May 25, 2024

FHA – Ready To Join Fannie And Freddie

Multiple Reasons For High FHA Default Rates

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

Delinquencies Rise

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

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

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

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

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

MBA Delinquency Survey

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

Change from last quarter (second quarter of 2008)

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

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

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

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

FHA Delinquency Crisis: 1 in 6 Borrowers in Default

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

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

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

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

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

FHA Approval Process Outsourced To FHA “Direct Endorsed Lenders”

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

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

The Next Hit – Quick Defaults

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

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

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

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

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

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

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

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

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

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

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

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

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

FHA Losses Mount As Regulators Snooze

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

Will The FHA Be The Next Government Bailout?

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

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

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

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

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

Loan Modification Searches Go Parabolic – Making Home Affordable Guidelines

Loan Modification Enters Mainstream Vocabulary

If you had used the term “loan modification” six months ago, most people would have given you a blank stare.  With the passage of the Homeowner Affordability and Stability Plan, the term loan modification has now entered the mainstream vocabulary.  News coverage of the government plan to help homeowners with their mortgage problems via loan modification has generated  huge interest in this topic as can be seen by the increased Google searches on “loan modification”.

Loan Modification Assistance Programs

HUD’s website provides details on the modification program and also warns homeowners to beware of foreclosure rescue scams.

  • There is never a fee to get assistance or information about Making Home Affordable from your lender or a HUD-approved housing counselor.
  • Beware of any person or organization that asks you to pay a fee in exchange for housing counseling services or modification of a delinquent loan. Do not pay – walk away!
  • Beware of anyone who says they can “save” your home if you sign or transfer over the deed to your house. Do not sign over the deed to your property to any organization or individual unless you are working directly with your mortgage company to forgive your debt.
  • Never make your mortgage payments to anyone other than your mortgage company without their approval.
  • Need urgent help? Contact the Homeowner’s HOPE Hotline: (888) 995-HOPE

Making Home Affordable RefinanceGeneral Features & Eligibility

Some of the features of the new loan modification program include reducing the interest rate to as low as 2%, increasing the mortgage term to 40 years and possibly reducing the principal balance of the mortgage loan.  Note that after 5 years, the interest rate could start to increase each year.

Some of the basic guideline qualifications are:

1.  applies only to a first mortgage on a principal residence,  2. income verification is required, 3. there must be a financial hardship, 4. the mortgage must be owned by Fannie Mae or Freddie Mac, and 5.  the current mortgage payment must exceed a specified percentage of monthly income.

HUD has an easy to use program on their website that allows a homeowner to determine program eligibility –  see Do I qualify for a Making Home Affordable refinance? Answer these questions:

Home Mods Get Complicated

In theory, a loan modification is a simple concept.  The reality of loan modification is that it has become ever more complicated, involving multiple parties and numerous financial, tax and legal issues.  The government has become deeply involved with loan mods and government programs tend to become complicated, confusing and bureaucratic.

At a minimum the following questions should be asked and the answers understood by every homeowner before deciding on a particular course of action.

1. Exactly what would be the terms of my proposed loan modification?

2. Are there tax issues involved?

3. Is the benefit of owning my home outweighed by the costs?  In other words, would I be better off renting after considering my income and all the numerous costs of home ownership?

4. What is the impact on my credit score?  It will be difficult to obtain any type of future loan with a low credit score.

5. If I decide home ownership is not the best option – do I let the home be foreclosed or attempt to negotiate a short sale with the bank?  What are the pros and cons of each option?

6. If I accept a loan modification but receive no principal forgiveness, does it make sense to stay in the home if the loan balance still exceeds the value of the home?  Any sale of the home under this condition would mean bringing money to closing that may not be available.

7. Is it cheaper to rent than to remain in the home after the loan is “modified”?

8. Will housing prices increase going forward?  Keep in mind that real estate prices in Japan are still far below the peak prices reached in 1990.  There is no divine rule which mandates an increase in housing values.

9. Are there legal issues involved with the loan modification that should be reviewed by my attorney?

Not much in life is simple.  Do your homework before you finalize any decision involving your home.

Are Geithner’s Days Numbered? Banks And Investors Have Zero Confidence

First Impressions Hard To Reverse

The old saying in the recruiting business is that one is judged in the first 15 seconds of a job interview.  Irregardless of what happens for the rest of the interview, that first impression cannot be changed.  No doubt, Treasury Chief Geithner wishes that he could take back that first big interview on February 10 when he announced his Financial Stability Plan.  The plan was so lacking in details that one could only wonder why Mr Geithner did not postpone his grand announcement.   Investors on Wall Street rendered prompt judgment on Mr Geithner with the Dow plunging almost 400 points.

Forget The Learning Curve

A month later, Mr Geithner has still not come up with anything of substance to deal with a broken banking system, which by some estimates could cost upwards of $4 trillion dollars.  In fairness to Mr Geithner, he is tasked with solving a problem that only time and the free markets may ultimately cure.   There are no quick and easy answers to the banking and housing crisis, but we cannot afford the luxury of allowing Mr Geithner a multi month learning curve period.    Mr Geithner’s delay in coming up with a detailed plan after his disastrous first attempt may have destroyed his credibility to the point where it doesn’t really matter what he does for an encore.

Banks Burning Mad As Geithner Fiddles

“As Americans recover from the shock and disgust of this latest [AIG] revelation, they will justifiably ask who got us into this mess,” writes Henry Blodget. “The answer, in part, is the same man who has yet to come up with a coherent plan to get us out of it: Tim Geithner.”

Geithner told Bloomberg TV this weekend he will “move quickly to lay out a new financing program” to help banks deal with their toxic assets.

In other words, Geithner still hasn’t put the finishing touches on the “Financial Stability Plan” he announced in mid-February to rousing condemnation because it lacked detail. More to the point, Geithner still doesn’t have a coherent plan he’s willing to share a year after the Bear Stearns-JPMorgan shotgun wedding.

Similarly, Geithner & Co. have yet to unveil their new blueprint for regulating banks. But, again, it’s coming soon

Recipients Of Bailout Cash Stage Revolt

The original TARP bailout plan which was supposed to save the banking industry from collapse has turned into a disaster.  Many banks are saying that they were forced to take expensive TARP money that they did not need or want and now want to return the money – see Banks Push Back On Bailout Plan – Wells Fargo Calls Stress Test Asinine.   The Chairman of Wells Fargo voiced some remarkably blunt criticism of the TARP plan yesterday when he called the governments plan to “stress test” banks asinine.  Relations between the banks and Geithner’s Treasury seem frayed beyond repair at this point.

Effective Leadership Needed

Mr Geithner seems to command zero confidence or respect at this point – he should be replaced by someone who can get the job done.

First Time Homebuyers In 2009 Helped By $8,000 Tax Credit

Large Benefit For First Time Homebuyers

The stimulus bill (American Recovery and Reinvestment Act of 2009) recently signed into law provides a large incentive to first time homebuyers.  The purchaser of a principal residence made on or after January 1, 2009 and before December 1, 2009 is allowed up to an $8,000 tax credit.

Some of the key features of the tax credit are as follows:

-the credit may be taken on either the 2008 or the 2009 federal tax return.  By allowing the credit to be taken on the 2008 tax return, a homebuyer can realize the $8,000 tax credit this tax season instead of waiting until next year.  Since the amount of the credit varies based on income levels, this factor should be considered prior to deciding what year to take the tax credit.

-the tax credit is based on 10% of the home’s purchase price.  To obtain the full $8,000 tax credit, the purchase price would have to equal or exceed $80,000.

-there is a claw back provision on the tax credit if you sell the home within 3 years of the purchase date.  The amount of the tax credit that would have to be paid back is reduced if the gain is less than the tax credit taken.   For example, if the house was sold in less than 3 years for a $15,000 gain, the entire tax credit would have to be repaid.  If the home is sold for a loss, no repayment of the tax credit is required.

-the amount of the tax credit can be reduced or eliminated based on income.  If adjusted gross income is $75,000 or less for single filers or less than $150,000 for married couples filing jointly, the full credit is allowed.  For purchasers with income above these levels, the tax credit is reduced.  The tax credit is completely eliminated for income levels exceeding $95,000 for single filers and $170,000 for those married and filing jointly.

First-Time Homebuyer Credit Explained

See the National Association of Realtors “Frequently Asked Questions” for an excellent summary of the tax credit plan details.

FHA Increases Minimum Credit Score Requirement

FHA And VA Increase Credit Score Requirement

Effective March 6, 2009, a minimum credit score of 620 will be required to be eligible for FHA and VA loans.

The credit score requirement had recently been changed less than a month ago.  As of February 9, 2009 the credit guidelines had required only a minimum credit score of 580, subject to certain exceptions.

The increased credit score requirement is an attempt to lower the large number of FHA defaults, which have been running at about 12%.  A 580 credit score reflects a sub prime borrower and in conjunction with minimal down payment requirements, the risk of mortgage default is very high, as reflected in the FHA default ratios.

New Home Buyers With Empty Pockets After Closing

Another area that should be examined by the FHA in their underwriting guidelines is the amount of reserves that a borrower has after closing on a home purchase.  Many borrowers are left with empty pockets after paying for closing costs and the down payment to purchase a home.  As every homeowner knows, the expenses of maintaining a home are never ending.  In addition, a major and unexpected repair could be thousands of dollars that can put a severe strain on the family budget, leading to the inability to maintain the mortgage payments.

There are no guidelines per se that require a potential home buyer to have a specific amount of savings available after purchasing a home.   The ability to save should be viewed by the FHA as a prerequisite for home ownership.  Additional mortgage defaults do not benefit the FHA nor the homeowner.  Savings (reserves) of 3 to 6 months of mortgage payments should be considered by the FHA as a part of their underwriting guidelines.  Buyers might have to postpone the purchase of a home to acccumulate some savings and strengthen their financial position, but the end results would benefit all – a stable housing market with fewer defaults.

Update Regarding 620 FICO Score Requirement – April 2009

There are now some lenders that will do FHA loans at sub 620 FICO scores – see Sub 620 FICO Score Lenders

Update on This Topic: 

-See FHA Introduces New Minimum 580 Credit Score Requirement, September 6, 2010

-See FHA Zero Down Payment Financing Returns

Banks Tighten Lending By Restricting FHA Cashout Refi

FHA Loans Become Tougher To Qualify For

Effective January 1, 2009 HUD announced that any FHA cash out refinance would require two appraisals when the loan to value exceeds 85% – see FHA Takes A Closer Look At Home Values. Since the customer usually has to pay for the appraisal, this adds around $350 to the cost of refinancing with the FHA.  In addition, many underwriters are taking a very close look at appraised values, due to the continuing drop in home prices.   In turn, the close scrutiny of appraised values by the underwriters are making many appraisers more conservative in the values that they assign to a home.  The FHA also raised the down payment requirement on purchases to 3.5% and increased mortgage insurance premiums.

The net result is that an FHA loan not only has higher costs but also a higher probability of being turned down due to insufficient equity and more stringent underwriting guidelines.

Some Banks Reduce Cash Out Limits On FHA Loans

Two smaller banks today have reduced the cash out limits on FHA loans to 85% loan to value, despite the FHA guideline allowing 95% cash out.  Rumor has it that larger banks will also follow through on lowering the loan to value limits on FHA cash out refinances.   Tougher guidelines quickly spread industry wide, so expect many more lenders to make it more difficult to cash out on an FHA refinance.

Since FHA loans have a very high default rate (roughly 12%), it is only logical that banks are imposing tougher guidelines for borrowers.   The banks simply cannot afford to take on additional default risk given their weak financial position.

Many potential borrowers will continue to find it difficult to obtain mortgage approval until the economy recovers and the housing markets stabilize.  Based on the way things are going, it could be a long wait.

Bernanke Predicts 2010 Recovery In Stocks, Housing & Economy

Bernanke Predicts Recession To End In 2009

The stock market jumped over 200 points today, partly due to Federal Reserve Chairman Ben Bernanke’s optimistic comments to the Senate Banking Committee.  Some selected comments by the Chairman follow:

“If actions taken by the administration, the Congress and the Federal Reserve are successful in restoring some measure of financial stability — and only if that is the case, in my view — there is a reasonable prospect that the current recession will end in 2009 and that 2010 will be a year of recovery”.

Mr. Bernanke also sounded optimistic on housing as well, although without a specific time projection for recovery.

“I would anticipate some stabilization in the housing market going forward.”

Mr. Bernanke seemed to dismiss the need for bank nationalization stating that:

“I don’t see any reason to destroy the franchise value or to create the huge legal uncertainties of trying to formally nationalize a bank when that just isn’t necessary”.

Better financial market performance was also seen by the Chairman:

“I do believe that once the economy begins to recover, we will see improvement in the financial market.”

Mr. Bernanke also stressed his commitment to provide ample amounts of credit for all purposes:

“Our objective is to improve the function of private credit markets so that people can borrow for all kinds of purposes.”

Mr. Bernanke did temper his optimistic statements by noting that his forecast

“is subject to considerable uncertainty, and I believe that, overall, the downside risks probably outweigh those on the upside.”


If the downside risks outweigh those on the upside, how can Bernanke be so optimistic for a recovery in stocks, housing and the economy??  Based on the confusion and conflicting signals, let’s examine some previous comments by the Chairman for perspective on his batting average as an economic prophet.

Previous Forecasts By The Chairman

“At present, my baseline outlook involves a period of sluggish growth, followed by a somewhat stronger pace of growth starting later this year as the effects of monetary and fiscal stimulus begin to be felt.”
—February 14, 2008

The U.S. federal budget deficit has declined recently and is officially projected to improve further over the next few years. Unfortunately… the United States has already reached the leading edge of major demographic changes that will result in an older population and a more slowly growing workforce. A major effort to increase public and private saving is needed to prepare for the economic consequences of this demographic transition and to address external imbalances. As the global perspective makes clear, the reduction of the U.S. current account deficit also requires efforts on the part of the surplus countries to reduce the excess of their desired saving over desired investment.
—September 11, 2007

“Overall, the U.S. economy appears likely to expand at a moderate pace over the second half of 2007, with growth then strengthening a bit in 2008 to a rate close to the economy’s underlying trend.”
—July 18, 2007

“We will follow developments in the subprime market closely.  However, fundamental factors—including solid growth in incomes and relatively low mortgage rates—should ultimately support the demand for housing, and at this point, the troubles in the subprime sector seem unlikely to seriously spill over to the broader economy or the financial system.”
—June 5, 2007

“We at the Federal Reserve will do all that we can to prevent fraud and abusive lending and to ensure that lenders employ sound underwriting practices and make effective disclosures to consumers. At the same time, we must be careful not to inadvertently suppress responsible lending or eliminate refinancing opportunities for subprime borrowers.”
—May 17, 2007

“The information, expertise, and powers that the Fed derives from its supervisory authority enhance its ability to contribute to efforts to prevent financial crises; and, when financial stresses emerge and public action is warranted, the Fed is able to respond more quickly, more effectively, and in a more informed way than would otherwise be possible. “
—January 5, 2007

No need to assign a grade letter to the Chairman, but maybe we should hold off on celebrating the economic recovery.

Notable Links

Living Beyond Yours Means – California’s Economy Gets Worse

California’s Pain Is Only Beginning

BIG SUR, Calif. — As Sacramento squabbles over the state’s $42 billion deficit, Californians are getting a bitter taste of what’s to come after the steep budget cuts that are inevitable when legislators and Gov. Arnold Schwarzenegger finally hammer out a deal.

Some world-famous parks like Pfeiffer Big Sur State Park may not open this year. After-school programs in low-income areas are being scuttled, putting high-risk teens on the street just as police forces are being cut. Schools are closing classrooms, and some highway projects have ground to a halt. The state may not be able to monitor some sex offenders as required under law.

Other states face budget cuts too, but California’s budget mess stands out for its size. Its deficit is projected at $42 billion by mid-2010. Since Gov. Schwarzenegger declared a fiscal emergency 14 weeks ago, he and lawmakers have been deadlocked over how to close the gap. Democrats want tax increases and moderate spending cuts; Republicans seek deep cuts and no tax increases; the governor wants a combination.

The governor’s office warned Tuesday that if no budget deal is reached by Friday, the state would send layoff warnings to 20,000 workers. Gov. Schwarzenegger also said he intends to cut 10,000 jobs through layoffs and attrition to save $750 million over 17 months.

If it’s true that California sets the trend for the nation, we can all expect more economic pain.  California has discovered the limits of the theory that a government can borrow and spend its way to prosperity.  It will be interesting to see what outcome the state arrives at with its budget process.  Raising taxes would be self defeating and borrowing more would be total lunacy.  The last option result of cutting spending is already being deployed and will likely continue, putting a further drag on the state’s economy.  The era of reduced expectations is slowly dawning on California.

China Becomes Nervous Over US Debt Holdings

China Needs US Guarantee for Treasuries

Feb. 11 (Bloomberg) — China should seek guarantees that its $682 billion holdings of U.S. government debt won’t be eroded by “reckless policies,” said Yu Yongding, a former adviser to the central bank.

The U.S. “should make the Chinese feel confident that the value of the assets at least will not be eroded in a significant way,”  He declined to elaborate on the assurances needed by China, the biggest foreign holder of U.S. government debt.

Benchmark 10-year Treasury yields climbed above 3 percent this week on speculation the government will increase borrowing as President Barack Obama pushes his $838 billion stimulus package through Congress. Premier Wen Jiabao said last month his government’s strategy for investing would focus on safeguarding the value of China’s $1.95 trillion foreign reserves.

“In talks with Clinton, China will ask for a guarantee that the U.S. will support the dollar’s exchange rate and make sure China’s dollar-denominated assets are safe,” said He in Beijing. “That would be one of the prerequisites for more purchases.”

“The biggest concern for China to continue buying U.S. Treasuries is that if Obama’s stimulus doesn’t work out as expected, the Fed may have to print money to cover the deficit,” said Shen Jianguang, a Hong Kong-based economist at China International Capital Corp., partly owned by Morgan Stanley. “That will cause a dollar slump and the U.S. government debt will lose its allure for being a safe haven for international investors.”

The Chinese are correct to worry about the value of their US Treasury holdings.  It is becoming more obvious by the hour that the huge spending proposals coming out of Washington guarantee that the Fed will be printing money.  The Chinese may currently not be able or willing to liquidate their holdings in Treasuries.  The one certainty here is that the Chinese appetite for additional US debt securities will greatly diminish going forward.

Real Estate Long Way From Bottoming

The Reality Behind Real Estate

by Michael Pento, Delta Global Advisors, Inc. | February 10, 2009

Much has been written lately about the beginnings of a recovery in the real estate market. Just last week housing bugs (investment “bugs” are not exclusive to those who only love gold) were cheering the latest data point which they claimed as evidence the market is making a comeback.

So with all this good news out there, why am I still projecting a continuation of falling home prices? Inventories, especially the key reading of vacant homes for sale. The reason the number of vacant homes for sale is more salient than those that are occupied is that a home sitting vacant is much more likely to stay on the market until it is sold, regardless of price (as opposed to occupied homes, with owners who might simply pull the listing if they don’t like the price). Because the owners of so many unoccupied homes are banks, they are especially motivated to hit the bid on a property.

The reason there is an intractable level of homes for sale clearly stems from the faltering economy, which is causing massive layoffs and skyrocketing unemployment. The rate is currently 7.6%, a 17-year high. This compels homeowners (many of whom owe more on their home than it is worth) to walk away from their properties. After all, how much motivation do home owners need to abort if they are already upside down on the home and now find themselves without a job?

Home prices and mortgages rates may have to fall well below historical levels in order to clear away the massive buildup in inventories, and it’s a condition which may need to exist for a protracted period of time before home price stability can occur.

Healing takes time, but that is not part of our new administration’s plan to fix the real estate market. Instead, like his predecessor George W. Bush, the Obama team feels it is better to artificially prop up home prices at an unsustainable level rather than have them retreat to a price that can be supported by the free market. But then again, isn’t this just more evidence that the idea of free market capitalism is being trampled—by both parties.

The Government will waste huge amounts of resources trying to fight free market forces and fail in the end.  Attempts to establish artificial market prices has never worked and it will not work now.

PIMCO Demands That Fed Print Money

PIMCO Says World Faces Second Wave of Economic Crisis

Feb. 11 (Bloomberg) — Pacific Investment Management Co., which runs the world’s biggest bond fund, said the global economy faces a “second wave” of turmoil unless governments adopt larger spending plans.

“The economic setback is still in its early stages,” Koyo Ozeki, head of Asia-Pacific credit research at Pimco’s Tokyo office, wrote in a report on the firm’s Web site. “Any further decline in housing prices could accelerate the downturn, intensifying the pernicious feedback loop and possibly leading to a second wave in the financial crisis in the next six to 12 months.”

Bill Gross, Pimco’s co-chief investment officer, said on Feb. 5 the Federal Reserve will have to buy Treasuries to curb yields as debt sales increase.

“To overcome that second wave, governments worldwide would have to spend vast quantities,” Ozeki wrote. “The resulting erosion in their finances would increase the risk of dangerous side effects.”

It sounds like the largest bond fund in the world is getting so nervous about their bond holdings that Bill Gross is calling on the Fed to print money via the purchase of Treasuries.   We are reaching a very dangerous point in the nation’s finances when there seems to a consensus that printing money is the only solution to our economic woes.  The free market solution of restructuring and bankruptcies is being avoided at all costs.  Expect a long drawn out economic nightmare.

What is the end result of printing money?   See The Zimbabwean Dollar – The Point of No Return – this may be our future.

Japan’s GDP Down 50% In One Year?

Titanic Sails Again to Sink Deck-Chair Economy

Feb. 11 (Bloomberg) — NEC Corp. started a trend that will forever change Japan.

The nation’s largest personal-computer maker on Jan. 30 said it will fire more than 20,000 employees. That announcement would have been shocking enough had it not opened the floodgates. Since then, Panasonic Corp. said it will cut 15,000 jobs. Nissan Motor Co. is cutting 20,000.

Even during the darkest days of the 1990s — deflation, bank failures, public bailouts — companies avoided mass layoffs. NEC’s precedent seems to have made it fashionable to do just that. What’s next? Sony Corp. firing 50,000 people in Tokyo?

The psychological blow to Japan’s already skeptical consumers is sure to deepen the recession at a speed few thought remotely possible just two months ago.

“Japan’s recent economic decline is faster than that of the U.S., which has been experiencing the worst financial crisis in a century,” Kazuo Momma, head of research and statistics at the Bank of Japan, said in Tokyo on Feb. 9.

Momma said the world’s second-largest economy may have shrunk at an “unimaginable” speed last quarter. Gross domestic product fell at an annual 11.7 percent pace in the fourth quarter of 2008, according to the median estimate of 23 economists surveyed by Bloomberg News. That would be the steepest decline since 1974.

At this rate, Japan’s GDP gets cut in half in about a year.  The social and economic devastation we are experiencing will test governments worldwide.  Based on the governmental “solutions” we have seen so far, I would not be optimistic.   See the next link for what our future may look like.

Is There A Possibility For Optimism?

Boomers – Your Crisis Has Arrived

by James Quinn
February 10, 2009

“There is a mysterious cycle in human events. To some generations, much is given. Of other generations, much is expected. This Generation has a rendezvous with destiny.” Franklin Roosevelt – 1936

President Roosevelt was correct. The generation he was speaking to was already dealing with the worst financial crisis in the history of the United States, the Great Depression. By 1945, over 400,000 of this generation had lost their lives. Another 600,000 men were wounded. Much was expected and much was sacrificed. Every generation has a rendezvous with destiny. The generation that won World War II passed the ultimate test and proceeded to produce the next generation, the Baby Boom Generation. Their rendezvous with destiny is underway. Will it be a rendezvous with history that results in World War III, the collapse of the Great American Republic, dictatorship, or a return to the original Constitutional principles upon which this country was founded?

Based on the foolish actions of most politicians in Washington over the last thirty years, I fear for the future of our country. I don’t think the politicians in Washington comprehend the state of affairs. I sense the mood of the country turning. Fear, anger and disillusionment are the prevalent themes. Change is coming, but it is not the change that Barack Obama campaigned for. It will be forced upon us by circumstances beyond any one person’s control. While we are hurtling towards our summit with destiny, Congress continues its path of pork barrel spending, short term solutions, party politics, and condemning our children and grandchildren to a lower standard of living. The “leaders” of this country are using the tried and true method of using fear to ram through their $900 billion tax on future generations. President Bush used the same fear tactics to launch his invasion of Iraq. I see a similar success story with the coming stimulus package. Maybe the coming crisis will ultimately lead to Great Leaders rising to the occasion.

Another insightful writing by James Quinn with some very profound thoughts – well worth reading the full text.

When Does Gold Break Out To The Upside?

Investors Bet Gold To Reach $1,000

Feb. 10 (Bloomberg) — Gold speculators have increased their bets this year by 24 percent that prices will reach $1,000 an ounce by April.

Open interest in options that allow the holder to buy gold at $1,000 by April surged to 9,934 contracts as of Feb. 6 from 8,005 at the start of the year on the New York Mercantile Exchange’s Comex division. Mounting financial turmoil is boosting demand for the precious metal as a haven. Since Jan. 15, the price of the option has almost doubled, outpacing the 12 percent gain in gold futures.

Gold has gained for eight straight years and soared to a record $1,033.90 an ounce in March as mounting bank losses and a declining dollar increased demand for the metal as a store of value. Financial turmoil may push the price above that record to $2,000 as traders buy the metal as a haven, said Eric Sprott, the Canadian money manager who last year predicted banking stocks would collapse.

“The focal point is $1,000,” said Philip Gotthelf, the president of Equidex, who correctly predicted in October crude oil would fall below $40 a barrel. Gold above $1,000 is a “warning signal to central banks that people have already lost faith in currencies,” Gotthelf said.

My only question is why gold is not already selling at $5,000.  Once the $1,000 barrier is decisively breached, expect a massive gold rally with up moves of hundreds of dollars a day.  Gold is a thin market and the price will move accordingly.

Why Did So Few People Save For Hard Times?

A Recession of Biblical Proportions

Consumers usually build savings in booms, then raid their troves during busts – but not this time.

In booms we put away some of the abundance because we know we’ll need it in busts to come. Then, when the bad times hit, we spend some of what we’ve saved. But no more: Our recent bizarre behavior helps explain how we got into this economic mess.

For the first time since Genesis, consumers are doing everything backward. During the expansion from 2002 through 2007, our savings rate fell rather than rose. In mid-2005 it even went negative, and it mostly stayed below 1% until late last year. Then, as the recession really took hold, we again did the opposite: We increased our saving. As the economy shrinks, our savings rate has climbed to almost 3%.

Not only do we lack savings to dig into and spend during this downturn, but we’re also spending a smaller proportion of our incomes (which are themselves stagnating, so maybe it’s a triple whammy). Put it all together, and it’s clear why this recession is dragging on.

The central mystery: Why did we go into hock in the fat years? One argument is that we were behaving rationally. As our homes increased in value, they were doing our saving for us, so we didn’t have to save out of current income.

Nor was our borrowing binge focused only on mortgages; we were going heavily into most other types of debt as well. In fact, we were spending record proportions of our incomes just to service our personal debt – even with interest rates near historical lows.

Maybe it was just a mania, focused not on tulip bulbs but on the simple joy of buying, reinforced by a belief that bad times were no longer inevitable.

Whatever happens, don’t expect miracles. Spending and saving behavior evolves slowly, and our current mess is in some ways the culmination of a long journey. We may not suddenly start behaving with biblical wisdom. But at least let’s try not to forget how bad things can be when we get spending and saving backward.

Normal vs. Abnormal

It’s normal human behavior to want more than we have.   Our free enterprise system rewards hard workers by allowing them to live well.   What was not normal over the past decade were the ridiculous lending policies of the banks, encouraged and supported by the easy monetary policies of the Federal Reserve.

In fact, not much of anything was normal over the past ten years.  It’s not normal to lend borrowers large amounts of money without regard to income or credit.  It’s not normal to expect housing prices to rise 100% every five years.  It’s not normal to expect that a nation could borrow its way to prosperity.  The list goes on.

The really bad news here is that while consumers know what they have to do (save more, spend less) every action being taken by the Government and Federal Reserve is to continue the failed policies of the past, this time on an even grander scale.  Let’s all hope that the common sense of the governed will ultimately elect leaders who stop promising free lunches with borrowed money.