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Insolvent Banking System Eludes Government Containment

January 20, 2009 by 2 Comments

Denial Of Reality Becoming Impossible

The game of pretending that the world banking system and national governments are solvent becomes more difficult by the hour.

The true magnitude of the write downs that the banking industry needs to take to reflect the reality of asset impairment was highlighted by the Royal Bank of Scotland.   Pretending that the losses do not exist is no longer worth the effort since no one is fooled anymore.  There can be no recovery in bank lending unless impaired assets are written down and sufficient amounts of new capital are raised.  This is the point at which things get interesting since the capital markets are not open to the banks; the lender of only resort to the banking industry are the world’s central governments.  The really scary question now is whether the central governments have the financial capacity to recapitalize the banking industry (along with everyone else) without resorting to printing money on a grand scale.

Far from being contained, as some have proclaimed, the banking crisis continues to expand.  The debate is no longer focused on whether the banking industry is solvent.  The real question is whether central governments can contain the economic meltdown.

Consider the size of losses reported by Royal Bank of Scotland and the excuses and comments by RBS Chief Executive Stephen Hester.

RBS Expects Huge 2008 Losses

LONDON — Royal Bank of Scotland Group PLC said Monday that tough market conditions in the fourth quarter and mounting impairment charges could push it to a 2008 full-year loss of as much as £28 billion ($41.29 billion), the U.K.’s biggest ever corporate loss.

The government currently owns just under 58% of RBS after last year underwriting a £15 billion rights issue that saw little take-up by existing shareholders.

The move means RBS will now have to pay back less to the government, but it has also to agree to boost lending to consumers and businesses. The Monday update comes ahead of the announcement of its 2008 results on Feb. 26.

RBS Group Chief Executive Stephen Hester said: “The dislocation of credit markets and the global economic downturn continue to hit RBS hard, as with many other banks.

“We are making progress in recognizing excess risk and dealing with it. Significant uncertainties and risks inevitably remain.

“In this context, the support we are receiving from the government benefits all our stakeholders and enables us to provide more customer support in return.”

“With enhanced core capital, removal of the preference share dividend and the prospect of further asset and liquidity measures, RBS is able to continue its strategic restructuring purposefully,” he added.

What Chief Executive Hester is really saying is that he managed RBS poorly and took ridiculous lending risks; no one will buy our shares or debt securities and we need a government bailout to prevent closing the bank.  Nonetheless, we now recognize “excess risk” and are ready to start lending again once we receive government funding.

Hester should be fired for incompetence –  he dissipated investor money and bank capital and now wants to try his hand with government supplied funding.

The question of how the British Government will raise the funds to bail out RBS is answered by The Telegraph.

Bank of England Edges Closer to Printing Money

Under the scheme’s terms, the Bank will be able to buy assets including corporate bonds and commercial paper, a move which Mervyn King, the Bank’s Governor, called “an important additional tool to improve financing conditions in the economy”.

The asset purchase facility does not in itself amount to quantitative easing or “printing money”, because the scheme initially will be financed by Treasury Bills and does not involve an increase in the money supply.

However, the Treasury has given the Bank’s Monetary Policy Committee the option to go down that road by extending the scheme at a later date and paying for assets with what amounts to newly created money and not Treasury bills.  Quantitative easing is a more unconventional tool available to the Bank beyond interest rates as it attempts to halt the pace of economic decline in the UK.

“This does not mean that quantitative easing will definitely happen, but does allow the MPC to move fairly quickly if they want to,” he said.

Ross Walker, economist at Royal Bank of Scotland, said: “This framework could readily evolve into full-blown quantitative easing – we would expect it to do so given the proximity of Bank Rate [to zero] and deteriorating economic conditions, perhaps as soon as March/April.”

I agree with Ross Walker – full blown money printing will occur as demands on the British treasury continue to explode in size.   The British Government, approaching the limits of their borrowing capacity, will come to the rescue of RBS and others by printing money.  At this point, no one is even trying to pretend that RBS is solvent or that the British government can bailout every failing enterprise.  The end result will be a catastrophic destruction of confidence world wide.  When governments’ last resort is to print money, one can sense that the end of the old order is near.

Half of Europe Trapped in Depression

Events are moving fast in Europe. The worst riots since the fall of Communism have swept the Baltics and the south Balkans. An incipient crisis is taking shape in the Club Med bond markets. S&P has cut Greek debt to near junk. Spanish, Portuguese, and Irish bonds are on negative watch.

Dublin has nationalised Anglo Irish Bank with its half-built folly on North Wall Quay and €73bn (£65bn) of liabilities, moving a step nearer the line where markets probe the solvency of the Irish state.

A great ring of EU states stretching from Eastern Europe down across Mare Nostrum to the Celtic fringe are either in a 1930s depression already or soon will be. Greece’s social fabric is unravelling before the pain begins, which bodes ill.

This week, Riga’s cobbled streets became a war zone. Protesters armed with blocks of ice smashed up Latvia’s finance ministry. Hundreds tried to force their way into the legislature, enraged by austerity cuts.

“Trust in the state’s authority and officials has fallen catastrophically,” said President Valdis Zatlers,
who called for the dissolution of parliament.

Spain lost a million jobs in 2008. Madrid is bracing for 16pc unemployment by year’s end.

Private economists fear 25pc before it is over. Spain’s wage inflation has priced the workforce out of Europe’s markets. EMU logic is wage deflation for year after year. With Spain’s high debt levels, this is impossible.

Italy’s treasury awaits each bond auction with dread, wondering if can offload €200bn of debt this year. Spreads reached a fresh post-EMU high of 149 last week. The debt compound noose is tightening around Rome’s throat. Italian journalists have begun to talk of Europe’s “Tequila Crisis” – a new twist.

Greece no longer dares sell long bonds to fund its debt. It sold €2.5bn last week at short rates, mostly 3-months and 6-months. This is a dangerous game. It stores up “roll-over risk” for later in the year. Hedge funds are circling.

Printing money, a self destructive tactic is the last option left to the governments mentioned above.  Expect major social unrest in these countries as their governments collapse the national wealth through the printing press.

Depression Ahead, Prepare for Stock Rout

LONDON (Reuters) – Societe Generale said on Thursday that the United States’ economy looks likely to enter a depression and China’s could implode.

In a highly bearish note, veteran cross asset strategist Albert Edwards said investors should now cut equity exposure after a turn-of-the-year rally and prepare for a rout.

He predicted that the S&P 500 index of U.S. stocks could be set for a fall of around 40 percent from recent levels.

“While economic data in developed economies increasingly reflects depression rather than a deep recession, the real surprise in 2009 may lie elsewhere,” Edwards wrote.

“It is becoming clear that the Chinese economy is imploding and this raises the possibility of regime change. To prevent this, the authorities would likely devalue the yuan. A subsequent trade war could see a re-run of the Great Depression.”

Edwards has long been one of the most bearish analysts in London, first with Dresdner Kleinwort and then with SocGen.

The world Central Governments are resorting to the nuclear option – printing money – in a last attempt to hold the financial system intact.   Had they allowed selected major bankrupt institutions to fail, severe financial pain would have been inflicted on many.   The strategy of attempting to save all bankrupt industries with printed money will result in worthless currencies worldwide,  thereby guaranteeing financial ruin for all.

Filed Under: Bailout, Banking Industry, Confidence Tagged With: , , ,

All Time Low Mortgage Rates For A++ Borrowers Only, Fed’s Efforts Futile

January 15, 2009 by 5 Comments

As discussed on December 31, 2008 many homeowners attempting to lower their mortgage rate apply for a refinance, only to discover that they do not qualify for the “low advertised rate” (Few May Benefit From Lower Mortgage Rates).

Unless a borrower has perfect credit (at least a 720 FICO score), adequate income (debt ratio of 32% or less) and substantial equity in the home (loan to value of 75% or less), the rate will be higher due to adders.  Adders are fees imposed by Fannie and Freddie if the applicant does not fit into the little box of a perfect borrower.  Adders are imposed for higher loan to value, lower credit scores and cash out refinances.  The adders can easily amount to 2% of the loan amount, or $2,000 on a $100,000 loan.   If a borrower is applying for cash out with a FICO score below 680 many lenders will turn the loan down.

This is the reality of the mortgage market today.  Many borrowers applying for a refinance with visions of a 4.875% rate and a payment reduction are finding out that they do not qualify.   There is much in the news about the “mortgage refinance boom”.   Expect to see stories in a month or two about how few borrowers actually benefited from the lower rates.

The stories of how few borrowers actually benefit from the lower rates did not take long to be noticed.

Rates Fall, But Refinancings Are Limited – Wall Street Journal

Interest rates on fixed-rate mortgage loans for prime borrowers have fallen to below 5%, the lowest level since the 1950s, triggering a wave of mortgage-loan inquiries from borrowers eager to refinance. But lenders and mortgage companies say that as many as half of the people who want to refinance can’t meet the credit hurdles and won’t get approved.

Only about a third of U.S. mortgage debt outstanding is likely to qualify for refinancing, said Doug Duncan, chief economist of Fannie Mae. Nearly 70% of borrowers don’t make the cut, he said, most often because their credit isn’t good enough or they don’t have sufficient home equity. A significant number of homeowners owe more than the current value of their homes, a situation sometimes known as being “under water.” Others can’t profitably refinance, often because they hold jumbo mortgages, those above the $625,000 limit for loans that can be bought or guaranteed by Fannie Mae or Freddie Mac in the highest-cost areas.

Since December 31st when I warned that only the best borrowers would be getting approved, rates have continued to decline.  The best borrower can now obtain a par rate of 4.5%.  On an after tax basis, mortgage money  now costs around 3%.  (I remember when savings bonds used to pay 6%.)  The good news is that for those who handled their financial affairs properly, the reward is the lowest mortgage rate ever.  The bad news is that your home has crashed in value, your stock retirement account is 40% lower and your hard earned savings yield zero interest if you prefer to invest in government treasuries.   On my scoreboard, we are all losers here, regardless of lower mortgage rates.

Borrowers Who Take Cash Out On Refinances Are Not Spending The Money

Mortgage refinances being approved show a pronounced borrower preference for frugality.  Many borrowers refinancing are doing so only to lower their payments, not to take cash out.  Those taking cash are mostly paying off other high rate debt or putting the money into savings.   This is not surprising since an A+ borrower does not happen by accident – they are frugal by nature and do not run up large amount of debt for frivolous reasons.  Those most inclined to maximize cash out and immediately spend the proceeds are largely no longer qualified for loan approval, either because of income, credit or equity restrictions.

Fed’s Efforts Futile

The Federal Reserve has spent hundreds of billions of taxpayers’ dollars buying mortgage backed securities to artificially suppress mortgage rates.  If the Fed’s intention was to spur more debt and spending by consumers, they have largely wasted their time and our money.   See Fed’s Asset Purchases Continue To Expand.

Filed Under: Federal Reserve, Interest Rates, refinance Tagged With: , ,

Satyam’s Phony $1 Billion – How They Did It

January 12, 2009 by Leave a Comment

One would think that with the number of business frauds, Ponzi schemes and other financial deceptions exposed over the last decade that auditors would have a more skeptical and cautious attitude.

The Satyam case is particularly perplexing when considering one of the major fraud aspects of the case.  Satyam reported cash balances of approximately $1.11 billion when in fact they had 94% less, or only around $66.6 million.

What makes this fraudulent reporting of cash balances so strange is how the auditors could possibly miss over a billion dollars.   Verifying cash balances is a routine step in the audit process.   In addition, routine “topside” analytical procedures are usually employed to verify that a large number on the balance sheet makes sense.

For example, if a company reports a cash balance of $1 billion dollars, does that cash balance look reasonable compared to the interest income reported?    A quick check on what rate of interest the company was earning should have resulted in determining if the interest income the company reported from its cash holdings was reasonable.  Perhaps Satyam fraudulently inflated the income earned on their phantom cash as well, in which case this procedure may not have lead to suspicion.  A routine financial audit is not conducted with the intention of discovering management fraud.

Verifying cash balances , however, is an entirely different matter.  Cash balances are easily verified by sending a balance confirmation request directly to the banking institutions in which the cash is held.   Cash confirmations are a simple and routine audit procedure.  A company holding over $1 billion in cash and conducting business worldwide would have accounts with many different banks.  The odds of having someone at many different banks intercept and falsify a bank confirmation is highly unlikely; so how did the auditors miss $1 billion?

The most plausible explanation is that the auditors did not comply with standard audit procedures.   Once the bank confirmations are prepared by the auditors, procedure requires that they be taken directly to the postal service by the auditors.  Instead, I suspect that a very cooperative and friendly staff at Satyam offered to take care of mailing the bank confirmations, thereby saving the auditor the extra effort of independently mailing the confirms.   This breakdown in a routine audit procedure most likely resulted in the bank confirms never being mailed to the banks. The confirmations were retained and fraudulently completed by Satyam, and then mailed back to the unsuspecting auditor.  The doctored confirmations examined by the auditors matched what the company said they had in cash and everyone was satisfied.

Result: simple audit rule violated and huge fraud goes undetected.

Filed Under: Auditors, Corruption, Fraud Tagged With: , ,

30 Year Mortgage Rates At 4.5% – Is 3.5% Possible?

January 12, 2009 by 5 Comments

How Low Can Mortgage Rates Get?

According to Freddie Mac, the average 30 year fixed rate mortgage dropped for the 10th consecutive week to a new low of 5.01%.   This is the lowest rate reported by Freddie Mac since they began keeping track in 1971.

Rates have moved sharply lower over the past two weeks to all time lows despite the fact that the 10 year treasury bond did not move to new lows.  The traditional rate differential between the 10 year treasury and the 30 year fixed rate mortgage has disappeared due to the mortgage crisis and other factors.   Risk is now priced higher across all credit markets, including mortgage backed securities (MBS).

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.

Filed Under: Federal Reserve, Mortgages, refinance Tagged With: , ,

Inflation – The Real Long Term Threat To Financial Survival

January 9, 2009 by Leave a Comment

Concerned with the preservation of wealth and purchasing power?

The US Government Will Not Choose Deflation
by Rich Toscano and John Simon

Conclusion

We in the United States have been dumping our dollars into the world for years and we continue to do so. We owe a staggering amount of foreign debt denominated in dollars and we are gearing up to borrow even more. Our legislators and the stewards of our currency are rabidly hostile to deflation — they are hostile, in other words, to the idea of the dollar gaining purchasing power. They have shown via word and deed that they will do whatever it takes to prevent deflation from taking hold. When deflation is viewed as even a remote possibility, there are effectively no limits to the amount of money the government can create nor to what they can do with that newly minted money.

Under these circumstances, we just don’t believe that the dollar is going to gain purchasing power in any sustainable way. The current deflationary storm could continue for a while yet, but the longer it goes on, the more violent and severe its reversal is likely to be.

Deflation is a choice within the current monetary regime. It is a choice that our government has shown it will not make. There are serious long-term risks inherent in our dysfunctional monetary system, to be sure — but deflation isn’t one of them.

The writers construct an excellent case in explaining why the government must and will chose inflation.   A must read.

Filed Under: Dollars, Federal Reserve Tagged With: ,

We Are All Keynesians Now

January 9, 2009 by Leave a Comment

Do Deficits Matter?

In the short term, it may not matter what anyone thinks.  There is a near universal political consensus that spending is the only solution that will save the economy.  This consensus is backed by a long list of economic experts; the same people who in the recent past had been predicting clear skies and strong economic growth.

Will borrowing and government spending bring back happy days and prosperity?   We will not know the ending to our grand Keynesian experiment for a number of years.   What we may discovery sooner is the borrowing limits of the US Government.

In the long run, deficits do matter.

For those inclined to consider this matter further, the following links are good reads.

FOMC saw specter of depression, deflation

Minutes show members grappling with fresh approach to monetary policy

WASHINGTON (MarketWatch) – Members of the Federal Open Market Committee at their mid-December meeting saw increasing risks of depression and deflation as they grappled with employing new tools to stabilize an economy that was rapidly weakening, according to truncated minutes of the meeting released on Tuesday.
“The overwhelming message gleaned from the minutes of the meeting is one of fear — fear of a deep recession, and fear of a debilitating deflationary spiral that would capsize a debt-laden economy,” wrote Joshua Shapiro, chief economist for MFR Inc.
Some participants at the meeting saw “the distinct possibility of a prolonged contraction, although that was not judged to be the most likely outcome,” the minutes said. Inflationary pressures were likely to dissipate, and “some members saw significant risks that inflation could decline and persist for a time at uncomfortably low levels.” Read the Fed release.

The Deficit Spending Blowout

But there’s more. None of that includes the new fiscal “stimulus” that President-elect Obama has promised to introduce upon taking office in two weeks. The details aren’t known, but Mr. Obama and Democrats have been talking about at least $800 billion, and probably $1 trillion, in new spending or various tax credits and reductions over two years. Toss that in and add more expected bailout cash, and if the economy stays slow the deficit could reach $1.8 trillion, or a gargantuan 12.5% of GDP. That 2006 Democratic vow to pass “pay as you go” budgets seems like a lifetime ago, which in political terms it was.

Obama on Stimulus: Details To Come

So, who then determines what’s an infrastructure project? The infamous “Bridge to Nowhere” was “infrastructure.” Plans were drawn up for it. Workers would have been employed to build it. What’s the difference between pork, a boondoggle and useful infrastructure?

U.S. projects the biggest deficit since World War II.  Can the country borrow its way back to prosperity?

Reasons abound for the ballooning deficit, including a 6.6% decline in tax revenues compared to 2008; more than $180 billion in transaction costs associated with the Troubled Asset Relief Program (TARP), the Treasury Department’s bailout fund for the U.S. economy; the $240 billion price tag of the government’s takeover of mortgage buyers Fannie Mae (nyse: FNM – news – people ) and Freddie Mac (nyse: FRE – news – people ); and increased spending on unemployment compensation.

Stimulus may spur jobs – abroad

NEW YORK (CNNMoney.com) — President-elect Barack Obama this week proposed a massive economic stimulus program with a lofty goal amid a deep recession: create 3 million jobs.

How many of those jobs will end up in China, South Korea or other countries?

Crisis and plan to fix it unprecedented

“I know the scale of this plan is unprecedented, but so is the severity of our situation,” he said. “As the economy recovers, the deficit [will] start to come down. We cannot have a solid recovery if our people and our businesses don’t have confidence that we’re getting our fiscal house in order.”

German auction fails and Britain debt hits danger level

There are fears that the next crisis in the global financial system could prove to be a rebellion by the bond vigilantes, already worried by talk of a bond bubble. This would push up rates used to fixed mortgages and corporate bond deals. Central banks can offset this for a while by purchasing bonds directly — “printing money” — but not indefinitely.

The US alone is expected to issue $2 trillion (£1.3 trillion) of debt this year, and the Europeans are not far behind. Italy alone must tap the markets for €200bn as it rolls over its huge stock of public debt and meets the cost or recession. Fitch Ratings said Ireland, Greece, the Netherlands, and France face a heavy calendar of auctions as maturities fall due.

Filed Under: Bailout, Interest Rates Tagged With: , , , , ,

Congress Proposes Cram-Downs As New Mortgage Solution

January 7, 2009 by 2 Comments

The plight of homeowners delinquent on their mortgages has been the focus of much debate lately.  There have generally been two major lines of thinking:

-The best course is to let free market principles apply.  If homeowners cannot afford the mortgage payment, the old fashioned remedy of foreclose should take place, turning an overburdened homeowner into a renter.

-Those more inclined to assess the loss of a home in terms of human suffering rather than as an economic equation have sought to provide relief to struggling homeowners by modifying the terms of the original mortgage.

As the number of mortgages in default grew, the situation attracted the attention of politicians.  Their viewpoint seemed to focus on helping the homeowner stay in the home, regardless of cost.

The governments’ efforts to encourage the banking industry to cure the foreclosure problem through voluntary participation in loan modifications was a failure.   For a variety of reasons the loan mods were not working.   Data from the Comptroller of the Currency shows that over 50% of modified loans re-defaulted within 6 months.  With many loan mods, payments went up for the borrowers and principal was hardly ever reduced.  The loan mods actually left many borrowers in a worse position than when they started.  In addition, most of them had negative equity before and after the loan mod.  The negative equity position locked them into the house, unable to sell or refinance.

Today, from Washington, a new solution – giving bankruptcy courts the power to alter the terms of the original mortgage.

Lawmakers Set New Mortgage Bankruptcy Bill

WASHINGTON (Reuters) – Legislation designed to stem foreclosures by allowing bankruptcy judges to erase some mortgage debt will be introduced by Congressional Democrats on Tuesday, and hopes are high that it will pass after a similar plan failed last year.

“Economic conditions have only worsened since we last debated this plan,” said Rep. Brad Miller, a member of the House Financial Services Committee who plans to introduce a bankruptcy reform bill on Tuesday. “Until we stop the slide in foreclosures and falling home prices, the economy will get worse still.”

The legislation would change allow bankruptcy judges to modify home loans in the same way that they currently may modify other unsettled obligations, such as credit card debt.

The lending industry has said that allowing bankruptcy judges to modify mortgage obligations would change how they weigh risk. Currently a lender knows that it has recourse to foreclosure if a borrower fails to meet mortgage payments, but the lender does not have to factor in the possibility that the payments it receives could be decreased by a judge.

What will be the impact of allowing bankruptcy judges to discharge (cram-down) mortgage debts?  Some of the issues and questions to be considered include the following.

1.  Interest rates are correlated to risk – that’s the way things work in a free market.   If a mortgage loan is made with the risk of principal impairment by bankruptcy, this risk has to be priced into the loan rate.  Reducing mortgage principal by legislative fiat may bring unintended adverse consequences.

According to The Mortgage Bankers Association “It is our position that if this proposal were to become law, mortgage rates would increase by at least one and a half points. In addition, lenders will be forced to require higher down payments and charge higher costs at closing. All these increased costs would be necessary to account for the new risks that lenders will face when judges decide to change how much borrowers owe on their mortgages.”

2.  Since total mortgage delinquencies are less than 10% and not all of these cases will wind up in bankruptcy,  cram downs might help less than 5% of mortgaged homeowners.   If the MBA is correct and mortgage rates rise significantly due to cram downs, expect a significant backlash from the other 95% of mortgaged homeowners who will wind up paying for the losses through higher interest rates.

3.  According to The Housing Wire, 50% of Americans oppose bailing out troubled homeowners. “These findings indicate that there are significant political barriers to proposals now being drafted in Congress”

The bankruptcy discharge of a mortgage balance will be viewed by many as the ultimate bailout.  The final compromised bill may result in contorted regulations that ultimately benefit few homeowners.

4.  The free market has a solution for “troubled homeowners” which is known as foreclosure.  Does the free market solution lose all merit merely because the number of foreclosures increased dramatically due to imprudent borrowing and lending?

5.  According to Rep. Brad Miller, “Until we stop the slide in foreclosures and falling home prices, the economy will get worse still.”   Rep. Miller is confusing a symptom of the disease as the cause.  Falling home prices did not cause our economy to weaken.    The housing asset bubble that burst was due to reckless lending, fueled by a government providing easy credit and obsessed with making everyone a homeowner. Political interference in economic matters usually delays a solution by impeding the free market forces that will ultimately prevail anyways.

6.  If the mortgage cram down bill is passed, it will drive many homeowners to bankruptcy, lured by the promise of wiping out mortgage debt.   The loan modification program allowed the banks to pretend that the amount they were owed would still be repaid over time.  When the loan gets reduced in bankruptcy, this illusion will be gone.  More write offs by the banks could lead to a self defeating cycle of tighter credit, stricter mortgage underwriting, weaker housing prices and further bailouts.

7.  How many homeowners that are incapable of handling the burden of home ownership will be allowed to remain in their homes, only to face foreclosure again at a later date?

8.  Continued massive government support of the mortgage market will be necessary since investor demand for mortgage securities is likely to remain low due to collapsing housing prices and the risk of mortgage debt being discharged by bankruptcy. How does an investor properly price a mortgage security where the asset value underlying the security is declining and also face the risk that the principal investment may be impaired by court decree?

9.  The Fed is now expected to absorb virtually all of the new mortgage backed securities this year.   With the Fed extending its purchases into virtually every asset class, a question comes to mind.  As the Fed assumes the losses of all failing economic entities in the country, at what point does the US Government begin to share the credit quality of those being bailed out?

Filed Under: Bailout, Banking Industry, Housing, Interest Rates, Mortgages Tagged With: , ,

Job Losses Continue – “Unprecedented Economic Conditions”

January 7, 2009 by Leave a Comment

Job losses continue to dominate the headlines in 2009.

Logitech To Slash 15% Of Work Force

ZURICH (Reuters) — Logitech International SA, the world’s largest computer-mouse maker, said it plans to cut 15% of its workforce and withdrew its fiscal 2009 financial targets, citing deepening global recession.

“During the December quarter, the retail environment deteriorated significantly,” Chief Executive Gerald Quindlen said in a statement on Tuesday, adding that the company expects the economic environment to worsen in coming months.

Cigna To Cut 1,100 Jobs

LOS ANGELES (Reuters) — Health insurer Cigna Corp. said Monday it will cut 1,100 jobs, or about 4% of its workforce, and consolidate certain operations as it copes with the economic downturn.

“Given the unprecedented economic situation we and our customers are facing, these actions are essential to ensure we can meet their needs for high-value, cost-effective products and services,” Chairman and Chief Executive H. Edward Hanway said in a statement.

The Cigna news follows a similar announcement last month from No. 3 health insurer Aetna, which said it would cut 1,000 jobs, or about 3% of its workforce, by the end of 2008.

UnitedHealth Group Inc., the largest U.S. health insurer by market value, said in July it was cutting some 4,000 jobs, or about 5% of its workforce, over the course of a year.

Alcoa to Cut 15% of Work Force, Unload Assets

Alcoa Inc. announced the elimination of about 15,000 jobs, more plant closures, plans to sell assets and a 50% cut in capital expenditures to contend with the sustained recession.

“Many of these things are painful and many of these things are drastic,” Alcoa Chief Executive Klaus Kleinfeld said in an interview Tuesday. “We will continue to monitor the dynamic market situation to ensure that we adjust capacity to meet any future changes in demand and seize new opportunities.”

Alcoa lost much of its luster in the recent commodity boom, failing to match the profit rise of other mining and metals companies, including rivals Rio Tinto Aluminum and UC Rusal. Both of those companies have also announced major cuts, shutting operations and selling businesses such as operations in China.

About 15% of the company’s employees and contractors will lose their jobs. Alcoa also is freezing salaries and hiring.

One day’s results – 3 companies cut over 17,000 jobs resulting in hard times and unemployment for many families.  Job losses have been an ongoing event and promise only to get worse as the job losses ripple throughout the economy.

The common theme in many of the layoffs is the eye popping size of the job cuts and company statements that conditions deteriorated significantly.  The size of the cuts do not suggest a typical slowdown but rather a “falling off the cliff” economy.

The only possible positive view one can take here is that when the news is this bad, it has to get better.

Filed Under: Economy, Jobs Tagged With: , , ,

Fed’s Asset Purchases Continue To Expand

January 7, 2009 by 1 Comment

The $8 Trillion Dollar Bailout

NEW YORK (CNNMoney.com) — Sitting down? It’s time to tally up the federal government’s bailout tab.

There was $29 billion for Bear Stearns, $345 billion for Citigroup. The Federal Reserve put up $600 billion to guarantee money market deposits and has aggressively driven down interest rates to essentially zero.

The list goes on and on. All told, Congress, the Treasury Department, the Federal Reserve and other agencies have taken dozens of steps to prop up the economy.

Total price tag so far: $7.2 trillion in investment and loans. That puts a lot of taxpayer money at risk. Now comes President-elect Barack Obama’s economic stimulus plan, some details of which were made public on Monday. The tally is getting awfully close to $8 trillion.

The amount of $8 trillion is incomprehensible to most people, including myself.   But there is an interesting way to contemplate the amount of $8 trillion dollars.  The total amount of home mortgage debt outstanding in 2008 amounted to only $10.6 trillion (see Mortgage Holiday).  If the government had simply used the $8 trillion to directly payoff consumers’ mortgage debt, all of us could have seen an 80% reduction in our mortgage payments!  Go figure.

Stop the Bankruptcy Cram Down

As Congress debates legislation to empower the Treasury to purchase troubled mortgage-related assets, some are trying to weigh the bill down with ancillary, unnecessary provisions. The one which concerns us the most is a provision that would allow bankruptcy judges to unilaterally change the terms of many mortgage loans, including the loan balance, as part of Chapter 13 bankruptcy proceedings. By granting judges this power, this bill would throw into question the value of the collateral that backs every mortgage made in this country — the home.

The fact remains that the lending community remains united against this idea. It is our position that if this proposal were to become law, mortgage rates would increase by at least one and a half points. In addition, lenders will be forced to require higher down payments and charge higher costs at closing. All these increased costs would be necessary to account for the new risks that lenders will face when judges decide to change how much borrowers owe on their mortgages.

Interest rates are correlated to risk – that’s the way things work in a free market.   If a mortgage loan is made with the risk of principal mark downs in bankruptcy, this risk has to be priced into the loan rate.

During the bailout vote, Democratic Senator Dick Durbin of Illinois argued for the right to give bankruptcy judges the ability to change the terms of a mortgage.  With the change of power in Washington, the odds of mortgage cram down legislation passing is very high.

Since total mortgage delinquencies are less than 10% and not all of these cases will wind up in bankruptcy,  cram downs might help less than 5% of mortgaged homeowners.   If the MBA is correct and mortgage rates rise significantly due to cram downs, expect a significant backlash from the other 95% of mortgaged homeowners who will wind up paying for the losses through higher interest rates.

Mortgage/Treasury Spreads Reflect Risk

Bloomberg) — Federal Reserve officials are focused on driving down the spreads between U.S. Treasury yields and consumer and corporate loans, after cutting the main interest rate to almost zero failed to revive lending.

Credit costs for households and businesses haven’t followed yields on government debt lower. Fifteen-year fixed-rate mortgages were at 5.06 percent last week, 2.59 percentage points above 10-year Treasury yields; the spread averaged 0.88 point in 2003, when the Fed slashed rates to 1 percent.

Chairman Ben S. Bernanke sees the thawing of frozen credit markets as critical to a recovery, and is determined to try to prevent a second wave of credit distress as the U.S. weathers bad economic news over the next two quarters. The Fed is now looking at ways to revive lending by using its balance sheet to hold loans and bonds that investors don’t want.

“Investors in general don’t want to take on the risk,” said Richard Schlanger, who helps manage $15 billion in fixed income securities at Pioneer Investments in Boston. “It is going to reach the point where the Fed will intervene again.”

If spreads between treasuries and mortgages followed the historical norm, mortgage rates on both the 15 and 30 year mortgage would be at least 1.5% points lower.   The question that is not addressed, of course, is how much higher would mortgage rates be without government price support?  Since private buyers see a poor risk/reward ratio in owning mortgages, does the government establish a permanent presence as mortgage lender of last resort?

In addition to providing price support to mortgages, we now have a Federal Reserve pledging to bring down consumer and corporate lending rates as well.   The announcement that the Fed would be buying mortgage backed securities brought down mortgage rates.  Can the Fed do the same in other debt markets by purchasing securities that free market investors view as too risky to own?

With the Fed extending its purchases into virtually every asset class, a question comes to mind.  As the Fed assumes the losses of all the failing economic entities in the country, at what point does the US Government begin to share the credit quality of those they are bailing out?

Filed Under: Bailout, Federal Reserve, Interest Rates Tagged With: , ,