Why the Bailouts Don’t Work and Why Wall Street Loves Them

The stock market came back with a vengeance yesterday.  On Friday’s episode of Mortgage Radio we noted that the market was vastly oversold from a fundamental perspective and suggested a rebound after the weekend.  This was prescient enough that the Mortgage Cicerone made note of it, which is high regard indeed.  So why am I not celebrating?  Because yesterday’s reaction was as irrational as the sell-off.  One thousand points?!  Sure the correction was in there, but so was the exuberance of a seemingly ceaseless font of federal gifts.  The markets like the latest ideas out of Washington and why shouldn’t they?  Wall Street has done a good job creating an aura of representation – most people now believe that was is good for Wall Street is good for America.  How else do you explain the frantic efforts our fearless leaders make each time the market drops?  The rally cry lately seems to be: “If we make the Dow go up, we must be on to something.”  This is nothing new.  For years now the markets have taken a preeminent position in economics beyond their reach or relevance.  One need look no further than earnings reports.  You might report record earnings for your company, yet your stock is pummeled because the reported earnings did not equal what the market had already priced in to the stock.  “You didn’t do as well as we thought you would do based on our self-serving judgment of what is best for you.” (Which is shareholder profits, of course.)

If you believe what you hear from the talking heads (and by virtue of the fact you are reading BHB, I doubt you do) the source problem for the economy is the toxic mortgage derivatives and their tentacle like reach.  Everyone bought these things, even when they didn’t know they were buying them.  Now (as the story goes) our problem is this: no one knows what this stuff is worth.  Everyone is marking down their portfolios, no one wants to risk lending money and the initial bailout (bailout 1.0) didn’t phase anyone; all because we don’t know the real value of these default swaps and CDOs.

I say that is a bunch of merde.  It is not that we don’t know what they are worth.  The problem is we don’t want to know what they are worth.  It is so much easier to let sleeping dogs lie and guess at the best solution, just so long as every elected official looks busy and Wall Street does not have to account for their true portfolios.  If we had to accurately price these investments rather than pawn them off on the government… as a great football coach once said about passing: “Three things can happen and two of them are bad.”

But the truth of the matter is we can know their value and more importantly we should.  Bear Stearns discovered their value and so did Lehman Brothers.  Countrywide, WaMu and Wachovia have all generated a value for their mortgage based holdings.  The problem here is that Rotarian Socialists believe the government should alleviate the pain of a correction.  Why actually put these toxic investments out on the open market (where, I might add, they would find a true value in short order) when you can hold on to them and refuse to lend money while hoping for a do-over courtesy of the government (which is to say: you and I).  Think of this as a game of poker.  There are, for simplicity’s sake, ten people sitting at the table.  Everyone has chips in front of them but only six are going to honor those chips.  The problem: you don’t know who those six are.  So what happens?  No one plays, that’s what happens.  The game (or in our case the economy) comes to a quick halt.  You cannot play in a game where the currency as well as others’ sense of obligation with regard to the currency are in question.  The easy answer is to call the bluff.  Everyone lay down their hands, (transparency in poker) and then everyone must color up and cash in.   It is that simple.  Sure, you might lose some money on that one hand where you didn’t get to play strategy.  But at least you smoked out the players who had no money to back their chips; the one’s that were playing for salvation and using your money to do it.

When the government decides to bail everyone out and buy our mortgages to boot, they are taking over the deal and keeping us stocked with chips; but we are still playing in a game with people that won’t be able to honor their bets.  All the new chips in the world won’t help us trust a game with players that can’t pay out.  If you want to end the credit crisis it is easier than you think.  No more bail-outs; let everyone get their bad debts out on the market.  Some will survive and some will break but the game will once again have trust.  One thousand points would have a lot more staying power in a game like that.

(This post was first published here.)

Filed under: POLITICAL & ECONOMIC FOLLY , bailout, stock market

You Don’t Always Get What You Want, But If You Try Sometime, You Might Find, You Get What You Need

If you are a mortgage holder who is either struggling with crushing payments, bitter for having overpaid for your home during the bubble, or who has extravagantly refinanced when prices were rising, the government’s landmark $700 billion bailout package has an important message for you: stop making your mortgage payments.

So says Peter Schiff, president of Euro Pacific Captital and author of “The Little Book of Bull Moves in Bear Markets” in his op/ed piece entitled, Just Stop Paying Your Mortgage.  You may or may not read it with tongue in cheek, but read it you should.

When a financial institution holds a mortgage, homeowners must live with the fear of foreclosure. Private institutions only have obligations to shareholders. In the case of a defaulting borrower, they will look to recover as much of their principal as possible. If foreclosure is their best option, they will take it in a heartbeat.

The government has no such obligations. Its only goal is to keep voters happy. After supposedly bailing out the fat cats on Wall Street, no politician wants to be accused of evicting struggling families. Once you understand this, all of your anxiety should melt away.

The law of unintended consequences is never so manifest, or insidious, as when politicians correct the free market with legislation.  (Except, perhaps, when they do so because they are …from the government and … here to help.)

(This post was first published here.)

Filed under: BUYERS, INVESTORS, LENDERS, POLITICAL & ECONOMIC FOLLY, REALTORS, SELLERS , bailout, government, law of unintended consequences

And Now, No Reason to Root At All

Last week, while watching the House contort itself in a self-serving round of navel-gazing over the bailout package, I pondered two connotations of their disconnect with the populace.  Taken together they are a question really, that looks at the motivation behind politicians’ decisions; the metaphysical understanding of a Representative if you will.  This question in particular asks why our elected officials vote for legislation they know their constituents are against.  At the time, many of our representatives had chosen not to support the bailout package; not because they were against it – quite the contrary, they wanted to vote for it – no, their problem was their constituents didn’t want it and the election was to close for a nice spin cycle.  So I wondered if they ignored the people who elected them because:

• …constituents are too stupid to understand

or

• …constituents are not the ones who pay their bills

Over the weekend I am sad to report the answer became clear.  The majority of America (at least the majority of America who contact their representatives) were against the bailout the first time around.  I had hoped it was due to the fact that middle America was smarter than the politicians and pundits surmised.  But then Wall Street had its little temper tantrum and middle America couldn’t wait for the bailout package to pass.  They told their representatives so with an onslaught of voice mails, emails and snail mails.

Walls Street’s melt down affected every-one’s retirement funds and investment funds and saving funds… if they elected to sell them that day.  Otherwise it made not a wit of difference to the average person on the street who does not expect to need those funds for years yet.  But people panicked anyway.

I learned from this episode a lesson most politicians must learn early in their career.  I learned that middle America did not read up on or have at least a passing understanding of what the bailout meant, nor did they look into and try to understand how Wall Street’s shoe stomping episode actually affected them.  Instead, middle America did what they always do: they swam over to the shallow end of the pool, dipped their face in the water for a second or two and then asked someone else what to think and how much to panic. The bailout package passed.  The market is down 500 points.  Happy Monday everyone.  There must be a lot of head scratching going on now.

By the way: Why do our elected officials vote what they think is best despite what their constituents may think or tell them?  Because we are simply too stupid to understand.

(This post was first published here.)

Filed under: LENDERS, POLITICAL & ECONOMIC FOLLY, REALTORS , bailout, government, Wall Street

No One to Root For…

I wrote yesterday that we were Front Seat to History, but main stream press continues to miss it and I fear I was a little too cavalier in my writing.  The real story here is not the initial failure of the bailout, but the in-your-face blatancy of our politicians.  There is no longer even the veil of accountability or representation.  I know this is a political philosophy question regarding representative government, but there has always been at least lip service paid to the idea of politicians keeping their finger on the pulse of their constituents.  Senator McCain said “Americans are frightened…” and the Democratic leadership is returning to the bargaining table in hopes of enticing more politicians from both sides of the aisle to vote against the wishes of the very people who voted them into office.  Today we had President Bush demand “Congress must act.”  In most scenarios, if  the White House disagrees with congress, the President takes it to the people and admonishes all of us to call, write or email our representatives and let them know how we feel.  But in this case there is no call to action.  Why is that?  Obviously the majority of America does not agree with the bailout as it is presently understood, but there is more to it.  Congress and our executive leaders are all of one mind: get this done despite what middle America thinks.  This has two connotations:

• Don’t bother representing your constituents – they are too stupid to understand.
• Don’t bother representing your constituents – they are not the ones who pay your bills.

Either way I want to SCREAM OUT to everyone watching this.  I want to say: Pay Attention!  It is rare that an event of this magnitude happens close enough to an election that we witness the true motivation of those who run for office.  If you feel a disconnect with your elected officials… is it any wonder?

(This post was first published here.)

Filed under: POLITICAL & ECONOMIC FOLLY , bailout, government

Wachovia Fails… Did You Notice?

Lost in the tsunami of bail-out failure, Wachovia gave up the ghost.  Wachovia now joins Countrywide and WaMu as the big three option arm originators now become three of the biggest financial failures of all time.  If this looks familiar to any posts you may have read here at BHB, including those on The Mortgage Dance and Wachovia Completes the Gang of Three, consider it pure coincidence.

Does it sound like I am gloating a little over the downfall?  I am.  Option arms were the tool and bribery was the modus operandi.  Loan originators fed their greed while homeowners lied to get homes they could not afford and Wall Street leveraged the whole thing to apocalyptic proportions.

I wonder if there is enough blame to go around.

(This post was first published here.)

Filed under: POLITICAL & ECONOMIC FOLLY , bailout, Wachovia

Front Seat to History

Whether or not you approved of the bailout, you have to count yourself lucky to be witnessing an historic event.  Take a good, hard look at what is unfolding before us.  One elected official after another said they could not vote for this legislation because their constituents back home were not in favor of it and would vote them out of office.  As a matter of fact, this was part of an openly discussed game plan yesterday before the vote:

Both parties were also scouring the political map to identify lawmakers who face little or no opposition for re-election in November, knowing they would be more willing to vote yes. New York Times News Service

Think about that again.   They wanted to vote for it, but the people they represented were overwhelmingly against it and would have thrown them out for approving the bill.  How often does anything of REAL importance happen this close to an election?  This is so close to election time that the legislators are accountable for their votes.  Imagine that!  And they are scared.  They can not do their politics as usual because they don’t have time so spin it.  This is a magical time to witness: politicians acting out of accountability rather than self-interest.  Were that it was always true…

(This post was first published here.)

Filed under: POLITICAL & ECONOMIC FOLLY , bailout, government

Keep Your Hands & Feet Inside While the Ride is in Motion

The bailout fails AND WAMU finally gives up the ghost.  It is going to be an interesting Friday!

(This post was first published here.)

Filed under: POLITICAL & ECONOMIC FOLLY , bailout, WaMu

Federal Bailouts, World Crisis… What About Little Ol’ Me?

Lots of talking heads.  Lots of outrage.  Even a little fear.  Keeping up with economic developments lately is taxing and I mean taxing in its most negative “IRS and April 15th” connotation.  Last night Brian Brady and I were interviewing Matt Padilla for Bloodhound Radio.  It was a great discussion and got me to thinking about what is (or rather should be) important.  I mean, the whole thing can be overwhelming: how did we get here, who’s to blame, what are the macro ramifications of this massive federal bail-out… makes one feel small and even a little lonely in the midst of this big economic world gone ’round the bend.

So I stopped on the way home for a big shot of wheat grass (substitute whatever manly libation you prefer here), calmed down and eventually found myself a little less interested in what it all means and a little more interested in what it all means to the real estate agent on the street.  In other words: What is the next step?

Last week I suggested that Wall Street’s Meltdown may actually help the housing industry.  Consumer debt will dry up in the credit crunch and this bail-out will not have much impact in that arena.  The financial industry is going to come out limping and take some time to lick its wounds.  Consumer debt has always been a risk and will end up on the back burner for a while, but the need for profits is always there; where will it come from?  Where is the supply of money going to be greatest?  Thanks to Uncle Sam it is going to be mortgage money that flows freely.  But flowing freely is not the same as distributed evenly and this is where the real potential lies for homeowners as well as real estate agents.

By the end of the year conforming loan limits are going to drop.  Here in San Diego they should end up around $625,000.  Under that limit there is going to be a large supply of federally backed (and encouraged) cheap money.  Over that limit, however, it is going to be a ghost town in a dust bowl surrounded by desert.  Over $1 million and it opens up a bit because you are generally talking about buyers with large sums of cash.  But between $625,000 and $1 million the ability to finance a purchase is going to tighten up and so too must demand.  As you may recall from Econ 101, when demand drops so does pricing.  On the other hand, back below the magic limit, the supply of money will create demand and here’s the really interesting part: that demand will bump up against a supply limit.  The supply of homes within that range is finite and the demand for homes below $625,000 will remain targeted; it is artificially capped.  What happens when increasing demand (due to cheap money) meets a finite supply?  Appreciation.

We can expect to see demand driven appreciation knockdown the oversupply of inventory in many parts of the nation over the next year (maybe two).  This will drive home prices up to, but not over, the conforming limit.  At the same time it will depreciate homes that are over the limit, possibly even push some below the magic line.  What does this mean to the agent on the street:

• If you are an agent working with move-up buyers within the temporary loan limits – but over the upcoming conforming limit – their window of opportunity is slamming shut.  Get them off the fence quickly and stop taking on new clients in that price range.
• Buyers below the new conforming range will see upward demand on appreciation in direct correlation to their distance from the conforming limit.  In other words, the closer in value your purchase is to the loan limit, the less appreciation you will see.
• Sellers below the conforming range will see greater demand and more price appreciation in direct correlation to their distance from the conforming limit as well.  In other words, the supply near the conforming limit will grow and appreciation slow (or stop) while the supply at the lower ends will decrease and appreciation grow.  If you already have a listing near the conforming limit, time is not your friend.
• As an agent, your marketing should be divided: for listings, your area of focus is the lower end homes where demand is going to increase and market time decrease.  For buyers, you can expect the best deals to be nearer the conforming limit where supply will grow and pricing will stagnate.

For the next couple of years you can envision real estate as a great freeway with virtually no tolls and cheap gas.  But the speed limit is absolutely enforced.  Cars starting out will see rapid acceleration, but as you near the speed limit there will be congestion and a corresponding drop in enjoyment.  Eventually the speed limit will be relaxed; in the mean time… enjoy the ride.

(This post was first published here.)

Filed under: BUYERS, INVESTORS, LENDERS, POLITICAL & ECONOMIC FOLLY, REALTORS, SELLERS , bailout, REALTORS, Wall Street

Alex, I’ll Take “Terrifying” for $1000

Even with all the financial failure that surrounds us, I still find myself loathe to accept any type of government intervention.  We throw around comments like “too big to fail” but rarely examine the end game.  Greg Swann recently reposted a very intelligent treatise on something he likes to call Rotarian Socialism and how each “fix” only begets a greater problem down the road.  As a matter of fact, Mr. Swann and I share a healthy fear of government and the implied force of violence that backstops all regulations and laws.

Earlier this week I followed a story out of Spokane, WA.  It centers around a Mr. Kevin Coe, convicted rapist and suspected serial rapist.  For the relevant details and background on this story click here.  Mr. Coe, however, is not the scary part of this story:

Coe has completed his sentence of 25 years in prison, but he is not getting out of jail yet.  Starting tomorrow, Coe faces a civil trial as the state tries to keep him locked up indefinitely as a violent sexual predator.

“We think he’s mentally ill and dangerous,” said Todd Bowers of the state Attorney General’s Office.

In 1990, Washington became the first state to create a program to keep behind bars people determined to be at risk of committing more sex crimes even after they have completed their sentences. A special facility near Tacoma holds about 300 of them, including Coe, whose sentence was completed in 2006.

A person is convicted of a crime and sentenced.  He never allocutes; he maintains his innocence throughout (despite the government’s repeated attempts at blackmail offered in the form of early parole) and he serves his FULL TERM.  At which time the government continues to keep him locked up; found guilty by a jury of legislators, of having the potential to commit another crime.

The state reserves the power to take away your property, your liberty and your very life.  They enforce this power at the tip of a gun.  All laws, all regulations (and, apparently now, all judgment on potential) is maintained by the government, ultimately, on penalty of death.  The abrogation of your liberty is a trifle by comparison.  Just ask Kevin Coe.

This is why the most terrifying thing in the world is not a murderer, not a rapist, not even the wholesale failure of our financial markets.  No, at all times the thing to be most terrified of is the government and its benign attempts to help.

Alex, I don’t think I want to play Double Jeopardy…

(This post was first published here.)

Filed under: POLITICAL & ECONOMIC FOLLY , bailout, government

How Wall Street’s Meltdown Helps Main Street’s Housing

Just for fun, let’s imagine a possible silver lining to the complete melt down on Wall Street.  In this scenario, the next big shoe to drop will be access to consumer debt.  No one is going to extend car loans, credit card debt, retail debt and so on.  But this may not be all bad for our industry.

Imagine John & Mary Homeowner talking about their day.  John says gas prices are up and his long commute is killing them.  They need to buy a different car.  “But no one is lending money for new cars,” Mary replies.  John decides that if he can not have a better ride, he will have a better destination.  “Let’s add on a nice deck for me to enjoy after my long commute.”  Mary smiles pleasantly and reminds John that no one will extend an equity line for home improvement.  Exasperated, John suggests they just buy a jacuzzi and settle for some easy relaxation.  But Mary points out that no store is offering credit, so large purchases are largely impossible.

What do you suppose John and Mary do?  What about next Sunday, out for a drive, when they see a nicer home, closer to work, with more square footage – and they realize they can own it for the same payments they are making now.  What happens when the only money available is purchase money? Thanks to Fannie & Freddie (and FHA, VA) home loans will be plentiful while every other kind of debt will disappear for a while.

Supply and demand… the meltdown might be just what we needed.

(This post was first published here.)

Filed under: BUYERS, INVESTORS, LENDERS, POLITICAL & ECONOMIC FOLLY, REALTORS, SELLERS , bailout, Real Estate Future, REALTORS, Wall Street