Some Thoughts on Fannie's Horrible Year

Fannie Mae released it’s annual and 4th Q numbers after the close on Friday and during one hell of a messy snowstorm. FNM posted a loss of $16.3b for the quarter and $74.4b for the year. An unmitigated disaster. The timing of the release suggests that they were hoping that no one would notice how bad the last twelve months were.  There was nothing particularly new in the most recent quarter, just more bad news. What is happening at Fannie is also happening at Freddie Mac and to a different extent at FHA. There are some trends that I think are worth noting.

It would be a gross overstatement to suggest that Fannie has found religion and is now committed to making ‘good’ loans versus ‘bad’ ones. In my opinion they still must tighten their lending standards if they expect to stabilize their credit losses. But they have moved to restrict lending to better borrowers. The process is ongoing, but the direction is becoming clear.

At this point all three of the D.C. mortgage lenders are pulling on the credit reins. It is obvious from the report the direction that has been taken. Significant additional measures have been announced by the Agencies that will kick in between now and June.

For those economists out there that are scratching their heads as to why they missed by a mile on their expectations of New and Existing home sales last month they need only look at this report for an explanation. It is harder to get a mortgage today than it was a year ago, It will be harder to get a mortgage in one month from today and even harder to get one six moths from today. For me the implications of this are very obvious. Broad RE values will have to go lower, high-end homes will suffer the most in percentage drops.

Consider the following slide.

A major issue for Fannie and the entire country is the REO problem. As of YE 2009 they had an inventory of 89,000 homes. Looking at the information provided one can add up the foreclosed properties from 2007-2009 (290,000) subtract the current inventory (86,000) and come up with a number of 200k homes sold in the past two years. And that number does not include short sales.. If you add in the REO sales by Freddie and FHA it is easy to conclude that the biggest seller of RE over the past 24 months in America has been the federal government. Great timing.

At one point there was some academic debate as to the causes of all of these defaults. In March 2010 the debate is over. The vast majority of defaults come because borrowers are underwater. Falling RE prices are the number one contributor to the default cycle. That being the case one has to wonder as to the wisdom of Washington trying to sell all of these homes during the down market. Their actions have no doubt made the losses at the federal level higher than they might have been. (They collect only 56% of the principal balance when a home goes to foreclosure) The policy of liquidating REO has also hurt millions of homeowners and financial institutions.

This is that ‘price discovery’ debate that is ongoing. If, ‘extend and pretend’ is wrong than surely accelerated sales of REO is right. I am one that believes that neither of these extremes is good policy. Both options take us down a dark road. If RE were to fall by an additional 20% nationwide it would, in my opinion, be a lights out situation. There would be nothing the Fed could do to stop us from falling over a cliff. At the same time there must be some viable alternative for the federal REO. The cost of owning and maintaining all of this property is staggering. Policies that would restrict REO sales may be beneficial to the ‘owners’ of our society, but they would not be fair to the ‘renters’. Don’t wait for our pals in D.C. to put this important social issue on the table.

The following chart looks at the fall in RE prices across the country. Not a pretty picture. Note that the biggest drops are in the West and that this area of the country has the highest single concentration of Fannie's book. For me this begs a question. Was Fannie (and the other D.C. lenders) a force that contributed to the crazy run up in prices in the region? Fannie went where the demand for mortgages was. Basically it was the Sunbelt. The other Washington lenders have the same portfolio. This is a chicken and egg question. Did the Agencies cause this? Or were they just sucked into a vortex?

The Agency’s concentrated lending added to the magnitude of the blowup. There is a lesson in this. At the moment no one in Washington is asking this question. That might well be because they already know the answer. In the red states, Washington poured on the gas. They were a force that helped create the bubble in the states that are now causing the problem, and they are taking a pasting as a result.

Fannie reported that it converted a portion of the 2008-1 Mandatory Preferred stock into common at a ratio of 1:2. This is not of relevance to the remaining Preferred shares that are not subject to a mandatory conversion to equity at this time. But it does, for me, set somewhat of a road map for the Pref. I have never felt comfortable with the idea that the Pref gets left out entirely in the cold when all is said and done with Fannie and Freddie. The junior subordinated creditors got paid out at a premium. The Pref gets dicks hatband. Odd outcome. Less than 6 months before Fannie went into conservatorship Fannie sold $2b of Pref through Merrill. That deal was done because Paulson was pushing to get it done.

Fannie owns or leases 2.7mm square feet of office space. That happens to be the same number of square feet in the Empire State Building. Fannie is a big company. Its 6,000 employees put it in the top 500 private employers in the country. But to think of FNM as a private company at this stage of the game is just a joke. Given the mess they are in I would guess that they will be creating new jobs for some time to come.

What's Up With HUD's REO Sales?

David Rosenberg at Gluskin Scheff commented today about possible problems at FHA:

FHA … THE NEXT SHOE TO DROP?
We have a contact in the mortgage business who took a good hard look at the delinquency data from the FHA, along with loss severities. There is a very good
chance that in the near future we will see the FHA insurance fund go negative.

You don’t have to have ‘a friend in town’ to get this insight. You just have to go to the HUD website for their REO sales. The number of HUD homes for sale is staggering. There are 50 pages of listings in just Ohio alone. HUD’s chief, Shuan Donovan was in Cincinnati recently. He wrote a blog about his trip:

“Yesterday, I had the opportunity to travel to Cincinnati, Ohio for the one year anniversary of the American Recovery and Reinvestment Act of 2009”…”What I saw in Cincinnati yesterday is just one example of the economic recovery America is beginning to experience.”

By my count the FHA is listing 500 homes for sale in Ohio. You have to wonder what Mr. Donovan is selling here. This American recovery he is talking about is being tripped up by the FHA’s REO sales.

It is both interesting and easy to look at the HUD properties for sale. I would encourage readers to take a gander. HUD is in every state. The HUD website takes you to this page where you can select the state you live in.

From this you are directed to a number of “independent” property management companies that all have contracts with HUD to dispose of the REO. The names of these third party companies are: Pyramid, HVH, HMB,Inc., Southwest Alliance, Citiside, Home Source, MCH, NHMS and Best Assets. A total of nine.

The individual web sites for these RE companies provide you with options to look at homes. Some of the Web sites are remarkably similar. Possibly this is just a coincidence. My guess is that all of these 'independents' are intertwined. Consider these:

Or these:

 

 

The Web site for NHMS looks similar to many of the others. Dig a little deeper and you find that NHMS is a sister company to Precient. This is yet another web site peddling government owned REO. They have the contract to sell what the FDIC is trying to offload.

So where do all these dots lead?  A fellow by the Name of Arthur Torano. 

There is big money to be made offloading government owned REO. To make money you must make sales. To make sales you must be the price leader in any neighborhood. There is a built in incentive to push broad RE prices lower. A questionable national policy.

Arnold and Ed – Good Plan/Bad Plan

California’s Governor (R) Arnold Schwarzenegger and Pennsylvania’s Governor Edward Rendell (D) were on TV on Sunday. These two were having a bi-coastal love fest. They have connected with another big shot, Mike Bloomberg, in an effort to steer the country toward a much larger program of infrastructure investment.

This is an old story. You don’t have to look too far to see that America is in need of some new ‘stuff’. They made the case that other countries are investing more than we are and as a result we are falling behind. Arnold made a good point when he said that the US was spending 5% of GPD on infrastructure in the 60’s and that paid off for decades. The current infrastructure investment rate is only 2.5%. The Cali Governor made it clear, the nation should revert back to that 5% level. It would create jobs today and the investments would pay of in the future with more jobs. Ed R. was almost slavering about all the steel his state could produce under those conditions.

This sounds good. But it is a dead end. A 2-1/2% increase in infrastructure spending translates to $350b a year, for at least the next five. With interest that comes to $2 trillion. Call it an extra $30 billion a month of funding requirements. That would of course be on top of the existing deficit. What is already on the table comes to about $120b a month. Forever. These two governors want us to go into hock for an addition 25% over our existing crazy monthly nut.

The Terminator gave an example of his thinking. He is planning a new $11b Bond to cover the cost of a major irrigation project. There are clear benefits to the proposal. But another $11 of debt is required. The solution to Cali’s problem is obvious. Borrow, spend and worry about paying it back later. At one point the bond market will just say “no”.

Ed. R. made his thoughts on deficit financing clear. His message was, if we don’t borrow and invest “We will become a second rate power”. The T added: If we don’t rebuild our infrastructure, “We will fall like Rome”.

QE interest rate management is over. We will be moving to more normalized rates over the next few years. If one takes the Fed at it’s word they will be unwinding their emergency measures. They are not going to be a buyer of incremental debt. The macro economic conditions are not producing the big current account imbalances that led to the foreign demand for our debt. The recent increases in holdings by the UK, Japan and Hong Kong are not sustainable. A historically big buyer, the SS Trust Fund bought half as much as they did in 2009 than in 2007. In three or four years they will begin selling their big holdings. As for those savers in the US, well they might pick up some of the slack. But not at the interest rates being offered today.

At the moment the US is benefiting from a global capital move to what is perceived to be dry land. That trend may well continue for some time. But at some point the pendulum will swing the other way and the capital will leave our relative safety. (Someone please show me who (major category-$100b per annum) is going to absorb the coming $5-8 trillion of supply?)

Ed and Arnold probably have it right. If we don’t borrow and spend we will become a second rate power. The problem that I have is that if we spend and borrow as much as is being suggested we will most certainly fall like Rome.

Toyota – The Japanese Perspective

The Japan Times had a story in the Sunday 2/21 edition that discussed the problems that Toyota faces in the United States. I thought it was an interesting take on this story. It provides a window on how this is being perceived in Japan. Some of it took me by surprise. For example:

The Japanese media primarily see this backlash as being culturally motivated.

Culturally motivated? What does that mean? Does that mean that the public lashing that Toyota is taking in the US is actually because Americans don’t really like Japanese people? What a bizarre perspective on this.

The article suggests that Toyota’s problems might be part of some high stakes maneuvering by the US military:

The American government now effectively owns General Motors, and thus has a stake in its revitalization. Certain publications infer even more nefarious purposes. Shukan Port claims that the U.S. is getting back at Japan for dragging its feet about moving the Futenma air base.

This about an airbase? Americans have been driving their cars involuntary into bridge abutments in order to influence the outcome of negotiations on a military base? The American government has whipped up the furry by their control of the press and made this a piece in a very big chess game? Give me a break. The word paranoia comes to mind.

This should make Toyota owners much happier. At least it would if it were true.

In the U.S., models subjected to recalls tend to have higher resale value since it's assumed they've been checked thoroughly and are thus safer.

The article dismisses the safety problems of Toyota’s cars with the following:

Automobile recalls are common, even in Japan.

Even in Japan? Does that mean there is an expectation of better quality cars in Japan than in the US? Is that what Japan believes? Is that the truth?

I loved this section. I can’t imagine a system that worked like this. Everything would be gray.

In Japan recalls are carried out in a low-key manner, normally publicized with very brief articles in the back of the daily newspapers. Unlike in the U.S., television as a rule doesn't report recalls, ostensibly because they are considered business transactions between manufacturers and consumers, but mainly because automobile makers are major advertisers.

The article suggested that the media and customer response to the safety issues were going to cost the silly Americans:

Governors of four states where Toyota operates factories have sent letters to the U.S. Congress defending the automaker. Toyota dealerships in America employ 172,000 people. Damage to the company's reputation places these jobs in jeopardy.

The Japan Times take on this does not add up to much. It shows that this paper and presumably many other people in Japan don’t really understand how we think and what we think is important. Japan became America’s largest external creditor recently. How stable could that be?

A “Tell” on the NFP Number??

I wish I could solve this riddle. If I could I would make a bundle. Maybe someone can make proper sense of this. If you like big data bases, understand complicated analytics and have a big computer read on. If not, let me suggest you click out now.

I have watched the Non Farms Payroll numbers for most of my life. I would guess that there are a few hundred economists who spend a week a month trying to make an educated guess at the headline. The MSM talks about the numbers for days before and after the release. The financial blogs are even worse. The fascination with the numbers is that they are damn near impossible to predict, and they always move the markets.

The fact is the Government publishes the critical data necessary to evaluate the current month employment and unemployment numbers weeks before the actual release of the NFP report. The February information is out, here it is:

Trust Fund Link.


The Social Security Trust Fund releases the February Payroll tax receipt numbers early. Obviously this can’t be a completely accurate number. February is not even over, so clearly this is an estimate. I have followed these numbers for some time and have found the preliminary numbers to match up pretty well with the adjusted count.

In looking at the numbers I have concluded:

-Over time there is a 100% correlation to rising employment and rising payroll tax receipts. Similarly the correlation exists where in periods of recession the rate of increase falls, or as in the case of 2008-10 the income goes negative. The severity of the recession determines the actual outcome.

-In the 1/2008-1/2010 periods employment fell by 8.24mm (revised BLS number). The Jan.+Feb. 2008 FICA total payroll tax was $98.7b. In 2010 it was 93.0b a drop of 5.7%. Multiply that times 135mm workers and you come up with a drop in payrolls of 8.27mm. That is a 30k difference over 24 months. That is a very high correlation. That this lines up so well is not a coincidence.

-The month-to-month correlations are not reliable. There are lags in the reported data. For example, if a person were fired it would show up in the BLS numbers the next month. But if the person got a severance that income would continue to be subject to SS tax. There would also be a distortion from people losing regular work and taking a job as a waiter at $5 per hour. This person would not show up as unemployed, but SS revenue would decline.

To look at this I think it would be necessary to look at the data both from SS and the BLS over an extended period of time. Twenty years of monthly data. It is all available. The question is can the seasonals and the leads and lags be evaluated and a methodology developed that would translate the SS payroll tax number into a predictor of the BLS NFP number?

I have two concerns with this:

A) Assume (100o to 1 chance?) that someone says, “Eureka! I have the number +/ 25,000 as a result of the peek at the tax data. (A very big deal) The minute that happens the Trust Fund will reschedule the release date of the data. The punch bowl will be gone before the party starts.

B) My worst fear is that there is some predictive value to looking at the tax numbers. And that someone figured this out four or five years ago and has been getting rich once a month ever since. I am not the only one who looks at these silly things.

Notes:

*Consider the February 2009-2010 numbers. (I use only the monthly FICA projected # as this is 95% of the data) 2010=47.5B, 2009=$51.5B. We lost $4b YoY. That is a very big drop. It comes to 8%. There are 160mm covered workers paying into SS. They range from an exec. to the paperboy. Based on this math 13.3mm are no longer getting a check and contributing to the system. This suggests that the NFP number is greatly understating the drop in employment. There would appear to be some very bad things happening outside of the BLS numbers.

*I don’t understand the leads and lags of this. But I have played with and watched the numbers. It is hard for me to accept the current wisdom that there will be a large increase in the February NFP given the drop in tax receipts.

*For SS to be seeing a decline of 8% in revenues in February is disturbing. Some additional months of data in 2010 are necessary to prove this trend. But should this decline hold, it is a very poor sign for the Fund.

Goldman on the Yuan - What Do They Know?

In my yearend projections for 2010 I said (among other things) the following:


-China will surprise us all and revalue the Yuan by 10%. The currency will still be undervalued.


On Monday morning Bloomberg has a story out quoting Goldman’s Chief European Economist as saying:

Feb. 15 (Bloomberg) -- Goldman Sachs Group Inc. Chief Economist Jim O’Neilll said China may be poised to let its currency strengthen as much as 5 percent to slow the world’s fastest growing major economy.

I doubt that Mr. O’Neill is making a guess here. I think he may have some real insight on this. When he says this, I listen:


“I have a strong opinion that they’re close to moving the exchange rate,”

Say this story is true and in the not too distant future China will adjust its currency against the dollar by a reasonably significant amount. Assume that they move by 5%. What might this mean in the scheme of things? What are the market implications, if any? Just some thoughts.

-If China does do something significant, it is another sign that should not be avoided. Something is up with China. They are changing direction. A currency move this week followed by the monetary moves last week is a clear indication that things have heated up, and they don’t like it. The two steps (assumes currency reval.) would prove that Chanos etal. were right all along. There is a bubble.

-If you were China Inc. and you owned the IOU’s behind a monster amount of empty buildings (and cities) the last thing you would do is to strengthen your currency and tighten monetary policy. But if the arguments in favor of reversing stimulus outweigh the consequences of extending fast money policies then it is not hard to predict that those empty buildings will remain so for a while to come. There would appear to be some urgency to the Chinese steps, should they occur.

-Should this happen it would come at a very inconvenient time. China’s currency is tied to the dollar. The dollar his risen against the Euro by 10% in the last two months. Therefore China’s currency has risen by the same amount against the Euro Zone. That is a big market for China’s exports. If they revalue against the dollar by 5% and the dollar stays where it is they will have taken a 15% hit on the terms of trade in just 60 days. If I were China I would be putting out the story, “Our currency is up 10% versus half the world. Stop yapping at us to make it higher still”. So that makes the timing of this (should GS be correct) very suspicious in my mind.

-All else being equal I would rate this a win-win for the Euro Zone and Brazil (again), a win-lose for the USA and a lose-lose for China. For the US it might be of some benefit to the big exporters, but I doubt it. Any improvement on pricing will be offset by a reduction in demand. For all of those Wal-Mart and Home Depot shoppers beware. Prices are going up.

The market outlook on this is murky for me. There are some checks and balances to this that could in theory bring some stability. Everyone has been leaning on the Chinese to hike their currency. So if they were to do it the spin would be, “Hey! Here’s some Good News!” I don’t see it that way.

-Last week the market tanked on the news that China was moving on reserves. This is no different. So if it was bad last week. It will be bad this week too.

-Should this happen it raises a big question about the HK dollar. Logically that would have to be re-pegged as well. Should that not take place I would expect a mega move into the HK$. I can’t imagine that the Central Bank will accommodate that.

The money flow to Hong Kong has been big and steady for some time. The reserves were $206B as of 12/31/2009. Should there be an adjustment in the HK$ rate there would be some very big overnight profits. At some point thereafter the reserve flow would reverse to more normal levels. Say 50% or $100b. That just means there is one less buyer of US Treasury bills at the next auction. Most of the hot money that went to HK was borrowed, so when the short-term flows are reversed the margin debt is paid down. There is no new or alternate buyer of those Tbills.

-China was supposed be a global engine for growth. Whatever your expectations were on that score a week ago you must revise them down today. A year ago there was all the talk of green shoots. There were many of them. China tightening its belt at this time and at this pace is a brown patch. In Europe there are dead tumbleweeds blowing around. These things do not make for an improving growth story.

-Using the wisdom of purchasing power parity an argument could be made that the Euro would be a tad undervalued should the Chinese move. I don’t see that happening either. Much to the chagrin of the Chinese the dollar could go right on rising. To hell with purchasing power parity.

-If you read the Chinese steps as deflationary, it has to be bearish for the commodities. They have all been backing up. This could cause that to continue.

-Gold could be interesting. Say the thoughts on the dollar were right and we move toward 1.30. Say the commodity markets followed that lead. That would imply that gold should move lower in sympathy. I would watch that one. These things that may be coming are on the side of the shelf that is marked: DESTABILIZING. I am not sure if this will come into the gold equation at this time. It will soon enough.

-In this environment the TLT is not the place to be. Not yet.

-On paper this could mean that China has less exports and more imports. Should that be the case their reserves will stop growing. Who is it that is going to be buying all of the paper that is being created by all of the debtors in 2010? At the moment I am having trouble of thinking of any ‘size’ buyers. Possibly Ben B will have to add some more demand to meet the supply. That would be very big tumbleweed.

The GS report got me to write these thoughts. This is all just blue-sky thinking. Probably nothing will come of it. I hope not.

Mankiw on Goldilocks Debt - Phooey!

Gregory Mankiw did a piece in the Sunday Times Biz section. He tried to make a case for a VAT. Along the way I thought he fluffed himself up (as usual) and played fast with some numbers. He also reinforced his Keynesian belief that growing debt is good for our economy.

On the subject of growing debt:

"...in the long run, a balanced budget is too strict a standard. Because of technological progress, population growth and inflation, the nation's income and tax base grows over time. If the government's debts grow at or below that pace, servicing the debt will not become a major problem. That means the government can run budget deficits in perpetuity, as long as they are not too large."

There is a flaw to Mr. Mankiw's thinking. Where are all the investors going to come from to absorb the perpetual debts? This same kind of thinking lead Spain and Ireland into a debt binge. We watch this play out every day. The debt service to GDP ratio Mankiw relies on is a flawed model. The total principal amount of debt has now been brought into question. That model is screaming, "There is too much paper out here!" Mr. Mankiw may look at his slide rule and say, "Gee wiz, this looks manageable". But, increasingly, global bond investors are saying, "Gee wiz, this is a mess, let's vote with our feet". Unfortunately, the bond market is much more influential than Mankiw.

In defense of ever increasing deficits Mr. Mankiw points to a recent period of our history. It just so happens that this period is the same period where Mr. Mankiw was steering economic policy. He was the Chairman of the Council of Economic Advisors from 2003 -2005. He helped frame the debt policy for the Bush administration. That thinking prevailed until 2007 when things started cracking up.

Again from the Times, in support of growing deficits: (And the great results his policies produced)

"Recent history illustrates this principle. From 2005 to 2007, before the recession and financial crisis, the federal government ran budget deficits, but they averaged less than 2 percent of gross domestic product. Because this borrowing was moderate in magnitude and the economy was growing at about its normal rate, the federal debt held by the public fell from 36.8 percent of gross domestic product at the end of the 2004 fiscal year to 36.2 percent three years later."

Notice that Mr. Mankiw says, "federal debt held by the public". This is a slippery use of numbers. Consider this graph that looks at the debt held by the public/GDP for the years in question.

This graph clearly confirms what Mr. Mankiw was saying. This important ratio fell during this period. But that is only half of the story. As a result of the Greenspan Commission on Social Security the Trust Fund was running mega surpluses during the same period. Look at the total Intergovernmental ("IH") holdings of debt for the same period. The IH share of the debt load was rising by $200 billion a year!


Now look at the combined Public and IH comparison to GDP. The debt to GDP stayed at 65% when the declines in Public and increases in IH are included. There was no improvement in the overall debt picture. This historically high Debt/GDP ratio is nothing to brag about. Were it not for the SS surpluses the Public sector debt would have exploded. Mr. Mankiw knows these distinctions. We all 'talk our book'.

I hope that Mr. Mankiw does not respond with, "I don't consider the IH, they are just a tax on future generations". If he did, I would take issue with him on that as well. The following is a slide from Treasury on the Public/IH numbers as of 1/31/2010. Half of our debt service cost goes to the IH.

The notion of ever increasing debt loads is old school thinking for a growing list of countries.  The market has driven almost all of the policy choices for the past two years. We built a market-based economy using a slide rule. Now the market is turning on us. Theoretical economics created and is perpetuating the notion that debt is good and growing debt is better. The markets are proving that this is wrong. To hell with the slide rules.

Solvency and Liquidity - Two Different Numbers

I wrote an article recently and quoted a CIA report on Spain’s External Debt as being $2.4 Trillion. A reader commented that I was full of crap and spreading false information. The reader made clear that the external debt of Spain was $1.25T (Euro 900b). The following graph from the Bank of Spain was sent to me to prove the point.

Here’s the data I relied on from the CIA World Fact Book.

I think of the difference in these numbers ($1.15T) as a gross and net calculation. Spain has 2.4t of external debt, but the financial institutions in the country have ~$1T in foreign assets. (It is much more complex than this simple arithmetic).

Many economists, (notably Stieglitz) have used the net number and multiplied it by ‘real’ interest rates and have concluded that the resulting debt service number, as a percent of annual GDP, is manageable. The conclusion from that camp is that there is a necessity for some budgetary action, but there is certainly no cause for alarm or, heaven forbid, panic.

In the early 80’s damn near every country South of Texas went belly up. I know. I ran part of Citi’s FX biz during that period. All my public and private sector Latin American customers were shut out of the capital markets. Their existing debts traded for pennies on the dollar.

From my seat I saw that the problems always started with the domestic banks. Their offshore funding lines were canceled one by one. They could not reduce their balance sheets fast enough; they went to the local Central Bank who said “No Mas” and the next day all the lights went out.

Things are much different today than 30 years ago. But there are some similarities. Financial institutions in every country have enormous cross border exposure. If you want to measure solvency it is appropriate to base the calculation on a country’s net external debt number. But if you want to measure a country’s liquidity risk you have to look at the gross number.

Every financial institution sets a country risk limit for its own foreign investment activity. This limit is further divided into exposure to the Public and the Private sectors. At the first whiff of trouble these lenders/investors try to pare back their risk to a country. The first place they go is to the private sector banks. They pull lines and deposits.

In the case of Spain, Banco X will record foreign liabilities; they will also have foreign assets offsetting it. If the market were to turn on “Spanish” sovereign risk and the availability or the cost of external borrowed capital were to become prohibitive, Banco X can simply reduce its balance sheet of the external assets. But think of the market conditions that would exist if this were to evolve. There would be trillions of assets looking to go through a very small hole.

The CIA data points to both the strength and weakness of our global system. The strength is the diversity, the weakness is the codependency. The External Debt of all countries was estimated by the CIA to be $57Trillion as of 12/31/09. It was $61T in 2008. An interesting YoY drop of $4T. In 2009 there was an explosion of global debt. The US alone added a few trillion. The drop in cross border holdings is therefore even more significant. It suggests that the willingness of the global system to absorb more and more external debt is in substantial decline. 10% is a reasonable estimate. This makes sense, given the global economic conditions. But it is a very troubling direction.

Also of interest is that in 2008 world GDP was $60T, almost exactly the same as the $60.7T of cross border debt. As this declined in 2009, so did Global GDP. Does this confirm the statement: Debt=Wealth?

We owe each other $60T. So long as all of these IOU’s keep changing hands in an orderly way there should be no problem. But unfortunately there is a problem. It is currently playing itself out in the second tier European countries. The global deleveraging is continuing. Today it is Spain and Ireland. As of now only a small percentage of the $60T is moving around. But there is every reason to believe that this movement of the deck chairs is going to accelerate. Deleveraging is never pretty. We went through that in 08-09.

The economists like Stieglitz are wrong. There is a reason to be worried. Bernanke’s weapons are spent. Treasury has no chance for a TARP II. Yet we are looking at a very deflationary outcome if the present trends continue.

We have seen credit spreads and CDS pricing widen out significantly for the PIIGS. A reasonable market reaction. If this trend extends to other classes of debt including high grade corporate, Agency MBS, or other higher quality sovereign names, look out. That will be the sign that the unwind of the 60T is accelerating. With it will go wealth and GDP.

A Boost for Finisar from Google?

Finisar  Corporation FNSR makes the subsystems and components for fiber optic communications applications (high tech switches). The company posted solid three month numbers Tuesday evening. The top line grew to a record $166mm in the most recent period. Sales were up 14% quarter over quarter and 32% year over year. Gross margins are in the low 30% range. With that margin all they need to do is grow the top line and the bottom line is going to come.

The stock opened up 10% and then began a bit of a fade. But as the day chart shows it came back strong after mid day, shortly after Google made its announcement regarding a fiber optic broad-band investment that it is going to make.

There are few details on the Google effort. The company said they were going to build an experimental fiber network that will target several cities and up to 500,000 people. They indicted the project would start soon. It will take years to measure success in this for Google. But it is certain that something quite big is about to happen in the world of fiber networks. Google does not do ‘small’ things. I doubt this is an ‘experiment’. This is just a first step.

I asked Finisar for a comment on the Google development. Companies can’t give out information. That said, the response I got from Finisar’s CFO Steve Workman was quite interesting. You can draw your own conclusions from his words:


I don’t believe we have ever confirmed that we sell to Google or not. But either way, more bandwidth ultimately generates more demand for our products. And the large server farms that are built by the likes of Google, Microsoft and Amazon for cloud computing and storage generates demand as well. For a good read on this topic you might try The Big Switch written by Nicholas Carr.
Regards,
Steve Workman
CFO

A Uruguay - Greece Story

Marcello, his wife Sylvie and their three kids lived in Montevideo, Uruguay in 2002. They were in their early 30’s and life was pretty good. Sylvie had a license to practice dentistry. It is a different standard then what we know. But she had education debt and she borrowed to build an office. She also borrowed $10,000 to pay for “license” required to open a business.

They borrowed money to buy cars, they had credit card debt. They did not look much different than your average American family. Their income was close to $100k; they had debt of $50k. A problem, but not a crisis.

Nearby Argentina had “Dollarized” its economy a decade before. Uruguay did the same. For years there were big benefits from linking to the dollar. Inflation collapsed. The availability of credit expanded dramatically, the economy prospered.

Sylvie and Marcello earned $100k in Uruguayan Pesos. The debt was in dollars. As long as the exchange rate of the UPeso was fixed there was not problem. But in 2002 there was a big problem. The charade of tying a local currency to a reserve currency at a fixed parity ended very badly. The Argentine Austral and the UPeso ended up devaluing by nearly 80%.

Think of Sylvie and Marcello, they went to bed one night owing $50,000 and woke up in the morning owing $400,000. (It actually took a year) They were busted. What could they do to get out from under? The whole family left the country and came to the US on a tourist visa. And Marcello worked off the books seven days a week to earn the dollars he needed to support his family and try to pay back the dollar debt.

These people weren’t dead beats. To me they were like any middle class family that got squeezed. They wanted to honor their debt and get back to living. The only choice to do that was to get an income in dollars. Their Peso income would no longer cover the debt.

A few years after they got here I got involved and negotiated a settlement with the various Uruguayan banksters that had lent them the dollars and put them at risk. We paid 25 cents on the dollar, so that meant the debt was cut to $14,000. Sylvie left with the kids. Marcello stayed for a while longer so he could pay me the 14k. A solid guy, he settled with everyone. They are all back home now. Life is okay again. They will never borrow money in dollars again.

There are similarities to Uruguay in 2002 and the PIIGS in 2010. Both converted/pegged their domestic currency to a much stronger reserve currency. The same benefits of reduced inflation and economic growth have followed as a result. But so has debt creation. Both in the public sector and the private sector.

The CIA puts Spain’s external debt (mostly Euro denominated) in 2004 at $780B. Six years later the same source put the number at over $2 Trillion. And that is why we have a problem today. CIA link.


The pressure is mounting for “something” to be done. The argument, “Greece should float out of the Euro” or, “There should be a two tiered Euro” is gaining some traction. While this process will ebb and flow throughout the year, it really has only one direction to go. It’s going to get worse. The idea that the PIIGS will work this out with budget cuts is just wrong headed. That is not going to happen. The development today where it appears that a lifeline may be extended to Greece is going to backfire on Germany. There will be too many hands sticking out requesting a soft loan. The steps that may come in the next few days may serve to defuse the problem. But the fuse will get re-lit before too long. At that point it will be a short fuse and nearly impossible to put out.

It is impossible to predict what will happen at this point. But if the resolution of this results in some fundamental realignment within the Euro Zone there is going to be a lot of pain. The end result will not be anywhere near as extreme as what happened in Uruguay. But we could end up with a two-tiered Euro that has a 20% or more premium from the Strong to the Weak.

Should something like that happen there will be millions of Sylvie and Marcello’s. The banksters will get stuck again, the economies will suffer, and like in Uruguay there will be a reversal of fortunes for many.

At the moment that still seems to be the most likely outcome. We will find out in the next few days. If the lifeline to Greece is actually just a thin thread and a quid pro quo promise of major budget cuts in Greece then this is going to end badly. There will be tractors all over Athens. They love the German tourists, but there is no way the Germans are going to dictate to the Greeks.

Hank's Book - My Take

If the financial history of the globe is a topic of interest to you Hank Paulson’s new book, On The Brink is a must read. Tim Geithner and Ben Bernanke were central parts of that part of our history, but after reading this book you come away with the conclusion that it was Paulson who was pulling the strings every inch of the way.

There were some aspects of the book that I found to be not credible; there was one critical section that I thought the facts were a bit distorted. I think there was one part of the story that was omitted. As a result I was left questioning how many other aspects of this story were ‘skewed’.

Start with what I think is an indisputable fact. Hank Paulson is one of the smartest financial guys in the world. He is one of the top investment bankers; he knows debt and corporate finance as well as anyone. Throughout his book Hank demonstrates his knowledge and establishes the fact that he knows everyone in the game on a first name basis.

Given that as a backdrop I have issues with the credibility of the following sections of the book:

I) What did he know (suspect) and when did he know it?

On August 17, 2006 the newly appointed TSec. Met in Camp David with president Bush and his economic team. At that meeting Paulson said


“If you look at recent history, there is a disturbance in the capital markets every four to eight years”.

Hank added in the book, “I was convinced we were due for another disruption”.

Hank was a very much a hands on CEO at GS before becoming TSec. He was a big risk taker, but he was very measured in his bets. I think it is important to look at GS’s record in the years preceding 2006 as a clue to Paulson’s thinking.

In the 2003-2006 periods Wall Street was coining money in originating/packaging and distributing Sub Prime and Alt-A mortgages. In those same years GS consistently ranked last or next to last on the league tables of how much of this business was done. If GS wanted to be #1 in this business they could have been. They had the brains, the balance sheet and the moxie. So for me this is a sign that the senior management at GS took a hard look at a big money making operation and said, “This one is going to stink, let’s keep a low profile”.

I think that Paulson was a big factor in steering GS away from the junk mortgage pitfall that ended up killing the competition. He had made up his mind on this issue years before the August 06 Camp David meeting. He saw on a daily basis the absolute junk that was coming from Wall Street. I maintain that when he spoke he knew in the back of his mind that the source of the “next financial crisis” he was warning about was going to be bad mortgages.

If in 2006 Hank had sounded the alarm bell as he had inside of GS there would have been a different outcome in 08 and 09. There were plenty of people (including myself) who were looking at the debt that was being created from the junk and saying, “This is just getting silly”. Paulson was too smart and too connected to have not seen this. He does not acknowledge this in his book. He claimed that he smelled trouble, but did not know where it would come from. I find that hard to believe.


II) The TARP debt for equity Flip Flop

Anyone who knows corporate finance knows that equity is worth 10X’s more than debt. Paulson knows this from forty years ago. With this in mind the time line of how the TARP program was shifted to one of buying distressed assets to buying the equity in the banks is important.

The TARP program was sold to the public and to Congress as a program to buy toxic assets that were “clogging” the system. Congress agreed to the $700b program on October 2, 2008. It contained a provision whereby Treasury could use the funds to acquire equity if necessary, but the expectations by all were that Treasury would be buying toxic assets and not common or preferred shares. Ten days later on October 12th Paulson changed the game and switched from buying trouble mortgages to buying equity in the banks.

In the book Paulson gives credit to two unlikely sources for the change in his thinking. Warren Buffet and Ben Bernanke. I think he just used those two as the basis for the change in plans. They just confirmed what he wanted do all along. Paulson makes reference to a discussion on September 30th 2008 with Bernanke:

“Ben Bernanke told me that he thought that solving the crisis would demand more than illiquid asset purchases”. In Bernanke’s view, “we would have to inject equity capital into financial institutions”.

So it was Ben that planted the seed for the massive flip flop on the use of TARP funds. I think the seed was already there and Hank used Ben to support what he had already concluded.

Nine days after TARP was passed (October 11) Paulson had a phone conversation with Warren Buffett. During that call Buffett urged Paulson to consider investing the TARP money in low coupon preferred stock in the banks as an alternative to buying assets. Paulson describes this as a ‘eureka’ moment. The point where he became convinced that this was the right way to use the money. He said of this phone call, “I was convinced Warren’s was the best way to make a capital purchase program attractive to banks”.

For me, this version of history does not pass the smell test. I believe that Paulson was well aware of the leverage that could be obtained by investing in equity versus debt. He describes in the book how $70b of equity could cover $700b in debt at a bank. Hank knew the value of equity. I maintain that his plan was all along to acquire equity, but he knew he could not sell that plan to Congress, so he masked his plans with a debt buyback. That the TARP legislation was drafted to give him the ability to buy equity was not a mistake of history, it was a part of a plan that Paulson had considered from the very beginning.

After the decision had been made to change the use of Funds and the money had been committed, Paulson continued to have Neel Kashkari (visibly) chasing after a methodology to implement an asset purchase program. This was done as a smoke screen to Congress to demonstrate that the original intent of the legislation, to buy troubled assets, was being pursued. No TARP money was ever used to buy the assets it was intended for.


The James Lockhart, OFHEO/FHFA Connection

A significant part of the book is spent relaying the facts leading up to the conservatorship of the GSEs, Fannie and Freddie. I think there was a significant misrepresentation of the facts in the book. On page 6 Paulson says:

“I had spent much of August working with Lockhart. A friend of the president’s since their prep school days. Jim understood the gravity of the situation, but his people, who had said recently that Fannie and Freddie were adequately capitalized, feared for their reputations”.

This is not factually correct. It was not ‘some of Lockhart’s people’ who made the statement that F/F were adequately capitalized. It was Lockhart himself. In the days that followed, both Paulson and the president* repeated Lockhart’s words. Headlines and links on this:

Link: Here

Link: Here

The fact that the president*, the TSec. and the chief regulator of the GSE’s all made misleading public statements regarding the health of the GSEs just months before they were put into conservatorship is an important part of this history. We now know, both from the book and other information, that there was a very high level of concern regarding the Agencies at exactly the time that these statements were made. These were listed companies with a big stock float; misleading information on their health was made public. Our highest officials repeated that information.

This aspect of the story was not put in the proper perspective. The implications of Lockhart’s words along with Paulson’s and the president’s role were glossed over. It is my opinion that a mistake was made with these statements. Paulson did not acknowledge that. This puts a taint on the entire narrative. If I can’t trust this aspect of the story, I have trouble believing in the rest of the information as well.

A Missing Link?

In numerous sections Paulson makes clear that as TSec he actually did not have much power to commit money toward fixing problems. He had no Bazooka and he wanted/needed one. To do anything,  he had to have the prior permission of Congress. TARP ultimately became his congressional bazooka. Hank and his staff knew early on that they needed the ability to act decisively and without the consent of Congress. They looked endlessly for ways to fight the battles without having to go to the Hill. They even used the 1934 Exchange Stabilization Fund to guaranty the money market funds. This step was effective; it showed how resourceful they were. It showed how far they were willing to push the envelope.

One unused arrow in Treasury’s quiver was the Federal Financing Bank ("FFB"). This is a doghouse bank owned by Treasury. It finances government agencies like HUD and the Post Office. It makes long-term loans to rural electrics, it provides financing for foreign arms sales. The FFB has made big loans to the FDIC in the past. It has a mandated ceiling on its balance sheet of $500 billion. In 2008 it had assets of only $50b, it had $450b of buying bower. So this bank had to have been considered as a tool for Hank to use. He left no other stone unturned. I, for one, can’t believe that he did not consider FFB when he was looking for a bazooka and he didn’t want to ask congress for a new one. There is no mention of the FFB in the book. I found that odd.

The following is not based on facts that I can deliver to you. Therefore treat it as such. **

I wrote a piece sometime ago on the FFB. Later on someone who claimed to have the minutes of the FFB May 2008 Board minutes contacted me. (The minutes are not public) I did not review this; portions of it were read to me on the phone. There was one comment that struck me. I do not recall the exact language. The essence was that in the minutes there was a reference to a meeting that took place outside of the Board Meeting and at that meeting there was some discussion of using FFB to acquire significant quantities of mortgage related assets. No details of that meeting were included in the minutes. As TSec. Hank Paulson was the Chairman of the Board of the FFB, he had to be part of those discussions. FFB was his “baby”.

My thinking on this has always been that the idea of using FFB to acquire assets was a continuation of the ‘Break the Glass’ plan that was developed by Treasury in February/March of 2008. This was the blue print for TARP. The missing link to the break the glass plan was where does the money come from? FFB was a possible candidate given that it was controlled and run by Treasury and had the capacity to buy a lot of assets. FFB was not designed to do this. My assumption was that it was looked at and it was determined that there were legal (political?) restrictions on FFB that would not allow it to be the bazooka that Hank wanted. (Note: FFB did go on to buy $400mm of worthless Hope Now bonds. So it was used as a popgun not a bazooka.)

There is another more speculative side to this. What mortgage assets were being considered for purchase? The toxic ones or was there consideration back in May of 2008 to acquire the MBS of Fannie Mae, Freddie Mac and Ginnie Mae? We will never know. There is no discussion of this in the book and the details of that meeting back in May of 08 will remain a mystery.

In the Author’s Note, Paulson says, “I have been blessed with a good memory”. I wonder why his memory is not so good on this aspect of the story.


Notes:

*On July 10, 2008 I was asked to draft a question re: the GSEs that would be posed to President Bush by a FOX business reporter. I did that, and the question was asked. Bush totally dodged my question and responded, “Their (F/F’s) regulator (James Lockhart, his childhood friend) has said, ‘they are adequately capitalized’”. End of interview. I don't have a clip of this, but Roger Ailes at FOX does. Someday it will be re-aired as part of this history.


**I write to government agencies all the time. I ask them questions. They often say, ‘Buzz off”. Sometimes they say, “Here’s the info you wanted.” It is rare that I do not get a response. I didn’t get any from these:


12/3/2009 to FFB
Hello, I am a journalist. I write about financial matters.


Can you provide me with the Email link that has the minutes of May 2008 FFB board meeting?


12/14/2009 to FFB
Hello again. I am disappointed at the lack of response on my request. Possibly I should put some cards on the table.


I have reviewed the May 2008 board minutes. I took notes but do not have a copy. I know that you have given this link to other journalists. I learned of this from them. They contacted me to help with a story on this. I know that there is a reference in the minutes to a secret meeting. I know that the topic of this secret meeting was a discussion as to the feasibility of the FFB acquiring Mortgage Bonds. This meeting is an important part of that history. I would like to know more about it. I believe my readers (2mm this year) would also like to know about it.


Please reconsider my request. Thank you.

FX Intervention an Option? - Maybe

Coordinated currency intervention may not be far off. I am not making a prognostication that this will happen. That is far to complex an issue to make a ‘call’ on. I want to make a case that the conditions are either presently with us or soon will be upon us for currency intervention to become an option that is exercised.

In my opinion there were at least a half dozen times in the past 18 months where currency intervention could have been an option to provide stability to a global financial system that was cracking up. But there was no coordinated intervention in the FX market. There was an unprecedented amount of fiscal and monetary actions taken by nearly every country in the globe, but it never came down to FX intervention as a policy option.

I bring up this history to re-enforce my point that intervention is impossible to call and is, based on recent history, a remote possibility. That said, should it come in the next few days and weeks it would be a measure of just how much pressure is building up and how unstable the system is.

Central bankers know they can’t control the value of their currencies. The markets are far bigger than they are. They best the can do is slow a process. A checklist for decision-making on coordinated intervention would include some of the following:


- How quickly is the market moving? Is the rate of change orderly?

 The movement in the $/Euro has not been disorderly. We have a 10% recent peak to trough move. That is big in currency land but it would not by itself be a justification to intervene and provide temporary stability.

A different way to measure how much stress there is out there is to look at the Euro/CHF rate. The Swissy has strengthened by 3+% of late. That may look like peanuts compared to the moves in the dollar. But it is actually a big deal. The SNB has been intervening to hold the 1.51 parity to the Euro. They gave that up after a long fight. Now they just look silly for having drawn a line in the sand then backing off. The Swiss just hate what is going on.

If you want to look at stress look at the move in the $/Yen and the Yen/Crosses today. The two big figure move might be considered disorderly. I am sure that there are some Yen traders that are puking in the garbage pail. The Japanese CB hates this. They don’t want a strong Yen and they hate when it gets moving too fast

-What is the cause of the capital movements?
It’s the sovereign story that is driving this. This is a bizarre factor that is driving the Euro/$ rate. The GDP of France and Germany are many multiples of that of Greece. Think of this as if the state of Utah was having a budget crisis. You wouldn’t dump the dollar just because of that. Yes we have Portugal and Spain to consider (Italy, in my opinion should be taken out of the PIGS). So go back to the US comparison and you have Utah, Georgia and Connecticut to worry about. But step back a bit, we are trashing the Euro based on this. The real comparison to the US and the EU is not Georgia or Utah; it is California and New York. The deficits and problems in these two states balance the problems in Athens and Madrid on the currency scale.

There is nothing rational about our markets. But moving massive amount of money around the globe because of problems in Greece is not rational. I say, “Never fight the tape”. Central bankers can’t say that. There is a good excuse for them to fight this tape.

-Is the rapid change in FX rates creating collateral damage?
Boy is it. Just look at the tape. This Greece story has gone global. It is raining deflation on us. VIX on everything just shot up. A few more weeks of this and you start taking points off of global GDP.

-What is the implication to the US?
The big Boss made a speech a week ago and said that we had to export our way out of trouble and export to create jobs. Well you can kiss that plan goodbye if the dollar keeps rising. You think this is good for John Deere, Cat, IBM, Microsoft, Apple, Boeing, Cisco or Intel? This is not good at all. It is one of the reasons the DOW is getting smacked so hard. A strong dollar is a decidedly brown shoot. Go ask Disney or Mike Bloomberg. How much do they make on foreign tourism? The White House knows this. I doubt Geithner does but there are plenty of others (Volker/Summers) who understand the implications of this. Bernanke knows this. He has bet his career on something. It could get derailed if the dollar gets too strong too fast. Everyone in D.C. hates what is going on. They are looking for solutions. Intervention is the one thing that is on the shelf.

-If left unchecked where could the instability lead?
This is a slippery slope we are on. The markets seem to have Greece in their cross hairs. But this will pass and those with loaded rifles will point elsewhere. This sovereign story could spread very quickly. It could jump out of Europe and go to Mexico overnight. It could go to Asia and make a mess of Indonesia, Philippines and Korea. Once it gets started it will be very difficult to stop. It is already moving fast. It could go global in a week. The worst possible outcome is that it goes uphill to the “stronger” countries. Like France, Germany, UK and of course the USA. If this disease is left unchecked and it spreads to some of the “Big Boys” it is an absolute lights out event. It would take years to recover from that. This is the most compelling reason for coordinated intervention


-Could currency intervention achieve anything in the larger picture?
No. And for that reason it probably will not happen. The best intervention could accomplish is buying some time for things to settle down. But if things remain unstable for much longer the utility of a short-term fix becomes larger.


-Are their any other considerations that might come into the decision?
I think so. Four come to mind.

a) The CDS market has been LEADING this market move. The Central Banks HATE the CDS market and the role that it plays in our economies and in the policy choices. The Central Banks can’t stop that. They have no power. But they could intervene in the currency markets. Because of the way things are connected, a jump in the Euro would also mean a narrowing of the PIG CDS spreads.

b) Central Bankers have studied the impact of Coordinated intervention for years. The biggest conclusion is that intervention can re-establish “two-way risk.” This condition is vital to restoring stability. There has been “no risk” to being short Euros and long PIG CDS spreads. As long as the perception is out there that there is little or no risk in these directional bets they will continue to move in one direction. Intervention can reestablish the notion of two-way risk. They do that by punishing market players that are constantly pushing the bet farther. CBs hate speculators. They would like nothing better than to catch them off guard and whack their pee pee.

c) China is a spectator to this in most respects. But their currency is tied to the dollar. Therefore their currency has just gone up in value by 10%. They hate that. Don’t assume that they have no say in the outcome of this. They would love to see currency intervention solve their problems.

d) If Paul Volker were running the show I think he would say, “Nip this one in the bud”. But Big Paulie is not in charge. Is he?


Will we see this headline?

EU, UK, Swiss, Japanese and US Central Banks Join in Coordinated Global Currency Intervention

Global Markets Rally

The odds are not good based on history. These things do not happen very often. But many of the pieces are in place for a CB response to this winter’s instability. Let’s put it this way. If they don’t intervene the trend will continue and markets are in for one hell of a set back.

Another Reason Why RE Defaults Will Explode This Year – IRS Form 4506

The government is flooded with loan modification requests at this point. They have been working through this disaster at an ever increase rate. They are now doing close to 100,000 per month. But the bad news is the pipeline is full. There are at least 3 million homeowners who need/want some form of adjustment on their mortgage cost.

The word is out on this one in every corner of the country. If you want a break on your mortgage the first step is you have to stop paying for at least three months. I know for a fact that this is correct. I have seen it in a half dozen cases in just the last year. The banks/servicer will tell this to you on the phone. “You don’t qualify for debt relief, you’re not 90 days late”. In my experience the person on the other end of the line hears this and says to their spouse, “Honey, I have good news! We’re going to get the break we need. All we have to do is stop paying the bills”.

We have created incentives for default. And they are powerful incentives. Tens of thousands of dollars a year are at stake. Most Americans will walk by a nickel lying on the ground. But they will stoop for a quarter and if it is a bill they will move quick.

The deciders in D.C. are well aware of this reality. One logical response is to accelerate the process of ReFi’s. Borrowers who start skipping payments would get attention earlier in the process. The length of time a borrower is in arrears would be shortened. This helps the lenders, which in this case is the taxpayers. Borrowers who get 6+ months behind almost never survive. The property goes into foreclosure. The hole is too big to patch after 7-8 months. While in some cases this is an inevitable outcome, a significant number of the problems could be cured if dealt with early. Foreclosure rates are killing us. It just devalues the housing stock more and sustains the cycle of default.

So the good folks in D.C have come up with a number of methods to accelerate the restructuring process. On balance I think they will prove to be successful. But in this case we have to be careful on how we define success. The new rules that will go into effect on June 1 will streamline the process. The guidelines have been established for getting debt relief. I think it comes down to this.

I) Show me yours and your spouse's tax return. We add those numbers up and multiply by 31%. That will be the targeted debt service for you.

II) If your income is equal to 31% or higher take a hike.

III) If your income is less than 31% you may apply. But if your income is only 24% (example) then there is nothing we can do for you, Sorry.

The eligibility for a ReFi has been narrowed substantially by these steps. The introduction of the requirement to provide IRS form 4506 (permission to disclose IRS tax data) is going to accelerate the process. How many people that are contemplating this are going to comply with that request? As of June no application will be accepted without it. No one wants to provide that information. This will cut the ReFi line quit a bit just by itself.

From my experience we are going to get three reactions to the changes that are coming:

A) “ I called the bank and they said we had to give them access to our IRS records. Screw that. I’ll show them. I am just going to stop paying until they throw us out”

B) “We are just at the 31% level so we get no break. We are under water by at least 100k. We are now paying 3k per month and there is no upside anymore. We could rent the place next door that is just as nice as this place for $1,500 a month. If we send the bank the keys and sign the deed in lieu papers the most it will hurt our credit is for a year. No big deal, our credit is shot anyway. Let’s take the extra $1,500 a month and go on a cruise and get back to living. This home ownership thing is not what it was cracked up to be.”

C) “The bank says we make too little to afford a reasonable ReFi. They don’t care that I drive a cab on the side and make a few extra bucks. They won’t knock down the principal to a level that we can afford. So we are up against it. We are going to lose our home. We are not paying a cent from now on. It will take them at least a year before they throw us on the street. I loved this place but now I am mad. Before we leave I am going to rip the copper out of the walls and steal the refrig, washer and dryer and anything that can be moved. I’ll show them whose boss.”

In my opinion the new streamlined process is going to be effective. It will do exactly what it intended to do. It will have the exact opposite effect of the “pretend and extend” policy. Many will argue that it is high time we did that. The sooner the better.

But there is a downside to this. The implication is that starting sometime in July and continuing for some time thereafter there will be a very big wave of new defaults, jingle mail, short sales, DIL transactions and foreclosures. It means RE will suffer and prices will likely have to fall. The timing for this could not be worse. At about the same time this will be developing the life support we have been getting from both fiscal and monetary policy will be in reverse.  Coupled with this, the government lenders are all tightening the terms for new mortgage credit. Think of this as a stool. All the legs are shot. It's not safe to stand on.

A Good Guy in D.C.?

Edward DeMarco, the acting head of FHFA, wrote a letter to some heavy hitters in Washington. Sen. Dodd-Banking, Sen. Shelby-Banking, Congressman Frank-Financial Services and Bachus-Financial Services. The letter was a cry for help. I sincerely hope that these important legislators do not ignore this SOS. If they do, some irreversible damage will have been done. Hundreds of billions of dollars are at stake. Even more significant, the direction of the government's future role in the mortgage market is going to be shaped by the corporate Exec’s at Fannie and Freddie. There could not be a worse outcome.


DeMarco laid it all on the line. He described the terrible mess that Fannie and Freddie are in. His words: “These calls on taxpayer funds are troubling to all of us.”

There was a significant amount of information provided regarding all of the new management at F/F. Those that are dirty from the past are all gone. Both Fannie and Freddie have new private sector Boards of Directors that meet regularly. There was a discussion that it had been agreed that both F/F would not do anything “new”.

As I was reading this I was getting the sense that in some ways DeMarco was mocking the charade that is happening. We have two ‘private sector’ entities with all of the trappings of Boards and high priced corporate talent. And at the same time these two dogs are sucking down taxpayer money at the rate of $10B a month. Losses are now expected to exceed a half a trillion. Why do we need fancy Boards and big buck talent to accomplish that?

The important sentence comes in the summary:

“The only (alternative) FHFA may implement today under existing law is to reconstitute the two companies under their current law”

That is polite Washington speak. What Mr. DeMarco said between these lines was”

“If you guys don’t get off your ass and pass some new legislation I am going to be forced to take us down a road that we should not go down. I don’t have a choice in this. I think this is a big mistake. Please do something to stop this. I don’t want to be the guy that puts the mortgage giants on a path that will end very badly. We have made this mistake before with the GSEs. I don’t want to make it again. Please help, before it is too late”

Mr. DeMarco should have addressed this letter to Tim Geithner. Nothing can happen with the GSE’s without strong leadership from Treasury. And we have a nincompoop running the shop. On the urgent need to address the problems with the D.C. lenders Weak Tim said on NPR recently:

"I don't think we're going to be able to legislate that until that process can start, until next year, because it's just a complicated thing to get right."

This problem is too complicated for the current Treasury Secretary? The head of the FHFA is urgently calling for help; Congress is frozen over health care and the changing political reality. Where is the leadership that is needed? There is none. There is a reason for that and that reason needs to be addressed. This letter points to one of a dozen issues that need attention from an effective T.Sec.

Here’s a plan for Tim, Chris, Barney, Rich and Spence. Finish the job. The conservatorship is a joke and a private sector GSE approach has already proved a disaster. Privatize these dogs. Get it over with. Then merge the two of them. Create a good bank and a bad bank. Do what you have to with the bad bank and don’t ever, ever make the mistakes of the past with the good bank. Get rid of that high priced talent that is costing so much and doing so little. De-list these deadbeats. That would save $20mm a year. Get rid of those big Boards and their “do nothing new” meetings. And if you’re looking for someone to run this mess, consider Edward DeMarco. He’s the only one who has spoken the truth about the Agencies for years. Listen to him.