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Bair and Dodd, the Village Buffoons

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November 14, 2008 – Comments (8)

Dodd and Bair (the FDIC) still can't get it through their thick skulls that there's nothing they can do that can stop the drop in housing prices. Foreclosures are only a symptom, really, of the problem, which was simple: People borrowed more than they could afford to pay because they assumed they would not HAVE to pay. They assumed they would refinance, cash out at an inflated price, or they didn't bother to do the math at all.

This Washington Post article explains just how demented Bair and Dodd are. They're currently touting a mortgage bailout for deadbeats that bases its costs to taxpayers on a fantasy. Bair's current bailouts at Indymac are not doing well, because reducing payments doesn't cover the disappearance of the massive fantasies that underwrote these mortgages and home prices.

Of course, this hasn't stopped her from contining to try and push this bleeding-heart plan through any government channel that will give her a listen. Since her own bosses have stopped listening to her, she's teaming up with Chris "I got a sweetheart deal from Angelo Mozilo and looked the other way while the entire housing Ponzi scheme was making him rich" Dodd.

Borrowers who have missed at least two monthly payments would be eligible for a reduction in their payment. The new payment would require that they spend no more than 31 percent of their monthly income, a relatively conservative standard. By comparison, lenders historically calculated that borrowers could afford to spend up to 28 percent of monthly income before taxes on housing.

In exchange, mortgage companies would receive a basic guarantee: If the borrower falls behind on the new monthly payments and the company ends up losing money on the loan, the federal government will cover half the loss in most cases.

The estimated cost of the plan is based on the assumption that only one in three borrowers who get a modification will be unable to make the lower payments. That would require a higher success rate than existing modification programs have achieved. About 45 percent of borrowers who received loan modifications from mortgage companies last fall already have slipped back into default, according to a Credit Suisse research note.

Bair and Dodd are either stupid, liars, or both, if they claim this plan can exceed by 22 full percentage points the success rate of the prior deadbeat workouts. 

I vote for some from both columns. Worst of all, they can't do simple odds in their head, because their rationale for the plan (that this would save the economy) requires an entire string of unlikely draws to come through in succession. Their fixup requires...

Greatly slowing the tide of foreclosures with such a plan (1 in 20 chance, I'd say, at best) and that this will put a floor under home prices (not a snowball's chance in Hell, let's call it 1 in 100 to be kind). And then it requires that somehow, people get so excited about living in their still-but-less-underwater homes that they head out and start buying Cozies for their Hummer spares and iPods for their dogs again. (1 in 2 chance, we know how American consumers are.) Still, I make the odds that this plan actually helps the economy to be 1 in 4,000.)

Oh, this would also require that people who feeling cash strapped not game the system, stop making payments in order to qualify for the deadbeat rewards program, and toss housing down an even deeper hole. That would require that people be too stupid to figure out how to save themselves thousands of dollars at their neighbors' expense, and I have more faith in Americans buck-sniffing ability than that.

What really needs to happen is that Dodd and Bair go back to high school and take economics 101, and pay attention to the stuff they teach in chapter one about supply, demand, and prices.

Home prices will "stabilize" when they reach a stable relationship with incomes and equivalent rental prices, and in many areas of the country, that means another 30% drop in house prices at least.

This dangerous waste of taxpayer money shouldn't get a second's hearing, and Bair should be shown the door for continuing to stump for this plan. Her job is to make sure bank deposits are safe by regulating the capital in banks' coffers, not plotting a failed social policy simply because she's been handed the keys to failed lenders.

What will save this economy is allowing the greedy, the idiotic, the naive and yes, the simply unlucky, to actually fail, so that the responsible can drive by, pick up the bargains, and get the wheels rolling again.

8 Comments – Post Your Own

#1) On November 14, 2008 at 9:11 AM, MarketBottom (29.36) wrote:

That is the truth if I ever heard it.

A simple way to cure the problem going forward is to put housing back in the calculation for consumer price index, like it was before Clinton/Greenspan rigged it to deflate inflation, and inflate GDP.

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#2) On November 14, 2008 at 9:46 AM, Bertlensk (< 20) wrote:

I read a suggestion elsewhere to reset all mortgages (in default or not) to 5% and 30 years. The idea is to make things equal - put money in the pockets of those who are not in foreclosure, and give a better chance to those who are.  Sounded good to me at first glance, any comments?

 

Also, I confess I'd sign up for this new mortgage program if all I have to do is skip two payments - me and a few million other homeowners I'm sure.  Why not?  

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#3) On November 14, 2008 at 10:55 AM, jesusfreakinco (29.00) wrote:

I am in as well.  Why not?  Skipping two payments will help the cash flow situtation ;)

 

 

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#4) On November 14, 2008 at 1:15 PM, leohaas (31.09) wrote:

As usual, you hit the nail on the head, Bent! Maybe Obama ought to contact you for a position in his Administration....

"I am in as well.  Why not?"

If you are eligible, then that means you are currently spending more than 31% of your net income on your mortgage. Only complete idiots put themselves in that kinda predicament...

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#5) On November 15, 2008 at 1:02 AM, Option1307 (30.15) wrote:

and complete retards, or both...

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#6) On November 15, 2008 at 5:03 AM, jester112358 (28.91) wrote:

Spot on analysis.  Too much common sense for any politician.  Everyone will now want to miss a couple of payments so they they free up some cash.  In the interest of fairness shouldn't renters who miss a couple of payments be able to renegotiate their rent?  I've been wanting to rent a nice place in Malibu for quite some time but my income won't allow it.

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#7) On November 15, 2008 at 11:23 PM, mandelman (< 20) wrote:

My Dearest TMFBent...

The reason the situation has deteriorated to the level at which it now exists, is that we, as a nation, have failed to fully recognize and understand the situation, it's origins, and it's changing impact. We need to calmly and intelligently take a look at this, because if we don't we will all most assuredly suffer far longer and to greater degree than would otherwise be necessary.

First of all, our current financial crisis was not caused by any one thing. Further, the "crisis" is not a static one, rather it is a dynamic situation that continues to change.  

While it's certainly true that lending standards were too lax, interest rates kept too low for too long, and that many borrowers overextended themselves, none of these factors can be considered the cause of today's situation... it is that together they represent a set of contributing factors.

It is worth noting that sub-prime borrowers and sub-prime loans are nothing new. In fact, investors often like sub-prime paper because it generally offers higher rates or return, albeit at greater risk. Junk bonds, for example, are sub-prime loans, and the companies that issue them for sale are sub-prime borrowers.

Another example of sub-prime loans not being, in and of themselves, the root cause of anything can be found in the following Warren Buffet memo to the Berkshire Hathaway Board of Directors on September 11, 2008. 

Apparently, in 2003 Buffet acquired Clayton Homes, the nation's largest manufacturer and financer of prefab and mobile homes. In his September memo to the Board, Buffet pointed out "how well Clayton's loan portfolio has held up, even though 45% of the company's loans are to borrowers with sub-prime credit scores".  According to the text of the memo:

"The company's loan delinquency rates have been stable: On June 30, 2004, the rate was 3.26%; last year it was at 3.5%, and now it's at 3.82%. (In comparison, the delinquency rate in the traditional housing market is around 6.4%.)  Annual credit losses are running steady at a reasonable 1.5% of the loan portfolio.  And Clayton's foreclosures have actually dropped from two years ago, from 5,823 to 4,588."

Buffet also points out that Clayton keeps all loans on its own books, as opposed to selling them to others by means of securitization.  As Buffet wrote in his September 2008 memo:

"When we make a mistake it costs us money, not some buyer thousands of miles away who ends up with an RMBS, CDO, or (horror or horrors) a CDO squared."

In case you're not familiar with these acronyms, and by the tone of your article I imagine that it's quite possible that you are not, they refer to various derivatives. A "derivative" is a financial instrument whose value is dependent on (or "derived" from) one or more underlying assets. Futures contracts, options and swaps are all derivatives, by the way, as are the RMBS, CDO, and CDO squared mentioned by Mr. Buffet in his memo.

And, by the way, if you're going to weigh in on this subject, and desire to do so credibly, then gaining an understanding of these financial instruments is not optional.

Okay, so beyond the obvious factors already mentioned that led to our current crisis, such as too much money being available too inexpensively, lax lending standards, and borrowers overextending themselves, here's what happened:

1. The crisis began when three things happened in concert:

First, the Fed began to raise interest rates.  The battle between raising and lowering interest rates is based which economic fear is greater: inflation or recession. When the Fed fears recession, it lowers rates.  When it fears inflation, it raises them. That's why, following the dot-com bubble having popped and our economy going into the recession of 2001-2002, the Fed, under Mr. Greenspan, lowered rates to very near zero. But, in 2005, with the real estate boom then in full swing and consumers spending like crazy as a result of feeling "house rich," the Fed began to fear inflation much more than recession, and it began raising interest rates -- 17 times in a row, to be specific, in an effort to cool the economy down. 

As was certainly easy to predict, within months the housing market cooled as home prices stopped increasing, stabilized, and then began to decline, as a result of the higher rates.

Second, some of the sub-prime loans, the ones that probably should never have been made in the first place, began to default as their adjustable rate teaser loans adjusted higher. Monthly payments increased, and those on the edge went into default.

(So far, none of this would be considered "new," different,or particularly troubling, right? It's what happened next that lit the fuse.)

The third thing that happened is what ignited the crisis, and was what many people didn't understand.

As you may know, the individual mortgages that banks and other lenders make at the retail level are packaged and sold in what's referred to as the "secondary mortgage market".  This secondary market is made up of various investors who hold such assets for the long term, and by selling their mortgages, the banks replenish their cash which they need in order to make new loans.  (And it's been going on like this for years and years.)

This time, however, things went a little differently. The residential mortgages were packaged and repackaged into the "new" various derivative securities (previously referenced by Mr. Buffet) including CDOs and CDOs squared, which were then sold to investors.  Derivatives are complex, even for those that deal with them every day, and they're relatively new to the investment scene.

CDOs and other derivatives are rated by credit rating agencies, like Moody's, Fitch, and Standard & Poors, and suffice it to say that these complex derivatives were difficult to rate. For whatever reasons, and the credit ratings agencies certainly all have their justifications for this, they basically slapped "AAA" ratings on all of them.

Investors may not have fully understood what a CDO squared was, but they sure as heck knew what "AAA" meant, and when they saw the returns, they bought the securities in large number.

The problem began when some of the sub-prime loans started to default, and investors realized that the securities they had purchased were not "AAA". Some of these investors were pension plans whose bylaws prevent them from investing in anything but "AAA" rated securities. When they saw that they were not properly rated, they had no choice but to dump them on the market, often at "fire sale" prices.

Within a short period of time, the secondary mortgage market began to freeze up.  You see, investors need to know two fundamental things in order to invest: the relative risk, which is determined by the rating, and the potential for return.  When investors realized that they could not trust the "AAA" ratings, they stopped trusting each other and therefore stopped investing.

With no secondary mortgage market, banks and other lenders could no longer sell their loans and recoup the cash needed to make new loans. With the supply of money now "tight," banks raised their credit standards, interest rates, and whatever else it took to drastically reduce lending. Some stopped lending entirely.

Now, as the Fed continued to raise rates to hold off inflation, and mortgage payments continued to "adjust" upward, homeowners could no longer refinance to a fixed rate loan, and not just sub-prime borrowers... all borrowers with adjustable rate mortgages.

Remember, many people take out adjustable rate mortgages fully expecting that should interest rates rise, they'll simply refinance to a fixed rate loan. Now, because of factors totally beyond their control, they couldn't, and as a result, defaults and foreclosures started to rise, which caused home prices to accelerate their decline, as the Fed continued to raise interest rates. The more prices fell while loans continued to adjust upward, the less equity people had, the harder it became to refinance, the more foreclosures occurred... and the downward spiral began.

2. What happened next was something that perhaps should be categorized as the law of unintended consequences... and it involved the accounting rules that apply to public companies, which are established by FASB, the Financial Accounting Standards Board. Here's where the infamous "write downs" came into play that ultimately led to the need for, and passage of the $700 billion "rescue bill".

FASB had new rules, known as FAS 157 and FAS 159, or lately as "mark-to-market" or "fair value" accounting, and although some companies implemented them a bit earlier, it was mandatory that everyone adopt these new standards as of November of 2006. (Check out when it was that the write downs took off and you'll see the connection.)

These new accounting rules required the auditors of companies to write down the value of certain assets to the "market price" each quarter... REGARDLESS of whether the underlying mortgages were performing or not.  So, as the real estate market declined, and as the market for RMBS and CDOs literally evaporated, the need to write down the value of mortgage-related assets increased.

It's important to understand that, prior to FAS 157 and 159, bank accounting required write downs relative to the performance of the assets.  In other words, as long as people were making their payments, no write down was required.  But, as of the fall of 2008, it didn't matter whether the borrowers were paying their payments as agreed, the mortgage-related assets had to be written down to the price at which they could be sold on that given day. Once there was no market for CDOs, for example, they could not be sold at any price (at that moment) so they had to e written down to $0 (even though they might be worth billions of dollars).

Banks have certain ratios they must maintain, and when you write down an asset, you need to find some cash to make your balance sheet balance, or you'll be in default. (Just check out the details of Washington Mutual's filing and you'll see what I mean.) 

This is why Hank Paulson suggested that the Federal Government buy these assets from the banks and Wall St. firms, because the government isn't subject to the public accounting rules. (It's also why he said that it was likely that the government would ultimately make a profit by doing so.)

The fatal flaw in Paulson's thinking was easy to see. He thought (and don't ask me why) that by taking these troubled assets off of lender balance sheets, they'd start lending again. Few agreed. (I, for example, had no question whatsoever.)

Why would a bank start lending again when foreclosures are continuing to decimate real estate values? They'd have to be stupid, which as much as some might want to believe, they are not.  If they started loaning again in today's market, they'd just be facing further write downs as prices continued to fall.

Then Lehman Bros. was allowed to go bust, and boy does our government regret allowing that to happen. Lehman's bankruptcy led to AIG's need for cash, which had to do with the insurance giant's issuing of Credit Default Swaps, which I won't go into here, and ultimately led to the total icing of the commercial paper market and pretty much put an end to lending altogether.

And this, my wanna'-be-economist friend is why GM needs money: Because when people can't get car loans, for the most part, they can't buy cars. No car sales for a month or two and GM is out of business. And, in an effort to make certain that you understand just how suicidal your "advice" on handing the crisis is, if GM goes under, among other things, we'll lose millions of jobs in a hurry. (Gee, I wonder what that will do to the pace and volume of foreclosures?)

Check these facts out... Each year, GM spends $31 billion on parts from outside suppliers. And since, there's a 70% overlap between GM, Ford and Chrysler in terms of these suppliers, when some of the 2100 follow GM down the proverbial drain, the other two automakers will feel it as well. Then there are the 14,000 car dealers that sell GM cars and trucks. That's almost half of the 29,000 car dealers in the U.S.

Of course, many of them sell other lines in addition to GM, like Toyota, BMW, et al. So, when a bunch of them dry up and go away as a result of our letting GM fail, that will also hit the other car companies right between the eyes.

Look, you don't seem like a bad guy.  And I don't believe you're guilty of anything but a deficient understanding of the situation as it stands today.

As soon as the dominoes started falling we needed to stop them quickly. We didn't. And the reason we didn't is because of people like you who wanted to believe the simplest of explanations: that irresponsible "deadbeat" borrowers and greedy aggressive lenders brought this on themselves, and therefore deserve whatever they get in return.

Not only are you wrong in your assumptions, you're not even in the ballpark.  And to think that somehow you and other "responsible" persons are going to come along and scoop up the bargains resulting from the misfortunes of others, well... it's astonishingly naive at best. At worst, it's a perverse and mean-spirited fantasy that sounds to me to be based in some degree of jealousy with perhaps a dash of bigotry thrown in.

You should really taking a few classes yourself or at least consider learning enough to change your mind and hopefully the minds of others.  Because, unquestionably, it is simplistic views such as yours that continue to prevent our nation from finding a solution to the crisis. No one, including me for heaven's sake, would want to "bail out" a bunch of irresponsible deadbeats that bit off more than they could chew, much less a bunch of greedy Wall St. types that made loans to people who shouldn't have been able to finance a pack of gum.

You should know that I am no bleeding heart liberal. Like you, I am a supply-side, free market, pro-business person. But, in the words of Richard Milhouse Nixon: "We're all Keynesians now." Supply side theory works, to a point. Think of it as a house on fire. You can put it out by spraying water from the front, to a point. After that, you need to hit it from all sides.

Our economy has been "hit" by the perfect storm. It wasn't the fault of sub-prime borrowers or Wall Street's CEOs. Think about it... how could sub-prime borrowers, people who can barely taken down a car loan, take down thetitans of Wall St. and the entire world's financial system? And as to blaming it on Wall Street's CEOs... do you mean to tell me that they all made the same fatal mistakes at the same time? Wow... that would be an incredible coincidence, don't you think.

And I can unequivocally assure you and all others of like mind, if we don't stop the foreclosures through government intervention in the form of guaranteed mortgages for certain "qualified" borrowers, if we don't rescue GM, the financial pain you personally will soon feel will be unlike any you have ever known.

One last thing... I do agree with your concerns about the potential for abuse that is inherent to Ms. Bair's and Mr. Dodd's plan as stated to-date. But let's not throw the baby out with the bath water, they are at least on the right track.

Because the "baby" we're throwing out, it is worth remembering, is the future economic prosperity of the United States of America.

I welcome your reply... 

 

 

 

 

 

 

 

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#8) On November 19, 2008 at 3:09 AM, milpo (53.69) wrote:

Not really.  The problem did not develop from the bottom up.  It developed from the top down. The dramatic alteration in LIBOR at the end of August was not a symptom of confidence lost, it was the cause.  It did not have to unfold that quickly.  The central banks got us addicted to credit market transactions, encouraged it, and made those outside the marketplace feel like rogues.  We all acquiesced and joined the new paradigmn. In fact, the whole world joined the party.  Are all global governments and investors stupid?  I think not.  They were simply too trusting.  In a single weekend, and through their mouthpieces Paulson and Bernanke, the central bankers made an arbitrary decision to withdraw and freeze credit.  They triggered and instigated the deflationary depression we find ourself falling into.  Then, on a schedule convenient to them, they will acquire anything and everything of value at pennies on the dollar at which time a massive inflationary spiral will begin. Pray that Gold does not continue to bottom. The closer Gold  gets to $300, the closer we will get to real suffering.

Milpo

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