’re selling?
A: Half.
Assume that this information is representative of what is going on at car dealers across the country. I believe it is. Some implications:
If the average rebate is $4,000 and the money behind it is $3 billion it means that a total of 750,000 cars will be sold as a result of the clunker program.
The $28,000 average price per car translates into a total sale value of $21 billion. Of that amount $3b will be borrowed by Treasury, the balance of $18b will be financed by the new owners.
A month from now the new payments will hit both households and Treasury. For Treasury the cost is $90 million a year. Just $7.5mm per month. Think of it as $7.5mm a month forever. For the households who are driving nice new cars the numbers are much worse.
If buyers finance their purchase with 8% money and a five-year payback the monthly nut for these cars is $375 million. Nearly $5b a year. The owners will have a fully paid asset at the end of the five years, but they have to pay for it in full. It comes to $500 per person each month on a fully loaded basis.
Maynard Keynes was an advocate of government intervention in the economy. He believed that it was the job of the public sector to provide stimulus when necessary. He legitimized the concept of deficit financing as an economic tool to increase total demand. He believed that stimulus/deficit financing should be used to offset a shortage of demand (recession) in the public sector. He maintained that if these steps were not taken the propensity of an economy to fall would accelerate.
Virtually every step that has been taken in the past 18 months has been done in the name of Maynard Keynes and his theories. Mr. Keynes is rolling in his grave over the Clunker program. He would never have advocated this approach. This stimulus works. But it is being paid for by the private sector. The end result of this will be that 750,000 households will have $500 per month less to spend for many years to come This very short term stimulus will quickly turn into an economic drag. A stimulus plan that depends on the private sector for financing and payment is not a stimulus. It is just a reallocation of income within the private sector. The plus today will be a negative tomorrow, the net is zero.
Over indebted consumers nearly killed us last year. CC’s, crazy mortgages, store cards, car loans you name it. We are not out of trouble yet from our debt binge. For the government to be crafting ‘solutions’ that just put another $18 billion of debt onto consumers is bad policy.
The Fed announced details of a TALF transaction this past week. This is the Term Asset Loan Facility where the Fed provides cheap (2.5%) non-recourse debt to finance a pool of newly issued consumer receivables. The amount of auto loans that were financed on August 6th was $550mm. That number will surely rise in the coming months as the Fed finances the ‘clunker’ auto loans. If it were not for this cheap funding (and a lot of arm twisting) the private lenders would not have made the car loans. It would seem that very little is being accomplished by all of this. We are still buying cars we can’t afford. We are still living beyond our means in both the private and public sector. Every step that is taken piles on more debt.
It is as if we are in a race to reflate. The long-term cost of the effort to return to ‘trend line’ growth could overwhelm us. More debt in the private sector is a bad trade off for short-term results. There are a lot of people in Washington who understand Keynesian economics. It would appear that they are more interested in selling cars than solving problems.
Lord Maynard Keynes would not be dancing if he knew his theories on economics would result in the Clunker program.
Friday, August 7, 2009
Fannie Has .9 Trillion in Troubled Loans - 8K
Fannie Mae’s 8k has an interesting slide. It is a look at their questionable assets. The slide is not easy to read. It can be found in the 2009 Second Quarter Supplement, on page 5.
The report describes FNM’s exposure to problematic classes of mortgages on their book. That total comes to a whopping .9 Trillion. The total book of business is $2.7 Trillion, fully 32% of their book is troubled.
The report muddles with the actual holdings, as there are overlaps in the descriptions. The actual numbers they provide include:
Negative Amortization Loans: $15b
Interest Only: $196B
Low Fico: $328B
LTV>90%: $265B
Alt-A: $269B
Sub Prime: $8B
Those numbers add up to $1.2 trillion. What this means that 50% of the loans in the book are troubled for two reasons. For example, $25 billion are loans that have high LTV and a FICO score less than 620. (AKA a “stinker”)
What might this mean? Some trends are emerging on this. Based on private sector experience with these types of troubled loans one could expect that 50% of these borrowers will go into default. On the defaulted loans the losses will be about 50% of the outstanding loan balances. In other words, losses of 25% on the troubled book are reasonable assumptions. That would imply a loss over time on these loans of $225b. And that does not include losses on Prime loans. And that is just Fannie.
The Administration has an estimate of $250b over four years for the full cost of cleaning up the Agencies. These numbers suggest it could be double that. No wonder Mr. Lockhart left.
The report describes FNM’s exposure to problematic classes of mortgages on their book. That total comes to a whopping .9 Trillion. The total book of business is $2.7 Trillion, fully 32% of their book is troubled.
The report muddles with the actual holdings, as there are overlaps in the descriptions. The actual numbers they provide include:
Negative Amortization Loans: $15b
Interest Only: $196B
Low Fico: $328B
LTV>90%: $265B
Alt-A: $269B
Sub Prime: $8B
Those numbers add up to $1.2 trillion. What this means that 50% of the loans in the book are troubled for two reasons. For example, $25 billion are loans that have high LTV and a FICO score less than 620. (AKA a “stinker”)
What might this mean? Some trends are emerging on this. Based on private sector experience with these types of troubled loans one could expect that 50% of these borrowers will go into default. On the defaulted loans the losses will be about 50% of the outstanding loan balances. In other words, losses of 25% on the troubled book are reasonable assumptions. That would imply a loss over time on these loans of $225b. And that does not include losses on Prime loans. And that is just Fannie.
The Administration has an estimate of $250b over four years for the full cost of cleaning up the Agencies. These numbers suggest it could be double that. No wonder Mr. Lockhart left.
Thursday, August 6, 2009
Fannie’s Trading Derivatives Hard, and Losing
It has been my contention that the Agencies were a factor in the bond market volatility in the past three months. Fannies 10Q has the following information regarding their derivative activity in the first six months of the year. As of June 30 FNM had a balance sheet of $900 billion. Against that position they bought and sold over the counter derivative contracts totaling $1.2 Trillion. On average $100 billion per day. There can be little doubt but that FNM has been adding to the volatility in the credit market.
As luck would have it, the end result of all of this was a loss of $2.2billion.
Who was the other side of these contracts? These big amounts require big Houses to price them. So this activity is done by just a handful of market makers. FNM had 22 days where they lost $100 mm. One can only wonder who was on the other side of those $100mm days.
Of interest is that FNM had to put up $13.5 billion of cash collateral to support outstanding derivative agreements. Wall Street will not ‘take their name’ any longer. This cash collateral requirement is similar to AIG. In that case the bulk of the cash went to GS. It is a decent guess that GS is sitting on a bunch of this $13.5b as well.
As luck would have it, the end result of all of this was a loss of $2.2billion.
Who was the other side of these contracts? These big amounts require big Houses to price them. So this activity is done by just a handful of market makers. FNM had 22 days where they lost $100 mm. One can only wonder who was on the other side of those $100mm days.
Of interest is that FNM had to put up $13.5 billion of cash collateral to support outstanding derivative agreements. Wall Street will not ‘take their name’ any longer. This cash collateral requirement is similar to AIG. In that case the bulk of the cash went to GS. It is a decent guess that GS is sitting on a bunch of this $13.5b as well.
Wednesday, August 5, 2009
CS Says, “Storm Risk Reduced”. Buoy 42001 says, “Watch Out”
Colorado State’ s hurricane forecast update was released yesterday. For the third time in six months they have reduced their forecast for the number of hurricanes this year. The CS team is lead by William Gray. His group has the brain and computer power to look at these complex issues. Their results over time are about the same as your average sell side analyst, so-so.
Markets fascinate me; I think it is their inherent unpredictability that sucks me in. Weather is not that different. There is tons of data to look at, but the outcome is often a surprise. I would not quibble with the CS outlook. However, there is some contradictory information. For those chart watchers out there, maybe some of you can see the error of my observations.
CS hangs its hat on the improved outlook based on two significant and observable conditions. Ocean temperatures and the existence of the El Nino weather pattern. Big storms need warm water to grow and the wind conditions resulting from El Nino tend to rip apart hurricanes as they cross the Atlantic.
The following two slides show pretty clearly that La Nina has become El Nino. These photos and actual buoy data are what the scientists relied upon in their recent conclusion that El Nino had re-established itself. What remains to be seen is how strong the El Nino will become and how long will it last. The average number of hurricanes has jumped in 1996 –2008 period versus 1944- 1995. I think the Vol for the El/La cycle has changed significantly as well.
The National Weather Service has a web site that tracks the changes in E/L conditions back to 1950 (Ocean Nino Index, ONI). I present data from 1997 on. I do not consider stock data that is pre 1997 either. We entered a new phase in both the weather and the markets since that time. Volatility and thereby predictability has changed markedly in the past decade. Most unscientific.
This slide looks at the 1997-2001 changes in El to La Nino conditions. The red is El the blue La, black is transition. Note the rapid change from red to blue. Under the slide are pictures from NASA that describe chronologically what is going on.
The following looks at the information from 2001 to present. From 01-07 we meandered back and forth with modest El Nino conditions. There were several periods during this period of time that it was incorrectly concluded that conditions were changing from El to La. In the fall of 2007 it became clear that La had re-established itself. Less than one year later it went neutral and presumably the next entrant on this chart will be red. Again below the slide of data are NASA pics. And discussion. Note that these folks have been confused and wrong about the status of E/L on a number of occasions.
2004 and 2005 were killer hurricane years. This occurred during a weak El Nino. Just about what we are looking at today. Chart watchers please tell me what is different from the 08-09 progression vs. the 04-05 progression.
Katrina was not a hurricane that formed off the coast of Africa and made its way to NO. It was a “Homegrown”. It started as a tropical depression in the Bahamas. It hit S. Florida then crossed into the Gulf. In the slide below the areas in white show a Cat. 5 hurricane with winds of 160 MPH. The water temperature in that part of the Gulf was the high octane source of energy that made this storm a monster.
The folks at CS have monster computers that drawn on thousands of data points. When they say, “Cooler water temperatures indicate a lower probability of severe hurricanes” we just have to accept that as a fact. This data comes from buoys that are all over the Gulf of Mexico. The following slide shows how many there are. Each one produces a report that includes water temperature every hour. There is a ton of data. I don’t have a Cray computer so I look at just a few buoys. My favorite is buoy #42001. It is right in the middle of that hot water that made Katrina. It is highlighted in white.
In August of 2009 the water temperature at 42001 is at near recent record highs. It is currently 86.7 degrees. There is an incredible amount of energy in this hot water. A historical look:
In 1999 the water at 42001 was hotter than it is today. By the end of the month the heat fell because a category 3 storm (Brett) sucked the energy out of the water. Brett was a bad one and started the higher incidence of big storms. In 2004 the 8/1 numbers were low, they fell by 8/31 because two small storms passed. 04 and 05 were without precedent. That water temperature was rising during both of those years in the 8/1 –31 period was a big contributor.
This information is not at odds with the CS forecast. They certainly do not exclude the possibility of a major storm this season. Based on the 04-05 experience when there was a large number of big storms while El Nino conditions existed, it is not unlikely that homegrown tropical depressions will form this year. If they pass by the hot waters in the central gulf those homegrown could get very big.
As indicated in the chart of water temperatures at Buoy 42001 it is possible that the water temperatures could fall during August as smaller storms suck up the energy. We are in a fairly critical 30-day period. All buoys are RSS feeds if you are interested.
I am no weatherman, so my view on this is irrelevant. That said, I think the conditions are ripe for one or two big storms to form in the central gulf in the next two months. If they spend enough time over the hot water they will grow. The existence of El Nino may steer these storms north and east, away from the oil/gas wells in the western gulf. The east coast of Florida to NO are logical end points for these storms should they develop.
Related:
-Vol is a financial concept, but is can be applied to anything. The link to the ONI index provides data back to 1950. It could be made to look like relative price change data. Can anyone draw a Vol chart from this?
-Florida has $7.8b in its CAT insurance fund. Katrina cost $100 billion.
-There is hot water all over the Gulf right now.
Markets fascinate me; I think it is their inherent unpredictability that sucks me in. Weather is not that different. There is tons of data to look at, but the outcome is often a surprise. I would not quibble with the CS outlook. However, there is some contradictory information. For those chart watchers out there, maybe some of you can see the error of my observations.
CS hangs its hat on the improved outlook based on two significant and observable conditions. Ocean temperatures and the existence of the El Nino weather pattern. Big storms need warm water to grow and the wind conditions resulting from El Nino tend to rip apart hurricanes as they cross the Atlantic.
The following two slides show pretty clearly that La Nina has become El Nino. These photos and actual buoy data are what the scientists relied upon in their recent conclusion that El Nino had re-established itself. What remains to be seen is how strong the El Nino will become and how long will it last. The average number of hurricanes has jumped in 1996 –2008 period versus 1944- 1995. I think the Vol for the El/La cycle has changed significantly as well.
The National Weather Service has a web site that tracks the changes in E/L conditions back to 1950 (Ocean Nino Index, ONI). I present data from 1997 on. I do not consider stock data that is pre 1997 either. We entered a new phase in both the weather and the markets since that time. Volatility and thereby predictability has changed markedly in the past decade. Most unscientific.
This slide looks at the 1997-2001 changes in El to La Nino conditions. The red is El the blue La, black is transition. Note the rapid change from red to blue. Under the slide are pictures from NASA that describe chronologically what is going on.
The following looks at the information from 2001 to present. From 01-07 we meandered back and forth with modest El Nino conditions. There were several periods during this period of time that it was incorrectly concluded that conditions were changing from El to La. In the fall of 2007 it became clear that La had re-established itself. Less than one year later it went neutral and presumably the next entrant on this chart will be red. Again below the slide of data are NASA pics. And discussion. Note that these folks have been confused and wrong about the status of E/L on a number of occasions.
2004 and 2005 were killer hurricane years. This occurred during a weak El Nino. Just about what we are looking at today. Chart watchers please tell me what is different from the 08-09 progression vs. the 04-05 progression.
Katrina was not a hurricane that formed off the coast of Africa and made its way to NO. It was a “Homegrown”. It started as a tropical depression in the Bahamas. It hit S. Florida then crossed into the Gulf. In the slide below the areas in white show a Cat. 5 hurricane with winds of 160 MPH. The water temperature in that part of the Gulf was the high octane source of energy that made this storm a monster.
The folks at CS have monster computers that drawn on thousands of data points. When they say, “Cooler water temperatures indicate a lower probability of severe hurricanes” we just have to accept that as a fact. This data comes from buoys that are all over the Gulf of Mexico. The following slide shows how many there are. Each one produces a report that includes water temperature every hour. There is a ton of data. I don’t have a Cray computer so I look at just a few buoys. My favorite is buoy #42001. It is right in the middle of that hot water that made Katrina. It is highlighted in white.
In August of 2009 the water temperature at 42001 is at near recent record highs. It is currently 86.7 degrees. There is an incredible amount of energy in this hot water. A historical look:
In 1999 the water at 42001 was hotter than it is today. By the end of the month the heat fell because a category 3 storm (Brett) sucked the energy out of the water. Brett was a bad one and started the higher incidence of big storms. In 2004 the 8/1 numbers were low, they fell by 8/31 because two small storms passed. 04 and 05 were without precedent. That water temperature was rising during both of those years in the 8/1 –31 period was a big contributor.
This information is not at odds with the CS forecast. They certainly do not exclude the possibility of a major storm this season. Based on the 04-05 experience when there was a large number of big storms while El Nino conditions existed, it is not unlikely that homegrown tropical depressions will form this year. If they pass by the hot waters in the central gulf those homegrown could get very big.
As indicated in the chart of water temperatures at Buoy 42001 it is possible that the water temperatures could fall during August as smaller storms suck up the energy. We are in a fairly critical 30-day period. All buoys are RSS feeds if you are interested.
I am no weatherman, so my view on this is irrelevant. That said, I think the conditions are ripe for one or two big storms to form in the central gulf in the next two months. If they spend enough time over the hot water they will grow. The existence of El Nino may steer these storms north and east, away from the oil/gas wells in the western gulf. The east coast of Florida to NO are logical end points for these storms should they develop.
Related:
-Vol is a financial concept, but is can be applied to anything. The link to the ONI index provides data back to 1950. It could be made to look like relative price change data. Can anyone draw a Vol chart from this?
-Florida has $7.8b in its CAT insurance fund. Katrina cost $100 billion.
-There is hot water all over the Gulf right now.
Sunday, August 2, 2009
Swiss vs US - Where Does This Go Next?
August 1st is the big celebration day in Switzerland. Not unlike the US 4th of July. Fireworks, picnics and parades. There must be more than a few folks in Switzerland who were sweating this weekend out.
It is not entirely clear at this point what the resolution to the UBS vs USA case will be. Both sides have announced that a “deal” has been reached. Details are due out next week. There are several press reports that suggest that the deal may cover 7,000 of the 52,000 names. The Justice Department indicated that it was after a “significant” number. This strikes me as odd. What would the criteria be for non-disclosure? If we get, “Accounts over $5mm will be handled separately”, there will be hell to pay. This would appear to be an ‘all or nothing situation’.
By Thursday this should be behind UBS. It will be interesting to see what additional fines may be involved. They already have paid $780mm, so this is getting expensive. An analyst at Union Bancaire Privee put the new fine as high as $5.5 billion. UBS shares caught a bid after the news of a deal last week. The shareholders can only hope that the fine is 20% of UBP’s estimate.
The question on my mind is where does this go next? This has never been just a UBS problem. There are a lot of other public and private Swiss banking institutions. There have been estimates that as many as 50% of the accounts in Switzerland may be ‘Black.’ It would seem reasonable to assume that less than half of the black accounts were with US citizens. Therefore the ‘resolution’ of the matter next week is just going to open up a whole new can of worms. What about the rest of the banks and what about all the other countries involved?
The Tribune De Geneve posed the question: L’IRS et l’administration Obama persisteront-ils ensuite dans leur lutte contre l’évasion fiscale en s’attaquant à d’autres établissements?
They ask, “Who’s next"?
Note on Withholding Taxes:
There is an aspect to all of this that I can’t understand. There are very long-standing Tax Treaties between the US and Switzerland. Among other things these treaties obligate each country to withhold tax on income derived from accounts in each other’s country. A Swiss citizen has withholding taxes applied to accounts maintained in the US. Similarly, an American citizen has tax withheld from accounts maintained in Switzerland. Both the US and Switzerland have similar tax treaties with all other developed countries.
Let’s be very clear on this. The Swiss government does not cheat on these Tax Treaties. All of the Swiss banking institutions similarly follow the laws of Switzerland on this. The tax treaties and the Swiss law require that a 35% withholding tax be applied to income on all US citizens accounts. When the withholding tax is collected it is sent directly to the Swiss Government. From there it goes back to the US when it is claimed as a foreign tax credit on ones income taxes. The only exception to this rule is when 1099 income forms are filed on the account. Black accounts by definition do not file income taxes so the amount of income that is withheld is never claimed. Overtime these amounts add up to big numbers. Some estimates:
The NY Times has put a number on the dollar value of the accounts with UBS at $20 billion. Assume that UBS has 50% of the US accounts and the rest of the banking industry has the balance. Assume further that of all the questionable accounts 40% are with US citizens and 60% are with the rest of the world. These estimates would suggest that the value of the troubled accounts is in the neighborhood of $100b. Of that, $60b is non US.
Another estimate comes from Reuters. They estimated that the foreign-owned assets in Swiss banks are equal to $2 trillion. The amount of hidden accounts would be just a fraction of that. 25%? $500b?
An informed estimate comes from a leading Swiss Private banker, Ivan Pictet. He suggested in an interview with Le Temps that the size of the offshore ‘private’ banking industry was about $1 trillion and that as much as half of that could be affected by changes in banking secrecy laws. That leads towards a conclusion that the problem is about $500B in total.
For the sake of discussion assume the number is $250b. That would seem reasonable given the foregoing. Assume further that income on these accounts averaged a very modest 2% for the last ten years. The final assumption is that the withholding rate on all foreign accounts was the same as the US, 35%. If anything these are conservative assumptions.
That comes to $17 billion. My own guess is that this number is closer to $40billion. And this has been going on a lot longer than ten years.
Who has this money? It is possible that it is being held by the Swiss. Their attitude would be, “We have to pay this when it is requested. In the mean time don’t ask”. If the money was sent to the US Treasury with a note, “Sorry, no SSN’s/Names on these amounts, you would have thought that someone would have woken up to all of this well before last year. That leads to the conclusion that it is still in Switzerland.
Either way, someone has some explaining to do.
It is not entirely clear at this point what the resolution to the UBS vs USA case will be. Both sides have announced that a “deal” has been reached. Details are due out next week. There are several press reports that suggest that the deal may cover 7,000 of the 52,000 names. The Justice Department indicated that it was after a “significant” number. This strikes me as odd. What would the criteria be for non-disclosure? If we get, “Accounts over $5mm will be handled separately”, there will be hell to pay. This would appear to be an ‘all or nothing situation’.
By Thursday this should be behind UBS. It will be interesting to see what additional fines may be involved. They already have paid $780mm, so this is getting expensive. An analyst at Union Bancaire Privee put the new fine as high as $5.5 billion. UBS shares caught a bid after the news of a deal last week. The shareholders can only hope that the fine is 20% of UBP’s estimate.
The question on my mind is where does this go next? This has never been just a UBS problem. There are a lot of other public and private Swiss banking institutions. There have been estimates that as many as 50% of the accounts in Switzerland may be ‘Black.’ It would seem reasonable to assume that less than half of the black accounts were with US citizens. Therefore the ‘resolution’ of the matter next week is just going to open up a whole new can of worms. What about the rest of the banks and what about all the other countries involved?
The Tribune De Geneve posed the question: L’IRS et l’administration Obama persisteront-ils ensuite dans leur lutte contre l’évasion fiscale en s’attaquant à d’autres établissements?
They ask, “Who’s next"?
Note on Withholding Taxes:
There is an aspect to all of this that I can’t understand. There are very long-standing Tax Treaties between the US and Switzerland. Among other things these treaties obligate each country to withhold tax on income derived from accounts in each other’s country. A Swiss citizen has withholding taxes applied to accounts maintained in the US. Similarly, an American citizen has tax withheld from accounts maintained in Switzerland. Both the US and Switzerland have similar tax treaties with all other developed countries.
Let’s be very clear on this. The Swiss government does not cheat on these Tax Treaties. All of the Swiss banking institutions similarly follow the laws of Switzerland on this. The tax treaties and the Swiss law require that a 35% withholding tax be applied to income on all US citizens accounts. When the withholding tax is collected it is sent directly to the Swiss Government. From there it goes back to the US when it is claimed as a foreign tax credit on ones income taxes. The only exception to this rule is when 1099 income forms are filed on the account. Black accounts by definition do not file income taxes so the amount of income that is withheld is never claimed. Overtime these amounts add up to big numbers. Some estimates:
The NY Times has put a number on the dollar value of the accounts with UBS at $20 billion. Assume that UBS has 50% of the US accounts and the rest of the banking industry has the balance. Assume further that of all the questionable accounts 40% are with US citizens and 60% are with the rest of the world. These estimates would suggest that the value of the troubled accounts is in the neighborhood of $100b. Of that, $60b is non US.
Another estimate comes from Reuters. They estimated that the foreign-owned assets in Swiss banks are equal to $2 trillion. The amount of hidden accounts would be just a fraction of that. 25%? $500b?
An informed estimate comes from a leading Swiss Private banker, Ivan Pictet. He suggested in an interview with Le Temps that the size of the offshore ‘private’ banking industry was about $1 trillion and that as much as half of that could be affected by changes in banking secrecy laws. That leads towards a conclusion that the problem is about $500B in total.
For the sake of discussion assume the number is $250b. That would seem reasonable given the foregoing. Assume further that income on these accounts averaged a very modest 2% for the last ten years. The final assumption is that the withholding rate on all foreign accounts was the same as the US, 35%. If anything these are conservative assumptions.
That comes to $17 billion. My own guess is that this number is closer to $40billion. And this has been going on a lot longer than ten years.
Who has this money? It is possible that it is being held by the Swiss. Their attitude would be, “We have to pay this when it is requested. In the mean time don’t ask”. If the money was sent to the US Treasury with a note, “Sorry, no SSN’s/Names on these amounts, you would have thought that someone would have woken up to all of this well before last year. That leads to the conclusion that it is still in Switzerland.
Either way, someone has some explaining to do.
Saturday, August 1, 2009
NY Times - More Support for Principal Reduction
The Saturday NY Times had an OP-ED piece titled, “Why Own When You Can Lease?” It was written by Daniel Alpert, who is described as a ‘managing partner in an investment bank’. Mr. Alpert admits to having an axe to grind in this. His thoughts should be read by lenders, borrowers and D.C. Mr. Alpert is another voice out there that is promoting the idea of broad based debt relief.
In brief, the proposal is to create a sale and lease back opportunity for underwater borrowers. The sale would be a deed in lieu of the mortgage. The lease would be based on fair market rentals. The borrower would walk on the old mortgage with little or no impact on their credit. They would continue to live in the home but at a much lower monthly cost. Sweet deal for a lot of trouble borrowers.This idea is going to be part of the solution. How big a part remains to be seen.
What is becoming increasing clear is that various forms of principal reduction are going to have to be part of the solution to the mortgage mess. As Mr. Alpert and others have pointed out, “If the government made it work that way with GM, why not me?”
What might this mean? There is no data, so a range of estimates. At this point the number of underwater borrowers is greater than 10%. I think it is equal to as much as 30%. Assume the number is 20%. That would imply a number between $2.5-3 trillion of mortgages that are affected.
The next question is, “How much are these mortgage underwater by? Another assumption, 30%. If this is in the ball-park then that would imply a mark to market on all of this of $1 trillion. Approximately 55% of all mortgages outstanding are held or guaranteed by Washington. Therefore the cost would be born equally by the public and private sector.
As crazy as this might sound, $1 trillion would be a very cheap price to pay to get this behind us. As far as economic stimulus goes, this one would send the economy and the market to much better levels.
My concern is that little or no action will be taken to provide true debt relief for underwater borrowers. We will continue to modify loans with better terms but no principal reduction. The results of this are already clear. More than 50% of modified loans re-default in less than six months. Over time that number will go toward 100%. We need to end the cycle of default. The current modification approaches are not achieving that.
The risk that we face is that the cycle continues and deepens. If my estimate of 20%/30% for underwater total/embedded losses moves to 40%/40% the cost jumps to more than $2 trillion. It is unlikely that the private sector could afford this large a write down without another TARP bailout. It is equally unsure that the public sector balance sheet could absorb another $1 trillion hit.
This problem is better addressed sooner versus later. Japan tried the ’bury your head in the sand approach'. Twenty years later and they are still paying for it.
In brief, the proposal is to create a sale and lease back opportunity for underwater borrowers. The sale would be a deed in lieu of the mortgage. The lease would be based on fair market rentals. The borrower would walk on the old mortgage with little or no impact on their credit. They would continue to live in the home but at a much lower monthly cost. Sweet deal for a lot of trouble borrowers.This idea is going to be part of the solution. How big a part remains to be seen.
What is becoming increasing clear is that various forms of principal reduction are going to have to be part of the solution to the mortgage mess. As Mr. Alpert and others have pointed out, “If the government made it work that way with GM, why not me?”
What might this mean? There is no data, so a range of estimates. At this point the number of underwater borrowers is greater than 10%. I think it is equal to as much as 30%. Assume the number is 20%. That would imply a number between $2.5-3 trillion of mortgages that are affected.
The next question is, “How much are these mortgage underwater by? Another assumption, 30%. If this is in the ball-park then that would imply a mark to market on all of this of $1 trillion. Approximately 55% of all mortgages outstanding are held or guaranteed by Washington. Therefore the cost would be born equally by the public and private sector.
As crazy as this might sound, $1 trillion would be a very cheap price to pay to get this behind us. As far as economic stimulus goes, this one would send the economy and the market to much better levels.
My concern is that little or no action will be taken to provide true debt relief for underwater borrowers. We will continue to modify loans with better terms but no principal reduction. The results of this are already clear. More than 50% of modified loans re-default in less than six months. Over time that number will go toward 100%. We need to end the cycle of default. The current modification approaches are not achieving that.
The risk that we face is that the cycle continues and deepens. If my estimate of 20%/30% for underwater total/embedded losses moves to 40%/40% the cost jumps to more than $2 trillion. It is unlikely that the private sector could afford this large a write down without another TARP bailout. It is equally unsure that the public sector balance sheet could absorb another $1 trillion hit.
This problem is better addressed sooner versus later. Japan tried the ’bury your head in the sand approach'. Twenty years later and they are still paying for it.
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