The No Oink Solution

The Federal Reserve cut the internal bank lending rate by a further half percent. More fixes at the top. Yet, with 23% of American homes underwater (loans are higher than the equity), what is the government “thinking” about? After all, there’s very little “bailout” money left after the pigs are the top bellied up to the trough. Well more than a day late, and vastly more than a dollar short!

Here’s the “talk in Washington”: The FDIC and Treasury are considering a plan to apply a small portion of the bailout money – estimated to be on the order of magnitude of $50 billion – to encourage lenders to refinance existing mortgages with lower rates for at least five years. Under this plan, the lender and the government split potential losses equally in the event of a default, which the government believes could support as much as $500+ billion of loans. Hey, the fix needs to impact trillions of dollars of loans! Note the disparity between the amount of money being deployed to bailout millions of individual taxpayers versus a pretty small number of corporate biggies: ten to fifteen times more for the companies!

There may be better plans, but here's one (I’ve presented a shorter version before) that multiplies the value of federal bailout money well beyond the federal investment and out-sources vetting and implementation to the originating banks. For those hedge fund managers, in order to protect their toxic balance sheets, who plan on suing banks that readjust mortgages, might I recommend simple Justice Department investigation towards a possible massive prosecution under the federal Racketeer Influence and Corrupt Organizations Act.

Here goes:

1. Impose a 120 day moratorium on foreclosures, and a 60 day grace period (loan extension) for those in current default. 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. 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.
4. Congress 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.
5. The meat of the new law I would suggest: 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.

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. We want a stock market recover that is sustainable? The Dow reacts faster than any other indicator... but let's face it, the markets need to see a s ustainable path to react to.

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

The Switch on the Wall

Consumer spending accounts for about 70% of the economic activity in the United States . There’s a Conference Board that measures consumer confidence, and this analysis, along with a host of other factors, is an economic indicator of the immediate future. The consumer confidence index reported today fell to 38 (from a revised 61.4 in September and well below analysts' expectations of 52). An Associated Press article today put this measurement in perspective: “The 23.4-point drop in the consumer confidence index from September to October is the steepest since it fell 36.9 points from October 1973 to December 1973, when the economy was in the throes of a severe recession.”

If you deal with consumers or companies that deal with consumers, this is bad news, but no surprise. Retail is turning tail. What is a surprise is the chorus of Congressional voices calling for an infusion of spending cash – in the form of a “tax rebate” (the failed $600/$1200 rebate concept we saw in February of this year) – to give consumers money to spend. The theory goes that if they have money, consumers will immediately go out, in a patriotic moment, and spend that rebate on stuff, maybe Christmas gift-stuff. Then we will stimulate the economy, and things will look up.

But it’s like assuming that the light switch on the wall is connected to the light that you want to turn on. What if that switch actually went somewhere else, and if you wanted to turn the ceiling light on, you'd actually have to go to the real switch on the other side of the room. Trust me, if you are worried about losing your job or your home, the last thing you'd do is buy stuff unless you want to go out in a blaze of spending glory before you file for bankruptcy or just plain don't need the money. Putting a band aid on a piece of skin near the wound but not on it… well you get it.

Until there is a moratorium on mortgages, a reasonable ceiling on mortgage interest, a serious reevaluation of the existing homeowners’ viability to sustain the homes they live in and a targeted federal intervention to help those who actually might be able to stay in their homes and carry a reasonable mortgage… until we shore up payrolls (and business credit liquidity) and incentivize new job creation… we're flicking the wrong light switch and throwing taxpayers’ money into a bottomless pit of bad ideas.

There’s enough help at the top of the economic food chain… and an expected Federal Reserve cut tomorrow in the discount rate (the rate accorded to banks by the government) still does not solve the immediate problems, since very, very few of us can even borrow money at any interest rate, even with the best collateral, because there is no loan money, no job certainty, no leveling off in housing price declines down here where most of us live.

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

How Institutions Respond

Based on the last ten days, as the Federal Reserve lowered the discount rate (the rate charged to banks) and the Treasury Secretary announced his policy to force high cost, interest-bearing preferred stocks into targeted banks, whether they need it or not, I thought you’d like to see some interesting quotes. Nine big banks got slightly better terms from Treasury, by the way.

The intention was to infuse capital into the system so that businesses could bank receivables, families and students could access loans for college, payrolls could get funded, etc. Trickle down theory at its best. What have the banks done? Borrowed to the hilt, and hoarded the money by lending it back to the federal government – they bought treasuries. No trickle down. No liquidity. No capital available for loans. Credit market still frozen solid.

The government has said they can’t force loans to be made: “There is no express statutory requirement that says you must make this amount of loans,” said John C. Dugan, the comptroller of the currency (federal government). So we just created the “cushion” banks need to sit on to make up for their earlier stupidity, but the ordinary person is simply out of luck? And that’s all the government can say?

With all of the complexity of this combined regulation, the exceptionally complex bank structure fomented by Treasury (plus bankruptcy, litigation, etc.), here’s a comforting headline from an online October 15, 2008 article in the ABA Journal (American Bar Association): Lawyers Hope Bailout Bill ‘a Full Employment Act’ for Law Firms.

Is the government doing the right thing? You be the judge. The Dow opened down this morning, some say because of lousy home construction data. What a surprise!

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