Groundhog Day Part 2 – The Frozen Class

Podcast: Play in new window | Download | Embed Continuing with our Groundhog Day theme – where change is part of life – we return to our housing crisis where the spillover effects from the finance sector into the “real” economy are now putting the $750 billion student loan program at risk[1] of serious default …

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Groundhog Day Part 1 – The Ignorance

Podcast: Play in new window | Download | Embed The movie Groundhog Day reminds us how life can get stuck in a rut if you aren’t open to change.  Sometimes change is hard, sometimes it gets forced on us, but there are often opportunities for us to “pick our poison,” as Bill Murray demonstrated so …

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Reversing the current

Podcast: Play in new window | Download | Embed The exposure of the housing sector to a sharp upturn in unemployment and prolonged wage stagnation wasn’t a secret among regulators or Congress.  It was a gamble[1] that was completely exposed in a Graham Fisher publication in June of 2001 during the “mild” recession which preceded …

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Summer in the Winter

Podcast: Play in new window | Download | Embed Today I have far more questions than answers.  My puzzled musings were caused by a thoughtful OpEd piece at Reuters written by Larry Summers[1] titled, “Why isn’t capitalism working?” Mr. Summers points out that over the past few decades the cost of a television is down …

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Housing – The Never Ending Story

Podcast: Play in new window | Download | Embed Living in Southern California, it’s hard not to be influenced by “The Business” (movies) even if one toils in less admired or profitable ventures, like housing finance. Were the Federal Reserve in “The Business” it’s latest publication “The U.S. Housing Market: Current Conditions and Policy Considerations[1]” …

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Groundhog Day Part 2 – The Frozen ClassGroundhog Day Part 1 – The IgnoranceReversing the currentSummer in the WinterHousing – The Never Ending Story

Jan
13

Groundhog Day Part 2 – The Frozen Class

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January 13, 2012

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Continuing with our Groundhog Day theme – where change is part of life – we return to our housing crisis where the spillover effects from the finance sector into the “real” economy are now putting the $750 billion student loan program at risk[1] of serious default as a function of a weak jobs market.  Recent college graduates and a growing sector of the American population are becoming like Bill Murray in Groundhog Day – members of the “frozen class” – people trapped in a Japanese style liquidity rut – a cash hoarding, non-consuming, non-investing  phenomenon we call the Great Recession.

 

As we noted in this blog earlier this week, the dangers in housing were well-known before the current crisis.[2]  Today the New York Times has published further evidence the Federal Reserve Bank’s 2006 sanguine approach to the issues on the ground and over reliance on busted economic models allowed for a hubris that trumps even the self-satisfied Phil Connors, Bill Murray’s character in Groundhog Day.  In finance, the value and service central bankers are supposed to deliver include judgment, wisdom, experience and prudence.  They need not be humorless, but per the Times, the Fed was stuck in a Phil Connors-like self-confidence rut.

Housing, and how it is financed, remains the most uncertain element of our economy.  Uncertainty may be everyday life in Washington, but it freezes private capital.  Now that the pristine borrowers who fit government loan programs have been refinanced, the housing sector is left with millions of properties (historically served through private sector loan programs) without access to liquidity.  This adds another segment of the population to the “frozen class.”

Absent consumer demand, the private sector continues to hoard cash because every day is Groundhog’s Day.  For consumers, investors and the government, the decision and commitment processes have become frozen.  All choices appear to contain an element of poison, but failure to choose leaves us stuck.

In the end, a cocktail of poisons will be required to thaw our markets.  Some challenging choices include:

  • Restoring life to the frozen class by: raising their wages, reducing their debt, and/or restructuring the debt overhang (trading a reduced debt for equity appreciation rights – addressed elsewhere in this blog).  The key in choosing, as in Groundhog Day, is to commit to do something that will force a different outcome.
  • We will soon have more empty homes (REO) than homeless[3] people.  Many families are doubled up.  We need to reverse this trend by making household formation more economically feasible.  The Federal Reserve’s REO to Rental Program suggestion, which is drawing so much political heat, is Uncle Ben’s attempt to have America not wake up with the same housing mess it goes to bed with each night.  He senses, I think rightly, the nation’s social fabric can’t afford the busted market’s  “clearing price” any more than we could afford the Fed’s original sanguine approach to the housing crisis.  The REO issue is serious – it has Great Depression damaging potential for an already weak housing sector.
  • Only the federal government can finance a Resolution Trust Corporation & FDIC program to seize the “zombie” institutions which the market has identified as frozen and in need of change through their price to book values.  Buy them, break them up along diversified, but manageable lines, and resell them as smaller, more transparent institutions with a government stake in the reorganized ventures.  Such an effort would demonstrate to private capital and foreign investors we are planning our future rather than delaying and praying tomorrow won’t be another Groundhog Day.  This option is important to consider now while foreign governments still finance American’s deficits at such low rates.  If we wait, as Europe has done, until there are no options, we may find the next step in our reforms even more punishing.

Let’s chose to change before our Groundhog Day experience becomes an economic ice age.

More to come…

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Jan
13

Groundhog Day Part 1 – The Ignorance

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January 13, 2012

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The movie Groundhog Day reminds us how life can get stuck in a rut if you aren’t open to change.  Sometimes change is hard, sometimes it gets forced on us, but there are often opportunities for us to “pick our poison,” as Bill Murray demonstrated so well when faced with choices.

In the real world, Europe is now learning the Bill Murray way, if you don’t pick your poison, the markets do it for you by simply ignoring the opportunity to work with you on your challenges.

Here in the US, the housing mess remains our largest challenge.  Since 2008 the private sector has pretty much ignored the chance to own mortgages not guaranteed by the government.  Their absence has left a punishing void.

In an attempt to minimize the damage, the Federal Reserve and Federal Government have used their capacity to lower financing costs, but they have subsidized and regulated the markets to the degree it no longer makes sense for diversified, large private sector lenders like MetLife to remain a lender.[1]

As a nation, we may never love housing the way Bill Murray was attracted to Andie MacDowell – but we do need a muse to see not everything about housing is bad and that change has a promising upside.

If we look at firms that help supply (rather than finance) the housing sector, a business like Home Depot, we see a stock price that is trading at a 3.8 multiple to the book (or accounting) value.  Those heavily involved in financing the housing sector, like Bank America/Countrywide, have their stock trading at 0.33 times their book value.

Both are in the housing business, one has a promising balance sheet the other does not.  The houses themselves are not the problem anymore than the Groundhog was Bill’s.  The debt overhang and how it was financed is the nightmare we wake up to day after day.

Bank and consumer leverage are at the center of our challenges.  Too big to fail and too big to manage are relative measures.   The “bigness” of any economic downturns which  institutions and consumers are be forced to live through should be governed by a progressive equity scale.  With lenders, dependency on wholesale funding to become larger should require more equity than firms with stable, diversified sources of financing.  For consumers, the absence of debt service flexibility must be mitigated through down payment (or equity) requirements when loans are extended.  For the benefit of all other borrowers and investors in the housing sector, the process must prevent either from being allowed to “bet the house” to succeed.

US Bank, which avoided lending aggressively in the overheated “sand states” during the boom years, has a stock price to book value of 1.72.  So, it is possible for a well diversified institution to make good decisions and get through a housing crisis with a reasonable balance sheet.

So how the housing sector is financed is as important as how borrowers finance their properties.  Monolithic or concentrated business models may look more efficient in the cost per unit metric, but they bring a special kind of leveraged operating risk with them.  These lean groundhog-like business models fear change like the groundhog fears his shadow.  We should fear them too.  The prudent public likes to fly with pilots that have a little gray hair, and in time, bankers with a little extra fat may replace the GQ image the finance industry presented in the past.

You may recall Bill Murray eventually escaped his Groundhog Day experience by developing a diversified portfolio of personal traits, not the least of which was the ability to let go of the past.  He addressed his past, by creating a different future.

Tomorrow we’ll look how we might start to diversify our approaches to the housing crisis to have a chance of waking up to a different and more promising future.

 

More to come…

 

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Jan
11

Reversing the current

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January 11, 2012

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The exposure of the housing sector to a sharp upturn in unemployment and prolonged wage stagnation wasn’t a secret among regulators or Congress.  It was a gamble[1] that was completely exposed in a Graham Fisher publication in June of 2001 during the “mild” recession which preceded the current Great Recession.

Rationalization for the continued consumer debt expansion that followed the report was made possible by shifting from a traditional macro measure of “sustainability” (consumer debt as a percent of  liquid assets) to a micro focus on debt payments as a percentage of income.  Through a variety of loan program risk adjusting and duration extension features, it was possible to make housing (an asset whose value was growing faster than the GDP) “affordable” for a middle class with stagnant wage growth.

That the inflation in housing made the middle class financing of consumption possible is a well told story.  The larger macro problem of how consumers will ever find a way to pay off the debt overhang is less reviewed in public, but not an issue lost on the Federal Government or the Federal Reserve.   The Federal stimulus package may have saved some jobs (for a while), but it hasn’t brought about a structural change that could fix the consumer debt problem.  The Federal Reserve is doing what it can with its printing presses to debase debt, but that exposes the economy to the world’s freaked out debt markets and commodity providers who on the first sign of a turn in the global economy will demand their pound of flesh in higher interest rates.

The other day the FRB suggested an REO to Rental program, which could be a start on addressing those consumers who will never be able to recover from the down turn.  Putting the mistakes of the past behind us is a start on the road to recovery.  But a real recovery will require jobs.

We’re going to need job creation in sectors that will have real wage appreciation when the day-of-inflation reckoning arrives, and I think building energy efficiency into the housing infrastructure is worth further discussion.  That coupled with the infrastructure projects needed to move land-locked energy sources to manufacturing and trading centers strikes me as economically prudent, if environmentally challenging.

Regarding the broader housing market I’d propose a long-term fiscal and monetary stimulus formed of energy-linked housing initiatives to turning every house, apartment and building into a net energy producing property wherever possible, hopefully wherever there is sunlight or wind.  This large-scale manufacturing, retrofitting and construction work would help us with job creation in the energy, housing and finance sectors.  It’s the equivalent of millions of small Grand Coulee Dam projects.

In the housing sector, the valuing and financing of energy efficiency is still in its infancy – it is a growth oriented area that could employ the traditional trades that manufactured collateralized paper assets of the past.  The construction aspects of such a venture are self-evident, that they could fit nicely in overbuilt sun belt markets is a plus.  One thing we can see in the latest CoreLogic Home Price Index[2] is that housing values are holding up in geographic areas with significant energy sectors.

During the Great Depression we worked to bring energy to the home, perhaps during the Great Recession we can reverse the current and turn on our economy in the process.

More to come…

 

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Jan
10

Summer in the Winter

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January 10, 2012

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Today I have far more questions than answers.  My puzzled musings were caused by a thoughtful OpEd piece at Reuters written by Larry Summers[1] titled, “Why isn’t capitalism working?”

Mr. Summers points out that over the past few decades the cost of a television is down 50 fold, when one holds the functional capacity of a television constant.

Cheap energy and advances in technology have provided for the creation of economies of scale in tradable goods and services, with televisions being a notable example.

Things as magical as smart phones and their supporting services are a new staple of global life.  Relative to median wages, thousands of market-driven goods and services are cheaper today than they were in the past.

The same thing is not true of education, health care or housing.  These three areas of the economy each have government agencies that promote and regulate them.  Why have the miracles of science and business management not created similar reductions in the cost of these goods and services?

Is it possible to introduce a venture capital type of business model that could produce trade-goods-like efficiencies without the direct involvement of the federal government or the central bank?

At the present the answer would appear to be a fuzzy yes and no.  That is to say, the federal government got massively involved in education, health care and housing because of the perceived “market failures” of the past. Once involved and providing significant forms of subsidy, the opportunity or necessity to evolve began to focus around legislated behavior rather than market pricing and technology signals.  You may recall that when Ma Bell held a monopoly in the phone business there was little innovation or creativity in the telecommunications industry.

Given that nothing seems to kill innovation like preserving the status quo, why, as a matter of policy, do regulators maintain the consolidation of banking and housing?

Are these, by their nature, social goods where a democratic regulatory process trumps the natural competitive economic environment that regulates tradable goods and services?  Do attempts to aggregate and democratize these sectors add to the public’s well being or lead to rent-seeking monopolies?

Is it possible that perceived market failures of the past were really just human failures?  Perhaps a change in management would have addressed the real sources of our problems.

In these wintery cold economic times, when the nation is in need of jobs and innovation in the “rescued” sectors of the economy, it may be prudent to return some industries to the wild in smaller competitive forms in search of trade-oriented solutions along the lines of the discussion Mr. Summers has started.

More to come…

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Jan
09

Housing – The Never Ending Story

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January 9, 2012

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Living in Southern California, it’s hard not to be influenced by “The Business” (movies) even if one toils in less admired or profitable ventures, like housing finance.

Were the Federal Reserve in “The Business” it’s latest publication “The U.S. Housing Market: Current Conditions and Policy Considerations[1]” probably would have gone directly to the discount DVD racks at Target and Wal-Mart.

In reading the Fed’s whitepaper, I’m reminded of an attractive actor in a movie trailer that fails to deliver at the box office; “the REO to Rental” scene in the Fed’s whitepaper had potential, but the plot collapsed in the tired retelling of every under-inspired effort to fix housing to date.

Like late-night talk-show hosts reviewing an entertainment project, Goldman Sachs and Fitch were underwhelmed, if polite, in their comments.   However, neither Cameron or Spielberg would green light this script as written, but unlike the imagined world of Hollywood, the housing issue is drama that must be addressed.  We can’t keep putting this script back on the shelf and hoping Brad Pitt’s agent will find it and turn it into a light-hearted comedy.

In old-fashioned western movie style, the Fed advises bringing a loaded gun to the housing fight because there are more than a few bad guys and a conflicted sheriff (played by the GSE’s regulator) who is torn between supporting housing values while minimizing tax payers losses.

The Fed warns there is no “silver bullet” or in Fed speak “bazooka” that can re-inflate the economy or housing market to the extent it has collapsed.  That a great deal of the REO inventory must be converted to investor properties is a well received plot feature, but the storyline is so complex it loses the audience’s enthusiasm in the telling.

In many ways this latest telling is a sequel to earlier projects like HARP and HAMP.  Aspects of those earlier efforts point to the dangers of complexity and the management of such complexity by student film makers, otherwise known as “folks learning on the job.”  Despite the investing public’s lukewarm response to those projects, the latest “REO to Rental” suffers from an absence of financing, complex script, and the need for an entourage of “A-listers” to carry the project, which is filming on location in such tough environments as Detroit, Atlanta, Riverside, etc.

Is there star making potential here?  Sure.  I’ve personally managed messy books-of-business like this.  I know for a fact this is a workable project, in the hands of an experienced team.  Presently, there are more under-employed mortgage finance people than there are out of work actors in Hollywood.  The GSE REO inventory has the potential to be a “franchise” if the director can have the freedom and patience to break up the property  into workable scripts.  As the Fed’s paper points out, two fifths of the inventory has the potential to rent out at cap rates in the 8% range.  Those are the kind of yields that make bankers cry as though they’ve won an Oscar.   However, the OCC & GSE standards around REO management practices are so outdated to the times, they make the Screen Actor’s Guild work-rules enviable.  Only in America can the banks and GSEs find a way to get black-listed from their own projects.

When it comes to Housing – The Horror Movie, we’re about $7 trillion (in lost equity) into this project and counting.  We (the tax payers) own about 250,000 homes we need to sell or rent in a market with millions of other units ready to join the chaos at the first sign of life.

As Stephen Spielberg reminds us, “People have forgotten how to tell a story.  Stories don’t have a middle or an end any more. They usually have a beginning that never stops beginning.“[2]

We’ve seen the first five years of this drama, it’s time to put a Hollywood happy ending on this Never Ending Story.

More to come…

 

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Jan
06

Your turn to push

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January 6, 2012

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Yesterday we looked at the challenges of predicting, planning and acting amid economic chaos.  Today we look at the other side of that coin.

While violent outcomes are possible in the paranormal investing environment, the chances of nothing happening present us with another kind of danger – astagnant economy that can’t fix itself[1].  We have a stalled economic vehicle that is worth more to us when it is moving.  What might it take to jump-start the machine?  Let’s consider a radical Main Street push in round number terms.

Absent economic incentives or a focused national effort, the MBAA estimates next year’s purchase money mortgage activity will total near $403 billion[2].

  • Given a national median home value of $165,000[3] and a conservative 80% purchase financing of such a home – we come up with 3 million transactions for 2012.
  • This limited universe of activity is caused by the 1 in 4 “underwater” homeowners, who can’t be a part of the housing churn, the 15 to 25 million citizens who are unemployed or underemployed, and the 10% to 15% of the home buying population whose credit was wrecked in the economic downturn.
  • A lot of these groups overlap, but the point is these folks are so weighed down they can’t help jumpstart anything without a change on Main Street.

Per Radar Logic[4] and other sources, we have 2 million homes in foreclosure and 4 million in some state of delinquency.  These 6 million homes need buyers.  Tough sledding in a market with 3 million opportunities.  If “motivated sales” (sales associated with this 6 million properties) remain 25%[5] of all transactions (.25 x 3,000,000 = 750,000) you can see we have years, if not a decade, of pushing our vehicle around if we don’t jump start it.

What if we could move the 6 million homes “off balance” like we do with wars and other unplanned disasters?  Motivated sales are typically at a 35% discount to normal transactions[6].  The cost (.65 x $165k x 6mm homes) is a TARP like $640 billion.  But, as Ben Bernanke recently pointed out,  with Cap Rates (aka returns on rental property) approaching 8%[7] this could be the best government real estate investment since the Louisiana Purchase.  At this rate of return, the Federal government could recover its original losses in the GSE’s in less than 4 years.  This is a loss they presently plan to collect off the back of taxpayers.

Thinking bigger, what if the underwater portion ($3.8 trillion) of the housing debt could be moved “off balance sheet” or converted from debt to equity?[8]   This is big, the kind of money we spend on wars, medicine, retirements; but what if it was spent to acquire assets and economic rights, while putting the private sector back to work?  Such a program would require a wide range small business private sector asset managers.

As a practical matter, only a fraction of the public would commit to this transaction as the mere announcement of a credible program would signal inflation and change the public’s behavior.  Absent a change, the mortgage debt of $8.9 trillion[9] is a mal-investment, 43% unsecured, and is a huge drag on consumer economic behavior.  If that debt were converted to equity appreciation rights in return for a new mortgage at market levels, the public’s need to hoard cash would convert into a need to deploy it.

Using the median home value again to approximate a generalized impact ($165,000 x .57 x 10 mm homeowners), the new mortgages would save them approximately $43 billion a year, money that can stimulate the economy as consumers buy new cars, appliances, do home repairs and other things they have delayed since 2008.

Unlike current taxpayer giveaways, the government ownership of real estate (above) and equity appreciation rights would immediately benefit from the absence of housing supply for sale and the inflationary nature of the increase in money supply caused by such a program move.

With this inflation, energy prices spike, green energy becomes competitive with fossil fuels and a value-added industry gets jump started because of market demand rather than government push.

Not interested?  The car’s out of gas and it’s your turn to push.

More to come…


[1] http://endoftheamericandream.com/archives/35-statistics-that-show-the-average-american-family-has-been-broke-down-tore-down-beat-down-busted-and-disgusted-by-this-economy
[2] http://www.mortgagebankers.org/files/Bulletin/InternalResource/79058_.pdf
[3] http://en.wikipedia.org/wiki/Average_Joe
[4] http://www.radarlogic.com/research/special/RPX%20Housing%20Market%20Review%20-%20Special%20Edition.pdf
[5] http://www.radarlogic.com/research/special/RPX%20Housing%20Market%20Review%20-%20Special%20Edition.pdf
[6] http://www.radarlogic.com/research/special/RPX%20Housing%20Market%20Review%20-%20Special%20Edition.pdf
[7] http://www.housingwire.com/2012/01/04/bernanke-calls-for-nationwide-reo-rental-program
[8] http://s.wsj.net/public/resources/documents/info-NEGATIVE_EQUITY_0911.html
[9] http://s.wsj.net/public/resources/documents/info-NEGATIVE_EQUITY_0911.html

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Jan
06

Quantum Economics

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January 6, 2012

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In recent years economists, financial advisors and policy mavens have been challenged with analytics that rival those of quantum mechanics.  Predicting economic behavior is as challenging as monitoring of particles at the quantum level, or so some would have us believe.  As with astrologers and other pseudo-scientists, one guess is as good as another. Nonsensical economic opposites are now joined in ways that make “wave-particle duality[1]” sound almost pragmatic.

Of late, noted PIMCO bond fund manager Bill Gross, has shifted his “new normal” predictions for the economy to a “paranormal” universe.  Cautiously avoiding a focus on the most probable of outcomes, he warns of the “fat tails” of destruction using an economic theory we might label “contraction-inflation duality.”

Bill’s prognostication is made rational, because he acknowledges the irrationality of what I call quantum economics –  an economic theory which changes polarity almost instantaneously based on observed government behavior.  These shifts in polarity have cataclysmic impacts on economic outcomes.  They dwarf the physics of everyday elements – like the economic behavior of citizens.

The difficulty with quantum economics for citizens of the land is most government behavior is not observable, so outcomes remain highly unpredictable.  Add to this, there are some related theories that state government can’t be observed specifically because it “does not move.”  For this reason, there are conservatives and liberals (two ends of a political duality) who deny there even is a functioning government.

Within the paranormal economic universe we find the housing galaxy – the source of many economic black holes.   As with the physical sciences, the variables impacting economic stability here can be listed, but the observation and causality of growth remain perplexing.  It is a quantum economics thing where the mere presence of government uncertainty (or special interests) influences the behavioral outcomes in unpredictable ways.

The astrologers who attempt to regulate and control this dimension of economic space-time live in a political super nova that encompasses the Washington DC region.  Real estate values and economic growth are poorly understood here because market pricing signals are ignored whenever possible.  Fiat money allows obstructionist behavior (often labeled truth-telling) to be confused with objectivity, which until recently was the universal approach making clear that which was uncertain.

Objectively speaking, current housing uncertainty factors include:

  1. Jobs and economic growth
  2. Shadow housing inventory
  3. Distress Housing – delinquent, underwater and otherwise sinking
  4. An absence of credit for those who would use it

For the few lenders who did not fall into a housing black hole, Washington’s gravity is as powerful as it is confusing.  Uncertainty around lender responsibility (for loan put-backs) tied to the four uncertainty factors above, coupled with almost invisible loan yields all challenge the predictability of lending profitability.

In humbler parts of the planet, citizens must marvel at the willingness of Americans to entrust their economic livelihood to the prognosticators of outcomes rather than the creators of them.  Even giants like PIMCO are captives of polarity of quantum economics.

Housing, the once entrepreneurial economic supernova that brought new jobs and economic life during financial downturns is now lost in a String Theory tangled so tightly in quantum economics one wonders how it will ever escape the gravitational pull of the spinners of government policy.

Maybe we will elect a proactive and practical government this time, but if not we had better start building a star-gate to a parallel universe where everything is the opposite of the world we live in.

More to come.

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Jan
05

“Things fall apart; the center cannot hold;”

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January 5, 2012

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From the morning’s internet headlines:

The common message – restore “trust;” find how to get it and how to keep it, because our problems are in more need of poetry than genius.

Absent trust, political and economic processes turn coercive.  Coercion can produce economic growth, but it’s rarely very inventive or humane.  Coercion subverts the inventive solutions that takes us to a higher ground, it destroys the culture, economy, the housing beneath our feet.

So, the world begins 2012 as unpredictably as it ended 2011.

Some believers are saying technology and its inherent “creative destructive” process is the source of the problem and the way out.

Others see a grim future in attempting to believe in politicians or technology, as they appear to be dividing the population into “haves” and “have-nots” rather than creating a common good.

Amidst uncertainty, a great deal of productive behavior comes to a halt as economic actors attempt to discern “what’s going on” and who they can “count on” to provide shelter from the storm.

In recent years, the absence of good “judgment” has been the most corrosive agent in unwinding trust.

Products, services, governments, educations were all “sold” in the traditional marketing sense with a fake religious zeal.

But in the post modern world, in the creative/destructive internet age, the four P’s – product, placement, promotion and price – have evolved into a monopoly we see as “product,” but which incorporates the very human trait of character.

Before falling into the financial abyss, character was something we could count on, even when judgment escaped us.  What was once a given, we have taken from ourselves.  The public is longing for trust – the predictability of character among the economic, political and cultural actors on the planet.

How do we turn back the clock, while the world moves forward?  We focus, we adapt, we develop and deliver solutions with a predictable (trustworthy) character.  Governments, corporations, institutions do not do this – people do.  It would be a mistake to wait on a miracle rather than create one.

Accept the frailty of human judgment.  This would be a modern miracle.

Don’t ask for what can’t be reasonably delivered without violating someone’s else’s trust or character.

All of the world’s economic problems started when financial engineers violated this survival need of another to meet an abstract financial performance measure of their own.

The future will continue to be bleary until we make character and trust “fashionable.”  Rather than tear character down, as we do so well as a nation, our survival depends on being led – in all things – by people who build it up.

In housing, the second coming will be the inventive genius of people balancing character, capability and collateral before coercion takes that freedom away.

More to come.

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Jan
03

Housing Surprises and The Bay of Pigs

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January 3, 2012

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Financial elites who advise politicians on housing often suggest that “housing problems” are “local.” That is, until they aren’t.  Like generals, these experts tend to fight the last crisis.  Today we have a government overly focused on regulations around mortgage lending operations, while the next potential banking collapse foments in revolutionary ways.

Iowa’s housing problems are less noticeable than those of the Southwest or Florida.  This is allowing Republican presidential candidates to avoid a head-on confrontation with existing and evolving housing issues.

The perversity of financial solutions in this area is that too much “good” credit can be a bad thing.  This kind of insurgency starts – counter intuitively – when interest rates are “artificially” too low.

When interest rates are low, bankers use leverage to create income.  They practice safe leverage (in theory) by lending to governments.  As we’ve seen in Europe, this works, until it doesn’t … and then the Castro’s come out of the woodwork.

American institutions now see this risk and tend to avoid lending to European banks.  However, all that American “risk avoiding” money must go somewhere.  As a politician, you might be encouraged to think keeping it in the United States would be a good thing.  It can be, if there is a private sector to manage the credit risk associated with such capital investments.  However, to make that happen rates must be higher than they currently are.

Since 2008, the FHA and GSE’s have dominated the “refinancing” of America’s best housing credits at historically low rates in an attempt to support housing and the economy.  Because these assets are liquid and are viewed as having little credit risk, banks are required to hold only nominal capital against these investments.  Through the magic of leverage, banks make billions and some consumers save a lot on their mortgage payments.  However our insurgency problem in this election involves “jobs.”  The answer to fixing housing or jobs isn’t another regulation, it isn’t more cheap money, it is market driven risk-adjusted profitable opportunity.

At present, no entrepreneurial firm in the world can compete with any US government enterprise or bank which can lose money in revolutionary ways – and remain in business.

Said another way, what banker will join a “revolution” if members of the government will pay him for simply financing their re-elected?

The system needs “democratic” not “government” reforming.

Our case in point, the Federal Reserve Banking system, hoping to stimulate job-creating lending has been buying government guaranteed debt from banks and pushing cash onto their balance sheets, but this only reinforces the risk-free lending concept.  Like overheated investment sessions of the recent past, banks only repeat the process of buying still more government guaranteed debt, driving prices higher and yields lower.

Now, as Edward Pinto points out in Bloomberg,[1] all of this government guaranteed  credit is sitting on the books of government guaranteed depository institutions where it is exposed to huge financing risk.  Is revolution in the air?

Perhaps.

Imagine a post-election environment where Congress collaborates no better than European sovereigns in the eyes of the world’s debt markets.  Bang – rates rise, driving government debt financing costs to the point that all social welfare programs must be cut or shut down.

At that point, the entrepreneurs are forced to become the lenders of last resort.

If, as in revolutions, the unexpected happens and mortgage financing costs were to double, we could find ourselves with housing assets worth $7 trillion less than the market peak 5 years ago and an insolvent banking system for the second time in less than a decade.

At that point the next President will probably enjoy his housing surprise the way John Kennedy enjoyed the Bay of Pigs.

More to come.

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Dec
26

Goodbye to the yellow brick load

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December 26, 2011

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At a conference meeting with Franklin Raines, then CEO of Fannie Mae, I asked him if he was concerned about the mortgage servicing rights business model.  His response was, “It’s not a Fannie Mae problem, we’re guarantors.”  I remember thinking to myself, “Spoken like Oz – and I’m not in Kansas anymore.”

Two weeks ago, the American Banker posted a story on Fannie Mae’s secretive move to correct flaws built into the current loan servicing business model[1].  Mortgage Servicing Rights (MSRs), once a mortgage yellow brick road of finance, have become the dirty brick load with structural flaws weighing on the economic recovery.

This tactical shift will involve some upfront costs.  It has the potential to expand and extend the role of the GSE’s into one more aspect of the mortgage market, a market that already has too much of the wrong kind of government involvement, but this move is taking the industry and the loan servicing issue in the right direction and should not be a clandestine affair.

Until the collapse of the mortgage markets in 2008, a flawed economic analysis of tail-risks and operational requirements allowed MSRs to be mispriced and mismanaged.  The unforeseen secondary effect was the failed business model contributed significantly to the collapse in all housing values and they have been crushing folks like the witches in Oz since then.

At the center of the conflict was the mistaken assumption that Loan Servicers, having economic “skin in the game” would allow enlightened self-interest to regulate a complex process.  The financial evolution envisioned a hybrid type of investment manager, credit manager, cash flow manager, high touch problem solving operations manager and low touch digital efficiency platform to all come into play to manage this complex value chain.  Instead we got highly leveraged Scarecrow-like (brainless), bail-out-required, solution.

Like the flawed characters in Oz, the MSR layered-risk business model was designed to collapse under stress.  Like squashed munchkins, the process occurred with smaller non-depository servicers.  This is because at the first sign of trouble, the operational financing liquidity that was needed to manage the loan servicing cash flow obligations dried up.  But, the same cash flow challenges were beneath the surface in larger depository institutions and with falling prices the laissez-faire approach to capital allocation encouraged still greater concentrations of exposure.

While the concept of such a business model is easy to discuss in theoretical terms, the execution tends to break down as large institutions reach for efficiency ratios that poorly correlate to the potential natural-disaster-like operating dynamics possible.

More complex than the mistakes of the Wizard, Loan Servicers were over-leveraged in every aspect of their “skin” with the potential to develop skin cancer in each and all of the fundamental servicing value components.   As market “chaos” hit every element of the value chain, the entire housing sector collapsed. Restoring housing requires a structural change in the loan servicing process.

Fannie Mae’s transference of Mortgage Servicing Rights to Special Servicers, compensated on a fee for service basis, may be the beginning of a better process for the housing market.  This approach starts to allow work to be allocated in a Ricardo-like fashion, where specialists in the task at hand can intelligently add value.

The new Basel regulatory capital requirements are already calling for a change in how MSRs are valued for capital purposes.  A number of large depository institutions need to lighten up their investments in MSRs.  It’s time to use our hearts, heads and courage the way Dorothy would.  The fee-for-service model can be a way out of the problem for everyone, provided the GSE’s are allowed the economic capacity to move servicing and ensure operating cash flows.

… more to come

 

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