Ice In The Fall

Consumers have largely been ignored in the Trouble Assets Relief Program as Treasury Secretary Henry Paulson has embraced the questionable “trickle down” notion of helping the big boys at the top to create liquidity in the markets as the money “flows down.” We know it didn’t flow.

Big financial institutions (with banking capacity) used cheap money from the Federal Reserve and the potential of the bailout funding to “de-leverage” – reduce the proportionate debt on their books to comply with regulations that required saner debt loads since some of these big boys became real banks (Goldman Sachs, Morgan Stanley, American Express – banks have stricter controls), to create cash reserves for possible losses and to provide money to buy “valuable failures” (their less-than-prudent competitors) and consolidate the financial industry. The result: with a few scattered local exceptions (small banks that didn’t play the stupid loan game and didn’t get bought out by loan-happy big boys), the only real banking taking place in America right now is with the mega-institutions at the top. JP Morgan Chase, CitiGroup, Wells Fargo and Bank of America.

There’s been an election since with a clear message – the emphasis will be on the consumer, the employee and the homeowner. With the writing on the wall, and a little bit more than two months until there is a change in Administrations, Henry Paulson seems to be waking up to the reality that the fixing at the top has had virtually no impact on most Americans with financial issues created by this meltdown. Since the change in focus is now inevitable, Paulson announced on November 12 that Treasury will no longer use the $700 billion bailout funding to buy troubled assets from troubled banks.

Instead, with writing on the wall morphing into screaming voices, Treasury will use $250 billion of the bailout fund to buy stock in functioning non-banking lending institutions as well as banks (specifically to bolster their balance sheets and encourage them to resume ordinary lending and in support of restoring the real estate market). Paulson also noted that the government was looking at a major expansion of the program into the markets that provide support for credit card debt, auto loans and student loans.

Wow! Two months since the first mega-fall of the markets and well after everyone knew about the subprime meltdown, the Department of the Treasury seems to have discovered that ordinary human beings are actually suffering in a way that makes it impossible to stabilize even the biggest financial institution. With crashing real estate values, plunging retail sales, rapidly escalating unemployment figures. I guess no one told him that 70% of economic activity in this country is based on consumers. Dirty little secret.

I’m Peter Dekom, and I approve this message.

Underwater World

Why in the world does anyone think we can reach “bottom,” much less begin to turn this economy around, when, in addition to massive job loss and a dwindling ability to fund payrolls (which washes through the retail community like a tsunami… costing even more jobs and creating even more real estate defaults), so many Americans’ savings are reflected in their homes? And 23% (a number that is rising fast) of all American homes are worth less than the outstanding mortgages? Look at these numbers, published this morning on AOL (the percentages of homes in each designated state that are “underwater”):

Nevada 47.8%
Michigan 38.6%
Arizona 29.2%
Florida 29.2%
California 27.4%
Georgia 23.2% (approximately the national average)
Ohio 22%
Colorado 18.3%
New Hampshire 17.2%
Texas 16.5%

What to do? Let me suggest an even more refined version of my past suggestion. But I sure hope we do not have to wait 75 days to begin implementation as a rudderless lame duck administration seems paralyzed and continues to focus on institutional rescue plans at the expense of homeowners.

1. Impose a 120 day moratorium on foreclosures, and a 60 day grace period (loan extension) for those in current default by act of Congress.

2. Impose a cap on all mortgage interest rates (I recommend 6.5%) on U.S. based owner-occupied residential real estate by act of Congress.

3. Congress should direct the Department of the Treasury (and the FDIC) to establish reasonable criteria ("Federal Standards") on what constitutes a creditworthy borrower and the basis of the appraised value of a home. Appraisals could be per property appraisals or, if there were sufficient volume, average price decreases could instead be based on an overall sub-zip code analysis.
4. We would mandate that the bank or thrift originating the loan (including successors that bought these banks) be charged with dealing in good faith with residential owner-occupied real estate borrowers who meet the above Federal Standards. They would be required, as a condition of maintaining FDIC status, to make the requisite reevaluations, but of course, they can require applying homeowners to pay appraisal fees. This would apply even if such banks "sold" the mortgages to a "bundling" hedge fund or other financial institution, which fund would be automatically subject to the restructure.

5. On petition of a federally regulated bank or thrift, based on reasonable due diligence by that lender, Treasury and/or the FDIC would be required (perhaps to a cap to keep the mega-wealthy from benefiting) to pay the petitioning bank a sum equal to the amount that value of the home in question exceeded the loan against the property if the borrower and the property meet the above Federal Standards, provided that: the homeowner accord the government a flat percentage of the gross selling price (whenever they sell with no time limits) reflective of that "underwater" contribution by the feds and that the homeowner would then continue to service the readjusted loan and occupy that house as the primary residence. I would suggest that this percentage vary to no more than somewhere between 5%-20% of the selling price (depending on the government investment), but the homeowner would be forced to pay this percentage only to the extent that the sold property will have appreciated above the mortgage price.

This keeps people who can afford the "carry" in their homes, reduces foreclosures (but clearly cannot eliminate foreclosures on property where there is no economic justification to subsidize a loan with a borrower who simply cannot pay a real mortgage), helps stabilize the housing marketplace (only bad credit borrowers would be defaulting), begins to restore consumer confidence (since most our economic perception is based on our jobs and our homes), gives taxpayers a real shot of getting their money back (maybe even a profit), does not create a massive federal bureaucracy to deal with millions of homes, does not reward the institutions who built their net worth on buying derivatives by bailing them out, and takes a smaller tranche of money - only enough to cover that part home loan that is underwater (not the whole loan) - which effectively supports the rest of the loan (a huge multiplier of value).

By addressing one huge grassroots problem, the rest of the markets can find that bottom that will trigger a recovery, albeit a long slow process that could take years. The old rule that the stock market is the first leading indicator of recovery seems to be a myth. True, the Dow reacts faster than any other indicator... but let's face it, the markets need to see a sustainable path to react to.

I’m Peter Dekom, and I approve this message.

Why People Still Matter

This morning, the Treasury began writing the checks under the bailout plan. $125 billion as a stock purchase to nine of the largest U.S. banks. Another $125 billion is slated for larger regional banks later this year. This “partial nationalization” effort will eventually include a nine figure purchase of bad assets from these financial institutions as well. Nothing for local banks. Nothing for people. Nothing for homeowners. Market reaction (the “truth detector” of business)? Instantly down on this news of course; the market rose later (part of the up-and-down volatility that won't end soon) based on news that sales of new single-family homes rose by 2.7% in September (mostly distressed properties at bargain rates, unfortunately), and then, the market flipped and ended “down.”

It will take months, by Treasury’s own assessment, for this bailout money to trickle down into the grassroots problems that need attention “yesterday.” That’s assuming you believe in that “trickle down theory.” Helping “people” seem too difficult, so why even try? Payrolls will go on bouncing checks, lay-offs will accelerate, and foreclosures will grow as housing prices continue to tumble.

Alan Zibel of the Associated Press wrote an article yesterday as to why the mortgage mess is so hard to fix. There are so many complications – such as investors for whom “fixing bad mortgages” means reducing their investment portfolio of “bad” subprime mortgages (and they're threatening to sue anyone who tries to fix this!), housing speculators who have no vested interest in home ownership and who walk away when their real estate is worth less than the mortgage, and there are lots of folks who chipped away at the truth to get loans they really knew they should not be getting.

Here are Zibel’s facts:

1. “Each day from July through September, more than 2,700 Americans lost their homes in foreclosure… That number, up from 1,200 a day a year ago, is a sign that the mortgage industry and government programs have done little to help troubled homeowners.”

2. “More than 4 million homeowners with a mortgage were at least one month behind on their payments at the end of June, according to the latest data from the Mortgage Bankers Association, and a record 500,000 had entered the foreclosure process.”

3. “The median home price in the U.S. dropped 9 percent in September from a year ago to $191,600, and is down 17 percent from the peak in July 2006, the National Association of Realtors said Friday.” California and Nevada were hardest hit.

4. “Already, 23 percent of homeowners with a mortgage owe more on their loans than their homes are worth, and that figure is expected to rise to 28 percent by this time next year, according to Moody's Economy.com.”

5. “The No. 1 reason people fall behind on their mortgage is loss of a job, or some source of income, perhaps from a divorce or death of a spouse. If a borrower is unemployed, lenders don't have many options but foreclosure… Two years ago, about 36 percent of mortgage delinquencies were caused by loss of income or unemployment, according to research by mortgage finance company Freddie Mac. But that number has risen to 45 percent this year as the unemployment rate has ticked up to a five-year high of 6.1 percent.” And it’s going to go a lot higher.

Which brings me back to why this meltdown has to be addressed from the bottom up… the markets cannot turn around unless the underpinnings of our economic system are solidified first. You don't build a house from the roof down; you need a solid foundation. Past blogs have focused on the specifics – how you actually start from the bottom and work up. People who say this is just too tough to deal with at the bottom so we might as well fix the top first just don't understand – sooner or later it’s the people who support the system that need the help… and then … well, the system will begin to work again.

Holding and creating jobs (and making sure payrolls are funded) is priority one, and stopping foreclosures and resetting interest rates and principal balances for solid and creditworthy homeowners is priority two (the federal government should focus on that portion of the real homeowners’ value that is below the loan value!). Everything else is down the list!

I'm Peter Dekom, and I approve this message.

Your Tax Dollars at Work

We've already looked at one reason banks have hoarded the cash – they want cash reserves for possible credit default swap calls and other “rainy day” scenarios. We know the top lending institutions, infused with fresh bailout capital from the Department of the Treasury, have openly stated that they have no intention of trickling that infusion downwards into the local lending markets – all this is documented in prior blogs. Here is another example of how they are spending that bailout gift from us humble taxpayers (according to an Associated Press posting on AOL this morning):

“PNC Financial Services Group Inc. said Friday it is acquiring National City Corp. for $5.58 billion, in one of the first concrete signs of how banks could use fresh investments from a U.S. government bailout program.

“The deal comes within hours of PNC Financial receiving approval for $7.7 billion in cash from the government under the $750 billion government program aimed at relieving the ongoing credit crisis.”

Kind of makes you feel warm and fuzzy all over, doesn't it? And the Federal Reserve is on the verge of another rate cut – money will get cheaper for the big boys, but trust me, most of us will continue to look at a credit debacle that has frozen us out. Markets are down all over the world, because the financial world feels that we are officially in a recession at last. Not sure how you all feel about all this, but it sure looked like a recession even last summer.

Companies and governments played with the numbers to make it look like this could easily be reversed, but if you are down in the salt mines, trying to operate a small business, pay your mortgage, retire on your pension and “investments,” get some minor financing from a bank for any bona fide purchase, want to put your kids through college by using your home equity line of credit or just clinging to your job and income by a slender thread (which has snapped for way too many of us), it’s been a deep recession for quite a while now. Even where you can find a loan, take a good look at the effective interest rates; I thought they were supposed to be falling?!

We still looking for a bottom, and I suspect the “flat, lean growth period” that will follow is likely to drag on for a long while, before it staggers very slowly upwards in a distant full recovery. I believe we will get there, but it won't be easy or fun for most. Lots of panic and overreaction in the markets, but the news, basically, isn't good. Where's there any relief in sight?

There’s a lender-opt-in federal HOPE for Homeowners Program on the table that allows lenders to reduce principal on loans to 90% of the appraised value of a house (lenders hate to devalue principal, by the way) and lower interest to an affordable level (a mortgage that will be insured by the Federal Housing Administration – the FHA). Unfortunately, unless lenders are in actual foreclosure scenario – where a huge loss is certain – it is unlikely that this structure will make much difference to those who have not defaulted.

Federal Deposit Insurance Corporation (FDIC) Chair, Sheila Blair has noted that in the Emergency Economic Stabilization Act (the big bailout bill), there are tools that can reach even beyond the above HOPE for Homeowners Act:

“Loan guarantees could be used as an incentive for servicers to modify [real estate] loans. Specifically, the government could establish standards for loan modifications and provide guarantees for loans meeting those standards. By doing so, unaffordable loans could be converted into loans that are sustainable over the long term. The FDIC is working closely and creatively with Treasury to realize the potential benefits of this authority.”

We will keep our eyes on the horizon, but someone really needs to accelerate the implementation of plans impacting ordinary working folks and homeowners. We need to intersect mortgages before they fail, freeze foreclosures now, cap interest rates on home loans... and the Treasury, FDIC and the FHA need to provide immediate federal lender guarantees to support homeowners who can sustain some meaningful level of monthly mortgage payments (the banks can tell us who they are). It’s all about the timing - now.

I’m Peter Dekom, and I approve this message.

What the “Treasury Talk” is Saying

A reluctant Henry Paulson announced this morning what the Department of the Treasury is prepared to do, if smaller banks request the help. There’s nothing in this plan for direct help to homeowners – no capping home loan interest rates, no moratorium on foreclosures – it’s directed at the smaller banks, who have no real options right now. And what’s worse, in a market with tight credit, Paulson’s preferred stock purchase (buying preferred stock, bearing interest, that gets paid back ahead of the shareholders’ common equity) plan is making the little banks pay a 5% return (rising to 9% in five years) on the government’s investment. That rate is a significant multiple of the rate that the Federal Reserve has set for its highest-rated bank-borrowers.

So this “interest generating” string pretty much assures that the small business and individual customers of those local banks who get federal aid will get socked with a higher rates and tighter requirements than the big boys and their customers (read: jobs and payrolls are still at risk if companies cannot reasonably bank their receivables). These higher rates make any qualified lender who accepts these terms much less competitive than any bank or savings & loan that does not.

Unlike the European governments, who simply guaranteed that on a temporary basis, they will support their banks from failure, the U.S. plan places an expensive layer, a financial burden on the cash-strapped, already-fearful local lenders. For those who want specifics, George White at thedeal.com summarized the government’s Capital Purchase Program (my notes are in brackets):

• The senior preferred shares will pay a cumulative dividend rate of 5% annually for the first five years that will reset to a rate of 9% annually after that.
• The government's shares will be non-voting.
• The maximum amount the government will invest is $25 billion or 3% of risk-weighted assets.
• The minimum amount the government will take is 1% of risk-weighted assets.
• Treasury will buy the senior preferred shares by year-end 2008.
• The government's senior preferred shares will qualify as Tier 1 capital and will rank equally with existing preferred shares and be senior to common stock. [Read: the government is a better position than the bank shareholders]
• The program is available to qualifying U.S. controlled banks, savings associations, and certain bank and savings and loan holding companies. The Treasury will determine eligibility and allocations for interested parties after consultation with the appropriate federal banking agency.
• Treasury may transfer the shares to a third party at any time.
• Treasury will receive warrants to purchase common stock with an aggregate market price equal to 15% of its investment.
• Participating banks must adopt Treasury's standards for executive compensation. [A retroactive clawback and a ban of any golden parachutes – a good idea – but the big parachutes are not likely going to be in these little banks in desperate need of federal assistance. It looks better on paper than what it really means to taxpayers.]

The markets rose mildly on the news – this was hardly the U.S. government reassurance they were looking for – but since the burden is on the smaller banks to “ask,” no one really knows if this structure has a chance of working. And think of the legal and advisory fees this exceptionally complex structure will generate – money to those who helped create this problem, a transaction tax that siphons off a chunk of the value of the $700 billion rescue package.

With nothing in direct aid to consumers, still looking at institutions before people, this plan lacks the transparency and simplicity of the European action. Don't expect the stock market to stay up. Don't expect the worries to vaporize. And don't expect this to help consumers or homeowners with any significant relief anytime soon.

I'm Peter Dekom, and I approve this message.