The Mortgage Insider

Is it just me, or does the current proposed financial reform sound somehow engineered by the very banks that caused this mess? It feels a lot like the suspicions I had around the distribution of TARP funds. We give these financial geniuses billions of our tax dollars to cover their bad bets—but heaven forbid we demand an accounting for what they do with it. I guess you can just add the phrase “political transparency” to your list of oxymorons, eh? So much for hope and change …

So let’s talk about “too big to fail” for a moment and examine the stakes involved here. Of the more than 8000 banks we still have left in the country, just four control nearly 40 percent of our country’s deposits: Wells Fargo, Bank of America, Chase, and Citibank. Now add everyone’s favorite, Goldman Sachs, and let’s talk about that nasty unregulated derivatives market. These five institutions have 97 percent of the industry’s notional derivative exposure (nearly $200 trillion1 still). If ever there was a case to be made for breaking up and compartmentalizing an industry into smaller parts, this one screams for intervention on the public’s behalf. You would think that would be particularly clear, given the fact that these very derivatives exposures (read as huge potential capital shortfalls) nearly just caused worldwide financial collapse. So clear, in fact, that even John Reed, the former head of Citicorp, apparently now agrees.

For those of you who don’t know, it was John Reed and Sandy Weill, CEO of the Travelers Group, who in 1998 arranged the $76 billion merger between Citibank and Travelers. Travelers owned the investment house Salomon Smith Barney, and combining all these together made Citigroup the world’s largest financial services company. However, this deal would not have been possible without the repeal of the Depression Era Glass Steagall Act in 1999. The Glass Steagall Act of 1933 expressly outlawed combining insurance underwriting, securities underwriting, and commercial banking together. You see, the first Great Depression had something to do with the financial sector being grossly over leveraged and operating in an environment laden with conflicts of interest and fraud. Talk about your déjà vu, huh? Oh, and did I mention the Glass Steagall Act would have also prevented this unregulated derivatives market from ever forming? So there’s that.

But wait, you ask, “These dates aren’t right!? How did a deal that violated federal law get done in 1998, if the law wasn’t repealed until over a year later in 1999?” Well, children, that it what my people call a successful “lobbying effort.”

For those of you without a proper legal background, “lobbying” is the legal form of bribery we allow of our public officials, by large commercial entities. These same officials justify this form of bribery as the “lobbyist’s right to free speech.” The practical form this “free speech” takes is, of course, as enormous campaign contributions. Those contributions are deposited directly to the personal campaign fund of the given public official, to squander as lavishly as he or she sees fit.2

Anyway, Mr. Weill and Mr. Reed made a bet that they had enough “free speech” on their balance sheets to get this Glass Steagall law repealed. They quickly added Gerald Ford (former U.S. President) and Robert Rubin (former Secretary of the Treasury under President Clinton) to their Board of Directors. So with both sides of the political isle covered and even more “free speech” to pass around, it only took a year and a half to take down this 66-year-old law that had served us all so well. President Clinton himself signed the repeal into law. So now you can all fully appreciate how ironic it is that John Reed now thinks: “As another older banker and one who has experienced both the pre- and post-Glass-Steagall world, I would agree with Paul A. Volcker (and also Mervyn King, governor of the Bank of England) that some kind of separation between institutions that deal primarily in the capital markets and those involved in more traditional deposit-taking and working-capital finance makes sense. This, in conjunction with more demanding capital requirements, would go a long way toward building a more robust financial sector.”3 Gee, Mr. Reed, what a keen grasp of the obvious you have.

Okay, so with the likes of Paul Volcker, and even our own Mr. Reed, singing the praises of breaking up these “too big to fail” banks, why does the current Administration’s reform effort appear headed in the opposite direction? After making Mr. Volcker head of his Economic Recovery Board, you would think it was because President Obama thought he might have some sense about how to fix this mess we are in. Well, not so much it seems. Both the senate and house versions of financial reform legislation create new super regulators and/or new government agencies, possibly funded with mandatory contributions from the “too big to fail” banks. This fund would then be used in the event the “too big to fail banks” pull this stunt again. But by doing so, this “too big too fail” notion is memorialized and codified into law. In other words, under these proposed reform measures, we accept having institutions large enough to pose a systemic risk, but we create an insurance policy for when it happens again. So you tell me, how would you ever know the fund was adequate and who would oversee the safety of such a large fund? Mmm … I seem to recall another large fund set up for insurance purposes. I believe they called it Social Security, but no one seems to know where all that money went either. And whose idea is this again? Well, I don’t know about you, but it sure sounds like a lot of “free speech” to me.

My advice for you? Use some real free speech and contact your representatives to demand some kind of common sense reform. In the meantime, mortgage rates won’t likely be this low again next year. So, if you are going to do anything with real estate, do it sooner rather than later.

1 According to the Office of the Comptroller of Curreny’s quarterly report on Bank Trading and Derivatives Activities 4th quarter 2008.

2 Feel free to Google “Keating Five” for further case studies in these sorts of effective lobbying efforts.

3 The New York Times, in a letter to the editor, published Oct. 22, 2009.

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In the news, the trade deficit (we import more than we export) jumped 18%, led by the greatest surge in imports in 16 years. Imports were led by automobiles and energy (oil), which are normally a signs of recovering demand amongst consumers. So this ugly number may actually be a good thing. On the other hand, these orders could be seen to replenish the (minimum) inventories needed, on the heals of the “cash for clunkers” program ended in August. Oil too can be distorted by hedging volume increases (speculation), set about by fears of a further falling dollar. It seems to me a bit early to declare the corner has been turned. But let’s hope so!

My concern here is that direct government stimulus in the economy over the last year is in excess of ($2.8T) 20% of our annual GDP (at $14T/yr). So should we be surprised that our growth last quarter was finally up 3.5%. Our should we feel short changed that it only amounted to a 9.7% turn around from 1 year ago levels. Call me crazy, but if I spend $20 to get a $10 benefit, I usually get a bit crabby. So we still need to see what the economy does when stimulus is withdrawn—whenever that may be. The unspent (collective) stimulus funds left are in excess of $8T. So if the dollar is already down 12% since March, what will it look like if they spend the rest of this, one wonders? The next few quarters will obviously be a critical test of this Keynesian spending theory, as the infrastructure projects and other shovel ready programs begin in earnest.

In other news, there are still over 300,000 foreclosure notices going out each month nationwide. Estimates are that fully half of those will become additional inventories eventually.  However, banks are currently actively delaying the marketing of those homes, in order to help support prices. Experts believe Denver metro should avoid any second dip in value, since our inventory levels are declining, and we never had the kind of over speculation seen in harder hit areas of the country. Let’s hope.

Have a great weekend!

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You may remember that little $787 billion economic stimulus bill, called the American Recovery and Reinvestment Act (ARRA). I wrote about it last January when the original proposal called for as much as $825 billion. I was disturbed back then by the size and delivery time tables. My reasoning was that if we were in such a state of emergency that we needed to drop nearly a trillion dollars to save us all, then why did the Congressional Budgetary Office indicate that approximately 30 percent of ARRA funds wouldn’t even be spent until 2011 or later?

Fast forward here to early November, and sure enough, eight months later, we have spent just somewhere around 21 percent or $168 billion of the total allotted for the ARRA. So that was the plan, right? The argument the Administration has made all along is that the New Deal failed not because it didn’t create any permanent new jobs, but because it was withdrawn too early. So paying people to dig holes and then fill them the next day, would have worked in the long run had we just given it more time. Makes sense to me. I can’t understand why you’d be scratching your head. Let me see if I can help you out here with the math.

According to CNNMoney.com and a handy little chart they created (http://money.cnn.com/news/storysupplement/economy/bailouttracker/index.html), we have spent $2.8 trillion of the $11 trillion+ allocated for all these sorts of government programs combined. Likewise, our economy normally generates an annual Gross Domestic Product (GDP) of approximately $14 trillion. So, dividing these numbers out, that investment of $2.8 trillion to save the economy is right at 20 percent of our annual GDP.  And how is that investment working out, you ask? Well 4^th quarter GDP in 2008 was down something like 6.2 percent. Meanwhile, this past Thursday, the Bureau of Economic Analysis (BEA) reported 3rd Quarter GDP at up 3.5%. So in a year, we borrowed and spent 20 percent of our annual GDP, to get an 9.7% percent turnaround in that same GDP. And all this without a single new permanent job created. Now you get it, right? I mean these are brilliant results really, and who could argue the need for even more of this kind of thinking?

Well, your wish for even more “investments” just like this are about to be granted, it appears. Congress has put together roughly $200 billion in new proposals for “Economic Relief.” But we are being instructed that these new programs should NOT be considered a second stimulus, even though some of them extend programs specifically included in the first stimulus. (Don’t make me report you to the government’s Web site for misinforming the public.) According to a recent Associated Press release: Nancy Pelosi said lawmakers need to hear from economists before settling on a package… “What is it that we can afford? What works the fastest?” Pelosi said. Well, I don’t know about you, but I can hardly wait for more clunker money. I missed the first one. But I won’t miss a second chance to stick my unborn grandchildren with the bill for a new car. I’m sure they will be miserable, unappreciative, little brats anyway. Serves them right!

In addition, the CNN chart does not include the $1 trillion the Federal Reserve has spent so far, buying mortgages from the big banks. (Thank goodness those trustworthy banks haven’t been grossly gouging the public, by charging nearly double the price they usually get selling mortgages.) And the Fed has also spent at least $300 billion buying U.S. treasuries to monetize some of our debt. That’s a fancy way of saying they simply printed money to buy that $300 billion dollars worth of treasuries. So we got that going for us to!

What does all that mean for mortgage rates? Well, the Fed seems committed to keeping rates down for as long as they are allowed to print our money. But with a nationwide campaign to audit the Fed looming, I wouldn’t wait much longer.

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“In my many years, I have come to the conclusion that one useless man is a shame, two is a law firm, and three or more is a congress.” – John Adams (2nd U.S. president)

Well, I think that adequately sums up yet another month of financial news, don’t you? Let’s review a couple of the more mind-boggling and egregious acts for fun.

We’ll start this month with the Administration’s circumvention of Article 1, Section 10, Clause 1 of the U.S. Constitution which is intended to prevent government from “… impairing the Obligation of Contracts …” otherwise known as the “Contract Clause.”

Our forefathers placed this clause in the U.S. Constitution for very good reason. As professor Zywicki, a professor of law at George Mason University, recently summed up in an article for the Wall Street Journal, “While the rest of the world in 1787 was governed by the whims of kings and dukes, the U.S. Constitution was established to circumscribe arbitrary government power. It would do so by establishing clear rules, equally applied to the powerful and the weak.”

Now, fast forward to 2009 and the Chrysler bankruptcy. We watched our own president browbeat senior debt (bond) holders into accepting 30 cents on the dollar, and then turn around and give the UAW 50 cents on their junior debt positions. So … let me get this straight. The Constitution is a sacred document when discussing the torture of Khalid Sheikh Mohammed, but it’s a worthless piece of paper when referring to contract law?  And what about more of those pesky unintended consequences, you might ask? Well, let’s just see how hard (expensive) it is to get private debtor-in-possession (DIP) financing lined up when GM goes through its bankruptcy—or eventually AIG, for that matter. Then, there is that toxic asset auction coming up one of these months. I bet the hedge fund and private equity guys (some of the same guys that were short-changed above) can’t wait to jump into bed with the government, knowing that any contracts may be subject to change shortly after the ink is dry. At least they will have the satisfaction of knowing it was their patriotic duty. I am sure that will be incentive enough, right?

This last month we were also treated to the stress test results for the nation’s 19 largest financial institutions. Pursuant to the Federal Reserve’s findings, 10 of the 19 were ordered to raise a total of almost $75 billion in additional capital. We were told that this was just a precaution against further economic downturn. The other nine were reportedly all quite healthy. That number was much better than most experts feared and sparked a nice little rally in financial stocks over the last few weeks.

So, what’s the hitch? Well, the only fact that concerns me is that the test purposely used a “cash flow” methodology for determining the value of these bank’s assets, rather than the standard account practice know as “market value.” This is a much more complicated (read as statistically manipulative) way to conduct the test. My guess is that it was determined early on that using standard accounting practices would have produced failing grades across the board, and that all 19 banks may actually be insolvent. So, this leaves one big question: If it was not for that reason, then why was this suspect method used? (Gee, wouldn’t it be nice if we still had any real journalists left in this country? Maybe then one of them might ask just that question.) If my suspicion is correct, then it appears the plan is to live with a bunch of zombie banks like they have in Japan. They have been in a recession for over a decade, waiting for their banks to earn their way out of the mess they made. And their banks were rank amateurs when it came to making a mess, as it turns out …

What does all of this collectively mean for mortgages and why should you care? Well, even if the Constitution doesn’t grab you, then maybe this fact will: Nationwide funding capacity for mortgages is down 85 to 90 percent from just one year ago. Yes, you read that correctly. That should tell you what shape these 19 banks are really in. That means getting a mortgage is taking much longer than usual. I see many clients who have waited with other lenders for 60 to 90 days without any results or answers, only to pull their loan applications and have to start all over. Then there is the other fact that the government’s $1.2 trillion program to suppress mortgage rates will be past its half-way point as early as the end of July. After that, rates will likely start drifting back up at an accelerated rate through the end of the year.

The bottom line is that if you are going to get in on these current mortgage rates, you need to start NOW! Once the government turns off the tap and this program is gone, I fear the mortgage market will go back to the same log jam we had before—but at substantially higher rates than before this program started. Unless you know something I don’t, you can’t simultaneously print $12 trillion dollars and avoid a severe case of inflation. Barring further market manipulations by Washington, think of mortgage rates approaching double digits again as early as late next year. I guess we’d better hope the housing market is all better by then, huh?

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The money powers prey upon the nation in times of peace and conspire against it in times of adversity. It is more despotic than a monarchy, more insolent than autocracy, more selfish than bureaucracy. It denounces, as public enemies, all who question its methods or throw light upon its crimes. I have two great enemies, the Southern Army in front of me and the bankers in the rear. Of the two, the one at my rear is my greatest foe. – Abraham Lincoln

As I mentioned last month, we had what I considered very suspect results from the Treasury’s “Stress Test” of our nation’s 19 largest banks. I was concerned because this so called test used a statically manipulative “cash flow” methodology, to value the banks’ toxic assets. My concern was that they were about to participate in an auction, that would expose the true market value of these very assets. Well… not to worry. The auction of toxic assets has apparently been postponed indefinitely. But wait…wasn’t that the magic bullet? Wasn’t that the way we were told that the banks would finally shed these toxic assets from their balance sheets and get back to business of lending? Haven’t we been told by our government all along, that we needed to cough up TRILLIONS of dollars in debt to pay for all these bailouts, to avoid another Great Depression? Weren’t we all under the impression that the sole source of all our problems economically was rooted in these “toxic assets” and the gross over leveraging they represented?  Hmm…

The really funny part is why the toxic asset auction was canceled …and you are just going to love this. Last month the 10 largest banks hired a firm by the name of the Clearing House Association. No, not the magazine subscription firm that shows up at your door with big oversize checks. However the Clearing House Association does show up routinely in Congress with big oversize checks, in a process we call lobbying. This time they were hired specifically to sell the idea that these banks should be allowed to bid on their own toxic assets at the PPIP (Public-Private Investment Program) auction. Yes, you read that correctly, and they probably used our bailout funds to finance this lobbying effort. Now normally the collective set of lap poodles we call our US Congress would sit up and bark as directed, whenever a request is made accompanied by large oversize checks. After all, the political malfeasance that allowed us all to get in this much trouble was certainly bought and paid for long ago. [See the Community Reinvestment Act and the Gramm Leach Bliley Act as un-indicted co-conspirators in this economic debacle.] But this time they managed to find enough political will to just say “NO”! And what was the collect response from our troubled banks? They told the Treasury that they refused to play then, and took their ball and went home. This of course has left the FDIC, the Treasury and Mr. Geithner looking like fools. So in typical political fashion, the FDIC and the Treasury issued statements that these banks really didn’t need to participate in the auction since they had collective been able to raise a paltry $100B in private funds since the stress test. I guess they figure that we as a population are so mathematically challenged, that we wouldn’t notice that $100B doesn’t begin to cover the even $1T of the several trillion dollars pledged to shore up the banking system. But if according to some new lap poodle math it does, then shouldn’t we be asking these representatives to explain, why then do they still need all these trillions of dollars?

In conclusion, mortgage rates are still low. But they are only low because of the $1.2T Federal Reserve mortgage program currently in place. Sooner or later, there will be a day of reckoning and these rates will be gone for many years to come. Don’t miss out. Call me, or call any other mortgage banker. Just don’t miss out on this opportunity to recoup some of these bailouts we will all be paying for the rest of our lives.

Dan Smith can be reached at 303-674-0201, or visit him on the web at www.ColoradoHomeLoans.com!

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Colorado Photo Slide Show – Images of Colorado

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Please click on a Colorado Photo below to view a larger image:

[View with PicLens]

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Let’s pretend you’re a politician and that you had created a program presumably designed to stem the tide of foreclosures. Next imagine that program was an utter failure, and that the rate of that failure was increasing. What should you do? Yes, the correct answer is to expand the program. Start by raising the stakes on the Home Affordable Refinance Program to 125% of existing home value, even in steeply declining markets. Good. And don’t stop there. Go ahead and propose that unemployed homeowners already in default, should be allowed to stay in the home even after foreclosure, and rent the property back from the bank. Genius! Pure genius! It was so simple I don’t know why I didn’t think of it myself. With no money or job to make a mortgage payment, these poor folks are ideal long term tenants. Sound like a bad dream? Well unfortunately that is exactly what our bright lads in Washington are up to now.

Several months ago I wrote about the Homeowner Affordability and Stability Plan (HASP). As a part of that program, $75B was set aside to help Americans stay in their homes and prevent foreclosures, in yet another program called “Making Home Affordable”. The Making Home Affordable Program is broken down into two distinct sub-programs, the Home Affordable Refinance Program (HARP) and the Home Affordable Modification Program (HAMP). At the time it was created, the Home Affordable Refinance Program allowed borrowers who were current on their payments to refinance; even if what they owed was as much as 105% of the value. But that program apparently needed a boost and on July 1 that limit was raised to 125%. Now correct me if I am wrong, but wasn’t this crisis caused by making sub-prime loans to 125% in the first place?

The “Home Affordable Modification Program” on the other hand requires lenders to modify the terms of existing loans for consumers who are in default, so long as they meet certain requirements. And of course, one of those requirements is that they be in default. I wrote then that this program looked like trouble for several reasons, not the least of which was the incentive it provided for consumers to “let their loan go bad” in order to qualify.  Call me crazy…but why spend billions of dollars to stop mortgage defaults, with a program that actually increases mortgage defaults? When I wrote that article in March, a little over 40% of modified mortgages re-defaulted in the first 3 months after modification. Now fast forward here to the end of July. Just 4 months later, that percentage of modified mortgages that re-default after three months has jumped to 50.4%. And after just 12 months post modification, the re-default rate is a staggering 63.3% (according to the Office of the Comptroller).

Well with a winning a program like this, the administration really had no choice but to double down, right? Sure enough, on July 16th Reuters reported that the Obama Administration was: … also weighing a plan to let borrowers who have fallen behind on payments avoid eviction by renting their homes instead… Senator Charles Schumer, a senior Democrat on the Senate Banking panel, said on Thursday he backed the idea of letting distressed homeowners stay in their homes as renters even after they default on their mortgage. “This could make sense as a last resort for troubled homeowners who would otherwise lose their homes and find themselves with nowhere to live…” Yep. Genius. Pure genius alright!

For honest advice from someone who cares, contact Dan Smith at 303-674-0201 or visit him on the web at www.ColoradoHomeLoans.com .

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