Matrix Blog

I like to read Bill Gross’ column every month (and podcast) and have mentioned it here on more than one occasion. He is a smart man and the zen-god of the bond market via his firm PIMCO. He is not without his critics and his columns have a lot of extra style stuff inserted that blur their clarity, but they are still worth reading. And the Beatles, of course, are still worth listening to.

This month Gross touches on asset-backed lending in his column, When I’m Sixty-Four, a tried and true (sort of) form of mortgage lending where the lender actually understands who they are lending too, something lost in the recent surge in securitization run amok. Of course, keep in mind that JP Morgan was a robber baron.

I’ve had a famous picture of J.P. Morgan on my office wall for 25 years. Even now, the old man seems to be staring at my back and taunting me with his famous quote written just below his vest with pocket watch in full view: “Lending is not based primarily on money or property. No sir, the first thing is character.”

If there is not swift action at a Federal level, we’ll likely slip into a significant economic downturn.

In my opinion, the private credit markets have forfeited their privileged right to operate relatively autonomously because of incompetence, excessive greed, and in minor instances, fraudulent activities. As a result, the deflating private market’s balance sheet is being re-nationalized in some cases with increased regulation, in others with outright guarantees and agency lending. Ultimately government programs which support private credit market assets may be required in order to prevent an asset deflation of significant proportions. Authorities must act quickly, with a shot of adrenalin straight to the heart of the problem: home prices.

Think of the recent Federal Reserve rate cuts as a bailout.

Politicians – especially those on the Republican side of the aisle – are adamant about not using taxpayers’ funds to bailout Wall Street or housing speculators, or whoever the current devil may be. The public seems to nod in agreement while at the same time not noticing that their watch is being lifted or their pocket being picked. Let’s see: Twelve months ago the yield on your money market fund was 5%+ but your next statement will probably feature something closer to 2%. Did your money market fund (which in aggregate approaches 3 trillion dollars) experience any capital gains in the process? Absolutely not. So it looks like your (the taxpayer’s) contribution to the bailout of banks, or Florida condominium speculators can at least be quantified: 3% foregone interest per year on whatever you own

Now think about how free markets work. How can they perform freely if no effective standards or guidelines are in place? It’s not about more regulation, it is really about effective regulation and removal of distractions or those that provide a false sense of security.

You only need to look at the state of the current credit markets. Investors do not trust the packages being sold, and that is why we are in the mess we are in.

Tags: Bailout Nation

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Can there be a bigger story than the housing/credit market/economy/weak dollar/recession right now? Client #9, George Fox…good grief.

Which begs the question: Do you get what you pay for?

I have been struck by all the recent solutions to the financial crises that we have slipped into, whose severity, by most accounts, caught government officials and financial institutions mostly unaware. Of course my favorite bubble bloggers have been saying so for quite a while, including The Housing Bubble Blog, Bubble Meter and Housing Doom. In fact, they have been screaming about it. Their perspective has largely been from the stand point of the absurdity or the void of logic of high prices paid and the greed. Not much dialog about the cause until recently, because few actually saw it, let alone understood it.

In retrospect, it was never about high housing prices alone, it was mainly about easy credit that enabled the purchase of property at seemingly any price. cart before the horse

The naming convention for the housing boom/bubble/bust should have been based on “mortgage” or “credit” rather than “housing.”

Anyway you slice it, we are in the middle of a real financial crises and I am hopeful that the recent stimulus package does not convince the powers that be that the problem is solved. The stimulus package is simply a baby step, but at least it is in the right direction. It looks like more reforms are being debated and discussed and (surprise, surprise) all deal with mortgages. A bailout is not on the table, nor would it be a solution, or fair to homeowners who were not greedy or did not take responsibility for what they were signing.

While ultimately, markets need to find their own balance and it is good for home prices to decline as part of the cycle, the exposure to our financial system based on ill conceived mortgage lending needs to be fixed. It really is scary how exposed our economy is on this one.

Innovative solutions will be next up on the Congressional agenda because rate cuts don’t ahem cut it.

With worsening strains in credit market threatening to deepen and prolong an incipient recession, analysts are speculating that the Federal Reserve may be forced to consider more innovative responses -– perhaps buying mortgage-backed securities directly.

As credit stresses intensify, the possibility of unconventional policy options by the Fed has gained considerable interest, said Michael Feroli of J.P. Morgan Chase. He said two options are garnering particular attention on Wall Street: Direct Fed lending to financial institutions other than banks and direct Fed purchases of debt of Fannie Mae and Freddie Mac or mortgage-backed securities guaranteed by the two shareholder-owned, government-sponsored mortgage companies.

Some legislative actions in the works right now:

• FHA will be expanded to shoulder more of the mortgage burden from the GSEs.
  
• Creation of a new mortgage corporation proposed by Senator Chris Dodd (see article: no I am not a staff member) that will enable refinancing for homeowners in trouble.
  
• Legislation to reduce the number of foreclosures is in development by the House Financial Services Committee. It sounds a lot like a bailout with the private sector writing down their mortgages to their current market value level.

I am actually impressed by the creativity of solutions being proposed but the details make or break their effectiveness. Right now we have sort of the inverse of the period which saw immense creativity of mortgage packages during the housing (mortgage) boom. Hopefully the solutions are not as complicated as the problems that caused this situation. I don’t need to find another tranch loaded with problems.

For some, this financial crises will teach many that you actually don’t get what you pay for and you don’t get what you borrowed either.

To digress…On the Beatles’ Revolution #9 single, parts of the song, when played backwards with a turntable, sound like “turn me on dead man.”

Coincidence?

Ok, back to work.

Tags: FHA, Fannie Mae, GSE, Bailout Nation, Freddie Mac

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The release of the Beige Book (last week) is always a fun read (yes, I am admittedly, pretty boring) because it allows the Fed to present a regular anecdotal description of the current economy. I’ve provided feedback to the Fed for this publication for a number of years and enjoy the national perspective submitted by each of the member banks. However, one thing I worry about is their ability to forecast with the rapid changes of late in the economy. Bernanke seems to be resigned to relying on the numbers as they come in, which of course, is behind the curve. Its like relying on the upwardly revised 2Q GDP numbers made irrelevant with the credit meltdown under our belt in 3Q.

The financial markets are probably expecting a half point drop at the next FOMC meeting on September 18th, so the impact of a generic 25 basis point adjustment is probably already built in. The Fed seems to be saying they will take action but probably not as aggressive as 50 basis points (1/2 percent) A 25 basis point move probably means no real impact on investor confidence in mortgage paper quality, no impact on rising non-conforming mortgage rates, no change to the housing market. With the full force of the housing downturn not to impact the economy until 2008 when resets peak, anything short of 50 basis points will be invisible.

If we get what we (I) wish for, a 50 basis point drop might actually make everyone even more nervous. In other words, the markets may think the Fed must know something we don’t because thats a bigger drop than we have seen in a long time. Crazy, isn’t it?

Recent distress in financial markets has “deepened” the housing slump, but the overall economy has seen little impact so far, the Federal Reserve said Wednesday in its beige book report. That assessment suggests that while a rate cut in two weeks may still be likely, officials may not see the same need for aggressive easing that financial markets expect.

Whether its a 1/4 point or 1/2 point drop, its not going to make any immediate difference to the housing market. Its a baby step towards investors getting back in the game, even though it doesn’t resolve the main issue: mortgage portfolios are laced with crap (sub-prime tranches) that no one seems to have a handle on.

As far as the perception of a Fed rate cut being a Wall Street bailout, I disagree. Its a moot point. I am more worried about the overall economy. The impact of housing as a drag on the economy hasn’t hit full force yet. I suspect not until mid-2008 or 2009. Mortgage resets are reported to be peaking in 2008 and the impact of a significantly lower number of sales transactions is just now beginning to hammer markets that are already weak.

The housing market is anything but beige.

Tags: Beige Book, Ben Bernanke, Sub-Prime, Bailout Nation

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My son planted about 30 tomato plants in our garden this year so needless to say, I am now full of tomatoes.

One of the things that have come out of all the upheaval in the mortgage markets has been the frequency and clarity of explanations as to what happened and how the markets got into this predicament. Hindsight is 20/20 so they say. It was not long ago that people were scratching their heads about how prices can rise at an expotentially higher rate than income for a seemingly indefinite period of time.

It was all about the Benjamins mortgages and how easily the payments could be managed. Downpayment became monthly payment in the dialog between buyers and lenders. Lenders reduced underwriting requirements to bare bones, appraisers were encouraged to become form fillers. The lending community came up with mortgage products to stimulate transactions and Wall Street responded, creating a labrynth of tranches designed to move risk around to the right places…except investors ulitmately figured out that few on Wall Street really understood the risk. And then the world changed.

As Jim Grant wrote in Time Magazine (special thanks to “the man who wears shirts that look like graph paper.”):

That is the way great ideas end, not with a bang, not with a whimper, but through reductio ad absurdum. You know investment bankers are not satisfied until every good idea is driven into the ground like a tomato stake.

Here’s a few recent summaries of what happened over this period of mortgage excess that I found particularly interesting.

How Missed Signs Contributed to a Mortgage Meltdown [New York Times] with a very cool chart. Things were moving so quickly but we should have seen it coming.

As far back as 2001, advocates for low-income homeowners had argued that mortgage providers were making loans to borrowers without regard to their ability to repay. Many could not even scrape together the money for a down payment and were being approved with little or no documentation of their income or assets.

In December, the first subprime lenders started failing as more borrowers began falling behind on payments, often shortly after they received the loans.

Reaping What You Sow: Hedge Fund and Housing Bubble Edition [Huffington Post]. This article suggests that a Fed rate cut represents help for the wealthy and not the masses.

Last week we got to watch as the markets went wild with the realization they were over leveraged on bad debt, until Bernanke rode in with a huge bailout, answering a question (and settling some bets) on whether he was an inflation fighter, or an inflationist (he’s an inflationist, and he has now proved it.)

Bloody and Bloodier – The subprime-lending crisis is worse than you think, and could crush financial and real-estate markets for years. [New York Magazine]. Besides sharing dentists, I can empathize with Jim Cramer’s pain as of late. Barron’s Magazine dedicated its cover story to analyzing how wrong his advice has been in his CNBC show Mad Money in the article: Shorting Cramer.

You’re losing money right now. This very minute. You’re losing money if you own an apartment. You’re losing money if you own a country home. You’re losing money if you own a stock or bond mutual fund. You’re losing money if you have a pension plan. You’re probably losing money here or there, you’re probably losing money everywhere (except maybe from your savings account and wallet). But this is no Dr. Seuss story. It’s more of a John Steinbeck tale, and we are the victims, a new generation of Tom Joads, and it’s the damn bankermen who broke us. No, there won’t be a police officer to investigate, and the government, at least this federal government, won’t save us.

Panic on Wall Street [Salon]. It starts with an obligatory blame Greenspan bent but goes deeper.

There is a standard explanation included as a paragraph in almost every story attempting to explain the current turmoil. It goes like this: Anxious to goose the U.S. economy out of its dot-com-bust doldrums, Alan Greenspan and the Federal Reserve Bank lowered interest rates to rock bottom in 2001. The resulting flood of cheap money encouraged an orgy of borrowing at every level of the U.S. and world economies. Whether you wanted to buy a house or a multibillion-dollar conglomerate, lenders were your best friends, falling over themselves to offer you whatever amount of capital you desired — and charging low, low rates of interest. Cheap money led to a growing complacency about risk. If you ran into trouble, you could just refinance your house, or borrow a few billion more dollars today to pay off the billions you might owe tomorrow.

Tags: CNBC, Alan Greenspan, Ben Bernanke, Sub-Prime, Bailout Nation

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I wonder if the NAR, in some respects is regretting the housing boom. With all the income the industry has generated, it has also generated attention that probably isn’t beneficial to the trade group in the long run. Commissions, multiple listing service data, statistical methodology, believability as a resource, etc.

In the article [NAR: Pittsburgh Condo Deal Puts Banks into Residential Real Estate [RISMedia]](http://rismedia.com/index.php/article/articleview/13611/1/1/) the National Association of Realtors contends that banks are getting into real estate despite regulations that prohibit this activity.

In a letter delivered last week to the chief counsel of the Office of the Comptroller of the Currency, the president of the National Association of Realtors responded to the recent defense by the OCC of its approvals permitting national banks to engage in new real estate and commercial activities.

[They are also fighting Wal-Mart Bank’s application Because It Mixes Banking and Commerce [NAR].](http://www.realtor.org/PublicAffairsWeb.nsf/Pages/REOpposeBanksandCommerce) [They] will actively oppose the application for federal deposit insurance by Wal-Mart Bank, a proposed Industrial Loan Company (ILC) headquartered in Salt Lake City, and requested the opportunity to testify at upcoming hearings. The Federal Deposit Insurance Corp. has scheduled public hearings in April in the Washington, D.C., area, and the Kansas City, Mo., metro area on Wal-Mart Bank’s application.

Since 2000, Realtors have opposed a pending regulation by the Federal Reserve and Treasury that would allow national banks to broker real estate and perform property management. Since 2002, Congress has blocked the regulation. It seems to be a matter of time before banks will have this option since every year this debate comes before Congress.

The NAR contends that by banks entering the real estate business, the safety and soundness of the banking system is at risk since it is a speculative investment. The idea posed is the the concentration of assets would be higher making the failure of one bank more critical to the financial system. [NAR contends that the top 5 banks hold 45% of industry assets [Mortgage News Daily]](http://www.mortgagenewsdaily.com/12212005_RE_Bank_Competitiveness.asp) and has a series of arguements why banks are a higher risk.

_Number of firms:_
Real estate – 98,000 to over 200,000 (depending on who is counting)
Banks – 8,000 to 10,000.

_Barriers to Entry:_
Real estate – usually less than $1,000 and a few weeks of studying time to obtain a license and enter the field;
Banking – large capital requirement.

_Taxpayer Risk and Historic Experience of Government Bailout:_
Real estate – none;
Banking – yes (historic evidence, S&L failures and RTC bailout.)

_Influence of Foreign Governments:_
Real estate – no;
Banking – large multinational corporations are subject to foreign government regulation.

_Consumer Data on Buying Habits and Possibility of Price Discrimination:_
Real estate – none;
Banking, -vast, often based on data mining of credit card purchase information.

_Cooperation with Competitors in the Sale of Products:_
Real Estate – yes, through MLS;
Banking – no.

_Degree of Regulation:_
Real Estate – minimal;
Banking – heavy.

_Social Promotion of Entrepreneurship, Women and Minorities, and Small Business:_
Real Estate – yes in every category;
Banking – yes in every category bus assessment is limited to owners of community banks.

Here’s a blog post on this issue from a banking perspective: [ALERT: NAR’s New Threat from Mega-Banks – There they go again? There who goes again? [Inman]](http://www.inman.com/blogger/2006/02/alert-nars-new-threat-from-mega-banks.aspx) All I read into this most recent industry warning by the NAR is the voice of a threatened professional association that insists upon denying the consumer the choice of any other ownership structure for real estate brokerage other than the status quo – Realtor-centric. Drill down and you will find a true fear that if banks were to be in the real estate brokerage business about the last professional association they would insist their operators belong to would be the NAR.

This is all very interesting and well-laid out on both sides except:

==> ==> ==> ==> ==> ==> ==> ==> ==> ==> ==> ==>
NAR says that banks are not a good idea because they place a higher risk on the banking system by being more speculative.

< == <== <== <== <== <== <== <== <== <== <== <==
Banks (more than just the included post on Inman) say that NAR has a monopoly on home sales and keeping banks out of the process only extends broker control further.

Confused? Be glad you are not a regulator. Its tough to see through the spin. At the end of all this, I think the banking lobby will win out over the broker lobby. They seem to have the OCC and momentum on their side.

Tags: Pending Home Sale Index, PHSI, Bailout Nation, NAR, National Association of Realtors

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