Adam Smith® Says

Time made a mistake when it announced this week that Federal Reserve chairman Ben Bernanke should be its Person of the Year. But if Bernanke was a mistake, who should be Person of the Year? I nominate Grandma — your Grandma, my Grandma, every Grandma — because Grandmothers as a group are doing a better job than Ben is this year at propping-up the American way of life.

But wait, didn’t Ben save us all from a Great Depression? Didn’t his inspired and bold action opening taps and taking an axe to hogsheads of money down at the Fed preserve our very way of life? No. He preserved Wall Street’s way of life. He saved the banks, not their depositors. In fact, he used the depositor’s money (our money and that of our children and grandchildren) to not save the depositors, which I find particularly ironic.

We had a real estate crisis that precipitated a banking crisis, but Ben only fixed the banks, and not all that well, either.

And Grandma? She wrote a check, lots of checks, to her kids and grandkids helping them keep their homes. There is right now a charitable transfer of wealth happening from the oldest Americans to their middle-aged children that is, in many cases, the only thing keeping the latter in their homes.

Funny nobody talks about this.

“All politics is local,” said Tip O’Neill, and it is true. Even politicians on the national stage are dependent on local or regional voters to return them to office. And so despite the national or international rhetoric, local values and concerns always have to be met in the end, something we are likely to see ahead in the way our economy is managed.

Out of the bubble years, you see, we’re now embracing slow growth as our national mantra. Pay as we go. This new norm means slower U.S. growth from a lower base with higher unemployment and lower U.S. living standards.  The U.S. is setting itself up for a weak new-norm recovery in 2010 as capital continues shifting abroad.

Only it won’t work. This slow-growth outlook cannot be sustained very long because too many states, cities and companies will be below breakeven. The new norm growth rate built into the bond market is below the stall speed for the economy.

In the end, Washington will have to change economic policy in reaction to slow growth and high unemployment.  We’re seeing this a bit already in the statements of Treasury Secretary Timothy Geithner supporting a strong dollar even though his agency is not yet doing anything to make the dollar strong.

Inevitably the state and local governments will come begging and rightly so. It is unclear whether that points to another ratchet up in federal spending, a tax cut, protectionism, regulatory relief from the small-business credit crunch, a departure from Washington’s weak-dollar policy in order to draw capital back to the U.S., or something else.

Whatever the solution the Obama Administration attempts to apply, it will mean the quick end of slow growth as local politics again holds sway.

My wife is a real estate agent in Charleston, SC and last month she actually sold a house. “Hooray, the housing crisis is finally ending!” she said. But that’s not likely. In fact housing is probably going to get worse, or at least that’s the conclusion of a pretty grim but convincing white paper on the subject from Amherst Securities Group LP, a leading dealer and market maker in mortgage-backed securities.

Home prices are being buoyed somewhat right now by the $8,000 first-time homeowner tax credit, but there are only so many first-time homeowners available to buy houses, say the boys and girls from Amherst. What happens when every first-timer who can afford a house owns a house? Trouble.

Home prices have also been buoyed by the simple fact that more people tend to buy homes in the spring and summer and those are the numbers we’ve been seeing – numbers that will seasonally drop in the fall and winter. We tend to annualized these seasonal numbers, too, making them look bigger, even though we know they are likely to drop.

Federal programs to help homeowners avoid foreclosure: forget about them, according to Amherst. The number of mortgages that will actually be saved by this supposed $75 billion program won’t even amount to a rounding error, they claim. And sure enough, it is easy to look through recent claims by the Obama Administration and see the awful truth: with 7 million mortgages in default right now averaging six months from liquidation, the idea that the Administration will modify (and thereby “save”) four million of those mortgages over the next two years, well that’s laughable. By the time the paperwork is finished for the 25 percent who MAY qualify for modification (that’s 1.75 million – nowhere close to four million) most of those homes will have been auctioned, IF buyers can even be found.

If there is a positive side to this I suppose it’s that the full $75 billion won’t have been spent.  Or is that a negative, given the outcome?

Another positive (a very negative positive at that), is that foreclosures will go slower than they historically have simply because the banks won’t be able to get rid of the extra houses – about SEVEN MILLION extra houses, Amherst estimates.

The number of mortgages in trouble is increasing faster than homes can be foreclosed or mortgages can be modified. That’s 300,000 homes per month — homes we haven’t even talked about — or worried about to this point — going under. Starting soon this shadow excess inventory of seven million homes – 1.35 times the number of homes that are usually for sale – will push prices back down in many communities. That’s a true inventory of almost 13 million homes for sale in a market that can, in a good year, handle a little over five million.

When supply goes up, prices go down. And supply is about to go dramatically up.

But this bubble, too, will decline in time, though to make it do so may require further federal effort. There’s little political stomach for a second bailout, but with the government having an equity position in so many banks there may be the moral suasion to change bankers – at least for awhile – into landlords. Because just are there are seven million families losing their homes, so too there are seven million families looking for places to rent.

When the “unsinkable” Titanic hit an iceberg and sank on its maiden voyage in 1911, as any teenage girl will tell you, the rich people got nearly all the lifeboats (except for John Jacob Astor IV who ordered another drink, giving up his seat), dooming the lower-class passengers including, of course, poor Leonardo DiCaprio. Much the same thing seems to be happening in the case of the current economic stimulus, where the people who are hurting the most seem to be getting the least.  I’m beginning to believe the crisis could have been fixed quicker and cheaper simply by helping the women and children instead of the bankers.

This began as a mortgage crisis.  Lenders dropped their standards on loans, giving them to people who shouldn’t have qualified, driving housing prices up in a bubble that eventually popped and here we are with eight percent of all mortgaged houses in foreclosure and home prices down 30-40 percent over two years ago.  The technique our government used to deal with this was to prop-up the bankers, not the borrowers.

Why?

That’s a question I have been asking all over and the smart money answer generally comes down to: 1) that’s the way the system is set-up; 2) that’s the way we’ve always done it, and; 3) it would be too complex to deal with individuals — better to deal, instead, with a few dozen banks.

Why?

The system was widely perverted to deal with the current crisis; it wasn’t “business as usual” at all.  Companies that weren’t (and still aren’t) bank holding companies were declared to be so and got money from the Fed and Treasury as a result.  Same for insurance companies and brokerage firms that remained as they were but got money still, through sleight-of-hand by Fed chairman Bernanke.

Doing things “the way we’ve always done it” is what got us into this mess.

And the miracle of information technology makes it just as easy to send money to people as it is to take it from them in the form of taxes.  Saying that a bank has to be in the middle makes no sense at all.

We could have taken a completely different approach to the problem and simply treated the symptom, inserting what computer jocks call a “wait state” in the mortgage system so panic could subside, adjustments could be made, and life could be eased back to normal.

Remember that economies are cyclical and a lot of good financial planning is simply leaving enough reserves to survive until things get better.  That could have been our major economic tactic in dealing with the crisis in 2008. Instead of pumping $700 billion to $1.3 trillion (nobody knows the real number) into economic stimulus, the U.S. government could have simply paid everyone’s mortgage — EVERYONE’S — for six months.

There are 51 million mortgages in America and the average mortgage payment in 2006 was $1686, so paying everyone’s mortgage for six months would have cost $516 billion — hundreds of billions less than the Bush/Paulson/Obama/Geithner/Bernanke plan.

The money people would otherwise have used to make their mortgage payments could have gone for other things, making it effectively a huge economic stimulus in its own right.  With mortgages paid in full there would have been no foreclosures OR bank failures.  Yes, there would still have been problems with the banking system that needed  correction, but there would have been six months to do the correcting.

Lehman Brothers would still be in business, Bear Stearns, too.  Merrill Lynch would be independent. AIG would not have failed. Even Bernie Madoff would probably still be in business — at least for awhile.

So why didn’t we do it that way?  Because it would have been putting women and children first.

I need a drink.

Take a look at the chart to the left, which comes courtesy of the Federal Reserve.  It makes the point that private label mortgages, which are mortgages securitized by Wall Street firms, mainly investment banks, are responsible for most of the mortgage mess we are in as a nation.  These are the white sections in these two related graphs.  There is a lot to understand here and it is particularly damning if examined closely because it shows Wall Street to be at best incompetent and at worst criminal.

All of the organizations and organization types mentioned in this table do the same thing — they buy or fund mortgages then package thousands of those mortgages together into securities they sell on the open market.  If the quality of every security was the same then the percentage of bad mortgages would exactly match the percentage market share for each player.  Yet that is far from the case.

Let’s do some numbers:

Organization        Mortgages (millions)          Troubled (100,000)              % Troubled

Banks/Thrifts              8                                            397                            4.9

Fannie Mae                18                                            444                            2.4

Freddie Mac               13                                            232                            1.7

Ginnie Mae                   6                                            378                           6.3

Private Label                8                                           1734                         21.6

All of these organizations perform similar functions, all employ the same staff functions, all buy, for the most part, from the same pool of available mortgages, except of course there are varying requirements for each organization like the maximum loan, minimum credit score, etc.  Yet the variation from best to worst is as high as 10-to-1.  How can that be?

From a strictly statistical standpoint it CAN’T be.  In theory the population of mortgages, like the population of homeowners, should be represented by a normal (bell shaped) curve, with the bad mortgages taking up a small section on the left side of that curve.  It should be a small section because, since these mortgage pools are designed by statisticians, in order to be statistically acceptable the risk must generally be within two standard deviation from the norm.

Here’s how it SHOULD look:

About 2.15 percent of mortgages are expected to go bad, represented by the white space on the left of the curve.  Some of the government-backed and bank/thrift mortgages were a little better and some were a little worse, but they are all clustered not too far from that 2.15 percent number, which is as it should be.  And remember this is during an unprecedented world financial melt-down.

Then there are the private-label numbers, which are precisely TEN TIMES worse than expected.  Statistically that’s crazy, but NOT crazy if the population of mortgage holders isn’t normal.  That would be the case, for example, if the population included a large number of people who had no intention to actually make their mortgage payments, which seems to be the case here.

Remember that these private label numbers include those from all Wall Street firms, including — presumably — some firms that weren’t intending to be crooks.  So the bad numbers within these numbers are actually even worse — far worse.

What’s particularly damning about these data is that the non-private label numbers are so good, yet some of those government programs DON’T EVEN TAKE CREDIT SCORES INTO ACCOUNT.

This is Wall Street rocket sciecne run amok.

One particular irony here is the notion that the Clinton Administration, forcing an end to blue-lining and encouraging lenders to make more lower-income mortgages, exacerbated the mortgage crisis.  Some people claim this policy change is the entire basis of the current problem.  Then why isn’t it reflected in the bank/thrift and various Federal program numbers?  They should be.

What these data say about the private label (Wall Street) mortgage securities is that there was systemic fraud.  Wall Street would like to pin that fraud on homeowners, but it is so pervasive that it really has to be more properly pinned in the statisticians who allowed it to happen and on their bosses who ORDERED it to happen.  These aren’t just bad decisions, they are statitically impossible with a normal population.  These are CRIMINAL acts costing billions of dollars and damaging the nation as a whole.  Yet who is going to jail for it?

Nobody so far.

The Obama Administration will tomorrow unveil its plans for a new regulatory agency with sweeping powers over mortgage and other lenders, yet the only real question is how will the banks game this system, too?

The Administration means well, but their concern for the welfare of major bankers at the general expense of American homeowners is a consistent cause for concern.  The Treasury announced yesterday, for example, that five national lenders had received $3.1 billion in TARP funds specifically for mortgage modifications and that this was the start of $18.7 billion in such funds to be spent on mortgage modifications from a $75 billion total fund.

Reading into these figures is an exercise in frustration, as has been most ObamaMath.

The $3.1 billion, for example, represents TARP funds that have been SPENT for mortgage modifications.  Under the law lenders can qualify for a $1,500 upfront fee per modified mortgage, though that payment comes only AFTER the mortgage has been modified.  $3.1 billion divided by $1,500 implies that these five lenders have altogether COMPLETED the modification of 2,066,667 mortgages or about four percent of all home mortgages in America.

Nope, it hasn’t happened.

A month ago the Treasury Department claimed this same program had so far resulted in OFFERS of modified mortgages to 55,000 homeowners.  Now the agency is implying that in four weeks they’ve ramped that up by more than two million.  Except that’s NOT what they are saying, just what they are IMPLYING.

What’s more likely, in fact, is that the banks are being paid for mortgage modifications IN ADVANCE, which isn’t the way it is supposed to be.  No homeowners are receiving ANY Federal housing benefits in advance.  But then homeowners aren’t beleagured bankers, they are just people losing their homes.

The Obama Administration’s efforts to help homeowners stay in their homes and avoid foreclosure by modifying mortgages have already failed.  One would hope the Administration is smart enough to know that.  Maybe they are just hoping we wouldn’t notice, but we did.

Federal agencies have announced a variety of programs to discourage foreclosures and encourage mortgage modifications.  Some of these programs are for people who are current on their mortgages, some for people who are behind, some for people who have equity, and some for people who have none.  None have these programs has been a success, nor will they be successes in any time frame that is useful to the economy. Continue Reading…

Prepare to be robbed, America, because the hedge funds are coming.  The federal plan to rid banks of their so-called “toxic assets” appears to be turning into an opportunity to transfer hundreds of billions of dollars risk-free into the pockets of hedge fund investors armed with sophisticated new software. It is a scam, a con on American taxpayers.

The toxic assets in question are, for the most part, mortgage securities created and sold during the recent housing bubble.  For banks to survive — and we’ve been told over and over again by Republican and Democratic administrations alike that it is absolutely vital that at least the big banks survive — they have to be relieved of these mortgage securities that would appear to have little or no value right now but will perhaps have some value over time. Continue Reading…