Oh Boy, Just What We Needed

Apparently, the global economy is not the only thing that is “melting down.” Remember that “other crisis,” that “global warming thing”? Okay, we know the seas are rising, desertification is claiming arable land, wildfires are increasing (right now there are raging fires all over California – in chi chi Montecito near Oprah’s house, Yorba Linda, Sylmar, all over the place, homes burning and people getting hurt), aquifers are drying out – it’s almost all bad. But when you look at one narrow area – like California – and apply research and numbers to the expected crisis, well the costs are staggering.

The University of California at Berkeley just released a study – California Climate Risk and Response by David Roland-Holst and Fredrich Kahrl – that actually runs the costs, line by line, sector by sector, for the State of California. According to the summary, the value of real estate (slammed by this financial crisis) will be impacted the most: “[T]he state has $4 trillion in real estate assets, of which $2.5 trillion are at risk from extreme weather events, sea level rise, and wildfires, with a projected annual price tag of $300 million to $3.9 billion over this century, depending on how warm the world gets. If no action is taken in the face of rising temperatures, six additional sectors, including water, energy, transportation, tourism and recreation, agriculture, and public health, would together incur tens of billions per year in direct costs, even higher indirect costs, and expose trillions of dollars of assets to collateral risk.”

Can we adapt and hence survive? Multiply this report times every sector and every area where climate change spells disaster. All over the earth. The costs are financially incalculable. It’s more that beach homes eliminated – entire coastlines will move miles inland – or the loss of habitat or water… the very essence of every region on earth will dramatically alter. Temperate areas will become deserts, disease-laden insects will migrate to regions where immunities have not developed, frozen wasteland will become farmland (hmm? Arctic farming?)… and people without means… well, they die.

But with our current economic collapse, who can worry about this “distant” future… or is a decade or two for huge differences that distant? Cheap fossil fuels (trust me, this is very temporary) and tight credit make some of these dreams seem too tough to contemplate now. Billionaire oilman T. Boone Pickens touted a massive Texas-based wind-turbine farm (electrical power generation) as his vision of what America needs to do to achieve a near-term significant reduction in the use of expensive and polluting energy from “burning.” You may have seen his ads on television. Unfortunately, because of the above factors, Pickens is delaying his effort, called the Pampa Wind Project, which was supposed to become the largest wind farm in the world, generating 4,000 megawatts of electricity, enough to power 1.3 million homes. That’s too bad.

The economic collapse allows us to create new jobs that use the environment better, generate power without damage to our planet and apply sensible consumption standards to every nation on earth. We need to move forward with job-creation with projects like Mr. Pickens’ dream, and as quickly as our economic leaders get us on this path, the faster we solve our economic malaise and reinvent our relationship with nature. Maybe economic contraction can also allow humanity to contract its waste and pollutants… some by not being able to afford to drive or heat our homes because of cost… and hopefully mostly because we will have invented and designed better ways to live within both our financial and our environmental means.

Hard to juggle so many mega-problems at once, but when you are rebuilding anyway, doesn’t it just make sense to rebuild in a way that just makes sense? We should factor in the environment in each choice we make to “recover” our economy. It just might save our lives. Just look at Southern California right now if you think the problem is off in the distant future. Your region is on the list, one way or another.

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

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.

When Motown Becomes Notown

When Motown Becomes Notown

General Motors has 55 plants scattered about the United States, employs – directly – about 250,000 people (down from 335,000 in 2006 and 266,000 in 2007) and currently funds pensions for about 480,000 retirees. There are suppliers, dealers (6,468 of them), lenders, advertising agencies…. well you get it… a whole host of other people who owe their livelihoods directly to General Motors. Then you get the “indirect” employment, from grocery stores to pharmacies, from landlords to carpenters, who rely on the GM employees to patronize their daily economic businesses. And in the past year, GM stock has plunged over 90%, from over $30/share to under $3. GM’s problems are more immediate than those of Ford; the latter thinks it can stumble along for a year with money it has already borrowed. GM says it’s almost completely tapped out.

Autoworkers fought hard for their benefits, although many analysts complain that in healthcare costs alone, labor has added between $1500 and $2000 to the price of the average GM car making vehicle uncompetitive with foreign imports. Wages are good even as plants close and workers find themselves unemployed. Pension plans seem to be mostly funded, so those risks are not the main worry, but as America turns its focus to old-world manufacturing, U.S. automakers are under the microscope, particularly as they lobby Washington for a massive cash infusion plus support in the lending markets going forward.

Voices cry out different messages. Did Ford and GM succumb to “big is better” just once too often, missing the rocketing price of oil and its impact on consumer buying habits? Should stupid management decisions be rewarded with bailout money? Surely they don’t think the recent collapse of the price of a barrel of oil, by more than 50%, is a reason to roll out the “big is better” wagon again? Is General Motors’ new Volt – an electric car that actually looks cool – a sign of future values? With the dollar strong, is it pointless to support a manufacturing sector than does not seem to be able to compete with Japan, much less Korea and, eventually, China? Yet I have trouble believing that there is no place for well-built American cars, particularly if “Yankee” invention solves the energy and pollution problems that we have been rubbing our noses in.

The harsh reality is average consumers are not buying cars right now; it’s a purchase easily delayed, monthly payments (where you can find financing) easily avoided. The other harsh reality is that if our major carmakers ceased operations, the ripple effect through the economy could push a horrible and deep recession to a level requiring additional years of recovery. A November 13 posting by the Associated Press, noting that GM’s failure could easily drag Ford and Chrysler down with it, because they rely on many of the same vendors, suggests how the United States might fare if our automotive sector failed: “A study by the Center for Automotive Research in Ann Arbor estimated that the failure of Chrysler LLC, Ford Motor Co. and General Motors Corp. would eliminate up to 3 million jobs, including those at parts suppliers and smaller businesses that rely on the automakers.”

Taxpayers should look at this support as being in their own self-interest; a loss of GM or Ford will slam most of us and drag this recession out even longer. And as the numbers below will indicate, the loss to the taxpayers from GM’s going under would be a vast multiple of the cost of any bailout – dollar for dollar. Bottom line, we have to do something to keep those jobs in tact to the maximum extent possible, but the question is how.

In a “reorganization” under U.S. bankruptcy law, shareholder equity erodes (in this case to zero, but it is pretty close to that now) and contracts with future performance (like union agreements, warrantees, etc.) can be rejected. And there is the stigma that comes from filing under such laws as the November 13, 2008 New York Times reported: “A study of 6,000 consumers last summer by CNW Marketing found that 80 percent of them said they would switch companies if G.M. or Ford filed for bankruptcy protection in the United States, suggesting that only G.M. loyalists would stand by the automaker.”

While GM’s complete failure would have a lesser impact than the loss of Lehman Bros., the Times added: “A bankruptcy filing by a single Detroit car company could cost the economy $175 billion in the first year of the legal case in lost employee income and tax revenue, the Center for Automotive Research estimated this week. Given the complexity, a G.M. bankruptcy case could last three years or more.” The company could limp along after reorganization, might need less bailout cash, but it may well be mortally wounded, dying in a full bankruptcy in the not-too-distant future.

Can “negotiated” federal bailout money accomplish the same general result as reorganization without the formal bankruptcy? Shareholders would have to agree to subordinate to the infusion, making their stock pretty much worthless, and unions would literally be forced to accept massive give-backs as the price of keeping jobs. Executive salaries would and should be slashed, and management would have to accept a significant contraction as well. But there might not be the stigma, warrantees would be good and the automakers wouldn’t shove tens of thousands of unemployed people into a world that needs job creation, not job loss. And as one cynical observer noted, even buying time for GM is in our interest – total liquidation in bankruptcy would be intolerable in this economy at this time… it might not be so terrible as an isolated reality in a few years when there is a recovery solidly underway.

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

The “Deciders”

The “Deciders”

Ever know one of those men or women who just happen to do one job so well that they keep getting promoted. Up and up and up. They may even have an educational pedigree that makes it all look so much more impressive. I work in the entertainment industry, and I see these fair-haired “boy or girl wonders” make a few good (lucky?) picks on film projects or TV shows, be declared “geniuses,” and move up the corporate ladder.

I also see bright folks who worked hard to get to a place of power, make all the right decisions based on that hard work, and then just assume that they “have the gift,” and believe that their decisions going-forward will all be good even if they stop working and learning in a changing universe. They keep applying what they’ve learned so well in the past and are even terrified of deviating from their experience path for fear of jinxing their decision record. They’ve learned to “talk the talk” and “walk the walk” such that everyone around them is convinced that they always have the right answer. They also tend to surround themselves with folks who confirm their perpetual “genius.” This can work for a while, but…

As empirical facts contradict their new choices, even as the marketplace and technology conflict with their perception, they are so isolated and surrounded by “yes” men and women that they actually believe that the choices were good at the time and whatever made them fail could not possibly have been foreseen or have been their fault. Blame others or “circumstances”!

They often remove people who contradict them and hang out with other equally “powerful” people to enjoy the heady lifestyle of the rich and powerful. They attend posh, invitation-only retreats, engage in lots of public speaking and public appearances, hobnob with world leaders… instead of spending time learning about the changes that will eventually provide the instrument of their demise. Sometimes, they'll even preach clear and distinct paths to future growth that are flat out wrong just to cover up an earlier mistake that is now proving costly.

I’ve seen broadcast television network chiefs tout the invincibility of their model, the necessity of broadcast network advertising to “mass market” products and services – even in a world where mass marketing has been dead for almost a decade and where network ratings average under 3 million viewers in prime time (out of about 100 million household(s) with television in the U.S.). When CBS – the highest rated network – plunged by over 70% in stock value in the current meltdown, the market caught up to the myth. Studio executives in search of a never-ending supply of “stupid money” were waking up to find that production financing for films was getting hard to come by these days.

It is so strange to watch this set of behavior patterns repeat itself at the highest levels of the federal government. I seem to recall a Harvard MBA, head of one of the most powerful investment banks on earth, groveling before the Securities and Exchange Commission to persuade them to relax the borrowing restrictions placed on financial institutions so that his investment bank could borrow more to buy theoretically valuable stuff like… er… subprime mortgage derivatives and credit default swaps. The SEC deferred to this powerful and legendary genius' sterling pedigree and said yes on April 28, 2004.

Sure his company bailed on a lot of that (apparently not-so-valuable) stuff after he left, and yeah, those borrowing levels proved toxic to two of the banks that got relief from those borrowing restrictions – Bear Stearns and Lehman Bros. His old firm is currently “de-leveraging” from the mistake of letting debt pile high on the company’s books (or as they called it, "significant market dislocation").

But in his next job, this Harvard ("genius") became a global political force; he was now a Cabinet Secretary to the President of the United States. He was hobnobbing with the hobnobbiest of the hobnobers. Unfortunately, he was still making the same decisions, surrounded by the same folks he had back at the firm. Funny thing though, for almost a year, every major decision he made turned out to be wrong. He announced new policies, selling them to Congress with his charismatic aplomb (and the credibility of his Harvard MBA and his tenure as the CEO of the leading investment banking firm in the world), and then reversed his own decisions, changed course and made contradictory pronouncements.

His governmental job description looked a lot like how he carried out his CEO responsibilities in his waning days at the bank. He advised and served major corporate institutions. He hung out with top financial ministers and “did what they did” even though his country was profoundly different. He was now faced with the responsibility of fixing the derivative mess he (lobbied so hard to) create. Only now, the economy was plunging at his every move. As the child revealed what everyone was too afraid to admit in Andersen's classic tale, the markets could now see that the emperor had no clothes. You’re not at Goldman Sachs anymore, Henry Paulson, and that Harvard MBA isn’t big enough to cover your posterior. Sadly, Henry, the markets are just like you... completely without direction!

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

Underwater World Revisited

OK, so the Treasury is not buying out bad mortgages from troubled banks; it’s not what the bailout bill said, but it’s just fine with me. Focus on the homeowner, the consumer and the employee… and Mr. Treasury Secretary, if those “financial institutions” you are buying into do not flow money down to the people that need them… Oh, I forgot, you’re gone in about two months. But in case we all forget how long two months can be… it’s been almost two months since the stock market melted on September 15! State legislatures are debating solutions to a federal economic problem, and private companies are creating their own bailout “plans,” because no one believes our government is on the right path. And the market is voting on your plan, Henry… it keeps falling!

Yes we need to create new jobs by opening up infrastructure repair and development immediately, we must act to un-freeze local credit and fund payrolls, incentivize employers who create new jobs (recreate the markets)… and yes, General Motors and Ford cannot die forcing literally hundreds of thousands of workers (at the plants, vendors’ facilities, etc.) into the ranks of the unemployed… but we also need a simultaneous and equally prioritized solution directed at America’s “savings account” – the measure of hope and the American dream – the housing market. Now! Not in three or six months, when the number of homes with negative equity (where the remaining mortgage is greater than the value of the house) could rise to one third more of the total!

Whether Americans were right or wrong to treat their homes as savings accounts is a question that is no longer relevant; it happened and the collapse of the housing market, combined with job loss (actual or feared), washes through the retail community like a tsunami… costing even more jobs and creating even more real estate defaults.

Why in the world does anyone think we can reach “bottom,” much less begin to turn this economy around, when 23% (a number that is rising fast) of all American homes are worth less than the outstanding mortgages? Look at these numbers (the percentages of homes in each designated state that are “underwater” or have “negative equity”):

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 repeat (broken record Dekom) one possible path that seems to be vaguely on the radar screen, in scattered parts. But I sure hope we do not have to wait 70 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. Lame ducks, start quacking!

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 (with the FDIC and the FHA) 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 owed to the taxpayers vary to no more than somewhere between 5%-20% of the selling price (depending on the size of 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 structure 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 (the work is done by the originating banks), 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).

The Federal Housing Agency announced an effort earlier in the week – to be implemented through Fannie Mae and Freddie Mac (which own or guarantee half of U.S. mortgages) – to begin a “restructuring” plan for those 90 or more days behind in their payments but who still have home equity of at least 90% of loan value, reducing the principal balance so that interest costs cap at 38% of the relevant homeowner’s income. Isn’t that just like the government – helping only those in serious default while ignoring the rest? So to get government help, you need to stop paying your mortgage?

JP Morgan Chase, Bank of America and Citigroup have all announced plans to freeze current foreclosures and restructure home loans with customers who are able to continue payments but might otherwise face negative equity. While the government is “considering” different additional “plans,” when the private sector believes that they can’t wait for a federal solution to the hemorrhaging housing marketplace, you know government action was needed “yesterday.”

By addressing this huge grassroots problem while restoring jobs, 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 my voice is getting hoarse from screaming this so often.

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, 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.

Taxing our Credibility

Taxpayers are biting the big one again. In years gone by, Congress became wary of big corporate structures with massive profits subject to federal (and usually state) tax actually looking for shell companies whose only real asset was something called a “net operating tax loss carry forward” (“NOL”) – in short a big loss that they did not have any profits to charge against. Since our tax code allows tax losses to be stored for a few years like a reserve (lean years being balanced by fat years), there were lots of companies whose only value were those losses. So big profitable companies used to buy these “tax loss” storage bins (the shell companies) for chump change (good for the shareholders in the “tax loss” company who didn’t expect much anyway), and use the losses in the acquired company to offset their profits and pay a whole lot less to a government in need of tax funds to operate.

In 1986, Congress limited this form of abusive tax avoidance, and this practice became vastly more difficult if not almost impossible to implement. The current Administration has opposed this law (it stifled the mergers and acquisition frenzy that obsesses Wall Street, they claimed), but until the “bailout” legislation, they had to stew in the fact that Congress was unlikely to repeal Section 382 of the Internal Revenue Code. This might seem like a pile of mumbo jumbo to most Americans… except right now, when the government really needs the money to care of “us;” maybe now is not the best time to add yet one more huge corporate “perk” to America’s financial institutions. The bailout bill has enough in it already for them.

As a part of the new bailout legislation (combined with the regulatory aspects of Section 382 itself), the Department of the Treasury believes that it has the power to waive that tax rule where they think appropriate (they call it the “Wells Fargo Ruling”). So in an era where the government is funneling cheap money to mega-banks by reducing the Federal Reserve discount rate, providing direct cash infusions into their balance sheets, it seems that whatever profits might have otherwise been taxed by the government in those financial institutions that made a big fat juicy profit, are now moderated or completely eliminated (maybe for years to come given the carry-forward provisions of NOLs) with this new interpretation.

How? As these mega-financial institutions use this government cash to absorb and eliminate their competitors and grow their market share (enhancing their long term power), they are obviously acquiring the losers – very cheaply I might add (a loser is a loser) – and they are also acquiring their loser-target’s pile of unused losses. And under the Treasury’s interpretation, the financial institution with profits now gets to reduce or eliminate those profits for tax purposes by applying the losses of the company they just bought.

The November 10 Washington Post reported this interesting reaction to the new rule: “ ‘It was a shock to most of the tax law community. It was one of those things where it pops up on your screen and your jaw drops,’ said Candace A. Ridgway, a partner at Jones Day, a law firm that represents banks that could benefit from the notice. " ‘I've been in tax law for 20 years, and I've never seen anything like this.’” Experts put the short term value on this little ruling at somewhere between $100 and $150 billion! Wells Fargo alone is rumored to get as much as $25 billion in benefits.

There are unemployed Americans – a list that just keeps growing – and mounting home foreclosures out here! Hey, what about the people in this country?! When does the government do something meaningful for us instead of reducing the money they will have to work with to the benefit of those who do not need it?

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

The Big Picture

Interesting to note how the lessons of history seem to be lost by those benefiting by economic gains that defy both logic and economic fundamentals. It’s fascinating how often I hear the follow kind of analysis from financial managers of substance: “Well, everyone knew that there would be an ‘adjustment;’ but we just didn’t know when or how big it would be.” Ignoring basic concepts, like borrowing more than you can afford to pay back, lending to people whom you know aren’t really going to be able to carry the loan, assuming that real estate prices and the stock market could only continue to rise, fighting a trillion dollar war with borrowed money (while lowering taxes), buying companies with mostly debt and very little equity… well you know the list.

We know the $10+ trillion “borrowed” federal deficit, the approximately $7.2 trillion “borrowed” subprime mortgage aggregation, and now we get to see exactly how borrowed (leveraged) corporate America is (and we know they’re getting taken care of first). The bailout plan (the Troubled Asset Relief Program – TARP to the financial community) is apparently a big attraction on the lecture program circuit, but occasionally, you get a pearl of wisdom or two from what presented.

For example, on November 10, Randal Quarles, a managing director at the Carlyle Group (a huge private equity firm) spoke at the Securities Industry and Financial Markets Association's Summit on TARP (as quoted in thedeal.com), addressing exactly how “borrowed” corporate America is: “How TARP develops from now will be driven by the logic of what's come before… There's been a massive increase in leverage in our financial system. It's at about 350% of GDP… The financial sector and households drove that. The last time that the whole amount of leverage was at this level was at the start of the Great Depression, and we're at twice the level leverage of the early 1930s.”

Wow! America has aggregate borrowings of 3.5 times the entire annual output of all goods and services in the U.S. So it needs to “de-leverage.” Quarles goes on to note that while the U.S. government is the balance sheet of last resort, the future lies in the hands of investors themselves: “Institutions are realizing that in this environment they need to anchor confidence… But I don't think TARP capital will be an effective signal of viability though. The only thing that can do that is due diligence by a private capital investor that's willing to put his money where his mouth is.” Smart financial institutions driven by fundamentals and not by loopholes that allow them to make a momentary buck? Ignore that “everyone else is doing it”? This, I’ve got to see.

Today’s highlights: Circuit City filed for reorganization today under U.S. bankruptcy law, analysts downgraded General Motors to a “zero” value company, and the feds increased their bailout stake in insurance giant, A.I.G, to an aggregate total of $150 billion. I wonder how many years it will take the global financial industry to forget the lessons of the 2004-2009?

I’m Peter Dekom, and I hope I don’t live long enough to see a repeat of this mess.

The 19th Hole

There are approximately 8,500 banks in the United States; two fewer as of this past Friday. One in Houston (Franklin Bank) and another in Los Angeles (Security Pacific) were shut down by the federal regulators. A total of 19 so far this year. Writing for the Associated Press on November 8, Marcy Gordon presented the details: “The Federal Deposit Insurance Corp. was appointed receiver of Franklin Bank, which had $5.1 billion in assets and $3.7 billion in deposits as of Sept. 30, and of Security Pacific Bank, with $561.1 million in assets and $450.1 million in deposits as of Oct. 17.”

A reflection of our times, but the real story in all of this resides with co-founder and chairman of parent Franklin Bank Corp., Lewis Ranieri, a pioneer – a legend actually – in the hallowed “vaults” of modern banking history. He must have been deeply saddened as he watched his 46 branches being transferred to the Prosperity Bank of El Campo, Texas. Gordon noted when the bank’s board of directors first spotted an issue: “Last spring, the audit committee of the company's board found in an investigation certain weaknesses in accounting, disclosure and other issues relating to residential real estate loans.” Routine stuff, really, except for that “special something” that defined Ranieri’s role in banking history.

You see, about two decades ago, Mr. Ranieri unwittingly lit the fuse – a really slow fuse – that would eventually explode in the subprime derivatives bomb. Ranieri is credited as the inventor of the mortgage-backed security – a commercially tradable piece of paper which reflects the aggregate value of a bundle of mortgages (i.e., the value of mortgages themselves supported the tradable paper). This allowed banks to “sell” bundles of mortgages to funds, investors, other banks, etc. – who rated the risk and profited from the income generated by homeowners’ making interest payments – at a lower value than the face of the aggregated mortgages (hence buyers could make money on the difference). This gave the selling bank a slightly lower profit on the originating loans, but it freed up capital to make lots more loans. They literally “made it up in volume.”

This did create “distance” between the homeowner and ultimate buyer of the mortgage – the originating bank was out of the loop now – but it allowed a larger pool of money to be available for people to buy homes. This is all a bit complex – and you may have to read this more than once – but yes, a mortgage-backed security is a pretty classic “derivative” – a tradable financial contract, or financial instrument, whose value is derived from value of an underlying asset or a pool of like-kind assets bundled together to create an averaging effect. The underlying asset(s) on which derivatives are based can be elements such as commodities, equities (stocks), residential mortgages, commercial real estate loans, bonds, interest rates, exchange rates, or indices (such as a stock market index, consumer price index (CPI), according to Wikipedia.

Yeah, residential mortgages. Where the derivative is based on some aggregation of debt, it can also be referred to as a “synthetic collateralized debt obligation” – whew, except “synthetic” is at least kind of a warning sign to look closer! Picture an aggregation of thousands of mortgages, separated into relative risk pools, where you can buy a “security” (a piece of paper like a stock or a bond) whose price is based on the total value of those pools (corrected for risk).

The real damage came years after Ranieri first introduced his mortgage-backed security… as this aggregation of mortgages was used in the post-2004 era primarily to bury and “rate” mortgage risk into manageable pools, which would enable the system – bankers believed – to tolerate lower lending standards and generate higher yields associated with higher risk loans. In short, when less-than-prime customers could borrow money where they would have been clearly denied a home loan in the past, this “mortgage-backed security” was supposed to manage the risk by pooling the loans to minimize the impact of individual defaults. From 2004 until the market dropped, home loans were now flowing like a raging river. Hmmmm?

With about $7.2 trillion in these subprime mortgage derivatives “out there” (many in default) and the bulk of the 23% of U.S. homes where mortgages exceed the value of the home falling into that subprime category, let’s just say they were wrong. Really, really wrong. There weren’t just a “few defaults” as the system had predicted. And with half of America’s banks likely to tap into the temporary FDIC increase in deposit coverage ($250,000 per accounts) and $40 billion of FDIC estimated losses from bank failures expected by 2013, isn’t ironic that the inventor of mortgage-backed securities was brought down by his own creation?

I’m Peter Dekom, and I learn something new every day.

Flattened by the World

By the end of 2008, approximately 100,000 factories will have closed in China in just one year. When demand slackens in the United States and the West, people in China feel the pain of their biggest customers… except they feel it worse. No unemployment insurance, no notice, no future. An awful lot of those plants, owned by people in other cities and other countries, have simply been abandoned, without notice, by their owners. The Los Angeles Times (November 3) reported how one owner skulked away in the night: “Shaoxing, China -- First, Tao Shoulong burned his company's financial books. He then sold his private golf club memberships and disposed of his Mercedes S-600 sedan… And then he was gone.”

Thousands of absentee owners are literally sneaking away from their factories. Hundreds, often thousands, of workers in a single factory. The L.A. Times explained: “If a [Chinese] factory operator went by the book, it could take two years to close a shop because of regulations and red tape… Others may flee not out of aversion to bureaucracy but because they want to get away with what cash they have left and not face angry suppliers, lenders, employees or regulators. Sometimes relatives and managers who help run operations flee too, and without anyone who can take responsibility, some factories have little choice but to shut down.”

It’s bad this year, but when migrant workers leave for a short break at Chinese New Year in February, some of them may find nothing to return to. It’s a good quiet time to shut a plant down with minimal interference from the workers. For those firms who file bankruptcy under Chinese law, the protection given to workers’ wages often leaves the owners with nothing. Funny how many fires have burned plants to the ground of late. On November 9, China announced an enterprise tax cut and a “stimulus” package worth $586 billion, their “bailout” fund.

We’ve got plenty of extreme examples of the impact of this global meltdown: Iceland’s economy has literally collapsed in a mountain of debt vastly beyond the entire country’s ability to pay – England even resorted to labeling Iceland financial “terrorists” in order to justify freezing Icelandic assets in U.K. banks, a measure that hastened the small island nation’s financial demise – and unemployment rates are skyrocketing to vast multiples of U.S. figures, countries like Hungary and Belarus aren’t too far behind, and even formerly “hot growth” emerging markets, like Brazil, are screaming like stuck pigs as investment capital hurtled out of their country at the first hint of the global financial crisis, leaving a wake of unpaid suppliers and unemployed workers in a collapsing market. The poorest nations see a financial collapse in terms of homelessness and starvation. Everyone, everywhere, is feeling the crushing pressure of a global economy gone wrong.

As the global financial summit approaches in the coming days, the need for global regulation of the financial markets is clear; to create a consistency of controls with information to be freely exchanged on a real-time basis between nations is truly the only viable option. Author Thomas Friedman put it well as he noted that “The World is Flat.” We literally are one giant economy with lots of special interests and multinationals pulling the strings. Nothing wrong with making money and creating jobs… it’s just making sure that such earnings are equally accompanied by responsibility and accountability. There can be no “safe havens” where rules and regulations do not apply.

I’m Peter Dekom, and we’re in this together.

The Presidential Race

I got to thinking during this election that no matter who won, I just had to play with exactly what “Black” and “African-American” meant (just two of the "words"- different folks have different preferences for how they’re “labeled” ), why we construct categories of bi-racial status for different groupings and racial mixtures depending on the races in question.

For example if a French or American Caucasian marries a Chinese, the resultant child is “Eurasian.” A few generations of intermarriage with "more" Asian or Caucasian, and the children down the line may be labeled under either Asian or Caucasian, but the “Eurasian” epithet will disappear.

When you got down to Native American/Indian mixes, it was and is considered an insult to call a White-Native American mix a “Half-breed,” a term that was widely used to describe people of mixed Native American (especially North American) and white European parentage. Mestizo is mostly used specifically of those people of the particular racial mixture of European and American Indian who inhabit and comprise much of the population of Latin America. Nasty being part Indian… until being one-eighth Native American got you into a college or university, qualified you as a “minority” on a job application or even got you a check from the local casino. Amazing how many “people of Native American heritage” appeared.

It seems that once a racial type is deemed negative, until you “pass” into another race, a little bit of color goes a long way. Rules were carefully devised to deal with the “property rights” inherent in American slavery. Any child of a slave was automatically a slave too. Words like “quadroon” (1/4 Black) and “octoroon” (1/8 Black) were common words in the early American lexicon, and rights and privileges were often determined based on such racial mixes. Both categories were considered "Negro," by the way. You’d think once slavery was gone, things would get a lot better. Only for those who had in fact been slaves at the time. Okay, we’ve moved on a bit from “Negro” or “colored,” but maybe not much.

Even as modern “enlightened” “young” people might not notice or have the opposite take, dark skin has very often been discriminated against. In the Subcontinent (South Asia, where you find India, etc.), darker skinned people tend to populate the lower parts of the Caste system, and they were (and often still are) denied opportunities – some were treated as “unclean” with folks washing and “cleaning” away the “contagion” as the “dark” folks left the room. Even Africans can treat each other differently based on skin color.

Not a whole lot dissimilar from the Jim Crow laws that supported the racial segregation of facilities, services, and opportunities such as housing, education, employment, and transportation along racial lines in the U.S. after the American Civil War (1861–1865) – a conflict that brought about the end to slavery. Even in World War II, military units were fully segregated. The famous school desegregation case, Brown vs. Board of Education, marked a turning point in American "sep arate but equal" policies that had, until this 1954 Supreme Court decision, been the rule in the land. Voting and civil rights laws followed, but other than having “lunch in the White House,” the closest that a Black man or woman got to the Presidency was as a visitor or an employee of the government.

So what about a modern day Black person in the United States ? Here’s Wikipedia: “[G]enetic research published in 2002 established that African Americans were a diverse ‘multiracial’ group in the broadest sense. Nearly all African Americans were descended from both sub-saharan Africans and Europeans… According to newer and more advanced genetic research, African Americans fall primarily into the first group with 80% of the population being ‘mostly African.’ Twenty percent has more than 25% European ancestry, reflecting long history of both groups in the U.S. The ‘mostly African’ group is substantially African, as 70% of African Americans in this group have less than 15% European ancestry. Since almost all have some detectable amount of European ancestry, the ‘mostly African’ group is multiracial in the broad sense. African Americans in the ‘mostly mixed’ group are almost entirely between 25% and 50% European. These findings confirm that African Americans are indeed a multiracial, ethno-racial community.”

A lot of people, not just American racists, are a tad uncomfortable about a man of clear African heritage becoming the next President of the United States. For example, Italian Prime Minister, Silvio Berlesconi, at press conference in Moscow the other day, said this about the new President-Elect: "I told the [Russian] president that [Obama] has everything needed in order to reach deals with him: he's young, handsome and even tanned." Wow.

So is Tiger Woods an Asian-African? Thai, maybe (they think so in Thailand )? Is Barack Obama a Eur-African or just “you’re Black”? And in a country where “minorities” are becoming a majority, does the word “minority” actually matter in our Democracy?! Isn’t it time to stop thinking about and labeling darker-skinned minorities as if we were still a nation of pre-Civil War slave owners?

I’m Peter Dekom, and I’m just puzzled.

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.