Guess What This Is?

Broken Camera? Really Late Night?

Guess what you're looking at (above):

A. A water color painting whose colors bled as a result of water damage;
B. A simulation of how cataracts affect one's vision;
C. What the front of your house looks like after a very late night.
D. An actual photo of a bank-owned foreclosure on MLS.

Answer: D.

The home, in Minnetonka, is listed for $110,000 and came on the market yesterday.

So who cares if a lender-owned property is marketed so badly?

Given that the lender is Freddie Mac, now owned by taxpayers, we all should.

Lake Minnetonka Walk-Out Rambler

Downtown Wayzata Stunner

Sprawling walk-out rambler overlooking Lake Minnetonka. Stunning
lakefront views, all-brick, over 100,000 square feet, opulent finishes.

Missed the property described above on MLS?

That's because it's not on MLS (and no, the 100,000 square feet isn't a typo).

Actually, it's not even a residential building, although it's built to resemble one.

Give up?

It's TCF's headquarters building, just west of downtown Wayzata (I was across the street for a closing on Friday).

The only blemish I could come up with is a too-close resemblance to Fannie Mae and Freddie Mac's headquarters, also built in the "faux residential" style.

No (Financial) Cure Without Proper Diagnosis

"We ALL Caused This Mess??" Hardly.

Put me in the camp that says, without an accurate diagnosis, it's not possible to cure our current economic mess.

So, here are two competing narratives explaining how we got to this juncture, both courtesy of Les Leopold (thanks to Ned Krahl for forwarding the Leopold piece):

Narrative #1: 'We Are All to Blame'

"We Americans sank ourselves in debt. We consumed more than we produced. We bought homes we couldn't afford and used them as ATMs. Of course Wall Street did its part by offering us mortgages they knew we couldn't really afford. The government also contributed mightily by pushing Fannie Mae and Freddie Mac to underwrite "politically correct" loans to low-income residents who shouldn't have been buying homes at all. In short, we all are to blame.

--Les Leopold, "Why the Big Lie About the Job Crisis?"; Huffington Post (9/3/2010)

If the foregoing is correct, here's what logically needs to happen next:

The era of excess is over. We need to cut back on spending and borrowing. We need to reduce government debt by raising the Social Security retirement age and cutting social programs. We've got to streamline our public sector by laying off public employees and cutting back their lavish pensions. And all workers will have to adjust to an era of intense foreign competition: We've got to reduce our wage and benefit demands if our companies are going to compete globally. We have to live within our means.

In short, we gorged ourselves until the economy crashed. Now we've got to tighten our belts and accept less to get it going again.

--Les Leopold

Contrast that with Narrative #2, "An untethered Wall Street crashed the financial system (and broader economy) while engorging itself."

Starting in the late 1970s . . . the financial sector was liberated from its New Deal-era shackles. Freed from any limits on constructing complex new financial products, hedge funds and too-big-to-fail banks and investment houses created an alphabet soup of new securities with the sky-high yields. The rating agencies abetted the crime by blessing these flimsy products with AA and AAA ratings.

Wall Street built this flim-flam of finance out of junk debt -- like sub-prime mortgages -- which it could pool, slice, and resell for enormous profits. In fact, selling these bogus securities was the most profitable enterprise in the history of Wall Street. Wall Street wrapped credit default swaps and collateralized debt obligations into pretty packages so that they could literally sell the same underlying junk assets again and again.

The whole scheme worked just fine as long as the underlying collateral (our homes) appreciated year after year. But as soon as housing prices peaked, it was game over. The upside-down pyramid of debt and junk financial instruments came crashing down. The entire credit system froze, tearing a gaping hole in the real economy.

--Les Leopold

Guess which narrative I find more accurate?

Prescribing Cures

Only once the disease has been diagnosed, can a cure be promulgated.

Here is Leopold's:

Through steep progressive taxes on the super-wealthy, fair income taxes on hedge funds and transaction fees on Wall Street's proprietary trading, we can keep that bubble from reinflating -- and in the process raise the money we need to put America back to work. With the revenue we collect, we can hire millions of people to weatherize homes and buildings and rebuild our infrastructure. Instead of laying off teachers we can hire more, and provide them with better training and support. We can expand universities and colleges too, and allow people to go to college for free, which will improve our peoples' skills -- and keep young people off the unemployment rolls.

--Les Leopold

The only step Leopold omits is holding Wall Street accountable -- through appropriate civil and criminal remedies -- for its transgressions.

$80 to Mow a Lawn. In Phoenix

Green Gold?

Interesting article in the Sunday NYT about the spiraling cost of bailing out Fannie Mae and Freddie Mac.

The article profiles one Phoenix-area Realtor in particular, who sold homes at the peak, and now sells them for Fannie and Freddie after they've repossessed them (albeit at dramatically lower prices).

But here's the line that caught my eye:

Fannie asks contractors to mow lawns twice a month during the summer, and pays them $80 each time. That’s a monthly grass bill of more than $10 million.

--"Cost of Seizing Fannie and Freddie Surges for Taxpayers"; The NYT (6/19/2010)

Nice gig, especially in Phoenix in the summer!

P.S.: the above recalls a favorite cartoon from the last baseball strike. It shows a striking (and overweight) ballplayer -- in uniform with his gut hanging out -- knocking on a random house doorbell with the caption, "mow your lawn for $20,000, Ma'am?"

Fannie, Freddie's Original Sin

The Fannie/Freddie Dilemma, Cont.

No Government-Sponsored Entity ("GSE") can serve two masters.

--New Testament

OK, so that's not exactly how the Biblical quote goes.

But it's an apt description of the conundrum facing would-be reformers of Fannie Mae and Freddie Mac, the two now-state wards that buy or guarantee a stunning 96% of all U.S. mortgages.

The philosophically pure solution -- dissolve them -- risks throwing the housing market into disarray (or worse) by creating a financial vacuum.

Meanwhile, the clean, business solution -- spin them out as for-profit's and sever their government guaranties -- likewise means no more government "sugar daddy" for the housing market.

The result has been a muddle: keep them alive, quarter-to-quarter, until the political will to tackle the problem head-on reaches critical mass.

Here's another take on the two, mutually exclusive missions assigned to Fannie and Freddie:

America may want a private mortgage market, or it might want the security of a subsidized market. What every administration since L.B.J.’s has coveted and what has always been a lie is that we can get a subsidized market free.

--Roger Lowenstein, "Cracked Foundation"; The NY Times Magazine (4/25/10)

Read the rest of Lowenstein's article for the complete (conflicted) history of Fannie and Freddie.

(More) Hemorrhaging at Fannie Mae, Freddie Mac

Legacy Losses -- or Fresh Red Ink?

If a sweater was 96.5% navy, do you think it would look navy-colored?

And if a chocolate bar was 96.5% dark chocolate, could the manufacturer bill it as dark chocolate?

And if the chance of precipitation was 96.5% . . . would you carry an umbrella?

What's with the inane questions? And the 96.5%?

According to Inside Mortgage Finance, that's the percentage of mortgage loans the government directly or indirectly provided financing for in the first quarter (The New York Times; 5/10/2010).

If housing finance isn't a nationalized industry -- at least temporarily -- I don't know what is.

"Near Collapse"

Based on Fannie Mae and Freddie Mac's recent results, the two companies need another $20 billion or so -- to survive another quarter.

As horrific as that number is, it's actually an improvement from their losses a year before.

What to do?

Some of the answer depends on whether that tidal wave of red ink consists of "legacy" losses -- incurred as real estate fell about 30% nationally the last four years -- or instead reflects ongoing, current losses.

Given Fannie Mae and Freddie Mac's famously bad accounting, no one really knows for sure.

"We Need the Eggs"

For now, the government is clearly consigned to writing that check quarterly.

But how long it can afford to -- or is willing to -- is a big question mark.

The dilemma recalls a scene from an early Woody Allen movie.

One of the characters complains to her friend that she has a crazy uncle who thinks he's a chicken.

"Why don't you send him to a psychiatrist?," the friend asks.

"We need the eggs," she replies.

P.S.: I know where to go to get at least a little of the capital needed to fill the Fannie/Freddie black hole: their former managements. As I recall, Franklin Raines et al walked away with hundreds of millions in pay during the period that these entities' losses were gestating (notwithstanding their Pollyanna financials).

That should make them poster boys for so-called exec pay "clawbacks."

More Pressure on Mortgage Interest Deduction?

Strapped Governments
Look for "Honey Pots"

"Because that's where the money is."

--bank robber Willie Sutton, explaining why he targeted banks

For the same reason Willie Sutton robbed banks, financially strapped governments (federal and state) inevitably are going to revisit the home mortgage interest deduction as they seek to close record deficits. (Also getting scrutiny: deductions for state property taxes.)

According to some estimates, doing away with the mortgage interest deduction completely could raise as much as $100 billion in additional revenue annually (read, taxes).

As policymakers try to restrain themselves, though, they should ask: what will that do to housing prices?

Given that the cumulative value of all U.S. housing is something like $16.5 trillion, according to Freddie Mac, even a 1% drop would destroy $165 billion in value, swamping the "benefit" of increased tax revenues.

Even that arguably understates the damage, due to a phenomenon called the "wealth effect" -- basically, economic-speak for people consuming more (or less) as their wealth fluctuates.

So, the ultimate economic hit would likely be a multiple of the $165 billion drop in home prices.

In view of the foregoing, what's far more likely is some combination of a cap on deductions, means testing, and the like.

P.S.: our legal system has a principle, called stare decisis, that requires judges to defer to -- rather than disturb -- established precedent. Literally tens of millions of Americans going back decades have bought homes with the expectation that the mortgage interest deduction would be respected.

If that isn't long-established precedent -- I don't know what is!

Shhh!! Don't Tell the Tea Partiers

"Hands Off My Mortga . . . Oops! Never Mind!"

As best I can tell, the tea party movement is angry about out-of-control government intrusion into people's lives.

Apparently, they're not aware of the following factoid:

There were $390 billion in new mortgage origination's in the last quarter of 2009. Excluding home equity lines, Fannie Mae, Freddie Mac, the FHA, and the VA stood behind up to 95% of those mortgages.

"Anyone who looks at the numbers says, 'My God, look what it's come to,'" said Guy Cecala, publisher of Inside Mortgage Finance.

--"Paul Volcker Says Mortgage Market Will 'Have to be Reconstructed"; The Huffington Post (2/19/2010)

The predicament reminds me of a scene from Annie Hall, an early Woodie Allen movie.

A woman is lamenting to a friend that her uncle thinks he's a chicken.

"Send him to a shrink," the friend advises.

"We can't," the niece replies. "We need the eggs."

Wholesale Price of Money Goes Up (A Little)

Fed Rate Bump

Today's leading financial stories are: a) the Federal Reserve's apparently surprise decision to raise interest rates on short-term bank borrowing; and b) the market's reaction to same (playing out now).

My take?

The action itself is relatively trivial: hiking rates on some arcane, overnight interest rate from .5% to .75% (yes, that's less than 1%) does not suddenly make money expensive (the same rates have been as high as 6%(!) in recent years, before "the deluge").

Clearly, then, the concern is that there are more increases to follow.

Given the hair-trigger nature of today's markets ("Explanation for Jumpy Markets"), you'd expect traders to overreact to the news -- like they now do to all news -- then settle down rather quickly.

As far as mortgage rates go, what the Federal Reserve and Treasury are doing (or not) with respect to funding Freddie Mac, Fannie Mae, FHA are much more significant than a trivial bump in banks' overnight borrowing costs.

The Equity Sharing Solution to the Fannnie/Freddie Morass

Revisiting "Capped Upside, Unlimited Downside"

[Note to Readers: this post originally ran Christmas Week, when it was read by . . . no one. In the wake of Barney Frank's announced plan to abolish Fannie Mae and Freddie Mac, I'm "popping" it to the top of the list.]

If you lend someone 97 cents to buy an asset that costs $1, what happens if the value of that asset falls to 95 cents?

How about 90 cents? Or 70 cents?

What if the borrower then loses their job?

Add eleven(!) zeroes . . . and you have the plight of Fannie Mae and Freddie Mac in a nutshell.

Background

One way or another, these so-called Government Sponsored Entities ("GSE's") -- and now FHA -- provide the bulk of the capital that finds its way into the U.S. housing market.

That capital takes the form of loan guaranties, mortgage origination, secondary market loan purchases, etc.; cumulatively, the foregoing aid -- investment, if you prefer -- amounts to hundreds of billions annually.

When dropping home prices -- and now, recession-induced job losses -- blow multi-billion dollar holes in these entities' balance sheets, what should the government do?

It would seem to have three choices: 1) shovel more money in; 2) require higher downpayments, to provide for a higher margin for error; or 3) get out of the housing subsidy business altogether, and pull the plug on the GSE's.

Option #3 has seemingly been taken off the table, because of the threat it would pose to housing prices generally.

Option #2, much less draconian, would also seem to undermine already shaky home Buyers' purchasing power, and therefore has also been rejected.

Which leaves option #1: support the GSE's with unlimited, open-ended capital infusions.

In fact, the government just decided to do exactly that, in an announcement purposely released on Christmas Eve to minimize scrutiny ("Fannie & Freddie, Uncapped").

High Costs, Dubious Benefits

Unfortunately, simply shoveling more money into these GSE black holes may be the worst strategy of all.

In the short run, it turns would-be home Buyers into armchair economists, trying to guess what the government will -- or won't -- do next to support home prices.

In the long run, massive government housing aid distorts prices, crowds out private lenders, and risks debasing the U.S. dollar -- thereby ushering in runaway interest rates.

If you think housing prices are under pressure now, just wait until long-term interest rates -- now around 5.25% for a 30-year mortgage -- hit 8%. Or 15%-plus, as happened in the early '80's.

Option #4

So what is the way out of this morass?

Go back to what happens to Fannie and Freddie as home prices fluctuate.

When housing prices fall, the GSE's suffer major impairments to their capital as borrowers default.

However, when home prices rise (yes, that can actually happen!), the most they stand to recover is the amount they originally loaned.

Heads, borrowers win; tails, the government loses (sound familiar?).

Instead, the GSE's should insist on sharing in any upside that borrowers enjoy.

The Stanford Model

Stanford University long ago established a similar housing subsidy for faculty struggling to afford expensive Bay Area housing.

In return for down payment assistance and low-cost mortgage money, the University effectively becomes a "partner" with the faculty-homeowner, enjoying a cut of the appreciation when the home is sold.

Emulating Stanford's approach not only would help the government's balance sheet, it would relieve pressure on foreclosures while putting borrowers on notice that there's no free mortgage lunch.

Over time, one might expect that realization to curtail their appetites . . .

Barney Frank: 'Pull Plug on Fannie, Freddie'

Dear Barney: Read This!

Imagine Ted Kennedy, before he died, admitting that the health care reform bill was a mess and that everyone should start over.

Or John McCain saying that campaign finance laws were unworkable, and should be scrapped (actually, the Supreme Court just said that).

So it's big news when Congressman Barney Frank, the biggest benefactor of Fannie Mae and Freddie Mac, announces that they're hopelessly flawed and that the U.S. housing finance system should be re-built from scratch:

The remedy here is ... as I believe this committee will be recommending, abolishing Fannie Mae and Freddie Mac in their current form and coming up with a whole new system of housing finance," said Rep. Barney Frank (D., Mass.), the chairman of the House Financial Services Committee.

--"Fannie Mae, Freddie Mac Should Be Eliminated, Frank Says"; The Wall Street Journal(1/22/2010)

Since Mr. Frank seems to be casting around for new ideas, I thought I'd direct him to my proposal for digging Fannie and Freddie out of the multi-trillion mess they're in (want the two word, Reader's Digest version? Here it is: 'equity sharing'):

When housing prices fall, Fannie Mae and Freddie Mac suffer major impairments to their capital as borrowers default. However, when home prices rise (yes, that can actually happen!), the most they stand to recover is the amount they originally loaned.

Heads, borrowers win; tails, the government loses (sound familiar?).

Instead, Fannie and Freddie should insist on sharing in any upside that borrowers enjoy.

Stanford University long ago established a similar housing subsidy for faculty struggling to afford expensive Bay Area housing. In return for down payment assistance and low-cost mortgage money, the University effectively becomes a "partner" with the faculty-homeowner, enjoying a cut of the appreciation when the home is sold.

Emulating Stanford's approach not only would help the government's balance sheet, it would relieve pressure on foreclosures while putting borrowers on notice that there's no free mortgage lunch. Over time, one might expect that realization to curtail their appetites . . .

--Ross Kaplan, The Equity Sharing Solution to the GSE Morass; City Lakes Real Estate Blog (12/29/2010)

Will this happen?

I doubt it.

Instead, my guess is that Congress will take a page from the mutual fund industry when it has a big loser on its hands.

Namely, the fund's stewards put the "loser fund" out of its misery by merging it with another fund with a better name -- and track record.

Fannie & Freddie, Uncapped

Best Time to Bury a Story? X-Mas Eve

The U.S. Treasury said it would provide capital as needed to Fannie Mae and Freddie Mac over the next three years, effectively opening its checkbook to the government-controlled companies in a bid to reassure investors in their debt.

Treasury announced the moves in a Christmas Eve press release, a week before its authority to change the terms of its agreements with the companies was set to expire. After Dec. 31, Treasury would need the consent of Congress to make such changes.

--"U.S. Uncaps Support for Fannie, Freddie"; The Wall Street Journal (12/24/09)

What's the significance of the foregoing?

Fannie Mae and Freddie Mac are the major suppliers of capital to the housing market at the moment.

The Treasury's move indicates that it doesn't plan to "cut off" either anytime soon, even after shoveling more than $100 billion into the firms since putting them into "conservatorship" in August, 2008.

The only thing surprising about the Treasury's announcement is the Christmas Eve timing: apparently, no one's working there at midnight tonight (an even better time to bury the news).

Exit Strategies

"Surge" or "Stay the Course?"

Depleted and demoralized by the huge sums it has already spent (and arguably squandered) trying to stabilize a still-hostile environment, the U.S. must decide its next move.

The three choices are to: 1) double down ("surge"); 2) "stay the course"; or 3) declare victory and get out.

U.S. forces in Afghanistan?

Try, the federal government and the U.S. housing market.

A partial list of all the direct and indirect financial support provided to the housing market to date includes:

--Record low mortgage rates, courtesy of the Fed's $1.25 trillion purchase of mortgages.
--Zero percent short-term interest rates, intended(?) to resuscitate the banks and promote private sector lending.
--Hundreds of billions shoveled into Fannie Mae, Freddie Mac -- and prospectively, FHA --to enable them to (continue to) fund and guarantee a huge chunk of all U.S. mortgages.
--Tax credits and incentives to home buyers, expanded and extended through April 30, 2010.
--A combination of financial incentives and political muscle designed to induce banks to modify non-performing mortgages in their portfolios.

In light of all the foregoing, the two, $64 billion (times 10) questions looming over the 2010 U.S. housing market -- indeed, economy -- are: 1) how much financial support will the government provide to housing going forward?; and 2) how long can it afford that amount?

Oh, yeah -- one last question: isn't "limited surge" an oxymoron (like "jumbo shrimp?").

Et Tu, FHA?

Hemorrhaging at FHA

FHA runs low on cash, fueling bailout concerns.

--Headline, The Boston Globe (11/13/09)

Here we go again.

First come the rumors of funny accounting and huge, buried losses.

Then come the vehement denials from company executives.

Finally, the truth comes out: the critics are vindicated, the losses are toted up, the discredited executives are booted (or not) . . . and the government provides a multi-billion dollar bailout.

Are we talking about Fannie Mae? Freddie Mac?

Well, yes. But this time, the embattled government agency is FHA.

Background

As you may or may not know, Fannie Mae and Freddie Mac -- the two biggest government-sponsored players in the housing market -- finally hit the (accounting) wall and were taken over by the government more than a year ago.

Both ultimately required tens of billions in government bailout money -- money they denied needing practically up until the end. In fact, they are still in business, still incurring losses, and still in need of more bailout money.

As Fannie Mae and Freddie Mac lending slowed down, much of the slack the last year has been taken up by FHA.

In fact, something like 30% of all mortgages made in the U.S. in the last year were backed by FHA.

Its appeal? Government insurance, plus low, 3.5% down payments.

No Margin for Error

Unfortunately, lending into a declining housing market to Buyers putting down a very slim down payment is a recipe for disaster.

In fact, my first-grader could do the math: 3.5% down, minus the drop in the local housing market (call it 5% to 20%), equals the amount FHA borrowers are underwater.

Throw in millions of recession-induced job losses, and the picture suddenly isn't very pretty.

Even if things aren't quite so dire, after Fannie Mae and Freddie Mac, I doubt that many people are going to give FHA executives the benefit of the doubt.

Bold Mortgage Prediction!

Mortgage Prediction: More Red Tape

Clients know that I demur when asked where I think interest rates are headed.

If Ben Bernanke, Chairman of the Federal Reserve, doesn't know with a high degree of confidence -- what chance does anyone else have?

That said, here's one major development that's easy to predict: there will be more red tape.

That's so because government, by default, is going to be more and more involved in the lending process.

In fact, it's likely to be the loan originator, the underwriter, the appraiser, the insurer, the servicer, and the securitizer (did I forget anything?).

Since the full nationalization of Fannie Mae and Freddie Mac almost a year ago, it's already playing many -- if not all -- of those roles.

If the old focus was making money (through any and all means), the new focus is not losing it.

That mindset -- plus government "process" -- is not likely to breed expediency or economy.

Fannie & Freddie "Add-On Fees"

"Airline Pricing" Spreads to Mortgages

Both Fannie Mae and Freddie Mac say they are tacking on extra fees to counter higher risks and losses associated with certain loan products, buyer equity stakes and credit scores . . . However, real estate agents, mortgage bankers and brokers are incensed at the new round of fee increases, calling them counterproductive in an environment in which housing needs help, not new impediments.

--Kenneth Harney, "From Fannie and Freddie, Here Come the Fee Increases"; The Washington Post (2/14/09)

Call it the spread of the "airline industry model." *

They can't figure out how to make money -- in fact, they lose billions every year -- so they have to recoup it any way they can. So they start tacking on fees -- lots and lots of them. For checking extra bags, in-flight food, headphones, fuel surcharges -- you name it. Each year, the list only grows longer -- and more annoying.

Get ready for the post-housing bust Fannie and Freddie pricing model. In addition to paying mortgage interest, borrowers can now expect to pay two different kinds of add-on fees:

One. Premiums, called "delivery fees," for Buyers who can't meet (newly conservative) downpayment thresholds; and

Two. Surcharges for disfavored housing categories (because they're supposedly higher risk). That includes condominiums and owner-occupied duplexes.

Just one more illustration of the old saying about banks "lending you an umbrella when it's sunny and demanding it back when it's raining."

And that's private lenders.

Add government bureaucracy and inefficiency to the equation, and you get the worst of both worlds (JFK famously remarked that Washington "combined the charm of a northern city with the efficiency of a southern one").

*The other parallel with airlines? Custom pricing (no two borrowers pay the same rate) that literally changes minute-by-minute. I attribute this latter phenomenon to modern computing power as much as anything else.