December 21, 2024

The Risk Of Higher Mortgage Rates

January 4, 2009 by 4 Comments

Mortgage rates again ticked higher Friday as the treasury market continued its sell off.  Most of the good news may already be priced into the treasury market that mortgage rates are based on.

Reasons why mortgage rates may increase:

1.  As the Fed’s efforts to stabilize the credit markets succeed, frightened money is moving out on the risk curve, selling treasuries and purchasing much higher yields on corporate debt, preferred and common stock and municipals.  To the extent that the Fed is calming the credit markets, their actions are  counterproductive to lower mortgage rates.

2.  The Fed’s announcement in late November of their intention to buy half a trillion dollars of mortgage backed securities is what kicked the mortgage rate decline into high gear.  Most of this may now be fully discounted.  The actual announcement of the purchase schedule of the MBS’s did nothing to lower rates.

3.  Without the backing of conventional mortgages by the government, mortgage rates would be much higher.   This can be seen from pricing in the jumbo fixed rate mortgage market where rates are as much as 2 to 3% higher since Fannie and Freddie do not purchase or guarantee these mortgages.  Many banks effectively do not offer jumbo mortgages since there is no secondary market for them.

4.  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 and loan modifications. How can 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?

5.  The question of how much financial support the government is able to continue to provide to subsidize mortgage rates becomes important, especially as bailout demands escalate.  There are reports today that the State governors are seeking $1 trillion in bailout support as their deficits grow.  Unless the funding ability of the US Treasury is infinite, price support for mortgages may be reduced.  The Fed is now expected to absorb virtually all of the new mortgage backed securities this year.  Meanwhile, the debt of the US Government continues to explode, possibly beyond the point where the debt can ever be repaid.  This scenario implies higher rates on all government backed debt.

Many investors expect the eventual outcome of the Fed’s quantitative easing campaign to result in much higher inflation.  Some very astute investment managers, who had correctly predicted the financial meltdown now view the treasury market as overpriced.

  • Jeremy Grantham of GMO describes the 30 year treasury bond as “ridiculously” overpriced and effectively forecasting only a 1% annual rate for the next three decades.  Mr Grantham sees the scenario where there could easily be a large surge in inflation.
  • Bob Rodriquez who runs the FPA New Income Fund and was up on the year in 2008 also sees a “massive bubble in treasurys”.  He is not buying treasurys since “We will not lend long term money to a borrower that capriciously erodes its balance sheet.”
  • Peter Schiff of EuroPacific Capital also sees a substantial risk of massive inflation and sharply higher interest rates at some point.   Eventually foreign investors will refuse to buy US Government debt based on concerns about the US ability to repay its debts.

The above scenarios may not be imminent but they do become more probable as the US Government depletes the Treasury with endless bailouts, guarantees and borrowing.

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

Promises That Cannot Be Kept

January 4, 2009 by Leave a Comment

Did Bernard Madoff run the biggest Ponzi scheme of all time, or does this honor actually belong to the US Government?

Is Social Security A Ponzi Scheme?

In the aftermath of the Madoff implosion, quite a few people have pointed out the parallels between a Ponzi scheme and Social Security. Arnold Kling, whom I respect, has written:

I’ve been thinking that Madoff is a perfect analogy for the public sector. The government gives people money, which it expects to obtain by taking the money from people in the future. Even the Center on Budget Policy and Priorities, not known as a right-wing organization, sees the U.S. fiscal stance as unsustainable (pointer from Ezra Klein via Tyler Cowen)—in other words, a Ponzi scheme.

Other people have gone farther. Paul Mulshine of the New Jersey Star Ledger wrote a column entitled “The Ponzi scheme that Baby Boomers are waiting to cash in on.” And Jim Cramer has called Social Security the biggest Ponzi scheme in history.

The article above discussed only social security and not the other two financial time bombs – medicare and medicaid.  The net present value future cost of these three programs is estimated at $52 trillion, a burden that we have thrown on future generations who may be unwilling or unable to pay.

Wages have been stagnant for a decade.  Politicians are afraid to raise taxes and voters don’t want to pay so the easy solution is to borrow the money and add more debt, a self defeating cycle.   Promises and free lunches are great ways to get elected but governments only redistribute wealth.   Without the ability to tax the productive capacity of its country’s labor force, a government would have no fiscal capacity.

Debts do matter, of course, it’s just common sense.  Merely because a governmental entity has taken on the debt in the name of the taxpayer does not mean we can get a free lunch.  Ultimately we fool ourselves to believe that debt obligations are not a problem –  the world learned this in 2008.   The government can promise all of us everything and we can keep electing the fools who say what we want to hear, but ultimately someone has to pay for the promises or they will not be kept.

Filed Under: Bailout Tagged With: , ,

The Terminal Debt Trap

January 4, 2009 by Leave a Comment

US Could Be Facing Debt “Time Bomb” This Year

WASHINGTON – With President-elect Barack Obama and congressional Democrats considering a massive spending package aimed at pulling the nation out of recession, the national debt is projected to jump by as much as $2 trillion this year, an unprecedented increase that could test the world’s appetite for financing U.S. government spending.

Despite those actions, the economic outlook has continued to darken. Now, Obama and congressional Democrats are debating as much as $850 billion in new federal spending and tax cuts to create or preserve jobs and slow the grim, upward march of unemployment, which stood in November at 6.7 percent.

Congress is not planning to raise taxes or cut spending to cover the cost of those programs, because economists say doing so would further slow economic activity. That means the government has to borrow the money.

Economists from across the political spectrum have endorsed the idea of going deeper into debt to combat what many call the most dangerous economic conditions since the Great Depression.

“When you accumulate this amount of debt that we’re moving into, it’s not a given that our foreign friends are going to continue on the path they’ve been on,” said G. William Hoagland, a longtime Republican budget analyst who now serves as vice president for public policy at the health insurer Cigna. “There’s going to come a time when we can’t even pay the interest on the money we’ve borrowed. That’s default.”

The unanimous conclusion of the politicians and economists seems to be that we can borrow our way to prosperity via fiscal stimulus conducted with borrowed funds or printed money.

It is, of course, delusional to think that we can spend and borrow our way out of a financial crisis caused by over spending and over borrowing.   The reason we are in a financial crisis is due to excess leverage and credit at every level of our economy.  The attempt to subvert free market solutions by socializing every loss will only expand and prolong our economic mess.

Foolish politicians promising easy and painless solutions are pandering at best.   Quantitative easing, fiscal stimulus, bailouts and guarantees are no solution.   We have a crisis because we spent our future.  The solution of hard work and a lower standard of living will eventually be forced upon us.   Massive new spending and borrowing at this point only brings us closer to a terminal debt trap where we have neither the capacity to repay nor the ability to borrow.

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

GMAC Sets Example For TARP Borrowers

January 1, 2009 by 3 Comments

This past week the Treasury used $5 billion of funds from the Troubled Asset Relief Program (TARP) to purchase senior preferred equity in GMAC, the financing arm of General Motors.  GMAC reacted immediately to deploy the funds by lending to new car buyers with credit scores as low as 621.

According to GMAC President Bill Muir, “We got the TARP money yesterday and today we’re out in the marketplace offering it to consumers”.

AutoNation Chief Operating Officer Michael Maroone was equally elated noting that “We want to get out there and let people know that we can get them credit now.  There are plenty of people with credit scores in the 600’s who want to buy cars”.

GMAC was masterful in showing its appreciation for taxpayer dollars by its quick lending, thus avoiding the criticism the banks received for not lending out their TARP funds.  The Treasury will, no doubt, show its appreciation by supplying GMAC with billions more as soon as possible.

The Treasury should reflect on the following points before advancing GMAC additional funds.

  • A credit score in the low 600’s is sub prime.  You earn such a score by paying late and taking on obligations in excess of your ability to repay.  A low 600 credit score reflects a financially stressed consumer, typically with little in the way of savings and in need of constant new credit to pay off old credit.   Any consumer in this category should think twice about buying an expensive new car.  What they should really be doing is trying to save some money, pay down some debt and visit the used car lot.
  • The free market was not providing car loans to sub prime borrowers for the reasons listed above.  The TARP fund is essentially subsidizing car loans, at taxpayer expense, so that customers who couldn’t buy a new car based on their low income or credit score, can now do so.
  • AutoNation’s Mr Maroone is certainly correct when he states that there are plenty of sub prime borrowers eager for loans.  I doubt very much that Mr Maroone would personally lend money to a sub prime borrower because he knows better.  Lending taxpayer bailout money, on the other hand, is apparently a great idea.   Have we already forgotten the results of lending to sub prime mortgage borrowers?

If the government really wants to get the lending machines running again, they now know where to go especially since GMAC also makes mortgage loans through its ResCap subsidiary.  Here are the results of GMAC’s mortgage operation:

GMAC mortgage lender’s future in doubt

courtesy of Reuters

The Residential Capital LLC affiliate of automaker General Motors Corp (GM.N) may soon join the ranks of U.S. mortgage lenders that failed to navigate the deepening housing crisis.

The specter of a ResCap failure grew after parent GMAC LLC on Wednesday said “substantial doubt exists regarding ResCap’s ability to continue as a going concern” absent more support from GMAC, best known for lending to GM customers.

Christopher Wolfe, an analyst at Fitch Ratings, added: “If GMAC can’t provide support that ResCap needs, then bankruptcy is an option for ResCap.”

The lender has lost $9.1 billion in the last two years, and said that as of September 30 it wasn’t receiving interest payments on 21.8 percent of loans, up from 5 percent a year earlier.

“We can only describe credit quality trends as ugly,” CreditSights Inc analyst Richard Hofmann wrote.

“With equity down to $2.3 billion, clearly ResCap cannot survive much longer at its current quarterly loss rate,” he added. “Absent of any government support, we believe GMAC’s statement points toward the filing of ResCap for bankruptcy.”

Conclusion

Lending more money to those least able to repay guarantees financial losses on a colossal scale.   In the very short term, Government subsidized lending may give the economy a modest boost.  In the long term, such reckless lending will result in the insolvency of our nation.

Filed Under: Bailout, GM Tagged With: , , ,

$700 Billion Debated – $5 Trillion Ignored

December 24, 2008 by 1 Comment

When the original $700 billion TARP bailout program was proposed by Treasury Secretary Paulson and Federal Reserve Chairman Bernanke, the American public was shocked.  The size of the bailout request was colossal, representing almost 10% of the country’s entire yearly economic output.  The country’s financial meltdown hit the front pages and caused public outrage.  Realization set in that the Government had been blindsided by the crisis and that interest rate cuts alone would not solve this problem.

Opposition to the bill’s passage was intense and the initial bill was defeated.   The Treasury and Federal Reserve insisted that the money was needed to prevent a collapse of the banking system.  Scare tactics were employed to sway voters minds.   President Bush informed us that the bill was necessary to protect America’s retirement plans and financial future.

TARP was passed and $350 billion quickly dissipated with little to show for it.  Secretary Paulson is now requesting the remaining $350 which will quickly disappear as well, with little assurance of ending the financial crisis.

Meanwhile, with virtually no public debate, the Federal Reserve has put the US taxpayers at risk for over $5 trillion dollars and counting.   This $5 trillion includes direct loans (such as to AIG),  debt guarantees and asset purchases from troubled institutions.

Bernanke, the non elected head of a central bank gone wild is committing vast sums of taxpayer money with no assurance of a positive outcome.  Are we to put our trust in a man who did not see this crisis coming, predicted that it would be contained and is now in charge of solving the problem?    Is Bernanke the savior or the guide on the road to financial Armageddon?

Mr. Bernanke’s predecessor at the Federal Reserve allowed the explosive credit growth and easy lending that fueled financial bubbles.  These bubbles are now bursting and collapsing the world economy.  We now have the lunacy of the Federal Reserve trying to convince us that easy money, which caused the problem, is now also the solution.  Easy money and low interest rates are the only answer the Fed has and so far all it has caused is financial insolvency on a worldwide scale..

The fact of the matter is, the Federal Reserve is not bigger than the US economy.   The power of the Fed is derived from the US free enterprise system.   The Fed cannot change the primary trend of market forces nor can it bailout an entire nation.  All they can do is slow it down and drag it out, as happened in Japan.  The end result of the Fed’s “rescue” is likely  to be an impoverished future caused by unmanageable debt burdens.

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

HUD Loan Modification Program Called A Failure

December 18, 2008 by 12 Comments

None other than the Secretary of Housing and Urban Development has declared the HUD loan modification program, known as Hope for Homeowners, to be a failure.   Steve Preston, HUD Secretary , blamed Congress for the program’s failure.  “What people don’t understand is that this program was designed to the detail by Congress”.

The Hope program,originally expected to help almost half a million people, has had only around 300 applications since its launch.   The chairman of the House Financial Services Committee blamed the Bush administration for opposing features of the bill that would have made it acceptable to lenders and easy to use by homeowners in default on their mortgages.   There have been calls by others on Capital Hill to use a portion of the TARP funds to ease and expand the Hope program.

In theory, the Hope program would have been beneficial to both borrower and lender by turning a defaulted loan into a performing loan.  It was structured to refinance a homeowner into a 30 year fixed rate mortgage insured by the FHA.

In reality, features of the Hope program seemed to have been designed to make it unattractive to both borrower and lender.  Specific provisions that created problems and made the program basically unworkable for all parties were as follows:

  • there was no obligation on the part of lenders to participate
  • the FHA would only insure  a new loan for up to 90% of the homes value.  Cash strapped borrowers had no way of coming up with the cash for the shortfall on what was owed.  For example, a homeowner owing $150k on a house now appraised at $100k could get a new low rate mortgage of $90,000 but only if he could come up with the $60k balance due on the original loan.   Someone with $60,000 available would probably not be in default on the mortgage.   The only other option to bringing $60,000 cash to closing was to request that the lender write down the loan balance to $90,000, which most lenders politely declined to do.
  • in order to qualify for the Hope loan, borrowers had to sign a statement testifying to the fact that all of the information they provided on their original loan application was accurate.  With the large number of stated income loans done in the past, many borrowers could not sign such a statement.
  • fees were to be assessed on any homeowner refinancing under the Hope program, monies that many homeowners did not have.
  • there were also limitations on the allowable debt to income ratio on the new loan in order to qualify.  Many would not have qualified even under the reduced loan amount and lower payment.
  • since the government was sharing with the original lender a portion of the losses on the refinance and loan write down, a portion of any future price appreciation upon sale by the homeowner would be due to the government

The amount of the new loan allowed under the Hope program and insured by the FHA has now been raised to 96.5% in an effort to make a refinance more appealing to the original mortgage lender.

Additional change to the Hope program are expected after the new administration takes over in January.

Filed Under: Bailout, Housing, loan modification Tagged With: ,

The Illusion Of Prosperity Ends

December 17, 2008 by 1 Comment

Every day brings more examples of the failed strategy of fostering economic growth through the use of easy credit.  Modern economies need credit to grow and prosper.   Applying credit growth on an exponential basis ultimately fails when borrowers become so leveraged that any hope of repaying their debts becomes impossible.

The Perils of Consumer Debt on Display in South Korea

After the Asian financial crisis hit South Korea a decade ago, the government helped the export-dependent economy recover by pumping out money and convincing people to borrow and spend more.

But this time around, the high household debt that accumulated in the past decade is depressing spending — an experience that has relevance around the world as governments seek ways to get consumers to help lift their economies.

As exports drop and South Korea’s economy slows, a high level of household debt is keeping consumers from spending more and the government — like others elsewhere — is wrestling with the question of how much to intervene.

“Everybody is too much in debt, so they cannot consume,” says Kim Kyeong-won, a senior vice president at Samsung Economic Research Institute.

Consumer debt in Korea expanded 350% over the last decade trailing average yearly economic grow of approximately 5%.

Korea is not just one example of reckless lending; it is a worldwide problem.  Ironically, the amounts of debt and leverage are so unsustainable that to cease lending to the overextended risks a collapse far worse than what we have seen to date.  We have reached the classic debt trap and the Federal Reserve acknowledges as much by extending virtually unlimited credit in every direction.

Bernanke Goes All In (Wall Street Journal)

If the current Fed believes there are limits to monetary policy, you can’t tell from yesterday’s Open Market Committee statement. The 10 members voted unanimously to take its target fed funds rate down to between 0% to 0.25%, from 1%. With Treasury bills already trading at close to zero as the world flees toward safe investments, the practical impact of this rate cut is negligible.

With the velocity of money collapsing as the recession deepens, the Fed is trying to put a floor under the economy by pledging an unlimited supply of dollars. Another goal is to fight the risk of deflation, or falling prices, as long as the economy continues to shrink. And judging from yesterday’s rally in stocks and bonds, many investors like the idea.

Now the Fed is embarking on a further monetary adventure and asking the world to believe that this time it will work. We sincerely hope it does. And if a lack of liquidity is the problem in some credit instruments, the Fed’s direct purchase of those assets should contribute to a credit thaw. It has already contributed to a decline in mortgage rates.

However, the larger economic problem today isn’t an overall lack of liquidity. It is fear and uncertainty. Banks, consumers and business are dug in their foxholes, conserving their cash until they believe the worst has passed. Meanwhile, investors around the world are deleveraging to reduce risk and cut their losses, a process that the Fed can do little about.

It would appear that whatever victory the Fed may achieve will do little to enhance the future financial stability of the consumer or the government.

Filed Under: Bailout, Economy Tagged With: , ,

California Ignores Growing Fiscal Crisis

December 10, 2008 by Leave a Comment

California’s budget crisis is growing worse as its shortfall for its current fiscal year has increased to an estimated $14.8 billion from a previously estimated $11.2 billion, Gov. Arnold Schwarzenegger said on Wednesday.

During a press conference broadcast on his office’s website, the Republican governor said he would call top lawmakers into a meeting to stress the need for fast action by the Democrat-led legislature on balancing the budget of the government of the most populous U.S. state because it may be out of cash by the end of February.

General fund revenues for November were down a staggering 18% from already reduced expectations.  The Governor had previously demanded action from the legislature to address the fiscal situation but was stymied by competing political agendas.  The Republicans don’t want to raise taxes and the Democrats don’t want to cut spending.   As California’s debt ratings continue to sink and investors boycott their debt offerings, it has become obvious that the previous solution of borrowing to cover out of control spending will not work this time.

California’s budget has increased by an astonishing 40% over the past four years.  Gov. Arnold Schwarzenegger was voted into office on a promise to cut spending and establish some semblance of fiscal sanity.  He soon gave this effort up when his popularity ratings plummeted as he attempted to rein in out of control spending. Every spending cut is essentially a reduction of benefits or cash payments to various voters.   The voters are apparently accustomed to ever increasing benefits and payments, without the nuisance of having to pay for them.  Pandering politicians have attempted to give everything to everyone at no cost and accordingly created a sense of entitlement by the voters.   Demands for new benefits will only grow larger with unemployment at almost 10% and surging higher by the day.

We are now seeing the end result of fiscal insanity – an over leveraged state that has reached the limits of borrowing, politicians who will not confront reality, voters who will not tolerate tax increases or spending cuts and the largest State economy on the verge of fiscal collapse.   This has been discussed as a national issue previously –   IOU’S Pile Up – Taxpayers Refuse to Pay.

The only action California has taken to date, which does not address the reality of their situation has been to offer IOU’s to the State’s vendors and suppliers.  Those who chose to accept these IOU’s will soon find themselves as bankrupt as the issuer.

This fiscal lunacy will continue until California has borrowed and spent its last dollar.  When this point is reached the next phase of Federal bailouts will commence with 49 other states lined up behind California.

Ultimately, serious minds will begin to question the financial integrity of the United States.

Filed Under: Bailout, Economy Tagged With:

Bank of America Receives Day’s Hall of Shame Award

December 9, 2008 by Leave a Comment

BofA to Offer Loans to Illinois Factory

Bank of America  Corp. said it will provide a “limited amount” of additional loans to an Illinois door-and-window factory, just a day after sit-in protests escalated into an intense labor-relations fight that threatened to have financial ramifications for the banking giant.

Last week, the factory notified its nearly 300 employees, of which about 80% are unionized, that it would close by Friday because Bank of America had told the company it would be cutting off all financing.

President-elect Barack Obama offered support for the employees, saying at a news conference that they are “absolutely right.”

A factory in Chicago declares bankruptcy and the employees stage a sit in for back wages that were allegedly unpaid.  The company was forced to close after Bank of America refused to extend further credit to a bankrupt enterprise.   State and local politicians roundly condemn Bank of America and the president elect states that the workers were “absolutely correct”.

Result – Bank of America extends more credit to a bankrupt enterprise.

It’s bad enough that the politicians are using taxpayer money to bailout enterprises that perhaps do not deserve anything better than bankruptcy court.  Is this the new simpler method of bailout mania – forcing the insolvent banking system to further fund bankrupt companies?  Does this remind anyone of central government planning, the same methods that the former USSR employed?

The precedent set here will only lead to further destruction of capital.  If the politicians want to become lenders, let them start their own banks with their own capital; they can be certain that they will have many customers and many write downs.

Bank of American should have resisted the political pressure and maintained what little they have left of underwriting standards.

Questions:

How do you say no to the next 1,000 companies that close their doors?

Was this factory the “victim” of a poor economy and Bank of America, or where they just another poorly managed, overleveraged enterprise?

Could the money lent to this bankrupt company have been better employed elsewhere?

Will the government’s vastly increased control over the banking industry (due to bailout funds and equity ownership) result in capital allocation being based on political pressure rather than sound business judgment?

Filed Under: Bailout, Banking Industry