Bloomberg reports, U.S. Foreclosure Filings Set Third Record-High in Five Months:

Foreclosure filings in the U.S. climbed to a record for the third time in five months in July as falling home prices and the recession left more homeowners unable to keep up payments or refinance.

A total of 360,149 properties received a default or auction notice or were seized last month, according to data seller RealtyTrac Inc. One in 355 households got a filing, the highest monthly rate in RealtyTrac records dating to January 2005, the Irvine, California-based company said in a statement.

“We’re in a deep hole,” Diane Swonk, chief economist at Chicago-based Mesirow Financial Inc., said in an interview. “There is a whole new wave of foreclosures tied to the cyclical dynamics of the economy.”

What is this ongoing foreclosure activity doing to home prices? It’s not good.

The median price of an existing single-family house dropped 15.6 percent to $174,100 in the second quarter, the most in records dating to 1979, the National Association of Realtors said yesterday. Almost one-quarter of U.S. mortgage holders are underwater, property data firm Zillow.com said Aug. 11.

What about the mortgage modification programs which were designed to stem this tide of foreclosures? In speaking with our friends at 12th Street Capital, who have canvassed a number of the large mortgage servicing operations, we have learned that successful mortgage modifications are typically only occurring with mortgages that are delinquent 30 days or less. After that, homeowners are increasingly inclined to ‘walk away’ from homes which are further underwater (mortgage balance exceeds home value). In fact, Bloomberg highlights:

“It has been more profitable to put a home in foreclosure than restructure the loan,” Swonk said. “The only thing that helps is forgiveness of principal, and there is little willingness to do that.”

The greatest surge in foreclosure activity remains in those states which have already experienced enormous problems. The top 5 being Nevada, California, Arizona, Florida, and Utah. That said, our entire economy is intricately linked and these markets (especially California) cover a large percentage of our population.

What are the implications for this ongoing foreclosure activity?

1. Banks will continue to keep credit standards very tight.

2. The new issue securitization markets for these assets will remain virtually non-existent.

3. State tax revenues will remain under pressure as property taxes received continue to decline. As a result, look for continued cuts in services and likely tax increases.

4. Retail sales will not have a meaningful rebound as the consumer wealth effect tied to home values remains under pressure. This morning Wal-Mart reported flat profit on lower sales. Additionally, overall retail sales were just reported to decline .1 (ex-auto sales, retail sales declined .6) versus a projected gain of .8. This is an UGLY number!! As a result, do not look for a big rebound in inventories which would drive GDP.

5. Unless and until banks fully acknowledge the true value of the assets tied to these home mortgages, the financial system is kidding itself (and doing a very good job of it) to think that our economy will have a true robust recovery.

More on these topics later today. Thoughts, comments always welcome.

LD

Is Barack Obama about to move into the rental market and become the largest single landlord in the process?

Hat tip to AK for pointing out this developing story. Reuters reports, Obama Mulls Rental Option for Some Homeowners:

U.S. government officials are weighing a plan that would let borrowers who have fallen behind on their mortgage payments avoid eviction by renting their homes instead, sources familiar with the administration’s thinking said on Tuesday.

First things first, I fully empathize with all those whom are struggling at this time. However, from the standpoint of economics and capitalism, would this program actually serve as an incentive for some homeowners to stop making their mortgage payments? Would it cause other perverse, unintended consequences as well? Would it redefine the American dream?

Under one idea being discussed, delinquent homeowners would surrender ownership of their homes but would continue to live in the property for several years, the sources told Reuters.

Surrender ownership to whom? The bank holding the mortgage? The mortgage servicer? Uncle Sam? How is a rental payment determined? If based on percentage of income, does this program actually serve as a disincentive for individuals to increase income, if only to lose this benefit?

Officials are also considering whether the government should make mortgage payments on behalf of borrowers who cannot keep up with their home loans, tapping an unused portion of a $50 billion housing aid kitty.

That $50 billion housing aid kitty is money still in the TARP. Not that the rule of law means much anymore, but does anyone want to check if we actually need to write new legislation on the disbursement of funds under the TARP for a program such as this? What happens when the $50 billion is exhausted?

As part of this plan, jobless borrowers might receive a housing stipend along with regular unemployment benefits, the sources said.

How much and for how long? Who would oversee the program? Think there is the potential for massive fraud?

A few other questions and comments.

1. The mere fact that this idea is being floated would seem to me to be an admission that the housing market is a long way from bottoming.

2. How would this program impact the principle of property rights? If Uncle Sam is effectively dictating how an owner of a property, be it a bank or otherwise, can utilize that property, does this become precedent for other assets as well?

3. Would Uncle Sam consider establishing incentives for the banks and the homeowners to develop a program such as this through the private market? A tax incentive of some sort for the bank? Do we care to try to embrace free market principles?

4. Do we even try to determine the long term impact of this program on our economy in general and housing in particular?

Little doubt this type of program would be a sharp turn left on our economic landscape.

LD

The economy is booming in at least one sector, namely fraudsters out to separate you from your money. These human stains have always existed, of course, but the meteoric rise in the sheer number of scams in recent weeks is startling.

And what better target than the already weakened? People who face losing their homes or have been laid off from their jobs are the juiciest quarry. At least vultures usually wait until their prey is dead.

Here are just a few of what these bottom-feeders are up to these days:

1. Promising to help people renegotiate their mortgage to an affordable level, complete with a money-back guarantee if they don’t succeed. Of course, there is that stiff upfront fee. After months of being strung along—time that troubled homeowners could have been pursuing legitimate assistance—they and your money are gone.

2. Offering opportunities to make money at home. (If you haven’t gotten spammed with these offers, you must have a Mac.) Some will “set you up” with selling supposedly nice items that you pay for up front. Cheap crap arrives that no one will want to buy. Others offer you work at no charge, but actually only want personal information so they can gain access to your banking information or sell it to someone who will. The work never materilaizes.

3. You could become a “Money Mule” (pitched with highfalutin’ titles as “shipping manager” or “international sales representative.”) This job actually does make people money, but they could lose it all along with their freedom. The Mule is instructed to open an account and accept anonymous payments and then transfer them to other accounts in foreign countries, getting a cut in the process. Of course the operations are illegal money laundering schemes, and the most vulnerable to getting caught is, of course, the Mule.

4. Low cost loans are proffered by crooks who will take their up-front fee and flee, leavng you stuck with your higher-priced loan as well as less than you already had.

The use of the Internet and some new wrinkles make it more difficult to tell the good guys from the bad. Modern scammers can find out a lot about a person before they attack, especially if they have a Facebook (or similar) page. Personalized approaches are perceived of as more trustworthy by potential victims.

These hustlers have also figured out that people are less likely to make a fuss about (or even notice) a small charge on their credit card bill. Yet, scamming a thousand people out of $10 each adds up to a tidy sum.

Even amateurs can now create impressive web pages that appear to be offering a legitimate service or product, but only want your money (and probably your personal information as well). You, of course, will receive nothing.

Preventing such predators from reaching your gates is the same as it has always been: Don’t give out personal information to anyone you don’t know and trust; Check your credit card and bank statements carefully; If it sounds too good to be true, it likely is; You should not have to pay for most services before receiving them, and so on.

Yet these scumbags are getting better and smarter and there are more and more of them, so watch out! You can be sure they are hovering overhead watching us.

See here and here for a couple of good articles on today’s scamming trade.

Why do these games remind me of our current banking system? The similarities are scary. Let’s access the most recent piece from John Mauldin’s site to “view the games.”

Mauldin’s guest, John Hussman, comments on these various “games” (TALF, PPIP, TARP, FDIC, FASB), in which taxpayers bear the brunt of the risk in the government’s engagement with financial institutions. Hussman writes of the PPIP:

this is a recipe for the insolvency of the FDIC and an attempt to bail out bank bondholders using funds that have not even been allocated by Congress. The whole plan is a bureaucratic abuse of the FDIC’s balance sheet, which exists to protect ordinary depositors, not bank bondholders.

In regard to the FASB’s relaxation of the mark-to-market accounting rule for financial institutions:

the irresponsibly rosy assumptions built into these models have been a large contributor to this near-insolvency, because they virtually ignored foreclosure risks.

Whether via the TALF, PPIP, or FDIC sales, the transferral of toxic assets to private investors will ultimately only have one outcome and that will be :

the public will suffer the losses that would otherwise have been properly taken by the banks’ own bondholders. You can tinker with the accounting rules all you want, and it won’t make the banks solvent. It may improve “reported” earnings for a spell, but as investors who care about the stream of future cash flows that will actually be delivered to us over time, it is clear that modifying the accounting rules doesn’t create value. It simply increases the likelihood that financial institutions will quietly go insolvent. I recognize that the accounting changes may reduce the immediate need for regulatory action, since banks will be able to pad their Tier 1 capital with false hope. But we have done nothing to abate foreclosures, and we are just about to begin a huge reset cycle for Alt-A’s and option-ARMs. As the underlying mortgages go into foreclosure, it will ultimately become impossible to argue that the toxic assets would be worth much even in an “orderly transaction.”

In a slightly different version of the game – and in attempt to attract more players, if not necessarily truly new money – the government is considering allowing the sellers of toxic assets to also be buyers. How does that version of the game work? The sellers (Citi, BofA, JP Morgan, et al):

can put up a few percent of their own money, and swap each other’s toxic assets financed by a bewildered public suddenly bearing more than 90% of the downside risk. The “investors” in this happy “public-private partnership” keep half the upside while ordinary Americans take the downside off of their hands. Some partnership.

The NYC sidewalk games of chance are best played outside so we need to make sure the weather is good. In a similar fashion, for the government’s games to work it helps if the weather, that being the economy, is improving. Well, the difference between partly cloudy and partly sunny is all in how you look at it. In a similar fashion, regarding consumer spending:

analysts have noted that year-over-year consumer spending has only declined very slightly, hailing this as evidence that economic concerns are overblown. The difficulty is that consumer spending has never declined on a year-over-year basis, except in this downturn, so that slight decline is actually the worst showing for consumer spending in the available data.

Games of chance can be fun; however, if an individual is spending money he does not have, the risks grow exponentially. To wit, Hussman summarizes:

I have no idea how long investors will remain enthusiastic about trillion dollar band-aids and eroding the integrity of our accounting rules. I do know that at the end of the day, what matters is the long-term stream of deliverable cash flows that investors can actually expect to reach their hands. It’s exactly that consideration that makes it clear that we will sink deeper into this crisis until we observe debt restructuring on a large scale. If we don’t restructure the debt, the debt will fail, because for many borrowers, the cash flows aren’t there, and it is not possible to service the debt on existing terms.

When my “old man” encouraged me to “hustle” and “take some chances,” I am not so sure this is what he had in mind.

LD

The main point I tried to highlight in that piece was the need for true price discovery for these toxic assets. A loyal reader provided tremendous insight in highlighting that the PPIP needs to assure that sellers are truly at arm’s length from buyers to insure that the price discovery process is real and fair.

There are potential concerns with this price discovery process highlighted in my piece Send in the Clown. Are the bank portfolios, located within the largest banks needing to sell toxic assets, attempting to prop the market higher?

I received some real time market color from KD at 12th Street Capital as to initial responses from customers, both buyers and sellers, who may participate in this PPIP. What have I learned?

If buyers and sellers previously had a wide gap in the perceived value of these toxic securities, then it appears as if that gap may have widened. While cheap government financing and loss mitigation allow buyers to pay higher levels, their bids are only higher by a few points. Meanwhile sellers, instead of working toward a middle ground in the price discovery process, have actually raised their prices.

How might this get rectified? Uncle Sam, in the persons of Tim Geithner and Sheila Bair, will strong arm parties on both sides to engage and transact.

What may expedite this process? Little publicity has been given to the fact that the two largest corporate credit unions in the country, U.S. Central Credit Union and West Corp Credit Union, failed last week. What do these credit unions own in their portfolios? Lots of toxic assets. Who will handle the liquidations? The FDIC.

Buyers know that forced liquidations by failed institutions will establish price levels. If I am a buyer, why should I be in a hurry to purchase assets, knowing that there are plenty of assets for sale.

Why is the administration making the case for new and unprecedented powers at potentially Treasury, Fed, and FDIC to overtake non-financial institutions?

Matthew Richardson and Nouriel Roubini write on the predicament facing certain banks (thank you, Andy):

Finally, we have to anticipate the likelihood that some banks will resist selling their loans and securities. Why? Currently, the government has been giving them the option to keep holding them with the hope that market conditions will improve.

Going forward, the government must insist on the banks’ involvement in the new program. The reason that financial institutions must be pressured is that they are the cause of the financial crisis. They took advantage of loopholes to avoid regulatory requirements, taking a huge bet on securities they were never meant to hold in the first place.

What happens if removing toxic assets from a bank’s balance sheet at near-market prices shows it is effectively insolvent? Then we will have to face the elephant in the room. We may then have to start asking, “Why keep insolvent banks afloat?” And having asked that, we will have to search for ways to manage the ensuing systemic risk.

Either way, once the plan is fully implemented, we will be entering a new phase of the financial crisis.

The powers that be in Washington know that the liquidation process of these toxic assets will inevitably cause the failure of even more entities, both financial and non-financial. To that end, they are making the case now for new powers to step in, take over certain institutions that may pose real systemic risk, and methodically liquidate them. If that is the case, as a potential investor I am behooved to wait and be patient.

Moody’s Cuts Wells, BofA Ratings. What prompted these cuts? Exposure to commercial real estate. Exposure to option-ARM mortgages. Exposure to California and southwestern U.S. market that has extraordinary high levels of delinquencies and defaults.

The waves are high and getting higher. The cross currents are vicious. The undertow is strong.

LD

I thank our loyal reader in Michigan, Mr. Fiscal Liberal, for sharing with us a piece written by Simon Johnson, the former chief economist of the International Monetary Fund, a professor at the MIT Sloan School of Management, and a senior fellow at the Peterson Institute for International Economics.

Mr. Johnson writes about the growing problems in Europe. I am hard pressed to see how the European situation, both in the East and West, can not end badly. There are too many economies that are effectively insolvent or on the brink of insolvency. I believe this is the region of the world which will experience increased economic strife leading to social unrest and political change. Can the problems in Europe be contained given the massively interconnected world of global finance?

Thank you again FL for sharing this very enlightening piece from Simon Johnson!!

G-20s Real Agenda Should be Saving Europe from Itself
By Simon Johnson
Last Updated: 10:28AM GMT 16 Mar 2009

The media coverage of the G20 finance ministers meeting this weekend was dominated by the apparent battle between those who support more fiscal stimulus and those who want to impose more regulations on the financial system.

This, we are led to believe, is the big debate facing the full G20 heads of government summit early next month: the US is pushing for a bigger global fiscal stimulus (2pc extra government spending from everyone, to be monitored by the IMF), while the continental Europeans are holding out for greater regulation. Gordon Brown is trying hard to cast himself as the broker for any apparent deal.

However, don’t be fooled by all this sound and fury. The rival agendas of fiscal stimulus and regulation are both red herrings at this point in time.

The reality is much less promising, for three reasons.

First, co-ordinated fiscal expansion made sense early in 2008, when it was first proposed by the IMF. But the severe downturn that followed the onset of financial panic last September means that very few countries can now afford to spend more or tax less.

And while the hard-headed redesign of regulation should be a top priority going forward, the G20 regulation agenda is weak.

Who really believes that establishing an international “college of supervisors” would achieve anything in terms of reigning in the power of major banks? Always a good principle to keep in mind when evaluating international reform proposals: anything that sounds meaningless is meaningless.

Second, while the conventional official reluctance to discuss unpleasant truths is always awkward, during a major global crisis it’s downright dangerous. Across the industrialised world, the financial sector has become too large and too politically powerful.

How do we break this power and move resources into something more productive and less inherently unstable? How do we deal with the failures of risk management, CEO leadership, and corporate governance in our still massive banks? Can we break them up before they break our economies?

There is not even an inkling of these major issues on the G20 agenda.

Third, politicians keep repeating something along the lines of “we face a global problem that needs a global solution” – this was Gordon Brown’s refrain in Washington recently. But the most pressing problems in 2009 are not so much global as European.

Back in the 1990s, much of east central Europe put itself on a high risk debt-fuelled growth path, egged on by Brussels. European Union accession countries were told that they could afford to import far more than they export – and that this difference would be financed by capital coming in from Western Europe. This was true, for a while, but now the crash in Eastern Europe threatens to bring down banks in Austria, Greece, Italy and other places that bet big on Hungary and its neighbours getting rich quick.

As Eastern Europe has plummeted into crisis, the West European response has been further bad advice. Countries with fixed exchange rates, such as Latvia, are told to cut wages and prices by 20-30pc, rather than devalue their currency.

Never mind that this is political suicide and bad economics. Brussels considers it better for the West European banks with capital at risk. Almost all of Eastern Europe is in trouble and will need to borrow from the IMF; the massive over-representation of Western Europe on the IMF’s board suggests that this will end badly.

And that’s not all. The crash of real estate in Ireland, Spain, and the UK worsens bank balance sheets that are already damaged from losses incurred in the crazy casino that was the American mortgage market.

The financial sector globally is shrinking, and this will lead to significant job losses in countries like the UK and Switzerland.

It gets worse. The US has banks that can plausibly claim they are Too Big To Fail, and this is bad enough – because it lets them get big bailouts. But Europe has banks that may be Too Big To Rescue – ask Iceland or, more recently, Ireland.

Far from being able to afford government expansion, European economies with big banks see the prospect of budget cutbacks – to persuade the financial markets that their governments are still good credit risks.

European countries face two types of future. On the one hand, countries that still control their own currencies can engage in creative monetary measures, pushing down the exchange rate and raising inflation; the Bank of England leads the way in this regard. Inflation will reduce debt burdens but of course comes with other costs. Think of it as the worst of all possible policy choices, apart from the alternatives.

And those most unpleasant alternatives are faced by Eurozone countries. Their economies are slowing dramatically, their banks are impaired, their budgets are constrained, and their monetary policy is in the hands of the European Central Bank (ECB).

These countries face the prospect of falling wages and prices. Most central bankers would recoil in horror as this deflation threatens further defaults and a deeper recession, but Jean-Claude Trichet, head of the ECB, is actually welcoming this development in Ireland and elsewhere.

The real agenda of the G20 should be helping save Europe from itself, for example by encouraging the creation of a €2-trillion European emergency economic stabilisation fund, funded primarily by richer Eurozone countries, and a major relaxation of Eurozone monetary policy.

Without such measures, we are likely on the path to a bigger slowdown in global growth and a more difficult recovery.

Simon Johnson, former chief economist of the International Monetary Fund, is a professor at the MIT Sloan School of Management and a senior fellow at the Peterson Institute for International Economics. He co-founded and contributes to the economics blog The Baseline Scenario.

At the core of most, if not all, of our economic problems lies housing. I do not need to replay the tape of low rates, shoddy underwriting, and Wall Street securitizations that all played a dramatic role in creating a bubble the likes of which we have never seen and hopefully never will again. All that said, housing is an enormous market with a wide array of factors impacting it. How does one track it? Are we supposed to rely on our local brokers telling us things feel better? Should we ask contractors if they are bidding on jobs? Dare we rely on our local or national media outlets to provide their expertise and pandering? If we did, housing may have bottomed 14 different times in the last 10 months. In all seriousness, how can we track housing? Welcome to Sense on Cents.

There are two indexes that have developed over the last few years and are enormously respected by market participants. One index, the S&P/Case-Shiller Home Price Indexes, is released on a monthly basis. This index tracks a variety of regions in the country but not every region. Still, all things considered, this index is widely watched as a reliable indicator of health in housing. The index is typically released toward the end of each month. The most recently released report was on February 24th, A Look at Case-Shiller Numbers, by Metro Area. In this report, all indications are that housing has yet to see any support.

Aside from the Case-Shiller Index, there is another index that tracks trends in housing and allows investors to reflect their opinions. This index, the ABX (Asset Backed Index), was created a few years ago by Wall Street to track trends in housing. Clearly given the emphasis on Obama’s housing, plans put forth by Secretary Geithner would have put some optimism in this index, right? Well, we are all aware of the enthusiasm put forth in Obama’s plan to support housing; however, no plan is a panacea and every plan has unintended consequences. Despite the best intentions in Washington, the market sees no bottom in housing.

The ABX is not traded on an exchange and thus easily tracked. Enter my friends at 12th Street Capital who shared with me a few days ago that the “ABX went out at its ALL TIME LOWs yesterday. The real money sellers continue to push it lower in conjunction with the stock market and other credit markets and clearly the street has no interest in supporting the current levels, hence unless you have some real money buyers come into the
market you could expect to see continued softening.”

There you have it. Both indexes that track housing are at all-time lows. Thus, while the stock market had a nice bounce the other day, before we get overly ebullient about the potential for stocks, we want to see if we are seeing any sort of support in these two indexes. For my money, these will be the first two indicators showing a turn in our economy and giving me confidence to invest in stocks.

LD

Oddly enough, the ABX market did not participate in the rally on Tuesday. In 2008 I would have said that the next day rally in ABX would almost be a certainty, however with continued uncertainty regarding government intervention on mortgages and MBS, it seems most longs are carefully picking their spot in the MBS market.

Charles Krauthammer is someone for whom I have developed a grudging respect, thanks in no small part to my friend, SusanUnPC at No Quarter, who encouraged me to read him (until SusanUnPC told me, I didn’t know that Krauthammer is a psychiatrist who is paralyzed as a result of a diving accident. Clearly, he has not let that stop him one bit.). What I have discovered is that he is a very deliberate thinker. I may not always agree with what he says, but I can’t disagree with how he reaches his conclusions, if you know what I mean. And it is Mr. Krauthammer’s article, The Great Non Sequitur, The Sleight of Hand Behind Obama’s Agenda(h/t to LisaB for this article), with which I want to begin. Again, it is the economy that he is addressing, and Obama’s response to it:

Forget the pork. Forget the waste. Forget the 8,570 earmarks in a bill supported by a president who poses as the scourge of earmarks. Forget the “2 trillion dollars in savings” that “we have already identified,” $1.6 trillion of which President Obama’s budget director later admits is the “savings” of not continuing the surge in Iraq until 2019 — 11 years after George Bush ended it, and eight years after even Bush would have had us out of Iraq completely.

Forget all of this. This is run-of-the-mill budget trickery. True, Obama’s tricks come festooned with strings of zeros tacked onto the end. But that’s a matter of scale, not principle.

All presidents do that. But few undertake the kind of brazen deception at the heart of Obama’s radically transformative economic plan, a rhetorical sleight of hand so smoothly offered that few noticed.

The logic of Obama’s address to Congress went like this:

“Our economy did not fall into decline overnight,” he averred. Indeed, it all began before the housing crisis. What did we do wrong? We are paying for past sins in three principal areas: energy, health care and education — importing too much oil and not finding new sources of energy (as in the Arctic National Wildlife Refuge and the Outer Continental Shelf?), not reforming health care, and tolerating too many bad schools.

The “day of reckoning” has arrived. And because “it is only by understanding how we arrived at this moment that we’ll be able to lift ourselves out of this predicament,” Obama has come to redeem us with his far-seeing program of universal, heavily nationalized health care; a cap-and-trade tax on energy; and a major federalization of education with universal access to college as the goal.

Amazing. As an explanation of our current economic difficulties, this is total fantasy. As a cure for rapidly growing joblessness, a massive destruction of wealth, a deepening worldwide recession, this is perhaps the greatest non sequitur ever foisted upon the American people.

Well, that’s ONE way of putting it! A non sequitur. Nicely put. He continues:

At the very center of our economic near-depression is a credit bubble, a housing collapse and a systemic failure of the banking industry. One can come up with a host of causes: Fannie Mae and Freddie Mac pushed by Washington (and greed) into improvident loans, corrupted bond-ratings agencies, insufficient regulation of new and exotic debt instruments, the easy money policy of Alan Greenspan’s Fed, irresponsible bankers pushing (and then unloading in packaged loan instruments) highly dubious mortgages, greedy house-flippers, deceitful home buyers.

The list is long. But the list of causes of the collapse of the financial system does not include the absence of universal health care, let alone of computerized medical records. Nor the absence of an industry-killing cap-and-trade carbon levy. Nor the lack of college graduates. Indeed, one could perversely make the case that, if anything, the proliferation of overeducated, Gucci-wearing, smart-ass MBAs inventing ever more sophisticated and opaque mathematical models and debt instruments helped get us into this credit catastrophe.

I can’t argue much with him there. And thank heavens SOMEONE is bringing up Fannie Mae and Freddie Mac. Both played a HUGE part in our current fiscal crisis, ye tfor reasons I don’t understand, these two institutions are rarely mentioned in the conversation these days.

Krauthammer continues:

And yet with our financial house on fire, Obama makes clear both in his speech and his budget that the essence of his presidency will be the transformation of health care, education and energy. Four months after winning the election, six weeks after his swearing-in, Obama has yet to unveil a plan to deal with the banking crisis.

What’s going on? “You never want a serious crisis to go to waste,” said chief of staff Rahm Emanuel. “This crisis provides the opportunity for us to do things that you could not do before.”

Things. Now we know what they are. The markets’ recent precipitous decline is a reaction not just to the absence of any plausible bank rescue plan, but also to the suspicion that Obama sees the continuing financial crisis as usefully creating the psychological conditions — the sense of crisis bordering on fear-itself panic — for enacting his “Big Bang” agenda to federalize and/or socialize health care, education and energy, the commanding heights of post-industrial society.

I guess that’s some of that Chicago-style politics we’ve heard about – not wanting a “serious crisis to go to waste.” That is just so offensive in so many ways, my head is spinning. Apparently, so was Krauthammer’s:

Clever politics, but intellectually dishonest to the core. Health, education and energy — worthy and weighty as they may be — are not the cause of our financial collapse. And they are not the cure. The fraudulent claim that they are both cause and cure is the rhetorical device by which an ambitious president intends to enact the most radical agenda of social transformation seen in our lifetime. (letters@charleskrauthammer.com )

Paul Krugman also takes as his jumping off point Obama’s address to Congress in this article,
The Big Dither (h/t to American Girl for this). You just have to love that title, don’t you? Anyway, Krugman doesn’t seem all that impressed with how Obama is handling things given his rhetoric:

Last month, in his big speech to Congress, President Obama argued for bold steps to fix America’s dysfunctional banks. “While the cost of action will be great,” he declared, “I can assure you that the cost of inaction will be far greater, for it could result in an economy that sputters along for not months or years, but perhaps a decade.”

Many analysts agree. But among people I talk to there’s a growing sense of frustration, even panic, over Mr. Obama’s failure to match his words with deeds. The reality is that when it comes to dealing with the banks, the Obama administration is dithering. Policy is stuck in a holding pattern.

Here’s how the pattern works: first, administration officials, usually speaking off the record, float a plan for rescuing the banks in the press. This trial balloon is quickly shot down by informed commentators.

Then, a few weeks later, the administration floats a new plan. This plan is, however, just a thinly disguised version of the previous plan, a fact quickly realized by all concerned. And the cycle starts again.

That sounds about right, doesn’t it? Just keep plying the same piece of crap, and give it another name! Yep – same plan, different day, same result:

Why do officials keep offering plans that nobody else finds credible? Because somehow, top officials in the Obama administration and at the Federal Reserve have convinced themselves that troubled assets, often referred to these days as “toxic waste,” are really worth much more than anyone is actually willing to pay for them — and that if these assets were properly priced, all our troubles would go away.

Thus, in a recent interview Tim Geithner, the Treasury secretary, tried to make a distinction between the “basic inherent economic value” of troubled assets and the “artificially depressed value” that those assets command right now. In recent transactions, even AAA-rated mortgage-backed securities have sold for less than 40 cents on the dollar, but Mr. Geithner seems to think they’re worth much, much more.

And the government’s job, he declared, is to “provide the financing to help get those markets working,” pushing the price of toxic waste up to where it ought to be.

What’s more, officials seem to believe that getting toxic waste properly priced would cure the ills of all our major financial institutions. Earlier this week, Ben Bernanke, the Federal Reserve chairman, was asked about the problem of “zombies” — financial institutions that are effectively bankrupt but are being kept alive by government aid. “I don’t know of any large zombie institutions in the U.S. financial system,” he declared, and went on to specifically deny that A.I.G. — A.I.G.! — is a zombie.

This is the same A.I.G. that, unable to honor its promises to pay off other financial institutions when bonds default, has already received $150 billion in aid and just got a commitment for $30 billion more.

Doesn’t that just BURN YOU UP??? That AIG is getting even MORE money? HOW is this going to help, especially since they seem not to have changed their behavior one whit. Krugman continued:

The truth is that the Bernanke-Geithner plan — the plan the administration keeps floating, in slightly different versions — isn’t going to fly.

Take the plan’s latest incarnation: a proposal to make low-interest loans to private investors willing to buy up troubled assets. This would certainly drive up the price of toxic waste because it would offer a heads-you-win, tails-we-lose proposition. As described, the plan would let investors profit if asset prices went up but just walk away if prices fell substantially.

But would it be enough to make the banking system healthy? No.

Think of it this way: by using taxpayer funds to subsidize the prices of toxic waste, the administration would shower benefits on everyone who made the mistake of buying the stuff. Some of those benefits would trickle down to where they’re needed, shoring up the balance sheets of key financial institutions. But most of the benefit would go to people who don’t need or deserve to be rescued.

And this means that the government would have to lay out trillions of dollars to bring the financial system back to health, which would, in turn, both ensure a fierce public outcry and add to already serious concerns about the deficit. (Yes, even strong advocates of fiscal stimulus like yours truly worry about red ink.) Realistically, it’s just not going to happen.

Oh, dear. Well, that’s not very encouraging, is it? No, not really, and Krugman doesn’t think so, either:

So why has this zombie idea — it keeps being killed, but it keeps coming back — taken such a powerful grip? The answer, I fear, is that officials still aren’t willing to face the facts. They don’t want to face up to the dire state of major financial institutions because it’s very hard to rescue an essentially insolvent bank without, at least temporarily, taking it over. And temporary nationalization is still, apparently, considered unthinkable.

But this refusal to face the facts means, in practice, an absence of action. And I share the president’s fears: inaction could result in an economy that sputters along, not for months or years, but for a decade or more.

That’s been the problem all along, isn’t it? The inability, or unwillingness, to face facts, from our officials AND the electorate, who have demonstrated that very characteristic for far too long. Heck, that’s how we ended up with Obama in the first place – the blind acceptance of his words with nary a glance at his deeds, the unwillingness to look at the FACTS about Obama, who he is, what his record is or is not, his connections to unsavory characters, his Chicago-politician history and style, his lack of policy, his blatant theft of ideas…

And the latter is the big problem now. Because he got over during his campaign by taking Clinton’s ideas, often whole cloth, he has NO idea how to implement them, or how to adjust them, or what is necessary for them to be successful. We are bearing the brunt of this Cheater in Chief, who hasn’t the foggiest how to adequately address the economic climate in which we find ourselves, through loss of jobs, homes, and retirement funds. A man who has gotten where he is not by his own hard work, but the King making of others. This man who provides the non sequitur, the Zombie plan, is not going to fix this disastrous economy. Inaction is not the answer, but WHAT the action is is crucial.

I can only hope that people of this stature, the Krugmans and Krauthammers among us, continue to speak out. Hopefully, prayerfully, their words will get through, and maybe, just maybe, we can get ourselves out of this “thing,” as Emmanuel said, not for political gain, but for the sake of the country.

Let’s review my specific projections from the January 2009 Recap:

For those who track the markets, there is a 75-80% correlation in the annual moves in equity markets with the performance in January. Without parsing words, this performance in January portends a very challenging year for our equity markets. All eyes and ears remain focused on Washington for a comprehensive financial rescue package (Bank Transition, insurance for other assets, aid to stem foreclosures, et al). Trade the range for now with a very wide band. Buy the S&P as it approaches 750 and sell it as it moves above 900. Otherwise….be patient!!

In the bond space, I did believe and continue to believe that despite the Fed and Treasury promoting the concept of quantitative easing (using the Fed’s balance sheet to buy Treasury, agency, and mortgage related assets), these rates will work their way higher simply due to the MASSIVE financing needs of our government and global governments.

The corporate bond space, led by high yield bonds, had very solid returns this month. As we mentioned, we thought these sectors had already priced in the economic turmoil to a much greater extent than the stock markets. High yield bonds were up almost 10% on the month. I would not add to that sector after that performance.

The dollar inched lower versus the Japanese yen. I believe the dollar will continue to weaken versus the yen, as well as the Canadian dollar. The U.S. dollar dramatically outperformed the Euro and the British pound. The economic situation in Europe is just as bad, if not worse, than in U.S. In fact, a number of European countries are being seriosuly challenged to raise funds. Sovereign credit risks (the risk that a government defaults) have risen considerably.

In the world of commodities, gold outperformed due to the global government credit risk, the threat of longer term inflation, and weakness in currencies. Oil remains very volatile but ended the month down 2.5%. Metals remain weak with anemic demand.

Add it all up and what is one to do? In my estimation, an investor is being paid to WAIT before making any major capital commitments. For those who are significantly underweighted stocks, a dollar cost averaging (add a fixed dollar amount on a regular basis versus one lump sum at one point in time) approach is always recommended. I am not going out on a limb to say that we will retest the lows (down another 7-9%) seen on November 20th.

Well, we have retested those November 20th lows and on the last two days of the month took them out by 2-3%. We are now down anywhere from 12-19% across the board for most stock indices on a year to date basis.

In a normal market environment, if stocks gave ground by 2-4%, one would expect government bonds to rally in a “flight to quality” move. The fact that equities are down 11% for the month and government rates have moved HIGHER is a clear indication that the overwhelming supply of government bonds to finance our deficit will continue to be a major issue going forward. The market absorbed well more than $150 billion in government supply (bills to 30 year bonds) this month. In the face of that, it is no surprise that rates moved higher. The question for investors is where does one go.

The enormous government supply along with the weakness in stocks did put a dent in the credit sensitive sectors of the bond market this month. The “crowding out” effect (government financing needs crowd out the availability of capital to flow to private enterprise) will continue to be a major problem.

In very volatile trading, the U.S. dollar did improve primarily versus the Japanese yen while only marginally versus the Euro (although it is significantly stronger vs the Euro on a year to date basis). As I mentioned to a reader, the yen seems to have weakned as many hedge funds have finished unwinding trades in which they had borrowed the yen. I missed this call and thus I was clearly wrong that the dollar would still weaken vs the yen.

Gold is up solidly on the year but actually had gotten higher than $1,000/oz during the month. I do not invest in gold simply due to a highly speculative contingent that plays in this commodity. I think many funds and managers have purchased this commodity as a safe haven move but are willing to sell those positions out for short term profits.

The BIG question is where do we go from here. Should I buy stocks here? Should I sell? Should I hold? Obviously, those are questions that can only be answered based on one’s personal situation. All I can offer is my assessment of the markets, the economy, Washington, Wall Street and hope it helps you navigate your own financial and economic landscape.

While the markets have retraced back to those November 20th lows and even moved lower by 2-3%, I still can not make a case for buying the market. Why? Very simply because overall market valuations do NOT clearly and distinctly display themselves as cheap. You may ask how is it that markets that are now down 50+% are not cheap. Remember that stock prices are a measure of forward earnings and the multiple paid for those earnings. A fair multiple is typically between 12-18% but in bear markets that multiple can get decidedly cheaper than 12. Let’s take a multiple of 15 times. At yesterday’s close of 735, that equates to an earnings projection on the S&P 500 of $49/share. That is overly optimistic and hopeful and thus the risk remains too high relative to the reward.

I always traded and invested based on the premise that “hope is a lousy hedge” meaning that one needs to fully review the risks prior to investing and not “close your eyes, buy in because it is down a lot, and HOPE it works.” I do think we are approaching a stage where the market may still move lower but then start more of a sideways price action. Why? Very simply because the volumes are declining on a lot of exchanges which indicate the selling pressure is abating. That said, I think investors are in NO rush to buy.

I actually have somewhat greater concerns about bonds than stocks. Why? I think a lot of investors have rushed into the bond market, that supply of bonds will increase not only in the government space but also the municipal space as towns, cities and states deal with their budgetary problems. Corporate bonds were very cheap relative to stocks coming into the year but have dramatically outperformed in the first two months. Given that a lot of investors in the corporate bond space are newer investors (looking for a place to park money), I think bonds across all sectors may start to weaken from here.

The U.S. dollar is benefitting from a flight to quality move given the major political and social issues elsewhere in the world. Additionally, as the U.S. government has shown it will not allow major banks to fail (although the banks’ shareholders can and will be diluted), a lot of money has flowed into the dollar. I think the Canadian dollar and Australian currency are fundamentally stronger than the U.S. dollar at this point.

In regard to Washington and its impact on the economy and markets, it strikes me that the Obama administration is hellbent on implementing as much of its social program and liberal agenda as quickly as possible. The markets are sending a very clear signal that his agenda is not pro-growth, investor friendly, or fiscally sound. He’s the President and the electorate sent the Republicans home, so we need to let our democratic process work. That said, the markets do not and will not stand idly by “HOPING” things work out.

I do firmly believe we will work our way through these economic challenges, but it will be a longer and harder road than most market analysts and political pundits would promote. Maintaining hope is a critically important part of our country and our moral fiber. I am ALWAYS hopeful, but I am not blindly hopeful. That would be called willful neglect.

Check out the piece, Buy and Hope Investing, written by John Mauldin, one of our Economic All-Stars (see left sidebar at Sense on Cents).

One thing I truly hope is that you find Sense on Cents helps you to navigate the economic landscape and that you will share the site with your friends.

LD

For clarification purposes and at the request of a number of readers, allow me to address this deduction. As proposed in President Obama’s budget, for those households currently paying taxes in the 33% and 35% brackets, the mortgage deduction would now be at a 28% rate. The proposal would not take effect until 2011.

This Mortgage Deduction Looks Less Sacred. Its effect can and is hotly debated by economists and housing analysts. In my opinion, though, there are a few points not debatable. This initiative is another method of achieving wealth redistribution. It will make housing more expensive at the margin. It will put pressure on housing in general and in upper income areas specifically. Given that there are no initiatives proposed to support those needing Jumbo mortgages, this tax change will only further negatively impact this sector of the market.

Lastly, is this Obama’s “crossing the Rubicon?” Don’t think for a second that this initiative just developed. How and why did we NEVER hear about this during the campaign? Did he know how negatively it would be received?

In summary, having “crossed the Rubicon,” how far does he penetrate into the territory?

We’ll be watching, but knowing how wildly optimistic his growth projections are in his proposed budget, Obama will need more $$$. The mortgage interest deduction just became fair game.

I need to call my accountant.

LD

***UPDATE: I was not aware at the time of my writing but it is reported that the Obama administration is projecting the economy will grow at a 3.2% GDP in 2010. That assumption is wildly optimistic. No respected economist would project that figure. Consensus has it in the 1.5-2% range. What does this mean? Well, lower growth means lower revenues, means higher deficits, means greater funding needs, means more borrowing, means higher government interest rates, means more “crowding out”, means slower growth for the economy going forward!!

There was little doubt about President Obama’s social agenda and economic platform during his campaign. While markets will somewhat discount campaign rhetoric, they do not discount economic reality. The markets are sending a strong signal that Obama’s economic proposals and proposed budget are anything but pro-growth. Obama Delivers $3.6 Trillion Budget Blueprint runs the risk of raising taxes at a time of economic distress. Raising taxes was a prime factor that increased the economic malaise in the 1930s. Obama is willing to take that risk as he sticks to his campaign plan and is pressured by the liberal wing of the Democratic Party.

We know that housing lies at the core of our economic crisis. Decreasing a mortgage interest deduction as proposed to fund his health care proposal will only serve to put further pressure on a large part of our nation’s housing market. I thought we were trying to stabilize housing.

Proposing a decrease in the deduction for charitable giving by the top 2% is not going to help increase — let alone hold — the level of giving when it is most badly needed. (Joe Biden needn’t worry about this given he has averaged $350 per year in charitable giving over the last ten years!! That’s right. Those stats are in his publicly filed tax returns). I thought we were trying to promote charitable giving.

Given that many small businesses file under the individual tax system as limited liability companies or Subchapter S corporations, Obama’s proposed tax increases will not serve to help employment. I thought we were trying to promote job growth.

Well, I can’t say that I’m surprised by Obama aggressively putting forth his agenda, but this is the redistribution of wealth that was hotly debated during the campaign.

I strongly believe the government should not focus on tax rates but rather tax revenues. What rates generate the most revenues and then spend it accordingly.

Additionally, if one thinks his tax increases are stopping at the top 2% or only those at 250k and above, let me share with you that these changes will effect those with taxable earnings of 208k. Well, 208k vs 250k. I mean it’s close. If you think he is stopping at that, guess again. The 2% Illusion is not reality!!

Obama is President so he writes the budget, but for every action there is a reaction and the markets are not reacting well.

Ceteris are NEVER paribus!

LD

LD

While there is tremendous volatility in the markets and commensurate anxiety as a result, there were some major stories and developments that got less play but deserved more.

Allow me to expound. Robert Shiller, a highly distinguished Economics Professor at Yale Univeristy and co-designer of the Case-Shiller Home Price Index spoke this morning on Bloomberg News. Shiller is the preeminent expert on trends and developments in housing. He made the following assessments:

1. Glad to see that Obama is making an effort to support housing but has serious concerns about the effort.

2. $75 billion allocated for loan modification is not nearly enough to make a truly meaningful impact. (remember there is another $200 billion allocated for Freddie and Fannie to refinance mortgages).

3. No plan or proposal for those holding Jumbo mortgages leaves a large part of the market without benefits. Those homes will likely hang over the market.

4. Shiller believes we may very well see a second wave of speculation in housing. He has this opinion because he thinks some buyers will try to “bottom fish” the market. He believes our view of housing as an investment vehicle as opposed to a means of shelter and comfort needs to change!

5. He finds it impossible to make a forecast on the housing market given the great uncertainties about the impact of the stimulus proposal and banking plans.

6. While he welcomes the Obama adminsitration’s efforts, he cautioned that this economic downturn led by housing will not be over quickly.

7. Confidence is badly needed and will only return when our government and global governments are able to develop strategic and robust long term planning.

What do I think of Shiller’s comments? I think he is stating that Obama’s housing plan is well intended but given that we can not distinctly segment the housing market by sectors that it will have a marginal impact. Additionally I think he is being cautious in stating that Americans need to change their mindset about homes being piggy banks. I measure his comments next to former Australian Treasury Secretary Keating and I see the same message; this downturn will take considerable time to turn around!

I also listened to the cult-like NYU Professor Nouriel Roubini today as well.
He offered the following:

1. Strong possibility of a sovereign default in the Euro zone. He singled out Ireland, Greece, Iceland, Spain, Italy and Belgium as countries with the most issues within their banking sectors. He does believe that if only one or two countries expose their problems that the balance of the European Union will support them. He did not offer an opinion if the contagion is so massive and spreads. He did highlight the fact that Western European banks have outsized exposures to emerging Europe and the emerging markets elsewhere in the world. He singled out Estonia, Latvia, Lithuania, Belarus, and Ukraine as the countries with the greatest issues.

2. In the United States he thinks the prospects of a temporary nationalization of a major bank or banks may happen very soon. He does think the Obama administration’s moves so far (bank plan, housing) are in the right direction but do not go far enough.

3. Roubini does believe that the United States has moved quicker to address our issues than either Europe or Japan.

4. On the housing front he thinks that we will eventually have to move to a “principal reduction” program in order for it to be effective.

5. How will we pay for all this? Everybody’s taxes will be going up although not right away. We will also have to deal with increasing inflation.

Away from these two titans, there was a lot of rumbling in the markets and from Washington about bank nationalization. While Ken Lewis, CEO of Bank of America was all over the news defending BofA and how nationalization should not be a topic of conversation, I saw and heard nothing from anybody at Citibank. The market believes that Secretary Geithner will be out next week with more details about his Financial Stability Plan (hopefully it goes better this time) and there is an outside chance he releases something over the weekend.

From Washington I heard conflicting viewpoints on nationalization from Senator Dodd. Dodd was panned on Bloomberg at one point. I will admit he makes for a very easy target.

LD

1. Support is only provided to those homeowners occupying the residence. No support for speculators or developers.

2. The government will increase the portfolios of Freddie Mac and Fannie Mae to purchase mortgages that are refinanced. These portfolios are currently sink holes swallowing billions in taxpayer funds given irresponsible management and pathetic risk management over the last 15 years.

3. The government will work with and incent mortgage servicers to rewrite mortgages to 31% of income for these homeowners.

4. For those mortgage servicers who do not cooperate, repercussions will be made in terms of not providing government assistance to these entities if necessary.

5. Treasury will provide up to $200 billion to support these initiatives. Additionally the governmetn will provide $75 billion to encourage lenders and servicers to modify loans.

6. If mortgage servicers do not cooperate, the government will support judges to “cram down” the principal of the mortgage during bankruptcy proceedings.

The Obama administration believes these steps will support upwards of 8 million homeowners in staying in their homes. Jamie Dimon, CEO of JP Morgan, applauded the steps outlined as being comprehensive. With all due respect to Mr. Dimon, he is playing the political game and currying favor with the government given JPM’s position at the epicenter of this situation.

Make no mistake, the price for these programs is being borne by responsible taxpayers, investors, and future generations. To that end, Obama played the responsibility card at the end of his speech. He did not, however, provide any specifics on the responsibility front.

I would call on President Obama to be more specific by what it means to be responsible:

1. not fathering children out of wedlock…70% of African American newborns are borne to a single parent, 50% of Hispanics, 30+% of Caucasians. The two-parent family is the strongest and most effective social program ever designed!!

2. will abortion on demand promoted via the Freedom of Choice Act lead to greater responsibility? It is beyond naive to think that FOCA will lead to anything more than increased promiscuity and further destruction of the two parent family. How can Obama truly believe this Act will promote any degree of increased responsibility? This Act is pure politics placating the far left wing of the Democratic Party.

3. keeping your kids in school. Let me remind him again that 50% of inner city students are high school dropouts.

Homeownership is a privilege, not a right. Neither privileges nor rights come without responsibilities!! Responsibilities are not words or platitudes, they are actions and disciplines practiced everyday!! I am more than willing to help, but I have no interest in throwing good money after bad.

LD

This morning at 10am, the CEOs of the major money center banks in our country will be in Washington to face Congressional heat. Watch it LIVE on C-Span3.

These CEOs are easy targets for plenty of reasons. As a precursor to their testimony, I thought it may be helpful to view a 1-minute clip of Jamie Dimon, CEO of JP Morgan, commenting on the proposed stimulus plan, the state of the banking industry, and the concept of nationalizing the banking industry.

If I were questioning these CEOs, I would want to ask the following:

1. To all the CEOs, how do you justify paying $18+ billion in year end bonuses after having taken more than $150+ billion in government funding?

2. Why shouldn’t Citi be formally nationalized right now given the market’s belief that if positions were marked to market properly that the institution would be insolvent?

3. How do you justify the egregious process of raising rates on credit card lines for consumers who are not delinquent?

4. Mr Pandit (CEO of Citi), can you share with us the marks on the super-senior classes of CDOs that you held in your off balance sheet SIVs?

5. Mr. Lewis (CEO of Bank of America), did you feel any sense of obligation to your shareholders to reveal the expected losses from Merrill Lynch prior to asking those shareholders to approve the deal?

6. To all the CEOS, please share with us your opinions as to how much more capital needs to be injected into the banking system in order to recapitalize the system?

7. Mr. Dimon, (CEO of JPM), your bank is the largest player in the CDS (credit derivatives) market, please share with us how this market should be regulated going forward?

8. WHERE’S THE MONEY???????

We will now open this thread to “NQ World” . . . what do you want to ask or say to these bank CEOs!!! Don’t be bashful!!