Real Estate Blog

A guest post from Frank Shump. Frank is a veteran from the financial services industry, and currently authors a blog called Thefinancecastle.com, which documents his thoughts on money matters and his adventures in self employment.

By and large the average American consumer is usually a resilient creature. Even through minor recessions and increasing prices in the past, we’ve managed to just keep on trucking and buy things we need (and of course some things we don’t). In most times when our economy was heading into a recession, the general public’s view was to downplay the amount of fear we’re feeling and keep on doing what we’re doing until the cycle trended back upward. This time, however, things appear to be different. An increasing number of consumers are scared, jittery, and angry about the current economic condition, and they have every right to be.

A recent poll put out by CNN/Opinion Research Corp. showed that seventy-five percent of those surveyed believe that things are going badly in the United States. After years of easy credit and rampant consumerism, it appears that as a nation we may finally be coming to the realization that the party, is in fact, over.

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Alan Greenspan attempted to mimic Michael “Heckuva Job, Brownie” Brown during his testimony before congress yesterday. Mr. Greenspan attempted to place blame squarely on anyone except himself. Mr. Brown’s performance in the same role was slightly more credible because he was utterly unqualified for the job he held, a claim Mr. Greenspan cannot make.

Mr. Greenspan claims to have been overtaken by events so rare that no one could have seen them coming. He called it a “once-in-a-century credit tsunami” and that it was impossible for anyone to have been prepared for it. Mr. Brown made the same claims about hurricane Katrina and the destruction of New Orleans with every bit as little justification. The record of warnings about both disasters is substantial and undeniable.

“Those of us who have looked to the self-interest of lending institutions to protect shareholder’s equity — myself especially — are in a state of shocked disbelief,” said the former Fed Chairman. He called this “called this “a flaw in the model that I perceived is the critical functioning structure that defines how the world works.” This statement by itself boggles the mind. If it is true then Mr. Greenspan is a naive and gullible fool with no understanding of how business actually operates. It is also possible that this was a self-serving lie. I do not know which explanation to prefer. Either way makes me tremble at the thought he was in charge of the Fed for 18 years.

Mr. Greenspan studiously refused to accept any shred of responsibility for the crisis, pointing his fingers at   investors who did not understand what would happen when home prices stopped surging upward. “It was the failure to properly price such risky assets that precipitated the crisis,” he said, making no mention of the absurdly lax regulatory environment that made these bad loans possible.

The consequent surge in global demand for US subprime securities by banks, hedge and pension funds, “supported by unrealistically positive rating designations by credit agencies was, in my judgment, the core of the problem,” he said. “It was the failure to properly price such risky assets that precipitated the crisis.”

This was precipitated by Mr. Greenspan’s alleged inablity to understand that the desire for personal profit frequently trumps fiduciary responsibility. The role of government is to — at the very least — regulate the corrosive effects of greed on how business operates. That is why there are laws and courts dedicated to the enforcement of the terms of contracts and trades.

Mr. Greenspan’s comments bring to mind the scene in Casablanca where Claude Raines closes down the Rick’s casino as he pockets his winnings. His rationale: “I’m shocked, shocked to find that gambling is going on in here!” At least Raines’ character, Capt. Renault, had the good grace to admit he was a cynical SOB.

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Greenspan tries to play the ingenue

Guest post from: Constantine von Hoffman, a veteran business journalist who writes the blog CollateralDamage.biz, a humorous look at marketing, business and his dog.

Once upon a time the US actually had a law in place that would have at least hindered the current mess. Not surprisingly, that legislation – the Glass-Steagall Act – came out of the Great Depression. Just as unsurprisingly it was repealed in 1999 at a time when lawmakers and business no longer thought that “what goes up must come down” still applied to the economy.

Simply put, Glass-Steagall prevented the mingling of investment and commercial bank activities. If you did one, you couldn’t do the other. This happened because way back then it was thought that commercial banks were way too speculative – both with where they were investing their assets and also because they were buying stocks for resale to the public.

Thus, banks became greedy, taking on huge risks in the hope of even bigger rewards. Banking itself became sloppy and objectives became blurred. Unsound loans were issued to companies in which the bank had invested, and clients would be encouraged to invest in those same stocks.

Sound familiar?

In 1956 Congress – back when it had something resembling a spine – strengthened the act. They figured that insurance was also a high-risk activity that banks shouldn’t be in, so they banned them from underwriting insurance. <<Insert obvious reference to AIG here.>>

However by 1999 all was better and these things would take care of themselves! Here’s a terrifying quote explaining the thinking behind the repeal of Glass-Steagall: “Big banks of the post-Enron market are likely to be more transparent, lessening the possibility of assuming too much risk or masking unsound investment decisions. As such, reputation has come to mean everything in today’s market, and that could be enough to motivate banks to regulate themselves.”

Or not.

Although one of the names on the repeal was Phil Gramm’s – formerly Sen. McCain’s economic adviser – this was truly a triumph of lobbying dollars buying bipartisanship.

All in favor of re-pealing the repeal will signal by saying, “aye.”

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Once there was a law that would have prevented all this

I’m glad Hank Paulson is standing firm on his $700 billion bailout that he’s burdened us with. In his speech today he said that the bailout doesn’t protect every bank from failing. Phew, now I feel better that the $700 billion is not just the first round of drinks, but rather the entire bar tab. I mean, granted, it’s a bender - but maybe it’s like a bachelor party - once in a life time type of thing. Excessive, yes. Excusable? Maybe with a forgiving bride who’s too embarrassed to say anything.

Except I’m not stupid or too embarrassed, and I hope you aren’t either.

It has quickly become clear to anyone paying attention (and finally it seems people are waking up) that the $700 billion is just the first round in this debacle. How do I know? Well let’s look at the fine folks at AIG who needed a tidy $85 billion loan from the Federal Reserve to keep from going bankrupt are doing.

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Remember the saying “if all you have is a hammer, everything looks like a nail“?

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Bernanke hints at a rate cut

Some common sense from Federal Reserve Bank of Kansas City President Thomas Hoenig. Talking about economic calamity and the economy’s ability to recover Hoenig said allowing institutions to collapse is an important part of the process. It’s nice to hear some common sense once in a while. Take the time to celebrate it.

From Bloomberg:

Economies must “find a balance between financial stability and a stable price environment and in doing so must be able to allow individual institutions to fail,” Hoenig said in a speech today in Buenos Aires.

Turmoil in financial markets has persisted, even after the Fed started and expanded emergency programs to lend to commercial and investment banks. Changes in financial markets combined with the subprime-mortgage crisis have “raised anew questions about the role of central banks in maintaining financial stability,” he said.

“Financial crises will occur despite our best efforts to prevent them,” Hoenig said in prepared remarks at an event hosted by Argentina’s central bank. “The `Too Big to Fail’ issue will only grow in importance as the consolidation of the financial industry grows in both size and scope in future decades.”

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Institutions must be allowed to fail

Fannie Mae and Freddie Mac are on the verge of government intervention, reports the Financial Times.  As credit worries continue to wreak havoc on the financial markets liquidity concerns at the two massive GSE’s sparked a stock sell-off that left both company’s stocks down nearly 25%.

Any government intervention or recapitalization would severely undercut the value of any current shareholder stock by diluting the living daylights out of it.  Many had hoped that the mere notion of the US Treasury backstopping the GSEs would put an end to the market unrest.  This drove Fannie and Freddie stock higher as investors gained confidence that the market would stabilize with the weight of a US government guarantee.  Now that it looks exceptionally likely that it will actually happen investors are once again spooked.

From FT.com:

Fears about the financial system grew on Monday as money market liquidity tightened and sharp falls in the share prices of mortgage financiers Fannie Mae and Freddie Mac led the US stock market lower.

Fannie’s and Freddie’s shares lost 22 per cent and 25 per cent, respectively, after an article in Barron’s suggested that the US government was considering recapitalising the companies on terms that would all but wipe out existing shareholders.

The concerns about Fannie and Freddie also spread to their debt, which fell in price. This threatened to push interest rates on mortgages backed by the two firms higher and put further pressure on the battered housing market.

The price of insurance against default on Fannie and Freddie subordinated debt hit record levels in the credit default swaps market, according to data from Markit. Risk spreads on their senior debt – which most analysts presume would be fully honoured by the government in any rescue – widened to levels last seen in the immediate run-up to the Treasury’s July 13 rescue plan, Credit Suisse said.

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Fannie and Freddie on Verge of Bailout

The New York Post is reporting that a large sovereign wealth fund is angling to buy up US property on the cheap.  With a weak dollar and REO piling up, these foreign funds are looking for 50-cents on the dollar discounts in American residential and multi-family property.

Sovereign wealth funds are well-known for their high-profile purchase of American assets like the Chrysler Building in NY, but now they’re expanding to pick-up foreclosed properties at a huge discount.

With large-scale property acquisition Americans will be saddled with the debt of their excess while the property asset resides in the portfolio of a foreign state.  We’ve outsourced everything - we might as well start outsourcing our property as well.

From the New York Post:

There’s a new land grab starting in America.

Foreign money, which up to now has focused its attention on investing in iconic commercial real estate - like Barneys New York and the Chrysler Building - is now moving to scoop up tens of thousands of discounted foreclosed homes across the country.

One sovereign fund, said to have earmarked $29 billion to purchase foreclosed residential real estate, recently hired a West Coast mortgage broker and is starting to search for bargains, The Post has learned.

The search, which is being carried out, in part, by Field Check Group mortgage consultant Mark Hanson, who was retained by the broker, Steve Iversen, is concentrating on single- and multi-family REO (real estate owned) homes, or homes that have already been taken over by the mortgagee.

Neither Iversen nor Hanson would disclose the name of the client, but sources told The Post it’s a sovereign fund.

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American consumers, left with the debt and none of the assets

Nouriel Roubini, former White House economic advisor and most recently foreseer of the housing and credit bust has a great article in Barron’s where they dig in to his all-to-prescient forecasts of the economy.

Here is just a brief excerpt, but it’s more than worth the entire read.

From Barron’s (via Roubini’s blog RGE Monitor):

LIKE THE EXHORTATIONS OF JEREMIAH TO THE NATION OF Israel before the first temple’s destruction, the warnings of economist Nouriel Roubini fell on deaf ears. For the past two years Roubini, a professor at New York University, has cautioned about a huge housing bubble whose bursting would lead to a 20% drop in home prices; a collapse in subprime mortgages; a severe banking crisis and credit crunch; the near-failure of Fannie Mae and Freddie Mac , and a U.S. recession of a magnitude not seen since the Great Depression. So far, this latter-day prophet of doom has been on the mark, though time will tell about the recession part.

What recourse will the taxpayer have?

The taxpayer’s bill is going to be huge. I estimate this financial crisis will lead to credit losses of at least $1 trillion and most likely closer to $2 trillion. When I made this analysis in February everybody thought I was a lunatic. But a few weeks later the International Monetary Fund came out with an estimate of $945 billion, Goldman Sachs (GS) estimated $1.1 trillion and UBS (UBS) $1 trillion. Hedge-fund manager John Paulson recently estimated the losses would be $1.3 trillion, and late last month Bridgewater Associates came up with an estimate of $1.6 trillion. So, at this point $1 trillion isn’t a ceiling, it’s a floor. And the banks, as I’ve said, have written down only about $300 billion of subprime debt.

How long will it take for the collapse in the banking sector to play out?

It is happening in real time. Many smaller banks are going bust already. More than 200 subprime-mortgage lenders have gone bust in the past year alone. And many community banks will go bankrupt. Community banks usually finance everything: the homes, the stores, the downtown, the commercial real estate, the shopping center. If you are in a town or a municipality where there is a housing bust, the bank is gone. Of three dozen or so medium-sized regional banks, a good third are in distress. That includes the Wachovias and Washington Mutuals of the world. Half of this group might go bankrupt. Even some of the majors could end up technically insolvent, though they might be deemed too big to fail.

Take Citigroup. In 1991 there was a small real-estate bust, though the quarterly fall in home prices was only 4%, based on the S&P/Case-Shiller indices. Citi was effectively bankrupt and signed a memorandum of understanding with the Fed that allowed the government to give the bank regulatory forbearance. Citi was allowed to ride it out and try to recapitalize in a few years, and thereby avoid bankruptcy protection. This time around the S&P/Case-Shiller indices indicate home prices already have fallen 18%. The decline could be as much as 30%, because the excess supply is huge.

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The house passed the Freddie/Fannie bailout disguised as the homeowner rescue bill today by a nearly two-to-one margin. The bill provides $300 billion in money earmarked for helping consumers in trouble with their mortgage and explictitly guarantees the debt of the GSE’s through loans an cash infusions from the government.

You can read more at CNN.com.

I’m typing this from the new WordPress app on my iPhone at the airport. There’s very little you can besides type so unfortunately I can’t put in any links but at least now you know (like you hadn’t heard already…)

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Houses passes mortgage bill

If you haven’t read this piece by The Big Pictture’s Barry Ritholtz you’re doing yourself a disservice:

There is a choice to be made: Either we regulate the Banks, or leave it to the vagaries of the free markets to punish those who trade with, or place their assets in the wrong institutions. But for God’s sake, do not give us the worst of both worlds — do not allow banks the freedom to make horrific but preventable mistakes (i.e., only lending money to those who can pay it back), but then expect the taxpayers to foot the trillion dollar bill.

That’s not capitalism, its not socialism, its not regulation, and its sure as hell isn’t what free markets are. Our language is insufficient to describe this hodge-podge system, other than to call it a random patchwork of quasi-capitalism, quadrennial-socialism, and politics as usual. Ideological idiocy is the only phrase I can muster that has any resonance with the daily insanity.

We have entered into a fit of Orwellian madness: The American Capitalists, long the globe’s leading advocates for free markets, have become near Socialists. Halfway around the world, the Chinese Communists have picked up the baton, and are moving rapidly towards a form of Capitalism. Ironically, it is the once largest communist nations — the Chinese and the Russians — who holds much of Fannie and Freddie’s paper.

Hey comrades, who’s selling the rope to whom?

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Ritholtz: Idiots Fiddle While Rome Burns

Wilbur Ross, the billionaire, has put it best in a recent Bloomberg article.  “The average consumer is tapped out and burned out,” Ross said in the piece which covers the general malaise that the economy is facing as a result of credit and housing gluttony.

This is the crux of the problem.  Companies are reeling in poor bets made on consumer-credit like mortgages, 2nd mortgages, HELOCs, and credit cards.  The country has a negative savings rate and mortgage and credit-card delinquencies are on exponential growth curves.  No matter how low the interest rates, no matter how much cheap money is out there for institutions to lend, the borrowing public is tapped out.  Without some type of insane debt forgiveness program (the likes of which are under debate in Congress) the American public will be paying off the bill for this bender for quite some time.

Until that bill is paid the economy will have to look elsewhere than consumers for resuscitation.

From Bloomberg:

“The average consumer is tapped out and burned out,” billionaire investor Wilbur Ross said in a Bloomberg Television interview July 1. “By the time November comes, there’s only going to be two issues: jobs and houses.”

U.S. employers cut 62,000 jobs in June, the sixth straight monthly decline, the Labor Department said July 3. Unemployment held at 5.5 percent after rising the most in two decades in May.

June sales plunged 18 percent at General Motors Corp., 21 percent at Toyota Motor Corp. and 28 percent at Ford Motor Co., the three biggest auto retailers in the U.S., as consumers facing $4-a-gallon gasoline bypassed fuel-thirsty trucks in favor of small cars.

J.C. Penney Co., the third-largest U.S. department-store chain, said June 25 it will open fewer stores next year and reduce capital spending, citing “challenging” times for consumers. Analysts predict J.C. Penney’s profit for the second quarter, ending in July, will sink to 38 cents a share before some costs, the average of 17 estimates in a Bloomberg survey. A year ago, profit on the same basis was 78 cents.

“There is little driving consumer spending other than staples,” Michael Niemira, chief economist of the International Council of Shopping Centers, said in a July 1 statement.

As rebate-check spending ebbs in the second half, economic stability will depend at least in part on banks, according to Ghriskey.

“Do banks begin to lend more, take the chains off their lending practices to help the economy begin to grow again?” he said. “We’re not looking for a huge amount of economic strength in the second half, but we are looking for stability.”

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American Express announced intra-quarter guidance today saying that the company would be impacted by worse-than-expected credit conditions.  They expect their business to be impacted as economic activity slows and consumer late-pays and credit defaults on AMEX cards continue to mount.

From the Market Watch story:

“Business conditions continue to weaken in the U.S. and so far this month we have seen credit indicators deteriorate beyond our expectations,” Chief Executive Kenneth Chenault said in a statement.

“Today’s release indicated that the company would likely hold off on potential business building initiatives until business conditions improve,” the analyst wrote.

American Express has been hit by rising losses on its credit cards as the housing slump and slowing economic growth limit customers’ ability to repay debts.

Provisions for losses on American Express’s credit cards have risen over the past year to $1.15 billion from $783 million as the consumer credit market has weakened, Egan-Jones Ratings, a rating agency that’s paid by investors rather than issuers, noted.

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AMEX: credit conditions continue to worsen

Market Watch has the inevitable story of inflation now completely wiping out any gains that consumer’s have seen in income.  Inevitable, why?  Because the interest rate cuts and massive influx of capital in to the system have set inflation loose.  Gas prices are increasing geometrically, food prices are up, and there was even a heart-rending story of school lunch prices going up 25% in the bay area.

More on inflation from Market Watch:

Inflation erased all the gains in disposable personal income in April, while consumer spending was flat after adjusting for higher prices, the Commerce Department estimated Friday. Personal incomes, consumer spending and consumer prices all increased 0.2% in April, the government said in a report that suggests the economy weakened further in the second quarter of the year even as the first tax-rebate checks began arriving. Employee compensation dropped 0.1% in nominal terms, the first decline in a year.

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Your raise has just been eaten by inflation

Reader Paul (big hat tip to him) pulled a key comment out of the B of A press release issued earlier this week that addressed Bank of America’s efforts to help homeowners keep their home. The comment, burried at the bottom of the release was:

“We will continue to work with distressed borrowers to match the customer’s repayment ability with the appropriate loss mitigation option, including loan modifications, forbearances, repayment plans, lower rates and principal reductions,” McGee said. “

Paul thought it was absurd that no one pressed McGee on the last point which was “principal reductions.” This, he argued correctly, is a massive change in policy for the industry, as banks have been fighting tooth and nail to make sure that court-ordered principal reductions (cram downs) aren’t enforced from the bench.
The Implications of a BofA-led Principal Reduction Effort Would be Staggering

If Bank of America is truly making principal reductions a part of it’s “home-saving” playbook it would have incredibly wide-spread implications across not only the banking industry but the housing market and general economy.

As Paul mentioned, the press didn’t have a chance to grill him on this point and I agree with him that McGee needs to be held accountable for what he said and to outline in greater detail just what role these principal reductions are playing (or will play) in BofA’s loan modification process.

Bank of America, if they are making principal reductions even a trivial part of their options in keeping homeowners put they will set a precedent which will inexorably alter the housing market. Think of the ramifications of this action.

First of all, Bank of America’s adoption of this policy would make it essentially an industry-accepted practice overnight. Lenders of all types would gladly follow their lead in an effort to keep their REO rolls from growing exponentially. Why wouldn’t a lender take a $25,000 principal reduction if it keeps the mortgage current than risk the pain and headache of foreclosing for a property that might only sell for 50% of the current note?

The Ultimate Moral Hazard

Homeowners who are struggling with their payments due to myriad reasons (from fraudulently overstating their income to a resetting option-arm to death of the primary wage earner) will see principal reductions to keep them in their home. The homeowner next door in a comparable home will not see that relief as long as they continue to make their payments on time.

Homeowners are rewarded for feigning problems with their mortgage payments to get the reduction. It’s a less-painful version of mailing in your keys. Go down 60-days on your mortgage and get a nice chunk of your loan balance forgiven.

A Good Homeowner Gamble?

The argument that the mere idea of a damaged credit score is enough to keep full-balance folks paying right along while their neighbors get gifted $50k loses credibility in the current environment. If I’m a homeowner (which I am) and I’m current on my mortgage (yes, again) and I’m seeing all of the bail out plans and changes being made and I see Bank of America add principal reductions to their loan modification tool kit for delinquent borrowers I might start to think that there is going to be some government intervention on future credit as a result of this mess too.

Think about it - with all of the changes to save homeowners who are losing their homes and going down late on their mortgages the government will surely want to address future credit opportunities for those bailed-out. They may even be thinking of a way to help folks who suffered a foreclosure or late payments by a “resetting ARM” be distinguished in credit scoring from those who faced bankruptcy or late payments on consumer debt.

If I’m a homeowner who is seeing principal reduction around them I might trade $50,000 in debt forgiveness for a couple of years of higher interest-rate costs. Heck a back-of-the-envelope calculation might show that it’s worth it even without changes to current credit scoring methods and the laws governing same.

Is Once Enough?

Do you only get one shot at the reduction? Blown Mortgage regular Ann had this to say about the principal reduction path:

The question I have is what types of loans are going to be modified? Teaser ARMS? MTA’s? Also how do you modify? Based on True income when it was a liar loan? Principal Reductions in a declining market..does that mean that a year from now when the price goes down another 10% are those borrowers going to expect more? What about the average Joe next door, who isn’t a “troubled” borrower and now has a principal balance of $300K..while his neighbor had 50K forgiven and now has principal balance of $250K?

Seems to me there is no end in sight…

And that’s another major challenge. What happens to the neighbor who takes the write-down now, and then sees his neighbor take a write-down in six-months that is double the amount forgiven to him? Does that neighbor sue Bank of America for an additional reduction?

Where do Second Mortgages Fit In?

The questions keep going. What about second mortgages? Where do those fit in? Does Bank of America forgive debt on the second first or keep the higher-rate (mostly unsecured) second debt and reduce the principal on the first? How does that get figured out.

What did McGee Mean?

In the end Paul is right - what is Bank of America really considering with these loan modifications and principal reductions as they mentioned in their sweeping press release about homeownership. Did they “misspeak”? Were they only pointing to the options available in the entire universe of home-saving? It’s a question that needs to be drilled down on and Bank of America needs to be held accountable to what they said for the sake of all participants in this market.

What do you think?

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Is Bank of America headed towards principal reductions?