July 12, 2024

Archives for April 2009

Starbucks – Doing It Right

SBUX On The Right Road

There is an old saying that if you don’t know where you are going, any road will get you there. Starbucks seems to know where it wants to be and is also taking the right steps to get there. When the bottom starting falling out of the economy in 2008, Starbucks developed a plan for the continued success of its valuable franchise.

In February of this year Howard Schultz, chief executive of Starbucks, explained his long term plan for future growth and profitability. The essence of the Starbucks turnaround was to cut costs and convince customers that Starbucks coffee was value priced.   Mr. Schultz shrewdly based his plans on a forecast that the economy would be weak for a protracted period of time.

“I strongly believe we are going to be in this environment for years… it is a reset of both economic and social behavior.” – Howard Schultz

Strategy Starting To Pay Off

The latest quarterly results announced by Starbucks (77% profit decline) would seem disastrous at first glance.  Looking beyond the quarterly results, it matters more where Starbucks is going rather than where they have been. The company’s focus remains on cost cutting, selective price cutting  and portraying  Starbucks coffee as a high quality value priced product. The quarterly profit decline was due largely to the costs associated with store closings.  The important metric of customer sales shows  improvement from the previous quarter.

The key positive for Starbucks is that the decline in sales had minimal correlation to product quality.  Besides introducing some new coffee products such as  the Pike’s Place blend, the basic Starbucks menu was not changed.  Starbucks continues to deliver a high quality product and is adjusting their business strategy to reflect the reality of weak consumer spending.   The company is strong financially with a modest amount of net long term debt.

Profit From Short Term Weakness

Starbucks is one of the great American success stories.  None of Starbucks’ basic success ingredients have changed – superior management and a great product sold in a pleasant environment by friendly and well trained employees.  The company is taking the right steps to reposition itself for future growth.  The bad news has probably been discounted, making the stock  a great long term buy.  The flight to safety play is becoming yesterday’s strategy.  What would you rather own today – a five year treasury paying sub 2% or an ownership interest in a great American franchise?

SBUX Courtesy: stockcharts.com

Disclosures: Long SBUX

Frugality The New Lifestyle For Many

savingsHard Times Bring Back Thrift

Without the aid of easy credit, matching income with expenses has required cutbacks in consumer expenditures and forced price reductions and layoffs by businesses.  Frugality has become the new mantra for many as we can see from the following examples.

Dumped Pets Pay The Price Of Recession

From fancy cars to foreign holidays, Britons have had to relinquish all sorts of luxuries as the credit crunch takes hold. To this list we can now add pets: 57% more animals were abandoned last year than in 2007, according to figures from the Royal Society for the Prevention of Cruelty to Animals (RSPCA).

The number of abandoned cats rose by half; dogs by nearly a third. Horses, farm animals and exotic pets were also being left to fend for themselves.

Tim Wass, chief officer of the RSPCA inspectorate, said the cause was “everything to do with the economics about owning a pet”, from paying for food to veterinary bills.

In Glum Times, Repair Shops Hum

Economic fears are driving a resurgence for repairmen. When it comes to autos, computers and all kinds of appliances, consumers are more likely to repair what they have, rather than buying a new replacement.

Appliance-repair businesses, too, have seen an uptick in business in recent months, says Michael Donovan … even though the appliances he works on are not very expensive to buy new.

He and other business owners are surprised by the repair work people authorize these days. “Much to my amazement, people are spending $60 on repairing a vacuum that they bought for $100 new,” he said, adding that limiting new purchases is “definitely a factor on everyone’s mind.” Mr. Donovan has even seen a rise in repairs of small home items, such as electric razors.

Cars, however, are the most visible signs of the new frugality, with new-vehicle sales down sharply. Opting to keep cars running, consumers are extending the lives of their vehicles to nearly 10 years on average from eight just two years ago, says the Automotive Services Association, a trade group for repair businesses.

Starbucks Sales Down

Like many retailers in this difficult environment, Starbucks experienced further declines in comparable store sales in both its US and International stores during the quarter. Consolidated comparable store sales declined by 9% for the first quarter of fiscal 2009, with comparable store sales declines of 10% in the US and 3% in International for the period. Management believes that the negative comparable store sales are in large part a result of the ongoing global economic crisis and its effects on consumers’ discretionary spending…

Expect to see continued poor sales at Starbucks as consumers realize that one upscale beverage per work day can amount to over $800 per year.

Falling sales caused by frugality are  forcing businesses to cut costs and slash prices in an attempt to stimulate sales.

Yankees Slash Prices to Fill Costly Seats

Acknowledging their prices were too steep even by Yankees standards, the 26-time world champions announced a plan to fill thousands of empty high-priced seats by reducing prices and giving away much of the unsold inventory.

The Yankees cut season-ticket prices on some of their premium seats by as much as 50% — to $1,250 from $2,500 for some seats and to $650 from $1,000 on others. Customers who purchased such season tickets will receive their choice of a refund or a credit.

Mr. Steinbrenner said the team reviewed its pricing “in light of the economy,” and stated the changes were for the 2009 season only.

Whether or not Mr. Steinbrenner’s optimism is warranted remains to be seen.  I would expect further price cuts in the future as incomes remain weak and demand for premium priced services diminishes further.

Newcomers Challenge Office-Supply Stalwarts

In the grinding recession, companies are finding ways to save even on the cost of the lowly office pen. And that has created an opening for discounters to steal business from the office-supply industry’s big three.

The result: a wave of price-competition that is benefiting lower-cost vendors and encouraging companies to switch suppliers.

Count Me In for Women’s Economic Independence, a New York group that promotes women entrepreneurs, switched its business to Sam’s Club after a review of its Staples invoices. “It turns out we’ll be saving more than $7,000 on an annual basis,”said Nell Merlino, president and chief executive.

Franchise Sales Pull Back During the Recession

Annual applications from franchisers who want to do business in Maryland are down significantly so far this year, says Dale Cantone, an assistant attorney general for the state. First-quarter franchise-registration applications in Maryland fell 16% from a year earlier to 367.

Other states report similar falloffs. For instance, California’s filings from Jan. 1 through its April 20 deadline fell nearly 20% from a year earlier to 769. New York’s first-quarter registrations dropped 22% to 348 — the lowest number in five years.

The fall off in franchise sales is being blamed on a lack of financing.  Hopefully, the real reason is a more rational allocation of capital by lenders.  Does the average American city really need more fast food outlets, real estate firms or home decorators?

Forced Frugality

Have American consumers rejected the notion of  credit fueled economic prosperity or is something else at work?  The reason for the new found frugality correlates to the fundamental economics of adjusting spending to income levels.  Lower income levels, the threat of unemployment, lack of savings and the destruction of stock and real estate values have created a fundamental shift in consumer behavior that is not likely to change in the near future.

Salary Cuts: Ugly, But It Could Be Worse

A growing number of employers are resorting to salary cuts as the recession drags on. This month alone, A.H. Belo Corp., publisher of the Dallas Morning News, and the Atlanta Symphony Orchestra have announced pay reductions of as much as 15%.

At some companies, the cuts affect only executive and senior management levels, but many others are adopting an across-the-board approach or tiered salary reductions. Some companies are imposing permanent cuts, and some are promising to return employees to their full pay — eventually.

A January survey by global outplacement firm Challenger, Gray & Christmas found that of 100 human-resource professionals surveyed, 27.2% reported that their companies have imposed a salary freeze or cut.

Until the current recession, the practice of imposing pay cuts has been “very rare,” says John Challenger, chief executive officer of Challenger, Gray & Christmas, despite recent calls for capping executive salaries and bonuses.

Organizations in dire straits may have no choice but to slash salaries across the board. After being unable to make payroll in mid-March, South Carolina’s Charleston Symphony Orchestra cut the wages of all its staff and employees by 11.4%. Musicians in the orchestra also took a 11.4% hit in the form of unpaid time off.

Entrepreneurs Cut Own Pay To Stay Alive

A number of small-business owners have stopped paying themselves as they struggle to keep their companies afloat.

It’s impossible to know just how many owners are affected. But in a sign of the breadth of the trend, 30% of 727 small-business owners and managers surveyed by American Express Co.’s small-business services division said recently that they were no longer taking a salary. That’s a troubling sign for small businesses, which have created a significant share of the new U.S. jobs in recent years.

It’s not uncommon for owners to give up salaries from time to time to give their companies a temporary lifeline, but business advisers and owners say the prevalence of salary cuts now is unusual even for a recession.

“The situation overall is more dire,” says Jerry Silberman, chief executive of Corporate Turnaround, a debt-restructuring company in Paramus, N.J. Historically, he says, nearly half of his clients weren’t taking a salary when they come through his door. Now, it’s close to two-thirds. And if they do take a salary, it’s often not enough to cover expenses.

The prevalence of pay cuts, something rarely seen before, tells us that this economic downturn is different.  The unanswered questions are how much worse does it get and how long will it last?  Those businesses carrying heavy debts have the lowest chances of surviving as the downside of leverage shows its destructive capacity.

Newly Thrifty Americans Are Slashing Spending More Than The Numbers Show

How much have Americans cut back?
On the face of it, not much. The official data from the Bureau of Economic Analysis say that in February personal spending was down 0.4%, or $40 billion, from the year before. Certainly any drop is bad news, since consumer spendingrarely decreases–but $40 billion out of total spending of $10 trillion doesn’t seem like enough to wreak economic havoc.

A closer look, however, shows that Americans have tightened their belts more sharply than the numbers report. The reason? Official figures for personal spending include a lot of categories, such as Medicare outlays, that are not under the control of households.

After removing these spending categories from the data, let’s call what’s left “pocketbook” spending–the money that consumers actually lay out at retailers and other businesses. By this measure, Americans have cut consumption by $200 billion, or 3.1%, over the past year. This explains why the downturn has hit Main Street hard.

For those American consumers concerned with their financial future, harsh realities are setting in.  The massive structural imbalances caused by decades of stagnant income growth and huge increases in debt levels will not be cured quickly.  Household balance sheets will eventually improve but it will be a slow and painful process for many.  The Age of Frugality is here for the foreseeable future.

Not All Are Suffering

After reviewing the gloomy news above, let’s end on a positive note.  Many Americans are financially secure, by dint of personal effort or privileged positions.  Here are two examples of those in the later category.

CCAGW Opposes Congressional Pay Raise

(Washington, D.C.) – The Council for Citizens Against Government Waste (CCAGW) today urged lawmakers to make their first order of business when they reconvene in the nation’s capitol in January to introduce legislation to freeze congressional salaries at current rates.  All Members of Congress are slated to get an automatic pay raise in January, 2009 unless they vote to block it.  Each rank and file member of Congress is poised to see another $4,700 in his or her paycheck over the next year, an increase of 2.8 percent over their current $169,300 annual salary.

“Members of Congress don’t deserve one additional dime of taxpayer money in 2009,” said CCAGW President Tom Schatz.  “While thousands of Americans are facing layoffs and downsizing, Congress should be mortified to accept a raise.  They failed to pass most of their appropriations bills, the deficit is on pace to reach an unprecedented $1 trillion, and the national debt stands at $10 trillion.  In addition, this Congress has been ethically challenged, plagued with corruption allegations, convictions, and sex scandals.”

The list of monetary benefits (beyond salary) that goes along with being a member of Congress is too long to list, but suffice it to say that most members of Congress will continue to live the “American Dream”.

Money For Nothing-Paul Krugman

On July 15, 2007, The New York Times published an article with the headline “The Richest of the Rich, Proud of a New Gilded Age.” The most prominently featured of the “new titans” was Sanford Weill, the former chairman of Citigroup, (C) who insisted that he and his peers in the financial sector had earned their immense wealth through their contributions to society.

Soon after that article was printed, the financial edifice Mr. Weill took credit for helping to build collapsed, inflicting immense collateral damage in the process. Even if we manage to avoid a repeat of the Great Depression, the world economy will take years to recover from this crisis.

All of which explains why we should be disturbed by an article in Sunday’s Times reporting that pay at investment banks, after dipping last year, is soaring again — right back up to 2007 levels.

One can argue that it’s necessary to rescue Wall Street to protect the economy as a whole — and in fact I agree. But given all that taxpayer money on the line, financial firms should be acting like public utilities, not returning to the practices and paychecks of 2007.

So what’s going on here? Why are paychecks heading for the stratosphere again? Claims that firms have to pay these salaries to retain their best people aren’t plausible: with employment in the financial sector plunging, where are those people going to go?

In 2008, overpaid bankers taking big risks with other people’s money brought the world economy to its knees. The last thing we need is to give them a chance to do it all over again.

Few could argue with Mr. Krugman’s well penned article but will anything change?  With their high powered Washington connections, my bet is that the boys at Citigroup, AIG, Bank of America, et al will continue to do just fine.

More On This Topic

Recession Has Changed Lifestyles

A Reality Check For Economic Optimism


Financial interests in companies mentioned – None

K-Ratio Flashing Major Buy Signal For Gold Stocks

Gold Stock Buy Signal

One reliable  indicator that I have followed over the years to time the purchase of gold stocks is the K-Ratio.  At the present time, the K-Ratio is giving a strongly bullish signal.  The K-Ratio is computed by dividing the value of  Barron’s Gold Mining Index (GMI) by the Handy & Harmon gold price.  Using data from the latest issue of Barron’s, the K-Ratio is now at .90 and flashing a very strong buy signal.

The last extremely bullish reading was registered in late October of last year when the K-Ratio recorded an all time low reading.  Since last October gold mining stocks have advanced strongly with the XAU recording a 100% gain from the October bottom to its recent high of 140.

XAU Gold & Silver Index Courtesy StockCharts.com

K-Ratio Forecasting Major Up Move for Gold Stocks

The K-Ratio works best at extreme readings when the GMI is below the price of gold, which is the case now.  The old rule of thumb is that an extreme bullish reading occurs when the K-Ratio is at 1.20 or lower indicating that gold stocks are cheap compared to the price of gold bullion.  In the past,  a sub 1.20  K-Ratio has triggered gold stock advances of over 50% and bullion advances of over 25% within 6 months.

K-Ratio Courtesy:   Kaeppel’s Corner

Some major gold producers that usually perform well in a rising gold market are KGC, GG and GOLD.   I would look for all of these issues to show major gains in line with the performance of the XAU over the next six months.

More On This Topic

Gold, Silver – An Important Alert!
The Gold Direction Indicator is flashing another buy signal.  This indicates that the pull-back that started late February is probably finished.  A new rally is about to start.



Banks And Consumers Say No To More Debt

More Debt Rejected As Solution For Debt Crisis

How many times since the current financial crisis began, have we been told by the Government that the key to an economic turnaround is easier credit and more lending? The Federal Reserve and Treasury have supplied virtually unlimited amounts of credit and guarantees to the banking industry to increase lending activity. The government is refusing to allow the return TARP funds, demanding instead that the money be lent out.

There’s just one problem with the government’s attempt to force more borrowing;  consumers don’t want to borrow and banks have few qualified customers.   In a Wall Street Journal report that must be causing fits in Washington, we learn today that the major recipients of TARP funding have dramatically reduced new lending activity.

Bank Lending Keeps Dropping-WSJ

According to a Wall Street Journal analysis of Treasury Department data, the biggest recipients of taxpayer aid made or refinanced 23% less in new loans in February, the latest available data, than in October, the month the Treasury kicked off the Troubled Asset Relief Program.

Banks defend their lending, saying they’re eager to issue new loans, refinance existing ones and modify those in danger of default. Complicating their efforts, bank executives say, is a decline in demand among consumers and businesses.

But excluding mortgage refinancings, consumer lending dropped by about one-third between October and February. Commercial lending slumped by about 40% over that period, the data indicates.

Of the 19 banks, the only ones to originate more loans in February than October were BB&T Corp., a regional bank based in Winston-Salem, N.C.; Wall Street giant Morgan Stanley; and State Street Corp., a Boston-based company that provides financial services mainly to institutions and wealthy individuals.

One of the banks showing the biggest lending decline was J.P. Morgan Chase & Co. In October, the New York bank made or refinanced $61.2 billion in loans. That figure declined 35% to $39.7 billion in February.

J.P. Morgan executives defend their lending levels. In the first quarter, the bank extended about $150 billion in new credit to consumers and businesses, “despite the fact that loan demand has dropped dramatically,” a spokesman said. In March, the spokesman said, J.P. Morgan made $65.5 billion in new loans — slightly more than it made in October.

So Why Aren’t The Banks Making Loans?

Banks are in business to lend money so why the decline in lending activity?  The extension of credit under normal circumstances is vital to economic growth and prosperity.  The reality of the current situation is that the banks (and every other financial institution) have for decades recklessly extended credit without regard to the to the ability of the borrower to service the debt from income.

This financial crisis is different and will not be solved by extending additional credit to over extended borrowers.  The banks and their customers recognize the risk of too much debt while the Government continues to mindlessly encourage more borrowing.

US Consumers Facing Reality

As noted above, a JP Morgan spokesman stated that “loan demand has dropped dramatically”.  The reasons for reduced loan demand are obvious and include the following: declining income, a low savings rate, an already intolerable debt load and a trend towards frugality.  The American consumer has wisely concluded that more debt will only make his financial situation worse.

Debt Levels Soar As Incomes Stagnate

Household Debt Ratio

Median Family Income

The 2nd chart’s blue data curve since 1979 (in 1993 dollars) can be compared to the above chart’s 1970-1978 – showing next to nil growth. The pink data curve from 1979-2007 expresses this in 2007 dollars. This computes real income compound growth for this 37 year period (1970-2007) of a measly 0.26% per year (about $10/month) average, compared to 12 times faster income growth of 3.7% annually in the prior 23 years 1947-1970.

Income growth for the average wage earner has been essentially flat since the early ’80’s.  The early 80’s was also the beginning of the greatest credit expansion in history.  Easy credit growth on a massive scale did not increase real incomes in the past nor will it do so going forward.  The statistics on income will be even more abysmal when updated to 2009,  reflecting salary decreases and an unemployment rate approaching 10%.  The nation does not need more debt but rather more income.

Savings And Home Equity Decline

The false “prosperity” of the past based on credit fueled asset appreciation caused many consumers to believe that saving was no longer necessary.   The  collapse of values in stocks and real estate has now left many consumers with little net worth or liquid savings.

Personal Savings Rate

Owner Home Equity

The American consumers have recognized that borrowed money is not income and that taking on more debt is not the path to prosperity; they  are making the necessary sacrifices to improve their financial future.  The US Government, obsessed with pushing more credit onto over leveraged borrowers, would do well to follow the example of its Citizens.

More on this topic:

What Americans Are Willing To Give Up

French Warn America About Runaway Spending and Stimulus

Banks Move Quickly From Bust To Boom

Things Change Quickly

Bank Profits

Only a couple of months ago, the consensus view predicted a collapsing  banking industry that would need to be nationalized.  Banks were viewed as black holes with little chance of becoming profitable.  Fortune Magazine was estimating future write downs of as much as $4 trillion.  Citibank appeared to be on the verge of collapse.  The Treasury hastily put together the Public Private Investment Plan (PPIP) to keep the banking industry solvent by purchasing toxic bank assets.

Then, virtually overnight,  the situation seem to change.  Today’s headlines are filled with stories of banks reporting record profits and attempting to return TARP money that they don’t want or need.   Has every bank in the country suddenly become rock solid?  Let’s examine some aspects of the banking industry’s  “miraculous” turnaround.

Reported Profits Questioned

Wells Fargo’s Profits Look To Good To Be True –

April 16 (Bloomberg) — Wells Fargo & Co. stunned the world last week by proclaiming it had just finished its most profitable quarter ever. This will go down as the moment when lots of investors decided it was safe again to place blind faith in a big bank’s earnings.

What sent Wells shares soaring on April 9 was a three-page press release in which the San Francisco-based bank said it expected to report first-quarter net income of about $3 billion. Wells disclosed few details of what was in that figure. And by pushing the stock up 32 percent that day to $19.61, investors sent a clear message: They didn’t care.

Dig below the surface of Wells’s numbers, though, and there are reasons to be wary. Here are four gimmicks to look out for when the company releases its first-quarter results on April 22:

Gimmick No. 1: Cookie-jar reserves.

Wells’s earnings may have gotten a boost from an accounting maneuver, since banned, that it used last year as part of its $12.5 billion purchase of Wachovia Corp. Specifically, Wells carried over a $7.5 billion loan-loss allowance from Wachovia’s balance sheet onto its own books –

The upshot is that Wells could get by with reduced provisions until the $7.5 billion is used up, boosting net income.

Another quirk: The reserve was related to $352.2 billion of Wachovia loans for which Wells was not forecasting any future credit losses, according to Wells’s annual report.

Gimmick No. 2: Cooked capital.

The most closely watched measure of a bank’s capital these days is a bare-bones metric called tangible common equity.

Measured this way, Wells had $13.5 billion of tangible common equity as of Dec. 31, or 1.1 percent of tangible assets. Yet in a March 6 press release, Wells said its year-end tangible common equity was $36 billion. Wells didn’t say how it arrived at that figure. Nor could I figure out from the disclosures in Wells’s annual report how it got a number so high.

Gimmick No. 3: Otherworldly assets.

Look at Wells’s Dec. 31 balance sheet, and you’ll see a $109.8 billion line item called “other assets.” What’s in that number? For that breakdown, you need to go to a footnote in Wells’s financial statements. And here’s where it gets comical.

The footnote says the largest component was a $44.2 billion bucket that Wells labeled as “other.” Yes, that’s right: The biggest portion of “other assets” was “other.” And what did this include? The disclosure didn’t say. Neither would Bernard.

Talk about a black box. That $44.2 billion is more than Wells’s tangible common equity, even using the bank’s dodgy number. And we don’t have a clue what’s in there.

Gimmick No. 4: Buried losses.

How quickly investors forget. One week before Wells’s earnings news, the FASB caved to pressure by the banking industry and passed new rules that let companies ignore large, long-term losses on the debt securities they own when reporting net income.

Citi Swings to Profit, But Defaults Rack Units

Wall Street Journal –Citigroup Inc. said it earned a quarterly profit for the first time in 18 months, logging a $1.6 billion gain between January and March. But many of the banking company’s businesses continued to deteriorate.

Still, Citi’s bread-and-butter businesses, such as global retail banking and credit cards, suffered from swelling loan defaults.

The (profit) figures also include a $2.4 billion boost from a little-followed accounting adjustment under Financial Accounting Standards Board’s rule 159, which governs how banks value their debt.

Separately, analysts questioned whether Citi was skimping on its ongoing reserves, noting that borrowers defaulted or fell behind on loans at a faster clip than Citigroup socked away money to absorb coming losses.

Bank Bailouts Political Hot Potato

Certainly a lot of unusual items in the reported results, especially the $44 billion of Well’s “other assets” and Citi’s large gains from a questionable accounting change on mark to market.  Since bailing out the banks is highly unpopular with the public, it is easy to conclude that the federal regulators gave the banks extreme latitude in accounting for certain transactions to make reported results look better than they would have.  This accomplishes two things – it takes the bailout issue off the front burner and potentially builds public confidence that the banking industry is not on the edge of collapse.  Whether or not this is just kicking the can down the road remains to be seen.

Liquidity Is Not The Problem

The Feds have literally been force feeding cash into the banking system to stimulate lending.  Banks, having seen enough of the poor results of lending money that cannot be paid back, have concluded that lending more is not the answer.  This can be seen in the massive increase in excess bank reserves that have piled up at the Fed.

Excess Reserves

Excess Reserves

Banks Have Learned Their Lesson On Dealing With The Government

Trapped In Tarp- Forbes

It’s getting itchy under the TARP. Calling funds from the Treasury Department’s Troubled Asset Relief Program a “scarlet letter” for banks, JPMorgan Chase Chief Executive James Dimon said Thursday that his firm is eager to return the $25 billion they’ve received from the government, and will do so as soon as possible.

Many banks are eager to get out from under the government’s thumb. Earlier this week, Goldman Sachs ( GS news people ) announced plans to sell $5 billion in new shares to help repay its $10 billion in TARP funds sooner rather than later.

For Dimon, the goal seems to be steering clear entirely of the controversial government programs designed to rehabilitate the banking industry. JPMorgan won’t be participating at all in the Public Private Investment Plan, the Treasury’s program to buy unwanted assets from banks by matching capital from private investors and backing the assets with guarantees.

Dimon wants no part of it. JPMorgan will manage and sell its own assets, he says. “We don’t need” PPIP, he says. “We’re certainly not going to borrow from the federal government, because we’ve learned our lesson about that.”

Lesson For All

The cost of government aid far exceeds the benefits in the judgment of those running the banks.  The bankers now seem more inclined to take their chances rather than tolerate the micro managing of their businesses by the Feds; certainly something to consider for any company contemplating a request for government “help”.

Whether the banking crisis is over is far from certain at this point.  The economy remains weak and loan defaults continue to threaten the profitability of the banking industry.  One thing for certain is that most banks do not want the heavy hand of the government destroying their franchise.  Given the reality of these circumstances, the only banks likely to request TARP funds in the future will be the total basket cases.  Forget the new “stress test” – going forward the Treasury can save time and taxpayer money by simply assuming that any bank weak enough to request aid should be closed down.

Why Does The FHA Approve Loans That Borrowers Can’t Afford?


FHA Delinquency Rate Raises Questions

The latest delinquency rates reported by the FHA are troubling and raise serious questions about the qualification process for approving FHA  borrowers.   The latest FHA numbers focus on the number of borrowers defaulting within the first year of the loan as detailed in the Wall Street Journal.

Nearly 10.2% of borrowers who took out FHA-backed loans in the first quarter of 2008 had missed at least two consecutive monthly payments within the first 10 months. That was up from 2007, when 9.4% of FHA-based borrowers missed payments within the first 10 months.

But loans with seller-funded down payments, which have higher default rates, were “clearly adding to the overall losses,” said William Apgar, a senior adviser to HUD Secretary Shaun Donovan.

Congress ended the seller-funded down-payment program last fall. Loans made in 2007 with seller-funded down-payments were 60% to 70% more likely to have a 60-day default than loans made without the 100% financing, Mr. Apgar said. HUD officials told Congress that down-payment assistance programs accounted for 30% of all FHA foreclosures but just 12% of all loans.

Dubious FHA Approvals

There is obviously something very wrong with the FHA mortgage approval process when over 10% of newly approved borrowers default on payments  within the first ten months of the loan.  These borrowers should have never been approved in the first place.

The basic flaws in the FHA mortgage program have been discussed previously and center on low down payments and low credit score borrowers – see FHA – Ready To Join Fannie and Freddie. The FHA delinquency rate has exceeded 10% since 2001.  The high default rate cannot be blamed on the poor economy but rather the loose FHA underwriting standards.

The FHA goal of helping Americans to achieve home ownership is commendable but should not be done at the expense of bailouts by the American taxpayer.  The FHA is not helping those “lucky” homeowners  approved for mortgages who then discover that the financial obligations of home ownership are far greater than expected.   In this situation, the home owner becomes the loser when he should have been the winner.

By not providing long term affordable housing finance to homeowners the FHA is failing its basic mission.  To its credit, the FHA has taken some small steps to mitigate future loan losses by eliminating the seller-funded down payment program,  increasing the down payment requirement  to 3.5% and limiting cash out refinances to 85%.  In addition, the FHA has always made only full income verification loans.  The high FHA default rate, however, indicates that further initiatives are necessary.

Recommended Action To Reduce FHA Defaults

Two major initiatives that the FHA should undertake to ensure that they are not trapping potential home owners into becoming mortgage slaves are as follows:

1. Initiate a mandatory education program for first time home buyers on the risks and costs associated with home ownership.  A detailed proforma budget of all projected income and expenses should be put together to give the potential home buyer a detailed view of how realistic the goal of home ownership is and what sacrifices may be required in order to meet their payment obligations.  See Long Term Housing Stability Based On Strong Borrowers.

2.  There are many statistics and arguments being put forth as to why FHA borrowers are experiencing sky high default rates.  After cutting through the fog of confusing variables, the basic fact is that borrowers are defaulting for a very simple reason – inadequate income.   If the borrower does not have sufficient income, the odds of default increase.   Why has the  FHA not examined the correlation of income levels to default rates?

The qualifying debt ratio for a mortgage borrower is simply the the housing expense (principal, interest, taxes, insurance and mortgage insurance) divided by the borrower’s gross monthly income.  Recently, HUD Secretary Donovan stated that HUD has decided that they would seek mortgage modifications to bring a borrower’s debt ratio down to 31%, a “standard that is truly affordable for borrowers.  31% debt-to-income ratio is the right standard”. Secretary Donovan is correct and is essentially saying that the monthly housing expense should not be excessive in relationship to monthly income which is only basic common sense.

The paradox related to Secretary Donovan’s pronouncement is that FHA loans are routinely being approved at debt ratios considerably higher than 31%.  It is not unusual to see debt ratios on FHA loans well above 40% and sometimes as high as 55 to 60%.   Debt ratio approvals above 40% almost guarantee that the borrower is going to be under severe financial stress, leading to late payments and default.

The FHA is not unique in approving high debt ratio loans.  It is also routinely done by Fannie Mae (FNM) and Freddie Mac (FRE) – see Mortgages Still Being Approved For Unqualified Borrowers.

Unless the government lending agencies take a closer look at a borrower’s ability to repay, expect the cycle of mortgage defaults, foreclosures, bailouts and bank failures to continue.

More On This Topic

10 Mistakes First-Time Home Buyers Make

The Next Hit – Quick FHA Defaults

Rate of Default is Rising Among FHA Backed Loans

Tea Parties Draw Small Crowds – Are Taxes Too Low?

2009-04-15-hartford-tea-party-106 Hartford, CT Anti-Tax Rally

Anti-tax tea party rallies took place across the nation on tax day, April 15th.   All things considered, including the warm spring weather, the size of the crowds protesting seemed oddly small.

MSNBC -Whipped up by conservative commentators and bloggers, tens of thousands of protesters staged “tea parties” across the nation Wednesday to tap into the collective angst fueled by a bad economy

“Frankly, I’m mad as hell,” said businessman Doug Burnett at a rally at the Iowa Capitol, where many of the about 1,000 people wore red shirts declaring “revolution is brewing.” Burnett added: “This country has been on a spending spree for decades, a spending spree we can’t afford.”

In Boston, a few hundred protesters gathered on the Boston Common — a short distance from the original Tea Party — some dressed in Revolutionary garb and carrying signs that said “Barney Frank, Bernie Madoff: And the Difference Is?” and “D.C.: District of Communism.”

Tens of thousands nationwide,  1,000 in Iowa and only a few hundred in Boston, the site of the original Tea Party!  What gives?  Tens of thousands, in a nation of 300 million, is a statistical non event.

Who Cares, If You Are Not Taxed?

Did the small number of protesters indicate that people are not upset by taxes, or was it a case of  “why waste my time – nothing will change”?  Perhaps it was something else, such as the fact that a relatively small number of households pay virtually all of the individual income taxes collected.  Consider the following:

NEW YORK (CNNMoney.com)

The top fifth of households made 56% of pre-tax income in 2006 but paid 86% of all individual income tax revenue collected, according to the most recent data available from the Congressional Budget Office.

But once the various tax breaks to which they’re entitled are counted, the burdens of low- and middle-income tax filers as a group has been fairly low.

The Tax Policy Center estimates that for 2009, 43% of tax units (most of which are lower income households that may or may not file a return) will have no income tax liability or will have a negative income tax liability, meaning the government will actually pay them.

Wall Street Journal

The federal version of this spinning top is the tax code; the government collects its money almost entirely from the people at the narrow tip and then gives it to the people at the wider side. So long as the pyramid spins, the system can work. If it slows down enough, it falls.

It’s also what’s called redistribution of income, and it is getting out of hand.

A very small number of taxpayers — the 10% of the country that makes more than $92,400 a year — pay 72.4% of the nation’s income taxes. They’re the tip of the triangle that’s supporting virtually everyone and everything. Their burden keeps getting heavier.

As a result of the 2001 tax cuts enacted by a bipartisan Congress and signed by President George W. Bush, the share of taxes paid by the top 10% increased to 72.8% in 2005 from 67.8% in 2001, according to the latest data from the Congressional Budget Office (CBO).

According to the CBO, those who made less than $44,300 in 2001 — 60% of the country — paid a paltry 3.3% of all income taxes. By 2005, almost all of them were excused from paying any income tax. They paid less than 1% of the income tax burden.

It’s time to create an Economic Growth Code whose purpose is to fix and grow the economy, not redistribute massive amounts of wealth. A new tax code that creates growth and reforms our entitlement system is the only way to dig our way out of the hole we’re in.

Not only is the current code flawed from top to bottom, it is used by politicians to divide the public along class lines and fails to promote prosperity.

I’d also create a mechanism so tax rates go up or down for everyone — no more dividing the country by lowering taxes for some or raising them only for others. A revenue system whose purpose is to pay the government’s bills should apply fairly to one and all. If Congress wants to raise or cut taxes, it should do so for everyone.

Another benefit is that such a system will create an environment in which spending programs receive the scrutiny they deserve. It’s funny what happens when everyone pays the bills; Americans may want less spending so they can pay fewer bills.

Many Had No Reason To Protest

The stats on who actually pays taxes explains the low turnout of tax protesters.   If you are not paying taxes, which is the case for over 50% of the country’s wage earners, what do you have to protest?

Why the no show turnout for the 40% of workers who pay 30% of the taxes?   My guess is they probably couldn’t afford to take the day off.   And as for that exalted group in the top 10% of wage earners who pay 70% of the taxes, they were probably doing what got them into the top 10% – working hard to support the 50% that don’t pay taxes.

The federal tax code was never meant to tax “fairly” but has instead been used as an instrument for implementing   social policy and income redistribution.   Redistribution of wealth, necessary to some extent, has now reached a dangerous point when 50% of wage earners pay no taxes.  Those who are not taxed can chose to be wrongly  indifferent to the level of taxation or spending since it has no impact on them.  Politicians, of course, understand this situation and by promising more to the majority of voters who pay the least, keep themselves in office thus perpetuating trillions in deficit spending.   Those who pay the most have effectively been disenfranchised from the political process due to their small voting numbers.  At some point this untenable situation collapses of its own weight as the small number of people supporting the system are eventually taxed out of existence.

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Hartford, CT Tea Party

Hartford, CT Tea Party

Craig Stahl, Connecticut, who participated in the Hartford, CT Tea Party had this comment for Comrade Obama:

“Remember the focus of the TEA Parties is not just taxes, but the massive
spending by all Governments (state & federal), and the sudden shift toward
socialism. That will result in massive debt for our grandchildren.”

Some Banks Are Not Amused With 3.875% TARP Mortgages

TARP Dollars Deployed

It was previously discussed how two banks in Washington State are safedeploying their TARP funds to provide low rate financing for new home buyers.  The program was limited in time and funding allocation as detailed below:

To some extent, this low rate lending program is political theatrics and a public relations effort.   Although the banks in question are offering below market rates, Sterling Savings Bank is only allocating $25 million of its TARP funds to this program after receiving $303 million.  In addition, Sterling is accepting applications for this low rate program only from March 25 to April 15, 2009 and most borrowers will need a 20% down payment to qualify.  The program applies only to new home purchases and not refinances.

Competitors Not Amused With Low Rate Offer

Well run banks that did not request or need TARP funds would seem to be at a competitive disadvantage when trying to match the generous (although limited) offer from Sterling and Banner Bank.  One large bank that is a competitor was definitely not amused.  Here is the response sent to a customer who is refinancing and asked why her bank could not provide the same low rates that Sterling and Banner were offering.

The TARP funds we borrowed are a big topic here, everything is pointing to “XBank” giving the money back. The regulations are changing all the time and the Bank believes it might be in our best interest to simply return it as we are in good financial position.

The deals with Sterling and Banner if you read into them are for newly constructed home purchases, each bank has a list of homes to choose from.

They are doing this because most of the money they lent to these builders is not being paid back, so to avoid bank losses they are trying to help the builders sell the homes. These are very limited programs and they are only for people purchasing new construction homes that the bank owns, essentially banks are selling their foreclosures with special financing.

There are always two sides to every story but with the entry of the Feds into the banking industry, things will become ever more complicated for everyone.

By the way, good luck to “XBank” in trying to return the TARP funds.  The Feds are making it very difficult for the banks and investment houses to return taxpayer money that they now say they don’t want or need.  Here are some insights into  Goldman Sachs’ efforts to return TARP money.

Goldman Sachs’ Mad Dash To Repay The TARP Cash, Jr DeputyAccountant

I maintain my opinion that Goldman Sachs, America’s top economic terrorists, have an in at both the Treasury and the New York Fed (should this really come as that much of a shock?) and have therefore been tipped off that something wicked this way comes for TARP recipient banks. Why else would they be so suddenly compelled to return the TARP cash they never really wanted in the first place?

The official line is that Goldman’s “regulator” the Fed fears how it will look if GS is first through the TARP repayment gate – what the f***? Don’t we want this money back? If the banks which took the money in the first place, either by choice or by force (?), are now bragging about profitability (despite insolvency in many cases – a denial which will eventually come out in the wash as it always does) then shouldn’t the taxpayer report profitability along with them by getting our God damn TARP money back which should have never gone to any of the Street thieves in the first place?!

Only in Bizarro World would a broken country falling further down the debt spiral by the day actually turn away money from the very robbers who snatched it in the first place.

Cramer VS Roubini – Nasty


Round One?

Things got real nasty as two giants in the world of financial commentary engaged in a bare knuckles brawl.  Nouriel Roubini earned his reputation by being one of the few to correctly predict the ongoing economic crash and he remains stoutly bearish.  Jim Cramer has repeatedly called bottoms as the Dow cratered from 14,000 to 6,500 and has endured continual sniping from critics who have documented his inaccurate predictions.

Roubini is seen by many as a perma bear while Cramer could be called a perma bull.   Comedian Jon Stewart didn’t get much of an argument from Cramer when he accused Cramer of missing the signs of a “once in a lifetime financial tsunami”.

The true test of greatness going forward will be decided by who correctly calls the bottom to this depression/recession.   The bets have been placed – time will tell who is right.   In the meantime, it was certainly better to take Roubini’s advice for the past three years.   Those market investors who ignored the bearish calls of Roubini have taken a major hit to their net worth.

The entertaining remarks made by each gentleman about the other follow, courtesy of guardian.co.uk.

Roubini, a New York University professor who famously forecast a dire world recession as far back as 2006, has taken exception to remarks on a blog by Cramer that he is “intoxicated” with his own “prescience and vision” and is refusing to see green shoots of recovery in the financial markets.

“Cramer is a buffoon,” said Roubini. “He was one of those who called six times in a row for this bear market rally to be a bull market rally and he got it wrong.”

Roubini, who believes the situation is so gloomy that leading US banks may need to be nationalised, was dismissive of Cramer: “After all this mess and Jon Stewart, he should just shut up because he has no shame.”

Speaking to the Associated Press ahead of a speaking engagement in Toronto, the economist continued: “He’s not a credible analyst. Every time it was a bear market rally he said it was the beginning of a bull, and he got it wrong.”

Last week, Cramer told his viewers that the recent 20% rally in Wall Street markets was sufficient to judge that the downturn was past its worst: “Right now, right here, on this show – I am announcing the depression [is] over!”

Depression Over?

Let’s hope that Cramer gets one right this time with his prediction that the “depression is over”.