May 19, 2024

Archives for March 2009

Inflation, Deflation or World Depression?

calculatorShould We Discount The Consensus?

The debate on the outcome of bailouts and money printing continues.  A review of some of the current thoughts on Fed and Governmental action predict different possible outcomes – none of them particularly desirable.   When the consensus seems unanimous, maybe it’s time to discount the consensus?

The Marc Faber Interview by Peter Schiff

Marc Faber explains why bailouts and fiscal stimulus don’t work and are counterproductive to economic recovery.  Inflating our way out of the financial crisis is seen as the only option by the government.  Higher inflation  will be negative for both bonds and equities.

The Marginal Productivity of Debt

New money creation will only cause a further drop in price levels and cause a further contraction in the economy since the marginal productivity of debt has turned negative.  Bernanke’s flood of new money may cause something far worse than a depression.

Bailout Economics

Are we destroying capitalism by trying to save it?  The diversion of capital to failed enterprises is a recipe for disaster as money moves to the weaker hands.  What types of reform would foster an economic recovery?

Barack Obama as Herbert Hoover

How one small unanticipated event can trigger another depression.

Obama’s Auto Plan Gets Mixed Reviews

The administration’s first effort at ending the endless bailout cycle gets mixed reviews.  Sometimes you just can’t win.

US Mint Suspends Production of More Gold Coins

For those seeking the safety of gold coins, more bad news as the US Mint further restricts the production of gold coins.  Is the US Treasury seeking to limit the exchange of paper money into  hard assets?

Money Creation and The Fed

Does the explosive growth in the monetary base imply future uncontrollable inflation?

FHA – Ready To Join Fannie And Freddie

Multiple Reasons For High FHA Default Rates

Massive default rates in the FHA loan program are starting to raise a few eyebrows.  Without major reform of fundamentally poor lending policies, the FHA could soon join the failed ranks of her sister agencies Fannie Mae and Freddie Mac.

Delinquencies Rise

A spokesman for the FHA said 7.5% of FHA loans were “seriously delinquent” at the end of February, up from 6.2% a year earlier. Seriously delinquent includes loans that are 90 days or more overdue, in the foreclosure process or in bankruptcy.

The FHA’s share of the U.S. mortgage market soared to nearly a third of loans originated in last year’s fourth quarter from about 2% in 2006 as a whole, according to Inside Mortgage Finance, a trade publication. That is increasing the risk to taxpayers if the FHA’s reserves prove inadequate to cover default losses.

FHA Cash Cushion Has Fallen by 39% – The latest annual audit of the Federal Housing Administration shows a steep drop in the capital cushion the U.S. agency holds against losses from mortgage defaults.

As lenders shy away from risk, the number of loans insured by the agency has soared in recent months, fueling concerns it may be taking on too much risk.

If the FHA runs short of money to pay claims, Congress would have to provide taxpayer funds to make up the difference.

MBA Delinquency Survey

The Mortgage Bankers Association report on delinquency rates (loans that are at least one payment past due) shows the real potential for how many defaults the FHA could be facing.

Change from last quarter (second quarter of 2008)

The seasonally adjusted delinquency rate increased 41 basis points to 4.34 percent for prime loans, increased 136 basis points to 20.03 percent for subprime loans, increased 29 basis points to 12.92 percent for FHA loans.

FHA loans saw an eight basis point increase in the foreclosure inventory rate to 2.32 percent.

The delinquency rate includes loans that are at least one payment past due but does not include loans somewhere in the process of foreclosure.

Add the percentage of FHA loans in the foreclosure process to the total loans that are delinquent at least one month and we have a total default/delinquency rate of 15.24%.  Something is clearly wrong with the FHA loan program and another major bailout of a federal lending agency seems inevitable.  Let’s examine some data from an excellent article by Whistleblower to understand why the FHA default rate is so high.

FHA Delinquency Crisis: 1 in 6 Borrowers in Default

At a time when borrowers, lenders, regulators, and lawmakers are scurrying for cover from the subprime lending crisis, a new crisis appears to be emerging with FHA.
Just take a look at FHA delinquency rates:

Could FHA’s rising delinquency rate be due to FHA incorporating risky practices that have become standard in the mortgage industry? Since industry experts often cite 100% financing as being a major factor in the mortgage meltdown, let’s take a look at borrower down payment sources:

In 2008, borrower funded down payments declined 38% to total only 47% of endorsements while non-profit provided down payment assistance increased a whopping 1750% to 37% of purchase endorsements. These are staggering statistics, but could they possibly correlate with FHA’s delinquency rate? Let’s take a look.

The delinquency rate clearly rises in tandem with the increase in non-profit funded down payments. But why would down payment assistance from non-profit agencies possibly impact the delinquency rate so materially?
While legitimate non-profit agencies provide much needed assistance to deserving buyers in a manner that promotes successful homeownership, certain so-called “non-profit” agencies merely advance the borrower the down payment from the seller for a fee. Companies such as Nehemiah Corporation of America, H.A.R.T. and Ameridream are prime examples of companies that provide down payments that are dependent upon seller reimbursement. Since the down payment is seller funded, whether directly or indirectly, a Quid Pro Quo clearly exists. Furthermore, because sales prices are increased to absorb the down payment grant, down payment assistance is said to skew prices for everyone.
In 2005, HUD commissioned a study entitled “An Examination of Downpayment Gift Programs Administered By Non-Profit Organizations”. Later that year, another report titled “Mortgage Financing: Additional Action Needed to Manage Risks of FHA-Insured Loans with Down Payment Assistance” was completed by the U.S. Government Accountability Office. Both studies concluded that seller funded down payment assistance increased the cost of homeownership and real estate prices in addition to maintaining a substantially higher delinquency and default rate.

Note: The down payment assistance program was ended last year but special interest groups are lobbying for its reinstatement – see Campaign to Stop FHA Subprime.

FHA Approval Process Outsourced To FHA “Direct Endorsed Lenders”

Besides the factors mentioned above that contribute to the large amount of FHA defaults there is also the issue of the unique manner in which the FHA “outsources” the loan approval process.   The FHA does not directly approve loans but instead allows this to be done by HUD “direct endorsed FHA lenders”.  The direct FHA lenders are in turn supposed to follow lending standards set by the FHA.  Problems arise with this arrangement since loans can be underwritten and approved by the direct FHA lender’s own staff, an obvious conflict of interest.  The lender only makes money on loans that are approved.  This process is equivalent to leaving the bank vault unlocked and unguarded.

Theoretically, the FHA has the responsibility for policing the lenders who can approve FHA loans.   In practice, FHA oversight is almost nonexistent.    In the past two years, as the number of FHA lenders has doubled to almost 2,500 lenders, the FHA supervisory office has had no staffing increase.  If the FHA was fulfilling their supervisory responsibilities properly, the default rate would not be at a staggering 16% and outrageous examples of fraud and abuse in the FHA lending system would not be occurring.  Consider the curious case of the large number of FHA loans experiencing first payment defaults (the borrower never makes a single payment).

The Next Hit – Quick Defaults

In the past year alone, the number of borrowers who failed to make more than a single payment before defaulting on FHA-backed mortgages has nearly tripled, far outpacing the agency’s overall growth in new loans, according to a Washington Post analysis of federal data.

Many industry experts attribute the jump in these instant defaults to factors that include the weak economy, lax scrutiny of prospective borrowers and most notably, foul play among unscrupulous lenders looking to make a quick buck.

If a loan “is going into default immediately, it clearly suggests impropriety and fraudulent activity,” said Kenneth Donohue, the inspector general of the Department of Housing and Urban Development, which includes the FHA.

Once again, thousands of borrowers are getting loans they do not stand a chance of repaying. Only now, unlike in the subprime meltdown, Congress would have to bail out the lenders if the FHA cannot make good on guarantees from its existing reserves.

More than 9,200 of the loans insured by the FHA in the past two years have gone into default after no or only one payment, according to the Post analysis. The pace of these instant defaults has tripled in one year.

The overall default rate on FHA loans is accelerating rapidly as well but not as dramatically as that of instant defaults.

Under the FHA’s own rules, there’s a presumption of fraud or material misrepresentation if loans default after borrowers make no more than one payment. In those cases, the lenders are required by the FHA to investigate what went awry and notify the agency of any suspected fraud. But the agency’s efforts at pursuing abusive lenders have been hamstrung. Once, about 130 HUD investigators teamed with FBI agents in an FHA fraud unit, but this office was dismantled in 2003 after the FHA’s business dwindled in the housing boom.

William Apgar, senior adviser to new HUD Secretary Shaun Donovan, agreed that early defaults are a worrisome sign that a lender is abusing FHA-backed loans.

The Palm Hill Condominiums project near West Palm Beach, Fla., exemplifies the problem. The two-story stucco apartments built 28 years ago on former Everglades swampland were converted to condominiums three years ago. The complex had the same owner as an FHA-approved mortgage company Great Country Mortgage of Coral Gables, whose brokers pushed no-money-down, no-closing-cost loans to prospective buyers of the condos, according to Michael Tanner, who is identified on a company Web site as a senior loan officer.

Eighty percent of the Great Country loans at the project have defaulted, a dozen after no payment or one. With 64 percent of all its loans gone bad, Great Country has the highest default rate of any FHA lender, according to the agency’s database. It also has the highest instant default rate.

Some of the country’s largest and most established lenders are so concerned about this new threat to the credit market that they are not waiting for the FHA to tighten its requirements. Instead, they are imposing new rules on the brokers they work with. Wells Fargo and Bank of America, for instance, now require higher credit scores on certain FHA loan transactions and better on-time payment history.

Some experts who track FHA lending say the agency should not wait for lenders to take the lead on toughening the rules, especially given the mortgage industry’s poor track record for policing subprime and other risky home loans.

“Even if the market eventually gets these guys, they shouldn’t have to wait for the market to do it,” said Brian Chappelle, a former FHA official who is now a banking industry consultant. “The most frequent question I get asked by the groups I talk to is: ‘Is FHA going to implode?’ . . . They haven’t seen HUD do anything significant in the past two years to tighten up its lending.”

FHA Losses Mount As Regulators Snooze

The FHA escaped the financial collapse that occurred at Fannie and Freddie by an accident of circumstance.  During the lending boom, the FHA attracted few borrowers since putting a borrower into a sub prime loan was faster and more profitable.  Since the collapse of the sub prime lenders, the FHA’s share of the mortgage market has increased to around 33% today from 2% three years ago.  The reason for the big increase in loan volume is due to one factor – the FHA now has the lowest lending standards and its loan delinquencies prove it.

Will The FHA Be The Next Government Bailout?

Without immediate reform of the FHA loan program, the FHA will be the next lending disaster and government bailout.  The flawed lending policies that will eventually cause the collapse of the FHA include:

1. Minimal or no down payment purchases.  Study after study has shown the correlation between low down payments and increased mortgage defaults.

2. Lax lending standards.  FHA loans are routinely approved with low credit scores and insufficient income, resulting in high default rates.

3. Allowing the use of “direct endorsed lenders” who approve FHA loans without adequate oversight by the FHA is an invitation to fraud and abuse.  The direct FHA lenders have a vested financial interest in approving unqualified loan applicants – the results can be seen in the number of first payment defaults and loan delinquencies.

Putting borrowers into homes that they cannot afford is an injustice to the homeowner and perpetuates the foreclosure cycle.  The cost of the FHA losses to the taxpayer is a an expense we cannot afford.  It is time to rein in the FHA’s irresponsible lending practices.

Why It Just Became More Difficult To Get An FHA Loan -Declining Markets

mortgageNew Appraisal Guidelines Effective April 1, 2009

All FHA appraisals dated on or after April 1, 2009 must include a Market Conditions Addendum in order for the loan to be insured by the FHA.  There are also new guidelines for appraisers to follow when the property is in a declining market area.

Appraisal-Related Policy Changes and Clarifications

Due to current conditions in the real estate market, it is paramount that appraisers are provided with sufficient guidance to properly appraise and document the appraisal report. Fannie Mae recognizes the Uniform Standards of Professional Appraisal Practice as the minimum appraisal standards for the appraisal profession. In addition, Fannie Mae has established its own separate appraisal requirements to supplement the Uniform Standards.

Adoption of Market Conditions Addendum and Appraisal Reporting Requirements for Properties located in Declining Markets

For all appraisals of properties that are to be security for FHA-insured mortgages and that are performed on or after April 1, 2009, the appraisal must include the Market Conditions Addendum.

Use of Closed Comparable Sales and Active Listings/Pending Sales for Appraisals in Declining Markets

As economic instability continues to impact many segments of the economy and as home prices continue to decline in many housing markets throughout the country due to job losses and increased foreclosures, FHA finds it necessary and prudent to set forth additional guidance for collateral assessment practices for properties located in a declining market. This guidance is also effective April 1, 2009.

Declining Markets

Although there is no standard industry definition, for purposes of performing appraisals of properties that are to be collateral for FHA insured mortgages, a declining market is considered to be any neighborhood, market area, or region that demonstrates a decline in prices or deterioration in other market conditions as evidenced by an oversupply of existing inventory or extended marketing times.

Appraisal Reporting Requirements in Declining Markets

Appraisals of properties located in declining markets must include at least two comparable sales that closed within 90 days prior to the effective date of the appraisal.
In some markets compliance with this requirement may be difficult or not possible due to the lack of market data and, in these cases, a detailed explanation is required.

In order to ensure that FHA receives an accurate and thorough appraisal analysis, the inclusion of comparable listings and/or pending sales is required in appraisals of properties that are located in declining markets. Specifically, the appraiser must:

• Include a minimum of two active listings or pending sales

• Insure that active listings and pending sales are market tested and have reasonable market exposure to avoid the use of over priced properties as comparables.

• Adjust active listings to reflect list to sale price ratios for the market.

• Adjust pending sales to reflect the contract purchase price whenever possible or adjust pending sales to reflect list to sale price ratios.

• Include the original list price, any revised list prices, and total days on the market (DOM).

• Reconcile the adjusted values of active listings or pending sales with the adjusted values of the settled sales provided.

• Include an absorption rate analysis, which is critical to developing and supporting market trend conclusions, as mandated by the Market Conditions Addendum. F

Data Requirements

Data regarding market trends is available from a number of local and nationwide sources. Appraisers must be diligent in using only impartial sources of data.

Lender Responsibilities

Lenders are responsible for properly reviewing the appraisal and determining if the appraised value used to determine the mortgage amount is accurate and adequately supports the value conclusion.

Direct Endorsement lenders are reminded that if the appraiser they selected provides a poor or fraudulent appraisal that leads FHA to insure a mortgage at an inflated amount, the lender is held responsible, equally with the appraiser, for the integrity, accuracy and thoroughness of an appraisal submitted to FHA for mortgage insurance purposes.

Impact of New Appraisal Requirements

The new guidelines should ensure that an FHA purchaser is not overpaying when purchasing a home.  This benefit may be offset, however, by the fact that it may become more difficult for a purchaser to receive seller concessions from the seller since it will be more difficult for the concessions to be absorbed into the sales price. In the past, there would have been more latitude available by the appraiser to build the seller concession into the sales price through a higher appraised value.

The bottom line for many buyers may be that they now need significantly more cash at closing, in addition to the 3.5% down payment money.   It is not uncommon to have seller concessions of 4 to 6% which absorbed prepaid expenses and closing costs.  If the seller concession is not available, the borrower could easily be looking at additional cash out of pocket requirements of around $5,000 on a $150,000 purchase, in addition to the $5250 down payment.

Borrowers attempting to refinance (especially in a declining market), may find it much more difficult to do so with lower appraised values.  In addition, every reputable FHA lender will be examining FHA appraised values much more closely due to the lender liability for a poor or fraudulent appraisal.

The tighter appraisal guidelines should ultimately result in appraised values that more accurately reflect  housing values and thus prevent problems associated with inflated appraisals that occurred in the past.   Whether or not more accurate appraisals will lead to a more stable housing market is another matter, subject to debate.  A matter not subject to debate is that for anyone purchasing or refinancing through the FHA, getting a loan approval has just become more difficult.

Markets Plunging On Geithner’s Remarks

bearGeithner Does It Again

The Treasury Secretary said Sunday that some banks will need large amounts of financial aid.  Geithner’s comments seemed to imply that his recently announced rescue plan for the banking industry is only a first step and that additional government funds will be needed.  Markets responded with a massive selloff in Asia and the Dow futures are down heading into Monday morning.

Bloomberg: “Some banks are going to need some large amounts of assistance,” Geithner said yesterday on the ABC News program “This Week.” The terms of a $500 billion public-private program to aid banks “cannot change” for investors or they’ll lose confidence in the plan, he said on NBC’s “Meet the Press.”

The Obama administration is pursuing the most costly rescue of the U.S. financial system in history while facing taxpayer concerns the aid is bailing out Wall Street firms that took excessive risks. After allocating about 80 percent of $700 billion in aid approved by Congress, administration officials want to keep open the option of seeking more.

Geithner said the Treasury has about $135 billion left in a financial-stability fund while declining to say whether he will request additional money.

“If we get to that point, we’ll go to the Congress and make the strongest case possible and help them understand why this will be cheaper over the long run to move aggressively,” he told ABC News.

Most members of Congress probably wouldn’t support a request for new bailout funds because they aren’t clear about how the government used the $700 billion authorized in the first legislation, McCain said.

“We still don’t have the transparency and oversight,” McCain said on “Meet the Press.” He said his biggest concern is that the cost of stemming the financial crisis will worsen annual deficits projected to exceed $1 trillion for many years.

“What I am most worried about is laying the debt on future generations of Americans,” he said.

Private Investor Participation Is A Sham

It seems clear that there is dwindling public support for further massive bailouts of Wall Street and the banking industry.  Geithner’s plan of bailing out the banking industry with a “public/private” partnership is an attempt to deceive the public about the true extent of the cost of the bank bailout.

Taxpayer backed loans will be used to fund most of the asset purchases under the so called Public-Private Investment Program (PPIP).  Private investors can lose no more than their initial investment but can potentially earn huge returns if the assets purchased recover in value.  Geithner is offering these generous returns to lure in potential private investors who will be deceptively portrayed as the risk takers in the bank bailout, when in fact, the taxpayers are the ones at risk.

“We’re all mad here” – Lewis Carroll, Alice in Wonderland

Geithner’s solutions to solving the banking and financial crisis is increasing being viewed by many as something straight out of Alice In Wonderland.

Banks need to show more willingness to take risks and restore lending to businesses in order for the U.S. economy to recover from the recession, Geithner said.

“To get out of this we need banks to take a chance on businesses, to take risks again,” he said.

Banks did not become insolvent because they made too few loans or took too few risks.  The banking crisis was caused by too much lending to unqualified borrowers who are now defaulting.  Proposing to lend more to those already carrying an intolerable debt burden is sheer madness.   The President of the European Union, Czech prime minister Topolanek, called the bailouts and stimulus plans “a way to hell”.  The Emperor has no clothes and people are starting to notice.

The United States has been pushing other nations to imitate our borrowing and spending rampage with little success.  In fact, opposition to the American “solution” has become so vocal that this topic has been taken off the table by the Obama administration for the upcoming Group of 20 economic summit.

WASHINGTON — U.S. officials preparing for the Group of 20 economic summit on Thursday in London are playing down fiscal-stimulus targets and focusing on objectives such as new rules for tax havens and coordination of financial regulation.

European opposition to additional spending to stimulate economies has grown sharper over the past weeks. Obama administration officials have opted to back off the public spat.

Avoid All Pain At All Costs

A recession is the solution to curing economic excesses.  Recessions bring economic pain but lay the groundwork for a fundamental economic recovery by reallocating capital to healthy enterprises.  Attempting to paper over inevitable economic corrections with oceans of debt and spending only serves to further destabilize any recovery.   Economic policy makers did not see this financial disaster coming and their “solutions” have made the problem worse.

Rolfe Winkler, Option ARMageddon, makes a clear assessment of the current crisis.

The problem isn’t falling asset prices, it’s not rising foreclosures, it’s too much debt.

And yet American policy-makers appear convinced that more debt can rescue an economy already drowning in it. If we can just keep the leverage party going, all will be well. $787 billion to fund “stimulus,” another $9 trillion committed to guarantee bad debts, 0% interest rates and quantitative easing to drive more lending, new off balance sheet vehicles to hide from the public the toxic assets they’ve absorbed. All of it to be funded with debt, most of it the responsibility of taxpayers.

If I may offer just one reason this will all fail: rising interest rates. Interest rates need only revert to their historical median in order to hammer asset values, and balance sheets, into oblivion.

Picture it if you will: the economy stabilizes, money flows out of Treasurys, which drives interest rates back to normal. Asset values that had appeared to stabilize fall again. More writedowns ensue, more balance sheets turn up insolvent. The debt deflation conflagration ignites again, burning up what’s left of the economy.

If our experience to date has taught us anything it should be that kicking losses up to bigger balance sheets solves nothing. Losses have to be taken. The balance sheets on which they reside will end up insolvent. Why compound our problems by piling up more debt and concentrating all of it on the public’s balance sheet? Is American arrogance so great that we believe our Treasury and our currency will survive the trillions of $ worth of losses and stimulus we’ve already agreed to fund?

At the end of the day, flushing more debt through the system is the only lever policy-makers know how to pull. Lower interest rates, quantitative easing, deficit spending, it’s all the same. It’s all borrowing against future income. Each time we bump up against recession, we borrow a bit more to keep the economy going. With garden variety recessions, this can work. Everyone wants the good times to continue, so no one demands debts be paid back. Creditors accept more IOUs and economic “growth” continues apace. If it sounds like Bernie Madoff’s Ponzi scheme, that’s because it is.

But at a certain point, Ponzis get too big. There simply aren’t enough new investors to pay off older ones. In the aggregate, the same is true for Western economies. Their debt loads are now so huge, they are simply unpayable.

Economic Summit

The Group of 20 economic summit will accomplish nothing.  They have decided in advance to eliminate debate on the major issue – whether more debt will solve our debt problems.   The Czech prime minister should be the main speaker at this summit and our Treasury Secretary should be put in the front row.  It is a time for fiscal austerity – not more reckless borrowing.

Paul Volcker’s New Assignment – Tax Collector

dollarIs This What Volcker Had In Mind?

Paul Volcker’s unexpected endorsement of Mr Obama for President last year gave the Obama campaign a huge boost of economic credibility.  Mr Volcker’s endorsement calmed the fears of many economic conservatives who were skeptical about the Obama economic agenda.

Lawrence Kudlow, a former Reagan economic advisor, viewed the surprise endorsement as a signal that a future Obama administration would be more fiscally conservative than previously believed.

This is an unbelievable story. Former Fed Chairman Paul Volcker — Mr. Hard Money, anti-deficit, sound financial himself — has endorsed Senator Obama for President.

This is a big deal.

Once upon a time, many years ago, I was a Volcker speechwriter at the New York Fed. He’s a great American. He’s a classic conservative. He’s a man of fiscal and monetary rectitude. While he was originally appointed Fed Chair by Jimmy Carter, Volcker ultimately teamed up with Ronald Reagan to put the kibosh on runaway inflation. He would not have made this endorsement on a whim.

Is Paul Volcker the new Robert Rubin? Is it possible that Mr. Volcker is somehow tutoring Obama? Is it possible that Obama is more financially conservative than originally believed?

In his endorsement of Mr Obama, Mr Volcker seemed to believe that he would be involved in a high level position to help solve the financial problems facing the United States.

Paul Volcker, February 2008

However, it is not the current turmoil in markets or the economic uncertainties that have impelled my decision. Rather, it is the breadth and depth of challenges that face our nation at home and abroad. Those challenges demand a new leadership and a fresh approach.

Mr. Obama’s remarks at a press conference in November 2008 also seemed to suggest that Mr. Volcker would have a pivotal role in engineering a turnaround of the American economy.

November 26, 2008 – Obama Press Conference

Today, I’m pleased to announce the formation of a new institution to help our economic team accomplish these goals: the President’s Economic Recovery Advisory Board.

The Board will be composed of distinguished individuals from diverse backgrounds outside of government —from business, labor, academia and other areas— who will bring to bear their wisdom and expertise on the formulation, implementation and evaluation of my Administration’s economic recovery plan.

I’m pleased to announce that this Board will be chaired by one of the world’s foremost economic policy experts, a former Chairman of the Federal Reserve, and one of my most trusted advisors, Paul Volcker.

Paul has been by my side throughout this campaign, providing a deep understanding of financial markets, extensive experience managing economic crises, and keen insight into the global nature of this particular crisis. Paul has served under both Republicans and Democrats and is held in the highest esteem for his sound and independent judgment. He has a long and distinguished record of service to our nation, and I am pleased that he has answered the call to serve once again.

World’s Foremost Economic Policy Expert Appointed To New Position – Chasing Tax Deadbeats

Today, Mr Volcker can add to illustrious resume the position of leading a task force to chase tax deadbeats.  This is probably not the role that Mr Volcker envisioned as Chairman of the Economic Recovery Advisory Board.

Volcker Panel To Study Tax Reform

WASHINGTON (Reuters) – A panel led by former Federal Reserve Chairman Paul Volcker will study options for U.S. tax reform

Peter Orszag, director of the White House’s Office of Management and Budget, said the panel would study tax simplification, tackling tax evasion, and reducing “corporate welfare.”

He said the board would look at streamlining U.S. tax credits and being more aggressive at bringing in some $300 billion in annual uncollected tax revenues.

Time To Move On

Mr Volcker’s acknowledged expertise is being wasted in a largely irrelevant and undignified position, given the dimensions of the financial problems confronting the United States.

Some advice Mr Volcker – it seems that you have served your purpose and will not have a real role in any major policy decisions.  Your distinguished background, expertise and wisdom are being wasted in your presently assigned position.  Answering your country’s call to service was admirable, but you need to watch what they do, not what they say.

Nikkei Continues Rallying As Japan’s Exports Plunge 49%

Bad News Discounted?

One of the hardest concepts for investors to grasp is the ability of markets to discount bad news.  As the news mounts daily about the Japanese economic collapse, the Nikkei 225 continues to rise.   As pointed out previously (see Can The Economic News From Japan Possibly Get Worse?) the Nikkei has refused to penetrate the lows reached in 2003 and at this point is up almost 22% from the March lows.

The ability of a market to rally in the face of horrific economic news is usually a sign that the worst has been discounted.  The argument could be made that informed stockholders have already done their selling since mid 2008 and at this point are looking down the road a year or so for a recovery in business conditions.  Consider also that the Nikkei is back to the levels it was at in the mid 1980’s before the world started its grand experiment with unlimited credit creation.

Time will tell whether or not the Japanese economy is due for some type of recovery.  Bear market rallies of 20% or more are not uncommon after huge declines.  As long as the Nikkei can stay above the 7,000 level, perhaps the worst has been seen.

Long Term Factors To Consider

As previously discussed (See Nikkei – Black Hole or Buying Opportunity?), some long term factors to consider are as follows:

-the Nikkei is already off 80% from its December 1989 high and has perhaps discounted the worst that can happen.

-a multi year double bottom may be forming at current price levels.

-the most fundamentally bullish factor may be that the Japanese government has reached the limits on its borrowing capacity, thus precluding the continuation of costly and ineffective stimulus plans (see Japan’s failed strategy). With the government no longer able to subsidize failed enterprises, free market forces can now accomplish the restructuring necessary to rebuild Japan’s economy.

Credit Union Bailout Needed – NCUA Insurance Fund Insolvent

Corporate Credit Unions Fail

The National Credit Union Administration (NCUA) announced today that two major corporate credit unions have been put into conservatorship as the true size of their losses became apparent.

March 20, 2009, Alexandria, Va. –The National Credit Union Administration Board today placed U.S. Central Federal Credit Union, Lenexa, Kansas, and Western Corporate (WesCorp) Federal Credit Union, San Dimas, California, into conservatorship to stabilize the corporate credit union system and resolve balance sheet issues. These actions are the latest NCUA efforts to assist the corporate credit union network under the Corporate Stabilization Plan.

The two corporate credit unions were placed into conservatorship to protect retail credit union deposits and the interest of the National Credit Union Share Insurance Fund (NCUSIF), as well as to remove any impediments to the Agency’s ability to take appropriate mitigating actions that may be necessary.

The Federal Credit Union Act authorizes the NCUA Board to appoint itself conservator when necessary to conserve the assets of a federally insured credit union, preserve member assets and protect the NCUSIF.

Corporate credit unions do not serve consumers. They are chartered to provide products and services to the credit union system.

U.S. Central has approximately $34 billion in assets and 26 retail corporate credit union members. WesCorp has $23 billion in assets and approximately 1,100 retail credit union members. The member accounts of both credit unions are guaranteed under provisions of the previously announced NCUA Share Guarantee Program, through December 31, 2010.

Following initial actions taken by the NCUA Board January 28, 2009 (see NCUA Letter to Credit Union No. 09-CU-02, NCUA staff completed a detailed analysis and stress test of the mortgage and asset backed securities held by all corporate credit unions, including US Central and WesCorp. Specifically, this review determined that an unacceptably high concentration of risk resided only in the two conserved corporate credit unions. Securities held by US Central and WesCorp deteriorated further since late January 2009, contributing to diminished liquidity and payment system capacities, as well as further loss of confidence by member credit unions and other stakeholders.

The findings indicated an overall estimated reserve level, previously announced by NCUA, had increased from $4.7 to $5.9 billion. The specific computation and the impact of the refined reserve level are addressed in NCUA Letter No: 09-CU-06, which NCUA issued and posted online today at

The National Credit Union Administration is the independent federal agency that regulates, charters and supervises federal credit unions. NCUA, backed by the full faith and credit of the U.S. government, also operates and manages the National Credit Union Share Insurance Fund (NCUSIF), insuring the deposits of over 89million account holders in all federal credit unions and the majority of state-chartered credit unions.

Concern has been growing over the past year about the financial health of the corporate credit unions.  In November 2008, Price Waterhouse was asked to review NCUA recommendations for the realignment of the corporate credit unions.  The Price Waterhouse report was released January 16, 2009 and noted the following issues with the corporate credit unions.

Liquidity, Capital, Structure and Risk Management Issues

1. The primary purpose of corporates to provide short-term liquidity to (retail) natural person credit unions (NPCUs) has been constrained by the decline in market value of securities.

2. Corporates have significant unrealized losses that may become realized other than temporary impairments.

3. Corporates have significant unrealized losses that may become realized other than temporary impairments

4. Corporates have borrowed from external sources that should not serve as a sustained daily source of liquidity.

5. Low Tier 1 capital levels and capacity of regulatory capital to absorb risk are a concern for external lenders.

6. Risks from non-core activities jeopardize core, systemic clearing, settlement, and liquidity functions.

Recognition of major weaknesses with the corporate credit unions came too late to prevent their collapse.  Huge losses on mortgage related assets were mounting rapidly.  In late January 2009 the NCUSIF provided a $1.0 billion recapitalization loan to US Central Credit Union after US Central booked losses of $1.2 billion in December 2008.  After the NCUSIF capital infusion, US Central was technically in compliance with its required regulatory capital ratio.  Barely two months later, it became apparent that US Central’s losses were much larger than what they had initially indicated.

In conjunction with the capital infusion to US Central the NCUSIF also booked a $3.7 billion “Insurance Loss Expense” to cover their guarantee of all corporate credit union share deposits.  There are a total of 28 corporate credit unions, of which US Central and Western Corporate are the largest.

As admitted by the NCUA in their announcement of the takeover of US Central and Western Corporate, the estimated reserve required for losses at the corporates has ballooned to $5.9 billion (from $4.7 billion), within the past two months.

Who Pays For Credit Union Losses?

The NCUA is the administrator of the credit union insurance fund, known as the National Credit Union Share Insurance Fund (NCUSIF).  Since the credit unions are a cooperative mutual industry, all losses in the credit union system become the responsibility of all federally insured credit unions.  If the entire $4.7 billion had been recognized as an insurance loss, this would have wiped out 58% of the NCUA’s equity and required a massive increase in the insurance premiums for every federally insured retail credit union.  Congress requires that premiums on credit unions be increased if the NCUA insurance fund equity ratio drops to 1.2% or if the insurance fund drops below 1% of all insured deposits.

Total credit union deposits according to the NCUA exceed $600 billion.  Had the $4.7 billion losses been properly recognized, the NCUA’s equity would have dropped to only $3.3 billion from $8 billion, requiring  a $2.7  billion premium increase for the retail credit unions.  The retail credit unions, already struggling with high default rates, strenuously objected to the prospect of large premium increases to cover losses that they had nothing to with.   For example, the Congressional Federal Credit Union, in a letter to its members on February 12, 2009 noted its strong disapproval of the US Central bailout and the attempt to raise insurance premiums.

The National Credit Union Administration (NCUA), the federal regulator of credit unions and the administrator of the National Credit Union Share Insurance Fund (NCUSIF) announced in late January that it has used deposits in the NCUSIF to provide a $1.0 billion recapitalization loan to US Central Credit Union. As a cooperative mutual industry, any loss in the credit union system is theresponsibility of all federally insured credit unions. As I reported earlier this year, Congressional has no investment exposure to US Central Credit Union. The Board and management team decided fourteen years ago to avoid any uninsured deposits in the
corporate credit union system. Nevertheless, as a result of the NCUA’s decision to recapitalize the debt of US Central through the CU insurance system and as a participant in the co-operative credit union movement, Congressional FCU will be recognizing approximately $3.3 million extraordinary expense during 2009 for the recapitalization of US Central Credit Union.

It is significant for Congressional FCU members to be aware that the Congressional FCU Board and management have vigorously opposed the decision by the NCUA to “bailout” US Central through the use of our deposit in the NCUSIF. As indicated, the impact of this inequitable NCUA decision is that credit unions, like Congressional FCU, who had long ago made a sound business decision not to participate in US Central Credit Union, are being required to pay an insurance premium to recapitalize US Central Credit Union. Members should also recognize that similar actions by the NCUA would result in further undue burden being
placed on Congressional FCU.

NCUSIF is the insurance that protects credit union member deposits up to $250,000. The insurance fund is 100% funded by credit unions and provides coverage for member deposits in more than 8,000 credit unions. The Federal Credit Union Act, federal legislation for credit unions, mandates that the NCUA maintain the insurance fund at a minimum level of 1% of total insured deposits in the credit union system. Each credit union maintains an account with the NCUSIF in an amount equal to 1% of the insured shares. As the funds for the loan to US Central are withdrawn from the NCUSIF, Congressional FCU will be required to expense our portion and then re-fund our NCUSIF account back to 1%.

How A $4.7 Billion Loss Is Not A Loss

In order to avoid the imposition of large insurance premium increases on the retail credit unions, the NCUA offset the $4.7 billion insurance loss with a $4.7 billion accounting entry called “accrued recapitalization and premium income”, which represents the premium income due from the credit unions to fund the insurance losses. This offsetting accounting entry by the NCUA eliminated the $4.7 billion loss and allowed them to remain technically solvent with an unchanged equity level.

This offsetting entry to the $4.7 billion reserve was made despite the fact that the NCUA has not assessed or collected any of the additional booked insurance premium from the credit unions.   Judging by the outraged response of the Congressional Federal Credit Union cited above, it is unlikely that the NCUA can impose or collect the huge insurance fee increases necessary to replenish the insurance fund of the NCUSIF.  Keep in mind also, that this original $4.7 billion reserve to cover corporate credit union losses is now inadequate as admitted by the NCUA which increased its estimated losses at the corporates to $5.9 billion in its March 20 announcement.

The NCUA’s “creative” non GAAP (generally accepted accounting principles) accounting was explained in a Credit Union National Association (CUNA) letter in early March 2009.

CUNA Explains NCUSIF Accounting

ALEXANDRIA, Va. (3/2/09)—The most recent monthly National Credit Union Share Insurance Fund (NCUSIF) report showed the fund booked both the expenses and the income associated with the corporate credit union stabilization plan in January.

The National Credit Union Administration’s (NCUA) NCUSIF booked, for accounting purposes, a $1 billion expense for “Loss on Investment – Corporate” that is related to its capital infusion into U.S. Central FCU.

It also booked a $3.7 billion “Insurance Loss Expense” to control for the risk associated with NCUA’s guarantee of “excess” corporate credit union share deposits. The information was revealed last week at the NCUA’s open board meeting.

However, the NCUA also booked the NCUSIF’s $4.84 billion in “accrued recapitalization and premium income” in January, again for accounting purposes, despite the fact that NCUA has not yet collected the premium from credit unions.

Unless the NCUA adopts an alternative approach to how the costs of the corporate stabilization program will be paid or changes course on its accounting decision, its action could force credit unions to have to reflect all of their insurance costs for the corporate assistance, the replenishment of the 1% deposit and the premium, on their March call reports.

The NCUA, as a government agency, has flexibility to deviate from Generally Accepted Accounting Principles (GAAP) in its financial reporting if the Office of Management and Budget (OMB) and the Comptroller General agree to such a deviation.

Losses Expanding Geometrically

After taking a $4.7 billion charge to reflect losses by the corporate credit unions, the NCUA’s accounting method resulted in a zero reduction of their total equity.  This almost makes AIG accounting look sound.   In the real world the NCUA insurance fund is totally inadequate to cover the mounting losses in the credit union industry and its reserves are below those required by Congress.  The ability to deviate from GAAP, as noted above, allows the NCUA to maintain a facade of solvency.

Making matters even worse, Michael Fryzel, chairman of the NCUA now states that the 28 corporate credit unions have estimated unrealized losses of $18 billion at the end of last year.   To replenish the NCUA insurance fund, premiums on the retail credit unions would have to be raised dramatically or the taxpayer has to fund another bailout.  Mr Fryzel quickly made it clear what his choice would be.

Wall Street Journal

WSJ – Michael E. Fryzel, chairman of the National Credit Union Administration, the industry’s federal regulator, said the seizure was necessary to maintain the integrity of the credit-union system and protect the insurance fund that backs up deposits in thousands of retail credit unions.

In total, the 28 wholesale (corporate) credit unions in the U.S. were showing paper losses of about $18 billion as of Dec. 31. Mr. Fryzel said regulators aren’t concerned about the health of any other wholesale credit union besides the two brought into conservatorship.

NCUA had said it would make up the expected losses in the insurance fund by dunning the nation’s thousands of retail credit unions. But after an outcry from the industry, Mr. Fryzel said the agency’s board now plans to ask Congress in the coming week for authority to borrow money from the Treasury. He said the industry isn’t looking for a bailout, and would repay all such borrowings.

Conclusion – NCUA Bailout To Cost At Least $15 Billion

The NCUA’s insurance fund is insolvent.  With total estimated losses at the corporates of $18 billion, the NCUSIF has equity of only $3.3 billion (after taking write-offs of $4.7 billion), leaving a black hole of at least $10 billion.  In addition, to maintain a statutory capital ratio of 1.2%, another $5 billion is necessary since the NCUA’s equity base has been depleted.

The losses of the corporate credit unions is estimated at $18 billion by the NCUA.   How can Michael Fryzel say that regulators aren’t concerned about the other 26 corporate credit unions after stating that their losses are at least $18 billion, and the loss estimates have been increasing dramatically month after month?

In addition, the NCUSIF has already paid out $1 million in claims on two failed retail credit unions in just the last month.  There are 8,000 retail federal credit unions insured by the NCUA fund that have an insured asset base of $611 billion and almost $400 billion of loans outstanding.  Credit unions make mortgage, credit card, car and personal loans to their members.  Delinquencies on similar loans at other lending institutions are running at upwards of 10%.  How many more retail credit unions will fail and what will the losses amount to?

The credit unions will be another large hole in the taxpayers’ wallet.  A best case scenario leaves the NCUA short by $15 billion.  Based on previous loss estimates that have spiraled upwards, the final total will probably be much larger.

30 Year Fixed Rate Of 3.5% Likely As Mortgage Rates Plunge

Fed Goes All In

The Federal Reserve announced that it intends to purchase massive amounts of mortgaged backed securities and long term treasury debt.  Yields on the 10 year treasury, from which mortgage rates are based, saw the biggest drop in yield since 1962.

Since mid December of last year the yield on the 10 year treasury had risen from a low of 2.07% to a high of almost 3% yesterday.  Almost half of that 50% increase in yield was erased today as the ten year closed at 2.53%.

Given the Fed’s open ended determination to lower mortgage rates, it is very likely that we may see the 30 year fixed rate mortgage at 3.5% or lower.  The Fed’s plan to purchase a massive amount of mortgage backed securities is certain to cause a large drop in mortgage rates.

U.S. central bankers decided yesterday to buy as much as $300 billion of long-term Treasuries and more than double mortgage-debt purchases to $1.45 trillion, aiming to lower home-loan and other interest rates.

Yesterday’s decisions will add $750 billion in purchases this year of mortgage-backed securities issued by government- sponsored enterprises Fannie Mae, Freddie Mac and Ginnie Mae, for a total of $1.25 trillion. The Fed has already announced $217.1 billion in net purchases out of $500 billion planned through June, under a program unveiled in November.

The central bank will also double to as much as $200 billion this year its planned purchases of debt issued by Fannie Mae, Freddie Mac and Federal Home Loan Banks. The Fed bought $44.4 billion of the so-called agency debt

The rationale for seeing generational lows in rates is the same as I proposed on January 12, 2009.

30 Year Mortgage Rates – Is 3.5% Possible?

The Federal Reserve’s direct purchases of mortgage backed securities initiated late last year was successful in its goal of lowering mortgage rates.   The Fed’s direct purchases of MBS has stabilized the mortgage market and lowered rates.  There are arguments being put forth that due to the Fed’s intervention, mortgage rates have artificial price support.  Nonetheless, if the historical yield spread between the bond and the 30 year mortgage is re-established, we may see a 30 year fixed rate in the 3.5% range.  Something to think about for those contemplating a mortgage refinance.

Last week, a borrower with excellent credit, necessary income and home equity was able to obtain a par rate of 4.5%.   The question of whether the Fed is manipulating mortgage pricing at this point or how long such price support can last is somewhat irrelevant.  The major fact to keep in mind is that the Fed appears to be relentless in its campaign to drive down mortgage rates.   If the Fed can stabilize the MBS market we may be looking at mortgages rates in a range we never thought possible a short time ago.

30 year fixed rate mortgages in the mid 3% range would cause a huge refinance surge.  Keep in mind that over the past five years, homeowners had multiple opportunities to refinance in the low 5% range.  Unless the borrower is taking cash out, it usually does not pay to refinance for less than a one percentage point reduction.   At 3.5% rates, it would make sense for almost every homeowner with a mortgage to refinance again.

Bill Clinton’s Bonus Makes AIG Employees Look Like Petty Thieves

Clinton Walks Away From $20 Million Bonus

The AIG bonus scandal comes at a bad time for Bill Clinton, who reportedly walked away from a $20 million “good bye” bonus from Yucaipa Partners.   With the AIG crowd getting blasted for paying bonuses to employees who ran the company into the ground (see AIG Says We Must Retain The Talented Staff That Lost $170 Billion), it would have been political suicide for Clinton to take a $20 million check, especially since it is unclear exactly how he earned this money.

Mr Clinton was not shy, however, about taking a very healthy paycheck from Yucaipa Partners prior to ending his association with the firm.

Bill Clinton Leaves Yucaipa

Beginning in 2002, Mr. Clinton served as an adviser to two domestic investment funds run by closely held Los Angeles-based Yucaipa. In that role he had an agreement in which he would receive a final payment based on a calculation of how much profits the investments had produced.

Additionally, Mr. Clinton was a partner in a foreign fund that also included an entity connected to the ruler of Dubai. Mr. Clinton received more than $12 million of partnership payments in recent years from the Yucaipa foreign fund.

He anticipated receiving a total of up to $20 million more as a payout from all three partnerships, according to people familiar with the matter.

What exactly did Mr Clinton do to earn $12 million so easily?  Does anyone believe that a company would pay someone $12 million without expecting to receive large favors in return?   Working for special interest groups certainly pays well, but don’t bother applying for the job unless you happen to be an ex President.  When it comes to unjustified payouts,  Yucaipa Partners should be getting the same scrutiny that AIG is receiving.

Geithner Does It Again – Did Not Contain AIG Bonus Disaster

How many times can you embarrass your boss without being shown the door?  See Are Geithner’s Day Numbered? Having been involved with the AIG debacle from the beginning, Mr Geithner should have been ahead of the curve on the bonus payouts and killed the plan from the start.

Mr Geithner has projected an image of bumbling incompetence from day one, starting with his poor explanation for not paying taxes.   Geithner’s performance in presenting his “plan” for saving the banks was widely criticized for lack of substance and he has been viewed as a lightweight ever since.

Uproar Over Geithner’s Role – Resignation Demanded

Lawmakers in both parties Wednesday questioned why Mr. Geithner didn’t do more to derail the bonus payments and two Republicans called on him to resign.

The uproar comes on top of a skeptical reception to Mr. Geithner’s plan to ameliorate the financial crisis and concern about his slowness in building a team.

From the outset, Mr. Geithner’s tenure was clouded by questions about his failure to pay personal taxes. Now, seven weeks into the job, he also finds himself pilloried by late-night comics.

Critics say Mr. Geithner stumbled badly on AIG, endangering the president’s broader agenda.

“It was Treasury’s responsibility to watch how these funds were used,” said Senate Minority Leader Mitch McConnell of Kentucky in a statement. “Obviously, they fell asleep on the job.”

Besides providing great material for the late night comics, Mr Geithner has contributed little.

All things considered, Geithner should be fired – the country deserves better.

Obama Takes Blame For AIG

To his credit, the President accepted blame for the AIG mess, and did not follow the usual political practice of “solving” a problem by blaming someone else.  The country needs to move on from this sideshow; there are far larger issues that need our attention.

Obama Accepts Blame

“Washington is all in a tizzy and everybody is pointing fingers at each other and saying it’s their fault, the Democrats’ fault, the Republicans’ fault,” he said at a town hall meeting Wednesday. “Listen, I’ll take responsibility. I’m the President.”

He also make clear that it isn’t really his fault. “We didn’t grant these contracts,” he said.

But he added: “So for everybody in Washington who’s busy scrambling, trying to figure out how to blame somebody else, just go ahead and talk to me, because it’s my job to make sure that we fix these messes, even if I don’t make them.”