Archive for the ‘Financial Services & Crises’ Category

How safe is your money market fund?

July 11, 2011

Punch line: Amid the Greek mini-panic this month, did you notice the really shocking news? To wit, U.S. regulators are worried about the “systemic risk” posed by the exposure of American money-market funds to European bank debt.

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According to the WSJ:

A 1983 Securities and Exchange Commission rule allows money funds to report a stable net-asset value of $1 per share, even if that’s not precisely true based on changes in the fund’s underlying assets.

The result is that investors have come to expect that money funds never “break the buck,” never decline in value.

But since 2008 U.S. money funds have been allowed to pile into European bank debt.

Half the assets in U.S. prime money market funds were invested in European banks as of the end of May.

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Bottom line: If Greece tanks and takes down some Euro banks with it, the impact will be felt by US money market funds … which could possibly break a buck …

So much for consumer deleveraging …

June 9, 2011

In the 1960s and 1970s, consumer debt as a percentage of after-tax income averaged a bit over 60%.

Starting in the Clinton years – and gaining steam through the Bush years – the ratio doubled – as consumers took out easy money mortgages and credit cards.

The 2009 financial scare prompted a wave of debt-reduction, but it looks like the austerity wave is becoming passé.

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According to the WSJ:

The economy is likely to be stuck with at best subpar growth until the private sector’s deleveraging, or debt-shedding, process is complete.

Households have made some progress lately, but this still looks to be in its early stages.

While debt as a percentage of after-tax income has fallen from its peak, it remains about 120% — well above the 89% it averaged in the 1990s.

And, there are signs that consumers are even starting to borrow again:

  • Consumer credit outstanding rose by $5.5 billion in April after a $6 billion increase in March.
  • Student-loan debt is at record-high levels
  • There has been an uptick in credit-card borrowing by cash-strapped consumers.

P.S. In Japan, deleveraging took the better part of 15 years.

[AOT]

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E*Trade tells baby: “Just shut-up !”

February 28, 2011

TakeAway:  E*Trade has generated a lot of awareness with its talking baby ads, but is losing ground to its competitors.

Byt, awareness doesn’t lead to customers if the message is wrong.  And, for most people money is not a joking matter..

E*Trade has caught onto this and is reworking its campaigns going forward.

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Excerpted from Bloomberg Businessweek, “E*Trade Looks to Outgrow That Talking Baby,” by Ben Steverman, February 16, 2011

E*Trade may boast some of the most popular advertisements on TV, but the company still can’t make a profit. Hobbled by bad loans that blew up in the financial crisis, it’s stuck at fourth place in the highly competitive online brokerage industry.

E*Trade executives are thus trying a new strategy: While not entirely abandoning their talking baby campaign, they’re spending more than half of an increased ad budget on messages without the stock-trading infant. The talking baby ads, which began airing during the 2008 Super Bowl, have been a hit with TV viewers. Nielsen says that an ad featuring the E*Trade baby with a sneezing cat was the third most-liked commercial during the 2011 Super Bowl, watched by a record 111 million people. Because of the baby, “we have much higher brand recognition vs. the competition,” says E*Trade’s chief marketing officer.

Despite the attention, the New York-based company has fallen behind rivals in assets and new customer signups. Since the end of 2007, E*Trade has boosted its number of brokerage accounts by 9.4 percent, to 2.7 million. That’s solid growth, but much of the online brokerage industry has seen a heavier influx of assets. Charles Schwab has increased its active brokerage accounts by 13.5 percent since 2007 and TD Ameritrade has boosted total accounts by 24 percent in that period. …

… What’s holding back E*Trade may not be its offerings but its customer image, something the talking baby ad campaign isn’t improving… It’s an unusual strategy for a financial company. “How many people want to take advice from a baby?” …

Edit by DMG

 

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Geithner declares Mission Accomplished: “Welcome to the Recovery”

August 6, 2010

Well, Treasury Secretary Tim Geithner did it. He declared Mission Accomplished.

In a New York Times op-ed, titled Welcome to the Recovery, he argues that the Administration’s economic plan is working — even better than expected.

“Recent data on the American economy shows that we are on a path back to growth.”

Among his points:

“From the start, President Obama made clear that recovery from a crisis of this magnitude would not come quickly”

Ken’s Note: Well actually, the president said that the almost $1 trillion in stimulus money would be quickly deployed to shovel ready projects that would keep the unemployment rate under 8%. As everybody knows, it has been hovering just shy of double digits.

“The new data show that this recession was even deeper than previously estimated.”

English translation: Our initial analysis was deeply flawed, but you can trust that we’ve got this sucker figured out now. Don’t judge us based on our track record.

“We  expect the unemployment rate to go up before it goes down.”

Ken’s Note: How much recovery can we stand?

“The economic collapse drove tax revenue down, pushing the annual deficit up to $1.3 trillion by last January.”

Ken’s Note: Who could ever have imagined that lower aggregate income would generate less tax revenue

“It would be irresponsible to continue the Bush tax cuts for the wealthy.”

English translation: Let’s defy all empirical evidence and see what happens when you raise taxes during a recession.

Kens Note: I love it when a guy who was caught cheating on his taxes lectures on taxpaying responsibility.

* * * * *

I don’t know about you, but I slept well last night…

NY Times, Welcome to the Recovery, August 2, 2010
http://www.nytimes.com/2010/08/03/opinion/03geithner.html?_r=1&ref=opinion

My take on the Stimulus …

February 22, 2010

The Washington Post says:

PRESIDENT OBAMA’S argument with Republicans over the effectiveness of the $862 billion American Recovery and Reinvestment Act — a.k.a., the stimulus bill — is not an easy one for him to win.

With unemployment at 9.7 percent, he has to make the counterfactual case that things would be even worse if he and congressional Democrats had not administered this dose of deficit-financed tax cuts and spending.

It does not help him that joblessness is well above what it was when the act went into effect a year ago — and higher than the administration predicted it would be after a year of stimulus.

Nevertheless, at its core, the president’s argument is correct.

You cannot inject $300 billion — an amount equal to about 2 percent of U.S. gross domestic product — into the economy without stimulating some short-run economic activity that would not have occurred otherwise.

But, the precise number of jobs that this additional demand “saved or created” —  is not provable.

Nor is it simple to disentangle the Recovery Act’s impact from the trillions of dollars worth of support from other sources, mostly the Federal Reserve.

But it’s churlish to assert flatlythat “not one net job” has been created. The country is better off because of the bill.

http://www.washingtonpost.com/wp-dyn/content/article/2010/02/18/AR2010021804662.html

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Ken’s Take

No surprise, I wasn’t a big fan of the bailouts or the fiscal stimulus program.  And, suffice it to say, empirical evidence hasn’t given me any reason to jump on the wagon now.

Here’s are the key points that framesmy thinking:

  • Christine Romer – chair of the President’s Council of Economic Advisers — made her academic reputation on research that convincingly proved that fiscal stimulus doesn’t work.  Her recent conversion makes me a tad suspicious, to say the least.
  • Adding almost $1 trillion to the national debt — the price tag of the stimulus when all the dust settles — is simply a transfer of resouces out of the private sector (eventually) to the public sector (now).  In other words, there will be a subsequent depressing effect on the economy.
  • A big chunk of the stimulus money (around $120 billion) went to extending unemployment benefits, food stamps, etc.  On one hand, I’m ok with helping  folks in tough times.  On the other hand, is it any surprise that the BLS reports record numbers of unemployed people who have stopped looking for work.  It’s called moral hazard, and economists have written about it for decades.
  • About 1/3 of the stimulus was “tax relief for 95% of workers”.  That’s true (I guess), but what was it?  Obama’s $400 rebate checks.  First, evidence seems to suggest that many folks used the money to pay off bills —  that’s certainly not stimulative.  And, I don’t understand why taxpayers (like me) should be paying off somebody else’s overextended credit card balance.  Even if you look at the tax rebate as a stimulant, how much stimulating can a person do with an extra buck-a-day in their wallet?
  • Another chunk of the stimulus actually went towards jobs.  As near as I can tell, about 3/4  of that (around $150 billion) went to preserving the jobs of government workers in states and locales that were spending way beyond their means.  Again, why should folks from fiscally responsibile places bail out some irresponsible local governments, fund marginal teachers hanging on (maybe they should be fired), and preserve bloated government bureaucracies?  I don’t get it.
  • Now, we’re down to the spending on things like roads and bridges and turtle crossings and fast trains between Disneyland and the Mirage (about $50 billion in total).  Even if those are all good things , the administrtion’s numbers say that the bill is over $100,000 for each associated job.  Give me a break.
  • Finally, they said: “Give us $787 billion and we’ll keep unemployemnt uner 8%”.  They didn’t do it.  Period.  Don’t give me “jobs saved or created” — they set the metric and failed to achieve it.

That’s my POV …

Conan gets $32 million … where’s the outrage? or the pay czar?

January 22, 2010

Punch line: Conan fails at 11:30 and gets $32 million to go away.  Where’s the pay czar when you need him ? 

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FBN: Conan, $40 Million & The TARP Takers by Brian Sullivan, January 19, 2010

Where’s the outrage?

Polls show the public is furious over the expected record bonuses being paid to wall streeters this year.   

Meantime, another large-font headline these days is the very public battle between Jay Leno, Conan O’Brien and NBC.   After trading public barbs (advantage: Conan) for a few weeks, that fight appears over.   Leno gets his show back and Mr. O’Brien reportedly gets $40 million to walk away.

Good for him.   But where’s the bonus bruhaha?

NBC is owned (until the Comcast deal closes) by General Electric.  Like many big banks, GE benefited from taxpayer handouts through backstops of debt for its GE Capital divison.   Not once, but a couple of times.  Imagine the headlines if a stock trader at a TARP-taking bank was paid anywhere close to that to walk away.   The AFL-CIO would issue a press release, Congress would hold another hearing and many TV news types would trip over themselves to out-populist each other.

If we’re going to browbeat the traders for getting their contractually-mandated percentage of business (which is what most of the bonuses are), then we must also be fair and hand out the same criticism for other TARP-takers with large payouts, regardless of the business they’re in.    We don’t have to like the bonuses.   We don’t have to like the banks or the bailouts.   We shouldn’t.   But we should at least follow the money.

Full article:
http://briansullivan.blogs.foxbusiness.com/2010/01/19/conan-40-million-the-tarp-takers/

Tanning salons sigh relief as bullseye shifts to big banks

January 21, 2010

Big winner from Mass results are tanning salons since taxing them was going to fund part of ObamaCare.  Maybe, just maybe, they dodged a bullet.

Now, the administration is picking on somebody its own size — the Wall street banks.

Since the announced “fee” on big banks got some populace traction, why not put on a full court press?

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WSJ: Proposal Set to Curb Bank Giants, Jan. 21, 2010
 
President Barack Obama is expected to propose new limits on the size and risk taken by the country’s biggest banks, marking the administration’s latest assault on Wall Street in what could mark a return, at least in spirit, to some of the curbs on finance put in place during the Great Depression.

The past decade saw widespread consolidation among large financial institutions to create huge banking titans. If Congress approves the proposal, the White House plan could permanently impose government constraints on the size and nature of banking.

The goal would be to deter banks from becoming so large they put the broader economy at risk and to also prevent banks from becoming so large they distort normal competitive forces.

Mr. Obama is also expected to endorse measures which would place restrictions on the proprietary trading done by commercial banks, essentially limiting the way banks bet with their own capital.

The proposal could have the biggest effect on Bank of America Corp., Wells Fargo & Co., and J.P. Morgan Chase & Co., which control a large amount of U.S. deposits, as well as Goldman Sachs, Morgan Stanley and Citigroup Inc., which have a large presence on Wall Street.

The rules could also keep banks out of the business of running hedge funds, investing in real estate or private equity, all businesses that have become important, profitable parts of these banks.

If investors believe the new rules could take effect, they could sell off the shares of most of the big financial stocks in the belief these companies would be facing years of turmoil and potentially lower profits.

The White House proposal would seek to return the “spirit of Glass Steagall,” meant to limit large banks from becoming too big and complex that create enormous risk.

Full article:
http://online.wsj.com/article/SB10001424052748704320104575015910344117800.html?mod=WSJ_hps_LEFTWhatsNews

Must read: "Americans feel increasingly disheartened, and our leaders don’t even notice."

October 30, 2009

Ken’s Take: I’ve said many times before that I love reading Peggy Noonan — even though I don’t always agree with her .  (For my more  liberal friends, keep in mind that she was onboard the Obama train in ’08.)

What she’s always able to do is dive down beneath the superficial and get to the core — the philosophical and emotive stuff that most other analysts miss.  She invariably provokes my thinking … and, she’s a wonderful writer to boot.

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Excerpted from WSJ: We’re Governed by Callous Children, Oct. 29, 2009 

The new economic statistics put growth at a healthy 3.5% for the third quarter. We should be dancing in the streets. No one is, because no one has any faith in these numbers.

Waves of money are sloshing through the system, creating a false rising tide that lifts all boats for the moment. The tide will recede. The boats aren’t rising, they’re bobbing, and will settle.

No one believes the bad time is over. No one thinks we’re entering a new age of abundance. No one thinks it will ever be the same as before 2008.

Economists, statisticians, forecasters and market specialists will argue about what the new numbers mean, but no one believes them, either. Among the things swept away in 2008 was public confidence in the experts.

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The biggest threat to America right now is not government spending, huge deficits, foreign ownership of our debt, world terrorism, two wars, potential epidemics or nuts with nukes.

The biggest long-term threat is that people are becoming and have become disheartened, that this condition is reaching critical mass, and that it afflicts most broadly and deeply those members of the American leadership class who are not in Washington, most especially those in business.

It is a story in two parts. The first: “They do not think they can make it better.”

The most sophisticated Americans, experienced in how the country works on the ground, can’t see a way out.

This is historic. This is something new in modern political history … Americans are starting to think the problems we are facing cannot be solved.

Part of the reason is that the problems—debt, spending, war—seem too big.

But a larger part is that our federal government, from the White House through Congress, and so many state and local governments, seems to be demonstrating every day that they cannot make things better.

They are not offering a new path, they are only offering old paths—spend more, regulate more, tax more in an attempt to make us more healthy locally and nationally. And in the long term everyone—well, not those in government, but most everyone else—seems to know that won’t work.

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And so the disheartenedness … of even those who have something.

This week the New York Post carried a report that 1.5 million people had left high-tax New York state between 2000 and 2008, more than a million of them from even higher-tax New York City. They took their tax dollars with them—in 2006 alone more than $4 billion.

You know what New York, both state and city, will do to make up for the lost money. They’ll raise taxes.

I talked with an executive this week.   He was thoughtful, reflective about the big picture. He talked about all the new proposed regulations on industry. Rep. Barney Frank had just said on some cable show that the Democrats of the White House and Congress “are trying on every front to increase the role of government in the regulatory area.”

The executive said of Washington: “They don’t understand that people can just stop, get out. I have friends and colleagues who’ve said to me ‘I’m done.’ ” He spoke of his own increasing tax burden and said, “They don’t understand that if they start to tax me so that I’m paying 60%, 55%, I’ll stop.”

Government doesn’t understand that business in America is run by people, by human beings.

Mr. Frank must believe America is populated by high-achieving robots who will obey whatever command he and his friends issue.

But of course they’re human, and they can become disheartened. They can pack it in, go elsewhere, quit what used to be called the rat race and might as well be called that again since the government seems to think they’re all rats.

***
And here is the second part of the story.

While Americans feel increasingly disheartened, their leaders evince a mindless callousness.

It is a curious thing that those who feel most mistily affectionate toward America, and most protective toward it, are the most aware of its vulnerabilities, the most aware that it can be harmed. They don’t see it as all-powerful, impregnable, unharmable. The loving have a sense of its limits.

When I see those in government, both locally and in Washington, spend and tax and come up each day with new ways to spend and tax—health care, cap and trade, etc.—I think: Why aren’t they worried about the impact of what they’re doing? Why do they think America is so strong it can take endless abuse?

They don’t feel anxious, because they never had anything to be anxious about. They grew up in an America surrounded by phrases—”strongest nation in the world,” “indispensable nation,” “unipolar power,” “highest standard of living”—and they are not bright enough, or serious enough, to imagine that they can damage that, hurt it, even fatally.

We are governed at all levels by America’s luckiest children, sons and daughters of the abundance, and they call themselves optimists but they’re not optimists—they’re unimaginative.

They don’t have faith, they’ve just never been foreclosed on.

They are stupid and they are callous, and they don’t mind it when people become disheartened. They don’t even notice.

Full article:
http://online.wsj.com/article/SB10001424052748703363704574503631430926354.html?mod=djemEditorialPage

Hey, Mr. Prez … Here’s a way to fund about 1/2 of your healthcare package.

October 27, 2009

Did you know …

TARP will expire on December 31, unless Geithner exercises his authority to extend it to next October.

Right now, Geithner is sitting on over $300 billion of uncommitted TARP funds, thanks in part to bank repayments. Treasury believes it has the authority to spend that returned money on new adventures in housing or other parts of the economy.

Since the TARP has largely ignored its designated mission — buying up bad mortgages and their derivatives — and has evolved into a $700 billion all-purpose political slush fund, why not simply declare success and throw the money at insuring the uninsureds?

Hmmm …. 

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HiLites from WSJ: Rolling up the TARP, Oct.  27, 2009 

Historians will debate TARP’s role in ending the financial panic of 2008, but today there is little evidence that the government needs or can prudently manage what has evolved into a $700 billion all-purpose political bailout fund.

TARP quickly became a Treasury tool to save failing institutions without imposing discipline (Citigroup) and even to force public capital onto banks that didn’t need it. This stigmatized all banks as taxpayer supplicants and is now evolving into an excuse for the Federal Reserve to micromanage compensation.

Even with the banks, TARP has been a double-edged sword. While its capital injections saved some banks, its lack of transparency created uncertainty that arguably prolonged the panic.

By stating expressly that the ‘healthy’ institutions would be able to increase overall lending, Treasury created unrealistic expectations about the institutions’ conditions and their ability to increase lending.”

TARP was then redirected well beyond the financial system into $80 billion in “investments” for auto companies. These may never be repaid but served as a lever to abuse creditors and favor auto unions.

TARP also bought preferred stock in struggling insurers Lincoln and Hartford, though insurance companies are not subject to bank runs and pose no “systemic risk.” They erode slowly as customers stop renewing policies.

TARP also became another fund for Congress to pay off the already heavily subsidized housing industry by financing home mortgage modifications. Not one cent of the $50 billion in TARP funds earmarked to modify home mortgages will be returned to the Treasury, says the Congressional Budget Office.

TARP’s Congressional Oversight Panel warns that the entire taxpayer pot could be converted into subsidies. They are especially concerned about expanding the foreclosure prevention programs that have been failing by every measure.

The political class has twisted TARP into a fund to finance its pet programs and constituents, and the faster it fades away, the better for taxpayers and the financial system.

Full article:
http://online.wsj.com/article/SB10001424052748704224004574489740879074028.html?mod=djemEditorialPage

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On B of A and Merrill …

The government also endangered one of the banks that they considered healthy at the time.

According to Fed documents, the government viewed BofA as well-capitalized, but officials believed that its tangible common equity would fall to dangerously low levels if it had to absorb the sinking Merrill.

In other words, by insisting that BofA buy Merrill, Messrs. Paulson and Bernanke were spreading systemic risk by stuffing a failing institution into a relatively sound one.

And they were stuffing an investment bank into one of the nation’s largest institutions whose deposits were guaranteed by taxpayers. BofA would later need billions of dollars more in TARP cash to survive that forced merger, and when that news became public it helped to extend the overall financial panic.

Full article:
http://online.wsj.com/article/SB10001424052748704224004574489740879074028.html?mod=djemEditorialPage

Justice prevails … B of A shareholders shielded from double-jeopardy

September 15, 2009

The HomaFiles were all over this one early (thanks to a provocative inquiry from SMH — an MSB alum).  We raised the issue way before the WSJ or anybody else. 

In an Aug. 26 post, HomaFiles asked whether it was double jeopardy for shareholders if the SEC fines a company for misleading or defrauding its shareholders.
https://kenhoma.wordpress.com/2009/08/26/an-irony-of-sec-fines-double-jeopardy-for-shareholders/

Apparently, the courts asked the same question …  and ruled accordingly.  Coincidence?

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WSJ,  Judge Tosses Out B of A Bonus Deal, Sep 15, 2009

A federal judge threw out the Securities and Exchange Commission’s proposed settlement with Bank of America over its disclosure of controversial bonuses paid to Merrill Lynch employees, in an unusual ruling that casts doubts about how the agency handles probes of major U.S. companies.

The SEC declined to sue bank executives, saying the banks’ lawyers wrote the allegedly misleading language and it couldn’t find evidence that bank executives intended to mislead shareholders.

Instead, the SEC sued the company itself, i.e. the shareholders .

In a rare scuttling of an SEC settlement, Judge Rakoff said the $33 million fine levied on Bank of America “does not comport with the most elementary notions of justice and morality” because the company’s shareholders — the victims of the alleged misconduct — are the same people being asked to pay the fine.

The judge also had little sympathy for the SEC’s argument that it would be too difficult to pursue executives, since they had been guided by lawyers. “If that is the case, why are the penalties not then sought from the lawyers? And why, in any event, does that justify imposing penalties on the victims of the lie, shareholders?” he asked.

He also had harsh words for BofA, which has recently filed court papers claiming its proxy statement was neither false nor misleading. “If the Bank is innocent of lying to its shareholders, why is it prepared to pay $33 million of its shareholders’ money as a penalty for lying to them?”

http://online.wsj.com/article/SB10001424052970203917304574413242609077958.html?mod=djemEditorialPage

Full article:
http://online.wsj.com/article_email/SB125294493976909051-lMyQjAxMDI5NTEyNDkxNDQ0Wj.html

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Summer Read: Bold Endeavors

June 24, 2009

Bold Endeavors: How Government Built America, and Why It Must Rebuild It Now by Felix Rohatyn

Background: Rohatyn was an investment banker with Lazard Freres before a second career in public service bailing out NYC from the brink of bankruptcy and serving as Ambassador to France under Clinton.

Central premise: “The nation is falling apart — literally. America’s roads and bridges, schools and hospitals, airports and railways, ports and dams, water lines and air control systems — the country’s entire infrastructure — is rapidly and dangerously deteriorating.

America needs to rebuild its infrastructure. It is a critical national priority, a costly long — term investment, and a visionary enterprise. It is a program that can provide tens of millions of much-needed jobs. 

It is an undertaking that can only succeed if it is directed, coordinated, and largely financed by the federal government.

And, contrary to the glib reaction for many contemporary ideological naysayers, large-scale public investments can work, and with remarkable long-term success.”

Consider 10 bold endeavors that were done by the Federal government and had a 

 

  1. Louisiana Purchase (1803) … doubled the size of the country, and put the Port of New Orleans under US control
  2. Erie Canal (1825) … linked the Atlantic Ocean to the Great lakes … established NYC as a major port and center of commerce
  3. Transcontinental Railroad (1869) … enabled coast to coast travel
  4. Land Grant Colleges (1862) … provided greater access to higher education
  5. Homestead Act (1862) …  incentivized people to move west and settle the new frontiers
  6. Panama Canal (1914) … shorten travel time from Atlantic to Pacific, economic and security benefits.
  7. Rural Electrification Administration (1936) … brought electric power to sparsely populated rural areas
  8. Reconstruction Finance Corporation (1936)  …  TARP v.1.0 … provided credit backstops and bailout funds to companies struggling out of the Depression.
  9. G.I. Bill (1944) … provided education benefits, supplemental unemployment benefits to service people returning from WWIIto
  10. interstate Highway System (1956) … provied “go anywhere” coverage for US citizens – in times of peace and war.

Bottom line:  The above is about all that you ever need, so save your money

Even credit card companies are tightening up …

March 13, 2009

Excerpted from WSJ, “Credit Cards Are the Next Credit Crunch”, Whitney, March 10, 2009

Currently, there is roughly $5 trillion in credit-card lines outstanding in the U.S., and a little more than $800 billion is currently drawn upon.

(That compares to total mortgage debt of over $10.5 trillion)

I believe that there will be at least a 57% contraction in credit-card lines. Of the $5 trillion, over $2 trillion of credit-card lines is likely to be cut in 2009, and $2.7 trillion by the end of 2010.

As we return to more realistic underwriting standards, certain borrowers will no longer appear worth the risk, and therefore lines will continue to be pulled from those borrowers.

Lenders have reduced credit lines based upon “zip codes,” or where home price depreciation has been most acute. Such a strategy carries the obvious hazard of putting good customers in more vulnerable liquidity positions simply because they live in a higher risk zip code.

Currently five lenders dominate two thirds of the market. Credit-card lenders are currently playing a game of “hot potato,” in which no one wants to be the last one holding an open credit-card line to an individual or business. While a mortgage loan is largely a “monogamous” relationship between borrower and lender, an individual has multiple relationships with credit-card providers. Thus, as lines are cut, risk exposure increases to the remaining lender with the biggest line outstanding.

* * * * *

Over the past 20 years, Americans have also grown to use their credit card as a cash-flow management tool.

For example, 90% of credit-card users revolve a balance (i.e., don’t pay it off in full) at least once a year, and over 45% of credit-card users revolve every month.

A relatively small portion of U.S. consumers have actually maxed out their credit cards, and most currently have ample room to spare on their unused credit lines. For example, the industry credit line utilization rate (or percentage of total credit lines outstanding drawn upon) was just 17% at the end of 2008.

Full article:
http://online.wsj.com/article/SB123664459331878113.html

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Stimulus tax breaks: going for the capillaries instead of the jugular

February 11, 2009

The tax cuts included in the current version of the stimulus bill deserve the resounding “thud” that they’ve been getting.

Setting ideology aside and just resorting to basic arithmetic reveals the plan’s glowing deficiency: it is so “in the box” and marginal that it is unlikely to have any measurable effect on the economy.  Rather than slashing at the economy’s jugular, the tax cuts barely scratch the capillaries.

For example, take President Obama’s pride and joy, the $500 refundable tax credit.  Does anybody really believe that $1.37 per taxpayer per day is going to jump start the economy?    Or, will an extra $40 per month save many struggling mortgage holders from foreclosure? 

Similarly, take the GOP’s idea of a $15,000 tax credit on the purchase of a new home.  Somebody buying a $150,000 home with a 5%, 30 year mortgage would save about $80 on their monthly mortgage payment (getting it down to about $750) and provide a $15,000 equity cushion, just in case home values fall further.  Is that really enough incentive to pull job-threatened folks off the sidelines? 

The annual AMT adjustment would have happened later in the year anyway, especially since its greatest impact is in Democratic strongholds with high state income taxes (think NY, CA. NJ, and CT). That said, its average impact is about $2,400 for affected taxpayers.  These folks earn enough to have an AMT problem, so an extra $200 per month isn’t likely to change their shopping behavior, let alone their life style.

The biggest business tax break is the tax loss carry backward which allows retroactive tax credits (refundable I assume) for companies that made money during the boom but are tanking during the bust.  Again, the extra money may keep some marginal companies on life support for awhile, but isn’t likely to turn a struggling company into a jobs creator.

Congressional thinking has been trapped in partisan boxes.  Many ideas have been death-branded as either old and tired, or as favoring the rich.  No big ideas have been proposed that could realistically get the economy moving again.

There are big ideas for the politicos to consider if they are really serious about moving the economy forward.

First, there is the tried and true investment tax credit.  Give companies a 15% ITC for investment spending in 2009, and a 10% ITC for investment spending in 2010.  If necessary, sweeten the pot by allowing 2009-2010 investments to be written off on a very accelerated basis (say, over 3 or 5 years).

Second, give multi-nationals a tax holiday on repatriated earnings.  Cut the 2009 rate from 35% to 5% or 10%.  Such a move could bring over $500 billion back into the U.S. from foreign stashes, and generate $25 to $50 billion incremental tax revenue.  Otherwise, companies will use the money in their foreign operations and the U.S. tax take will be zero.

Third, give companies that maintain or grow their workforce a payroll tax rebate.  For example, a company that contributes the same amount of payroll taxes in 2009 as it did in 2008 might get 25% of its aggregate contributions rebated; a company that pays in10% more payroll taxes year-to-year might get a 50% rebate. A company that shrinks its workforce gets no rebate.

Fourth, since a depressed housing market is the root cause of the economic turmoil, adjust the standard income tax deduction a bit and allow the two-thirds of all taxpayers who use it to deduct their home mortgage interest payments.  This move alone would put money into more than 35 million pockets, might save a few people from foreclosure, and could coax some new buyers into the market.

Fifth, eliminate capital gains taxes on all residential real estate purchased in 2009 that is held at least 18 months. This initiative would certainly get investor-landlords back into the market.  They could buy some of the existing excess homes’ inventory, and deploy it as affordable rental housing.

Sixth, eliminate capital gains on all stocks bought in 2009 and held for at least 18 months.  Doing so would jolt the stock market upwards.  Would it favor the rich? Sure.  But it would also help restore the value of soon-to-retire baby boomer’s IRAs.

These ideas are representative of the pool of big ideas that have been overlooked in the stimulus package. It is time for Congress and the President stop playing small ball and go for the fences.  Give us something that we can believe will work.

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Stemming foreclosures is tricky … no kidding

February 11, 2009

Excerpted from WSJ, “Finding a Way to Stem Foreclosures Proves Tricky”, Feb 11, 2009

The Obama administration provided few details about its plans to address the foreclosure crisis when laying out its economic-recovery program Tuesday, highlighting the challenges of creating a program that is fair and effective.

Nearly five million families could lose their homes between 2009 and 2011.One question facing the administration is how to win investor support for modification efforts while providing meaningful relief to borrowers.

President Barack Obama suggested that he would propose legislation to make it easier for loan-servicing companies to ease up on troubled borrowers while taking steps that might win investors’ support. Right now, he said, servicers are limited in their ability to modify mortgages that have been packaged into securities and sold to multiple investors. In addition, “the borrower is going to have to probably — if they get some assistance — agree to give up some equity once housing prices recover”.

Another challenge is determining who should get help. Those facing foreclosure aren’t just local residents hurt by job losses, but also real-estate speculators.

Another worry is moral hazard, or how to help those truly in need without encouraging others to fall behind on their payments.

Government officials are expected to create national standards for loan modifications that would be adopted by Fannie Mae and Freddie Mac. But there is little data on what types of workouts are most cost-effective. Data released in December by federal banking regulators show that more than 40% of borrowers were at least 60 days past due eight months after their loan was modified.

Forty-seven percent of loan modifications completed in November resulted in higher payments for borrowers, typically because unpaid interest and fees were added to the loan balance.

Coming up with an effective modification is complicated by the fact that many troubled borrowers also have home-equity loans or credit-card debt, auto loans or other obligations that can make it difficult to afford even a lower mortgage payment.

“You don’t want to modify a loan that you think will eventually redefault …. All that will do is delay the process and increase the cost.”

A focus for the government has been on how to determine the “net present value” of homes. Government officials think that if they can agree on a common metric for determining a home’s value, they can expedite how the loan is modified.

Full article:
http://online.wsj.com/article/SB123431365164570827.html 

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“Up to 4 million jobs created or saved”

February 10, 2009

Call me cynical, but Pres Obama’s promise of  “up to 4 million jobs created or saved” sounds like a pretty soft metric to me.

First, there’s the “up to” part.  So, if the final answer is, say 2 million, the metric is made.

But, the real weasle room is in the “created or saved”.  What exactly is a saved job?  How do you know one when you see it?

My bet: For the next year or two, we’ll be hearing that Bush’s failed policies left the economy in even worse shape than anyone imagined and we’ll get bombarded with TARP-like claims that things would have been even worse without the added spending.  Jobs will continue to evaporate, but at a slower rate than some made up “what if” number.

For sure, we’ll have saved up to 4 million jobs.

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Quick Takes from the Weekend … Geithner, Stimulus, Infrastructure

January 26, 2009

Is it just me, or is this stuff getting nuttier and nuttier by the day?

The very same people who are railing that the TARP hasn’t worked (I agree), say that Geithner (one of the plan’s key architects) needs to be confirmed because he’s the best man for the job (really?) and provides needed continuity (for a plan that they say isn’t working).  Huh?

Geithner — who will head IRS as Treasury Secretary — testified that he does his own  taxes using TurboTax (that’s good, I guess) and blames the software package for not prompting him that he needed to pay self-employment taxes.  And not a single Senator burst out laughing.

I really do think that cheating on your taxes is disqualifying for a job heading up the IRS.

* * * * *

The Congressional Budget Office says that less than 25% of the proposed stimulus package will impact 2009.

Geithner’s answer: 1/3 are refundable tax credits.  When it was pointed out that less than 12% of last year’s tax rebate checks provided any stimulus to the economy, Geithner replied “yes, but that will just be the first installment of a continuing program that (candidate) Obama promised the people”.  So, if it doesn’t stimulate, why’s it in a stimulus package?

* * * * *
Conservative critics are having a field day with some of the specifics, e.g. “aid to contraception clinics”.  An administration spokesperson said that part of the stimulus plan is geared to rebuilding the U.S.  infrastructure … and that the infrastucture is both physical (like bridges) and social.  Talk about Trojan horses. 

* * * * *

On the plus side, critics are opposed to the gov’t replacing much of its auto fleet with new cars.  I like that idea since it’s immediate, helps the auto industry, and can get some more fuel efficient cars on the road (provided that the replaced cars are taken out of service).

Also, there’s much opposition to sweetening unemployment payouts and food stamp programs.  Even if they are usually subject to abuse and usually become permanent entitlements, I say that it’s worth the price to help folks who are really struggling.

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What Really Lies Behind the Financial Crisis?

January 23, 2009

Published: January 21, 2009 in Knowledge@Wharton

Ken’s Take: Jeremy Siegel (a heavyweight finance prof) dismisses gov’t programs that encouraged sub-prime mortgage lending and pins the tail on investment banks, etc., that undermanaged a few “smart guys” who took large, over-leveraged bets on assets that had fatal levels of hidden risks.  His value add: pointed out that when IBs were privately held they managed risk more prudently because they were playing with their own money.  After going public, they were playing with shareholders’ money …

I think he underestimates the impact of “action one” — the origination of fundamentally bad loans.  But, I hadn’t heard the argument that public ownership of IBs enabled the problem.

* * * * *
What was the true cause of the worst financial crisis the world has seen since the Great Depression? Was it excessive greed on Wall Street? Was it mark-to-market accounting? The answer is none of the above, says Jeremy Siegel, a professor of finance at Wharton. While these factors contributed to the crisis, they do not represent its most significant cause.

While angry investors and taxpayers are anxiously looking to assign blame for the current state of the economy, it’s important to know not only which factors led to the meltdown, but which ones did not. The government programs encouraging home-buying by low- and middle-income families and short-selling of financial stocks — which was halted for a time last fall — have little to do with the crisis on Wall Street.

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Betting the house on mortgage backed securities

Here is the primary reason: Financial firms bought, held and insured large quantities of risky, mortgage-related assets on borrowed money.

The irony is that these financial giants had little need to hold these securities; they were already making enormous profits simply from creating, bundling and selling them.

“During dot-com IPOs of the early 1990s, the firms that underwrote the stock offerings did not hold on to those stocks … They flipped them. But in this case, the financial firms decided mortgage-backed securities were good assets to hold. That was their fatal flaw.”

There was a massive failure, not only by traders, but by CEOs of financial firms, their risk management specialists and the major rating agencies to recognize that an unprecedented housing-price bubble began building after 2000.

Their faulty reasoning was that the inability of homeowners to pay their mortgages — and the consequent foreclosures — would not pose a threat to their mortgage-backed securities. They believed that as long as home prices kept rising, the underlying value of the real estate would provide a hedge against the risk of such defaults.

They failed to realize that this reasoning was based on the assumption that home prices would go in just one direction — up. In fact, these assets became enormously risky once the housing bubble burst and home prices began their inevitable decline.

* * * * *
Under-managing the (few) smartest guys in the room

Many troubled banks and insurers continued to prosper in almost every other aspect of their businesses right up to the 2008 meltdown. The exception was the billions of dollars in mortgage-backed securities that they bought and held on to or insured even after U.S. home prices went into a free-fall more than two years ago.

AIG —  the insurer that received an $85 billion federal rescue package last September — is a prime example. Some 95% of its business units were profitable when the company collapsed. “AIG has 125,000 employees … Basically, 80 of them tanked the firm. It was the New Products Division, which had an office in London and a small branch office in Connecticut. They came up with the idea of insuring mortgage-backed assets, and nobody at the top decided it wasn’t a good idea. So they bet the house — and the company went under.”

Ultimately, the buck stops with corporate CEOs who didn’t ask hard enough questions about the risks posed by mortgage-backed assets.

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Playing with other people’s money

Firms like Lehman Brothers, Bear Stearns and Morgan Stanley  survived the much more severe Great Depression of the 1930s but collapsed during 2008. Why? One reason: back then, these firms were organized as partnerships. In such an organizational structure, the partners would have to risk their own capital. When the partnerships were reorganized as widely held public companies, however, they no longer had such constraints. “Back when it was a partnership, you had your life invested in that company.” Investment banks began making higher-return but higher-risk investments in recent years as public ownership increased.

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By many important measures, the economy is not nearly as battered as it was during the early 1980s, when unemployment, inflation, and interest rates were all considerably higher than they are today. Stocks — as evaluated by their price-to-earnings ratios — are undervalued to the point where they could draw enough investors to spark a recovery before the end of 2009.

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Full article:
http://knowledge.wharton.upenn.edu/article.cfm?articleid=2148#

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$1 trillion down, $1 trillion to go …

January 19, 2009

Goldman Sachs economists estimate that financial institutions and investors world-wide will ultimately realize $2 trillion in losses on U.S. loans, but have recognized only half those losses so far.

Note: roughly half of the projected write-offs are residential mortgages.  Good news: “only” $234 billion in commercial real estate.

image

Source: WSJ, “U.S. Plots New Phase in Banking Bailout”, Jan. 17, 2009
http://online.wsj.com/article/SB123214588361091677.html

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To stem foreclosures, you have to “cram down” loan balances … NOT !!!

January 16, 2009

If you’re up to speed on the proposals to modify mortgages to stop foreclosures, scroll down to  Loan Modification Math …

Background:

There seems to be momentum to “keeping people in their homes” by modifying the bulk of the 4.6 million mortgages that are currently in foreclosure or payment delinquent for longer than 90 days.

There have already been some voluntary lender efforts to modify distressed mortgages by lowering interest rates or extending the term of the mortgages (say, from 30 to 40 years).  Generally, the programs haven’t generated many modified loans … and for the loans that have been modified, about 40% become delinquent again within 6 months. (Note: I’ve seen ranges on this number from 35% to over 50%).

So, the Feds are pushing lenders to sweeten the mortgage modification packages.  Specifically, there’s talk of a broadscale government program that would pare mortgage interest rates to 4.5%.  And, there seems to be support for “cram downs” — having lenders reduce the principal loan balances to the current fair market value of the homes collateralizing the loans.  That is, if a defaulting loan is on a home that is “below water” — i.e. loan balance is greater than the home’s market value — the lender writes off the difference and issues a revised mortgage at the home’s market value.

These proposals strike me as both naive and very problematic.  In this and subsequent posts, I’ll summarize why I think cram downs are a bad idea.

* * * * *

Loan Modification Math

A frequent pundit refrain is that “you can’t get there with just rate and term adjustments — you have to reduce the loan balance to keep these loans out of foreclosure.”  Not surprisingly, there’s a lot of hand-waving but few numbers.

For the record, here’s how the math works.

Say, a person buys a home for $150,000 with no downpayment (as is typical with sub-primes), a 10% mortgage interest rate (maybe a bit low for sub-prime loans), and a 30 year term.  The monthly mortgage payment — for principal and interest — would be $1,269.

If the interest rate on the loan is cut to 4.5%, the monthly payment would drop by over 40% to $752.

If the interest rate is cut to 4.5% and the loan’s payback period is extended from 30 to 40 years, then the  monthly payment would drop to $666.  That’s about half of the original monthly payment! {Note: If the starting interest were more than 10%, the new payment would be more than half off).

Apparently, some politicos think that cutting the payment in half isn’t enough to make a difference.  So, they propose that lenders accept “cram downs” and reduce loan balances.

Let’s assume that the home’s fair market value fell by 25% since the time of purchase.  That would mean writing off $37,500 of the loan balance and reissuing it with a $112,500 balance.

If the interest rate is cut to 4.5%, the loan’s payback period is extended from 30 to 40 years, and the principal balance is reduced to $112,500, then the monthly payment drops to $499.  That’s less than 40% of the original monthly mortgage payment — a discount of more than 60%.

Are these folks serious ???

Cutting the mortgage rate in half for a defaulter — while keeping the hardworking, creditworthy folks next door at the full rate — is morally bankrupt.  Especially when the defaulter didn’t legitimately qualify for the loan by any reasonable underwriting standards … and is equally likely to default again.

What about the hardworking guy who has made payments for years but but just got got laid off in the tough economy?  Well, the half-payment may even be too much for him to handle.  Unfortunate, but true.  I say the bank (and Feds) should give that guy plenty of breathing space (e.g. suspend payments for 6 months).

In a subsequent post, I’ll show how government largesse might even give a defaulter free housing under the proposed plan.  This stuff gets nuttier by the day …

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Technical Stuff

Below is a graphical display of the above math.  The top line is reducing the interest rate to 4.5%; the middle line reduces the interest rate to 4.5% and extends the term to 40 years; the bottom line reduces the interest rate to 4.5%, extends the term to 40 years, and writes off 25% of the loan balance.

The takeaway: within a representative range of original interest rates, modified mortgage payments can be roughly halved by simply cutting the interest rate to 4.5% and extending the loan term to 40 years.

image

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Stop foreclosures: Keep people in "their" homes … huh?

January 15, 2009

Background

There seems to be momentum to “keep people in their homes” by modifying the bulk of the 4.6 million mortgages that are currently in foreclosure or payment delinquent for longer than 90 days.

There have already been some voluntary lender efforts to modify distressed mortgages by lowering interest rates or extending the term of the mortgages (say, from 30 to 40 years).  Generally, the programs hadn’t generated many modified loans … and for the loans that have been modified, about 40% become delinquent again within 6 months. (Note: I’ve seen ranges on this number from 35% to over 50%).

So, the Feds are pushing lenders to sweeten the mortgage modification packages.  Specifically, there’s talk of a broadscale government program that would pare mortgage interest rates to 4.5%.  And, there seems to be support for “cram downs” — having lenders reduce the principal loan balances to the current fair market value of the homes collateralizing the loans.  That is, if a defaulting loan is on a home that is “below water” — i.e. loan balance is greater than the home’s market value — the lender writes off the difference and issues a revised mortgage at the home’s market value.

These proposals strike me as both naive and very problematic.  Here’s another take on why these loan modification programs are generally bad ideas, and why cram downs, specifically, are a bad idea.

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Ken’s Take: Keep people in”their” homes … huh? 

The underlying premise of the proposed loan modifications —  “keep people in their homes” — is logically flawed

The overwhelming majority of foreclosures are investor-speculators and sub-primers — people with shaky credit ratings and undocumented incomes who put little or no money down when they “bought” their homes, who often made few if any mortgage payments — not even making a rounding error dent in their principal loan balances, and who have seen home prices slide in their neighborhood — putting their loan “under water”. 

Said differently, most of the mortgage delinquencies and foreclosures are on people who have no equity in the homes — they never did if they didn’t make a downpayment or a couple of years of mortgage payments and, in most cases, they have “negative equity” — since they owe more than the the homes are worth on the open market.

Bottom line: these folks are “occupants” not “owners” — unless they get credit for some sort of squatter’s rights.  There may be some legitimate reasons for enabling them to stay in the homes — but there’s no way that the homes are their homes.

In the next couple of posts, I’ll walk thru the economics: what crams downs aren’t even necessary, and the “free housing” moral hazard.  

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Markets bounce … Is that a light at the end of the tunnel ?

January 7, 2009

Though light trading volumes may be exaggerating movements and most pundits say a bear market that remains under way, there are some bright signs in the markets …  at least a short-term bounce, if not a turnaround.

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Excerpted from WSJ, “Suddenly, a Markets Turnaround”, Jan.  7, 2009

From junk bonds to currencies, mortgages, stocks and commodities, the markets that were most battered in the second half of 2008 are staging rebounds, sometimes of 10% and more from their low points.

The breather comes as the U.S. government continues to push investors toward taking more risk because the returns on risk-free assets like Treasury bonds are extremely low.

The Dow has gained 19.37% from its November low point, and the S&P 500 is up 24.22%.

Still, the fear has ebbed somewhat in the shell-shocked credit markets. Junk bonds have rebounded by over 11% from their low in December … and higher-quality corporate bonds have gained more than 4% amid an increasingly robust calendar of new offerings. Led by GE, at least $6.6 billion in new corporate bonds were offered Tuesday yielding investors well over 6%, compared with Treasury bonds, which yield between 0.1% and 3%.

The Fed has cut interest rates nearly to zero, and by June, the Fed plans to buy $500 billion, or nearly one-tenth of the entire $5 trillion market for good-quality bonds backed by mortgages that conform to standards set by Fannie Mae and Freddie Mac.  The hope is that by midyear the plan will have brought down mortgage rates and sparked enough refinancing that the housing market may bottom, which would give banks more leeway to lend money into the economy. Consumers have already been applying in droves to refinance their mortgages as the average 30-year fixed rate conforming mortgage hovers just over 5%.

The Fed’s buying, which would average out to about $4 billion a day, has already sent spreads in the mortgage market almost back to what traders call “normal.” Before the credit crisis took hold, the yield of an average agency-backed mortgage bond was 1.5 to 1.6 percentage points over comparable Treasury bonds.

After hitting 2.8 percentage points in late November, that spread finished Tuesday at 1.7 percentage points.

Still, many investors and market participants  are concerned about what happens when the Fed help  dries up.

“The government can make mortgages cost 3%, but they can’t improve anyone’s credit score”

Though major indexes’ gains from their November lows so far fit the traditional definition of a bull market, up 20%, few participants are interpreting them that way. Many say the market’s recent.

image

Full article:
http://online.wsj.com/article/SB123128801585159197.html?mod=testMod 

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Goldman: "Must pay to retain talent to insure continued success" … say, what?

December 24, 2008

Excerpted from IBD, “Bailing Out Bonuses”, December 22, 2008

Amid coast-to-coast cutbacks and layoffs by the thousands, bankers at the center of the financial crisis pay themselves $1.6 billion in taxpayer-funded bonuses .  In addition to the bonuses, they got club dues, financial planners, corporate jet travel, daily limousines and home security systems, courtesy of the taxpayers.

It’s obvious these banker bonuses had no correlation to productivity or performance. In the real world, enterprises provide such benefits only when executives produce results — that is, profits.

Goldman Sachs said it needed to retain and motivate its talent to ensure its “continued success,” not mentioning where this talent is threatening to migrate in a global and industry downturn.

Full article:
http://www.ibdeditorials.com/IBDArticles.aspx?id=314842162013024 

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Feeling pinched these days? Here’s why …

December 16, 2008

Economists estimate households will have lost more than $5 trillion in net worth since the summer of 2007 because of falling home equity and stock prices.

In recent years, households have used their big multiyear wealth gains as a means to afford more debt and as a surrogate form of savings, instead of socking away more of their pay. But by the end of 2008,  They are now more dependent on income growth to finance their spending and saving and less so on credit and wealth.

Source: Business Week
http://www.businessweek.com/magazine/content/08_51/b4113010266237.htm

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Ken’s Take: On average, that works out to be about $40,000 per household — or about 80% of median annual household income — i.e. the rough equivalent of an average person being laid of for about a year.  Ouch.

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Big Idea: Rallying private capital to stabilize housing prices.

November 25, 2008

Summary: Ken’s plan for handling part of the  foreclosure problem and geting housing back on track.  Guaranteed.

* * * * *

A stark reality of the current mortgage crisis is that there have been — and will continue to be – an unprecedented and destabilizing number of foreclosures that need to be absorbed into the housing market.  Until they are, home prices will continue to slide and the crisis will persist..

To date, most of the government’s programmatic emphasis has focused on mitigating the financial pressures on lending institutions and investors who funded bad loans, by injecting supplementary capital (loans or preferred stock purchases), or by buying toxic securities..  Some political rhetoric has centered on preventing distressed citizens from “losing their homes”, but few substantive steps have been taken.  Why?

First, once a mortgage has been “securitized” – as most have been — there are contractual limitations on possible loan modifications.   In these instances, mortgage “servicers” have their hands tied.  They are only empowered to collect payments and foreclose on non-payers, with very little latitude between the extremes.

Second, there is the proverbial elephant in the middle of the room.  Many so-called home owners are – truth be told — really “occupants” not “owners”.  Some have no equity in the homes.  Some never did – even before housing prices crashed, submerging loan balances under water.   Many wouldn’t qualify today for restructured loans under the most liberal of terms – e.g. lowered interest rates, extended payment periods, reduced principle balances (to the current fair market value of the homes).  Whether the people legitimately qualified for their initial loans is irrelevant.  Whether their initial loan terms were predatory is also largely irrelevant. Objectively, the low bar is whether they can foot the bill for a restructured mortgage.  The emerging evidence seems to suggest that many – maybe most – can’t.

That leads to an inescapable conclusion: regardless of what remedial government bailouts are enacted – the housing market will continue to be flooded with foreclosures. 

So, a pivotal economic policy question is how to get the foreclosed properties off the market and into the hands of private owners (i.e. not onto the government’s asset rolls), and how to keep them there until they can be remarketed at an orderly pace and higher prices.

Three straightforward changes to the income tax code – throwbacks to yesteryear — could provide the necessary financial incentives to rally private capital back into the housing market to buy, hold, and rent foreclosed homes: (1) eliminate ALL of the capital gains taxes on residential property that is bought from now until, say, December 31, 2010 and held for at least 18 months, (2) allow these “qualified residential properties”, if they are rented, to be depreciated for tax purposes at an aggressively accelerated rate (say, over 5 or 10 years) to generate high non-cash tax losses, and (3) allow ALL tax losses generated by these “qualified residential rental properties” to offset owners’ taxable ordinary income with no “passive loss’ limitations, thereby reducing their federal income tax liability.

For example, assume that an investor buys a foreclosed home for $200,000 and rents it out at a price that simply breaks even on a cash flow basis.  That is, the rental price just covers interest, taxes, insurance, maintenance, etc.  Assuming a 5-year accelerated depreciation schedule, the rental would generate an annual non-cash tax loss of $40,000 that could be used to offset the investor’s ordinary income.  If the investor were in the Obama-boosted 39.6% marginal tax bracket, that ordinary income offset could save the investor almost $16,000 in federal income taxes each year that the property is held and rented.  If the home were then resold – say, in 3 years for $250,000 —  the investor would book $170,000 in capital gains (the $50,000 home price increase, plus the $120,000 in depreciation claimed against ordinary income when the property was being rented), but the investor would owe no capital gains taxes. 

Such a program potentially offers several benefits: (1) it would entice private capital to buy (and hold) foreclosures and other distressed residential property, (2) it would likely provide affordable rental housing to people (maybe the current occupants of the homes) who realistically can’t and shouldn’t shoulder the costs of home ownership , and (3) it might take some of the sting out of President-elect Obama’s proposed tax hikes.

It’s a win-win solution to part of a thorny problem.

© K.E. Homa 2008  

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Bold Stroke: Cut capital gains rate on stock … to ZERO … here’s how & why

November 17, 2008

McCain was onto something when he proposed cutting the capital gains rate to 7.5% for the next year or two.  But, he left the idea half-baked and, as usual, didn’t communicate it very well

Here’s my bold stroke:

How:
Cut the capital gains rate to ZERO on stocks (not derivatives or other funky financial products) that are purchased after, say, November 15, 2008 and held for 12 months or until January 1, 2010 — whichever is longer.

Why:
The market seems to be a buying opportunity now, but investors are reluctant to jump in.  Why? Because of fear that (1) the market hasn’t bottomed — lending is stalled, TARP is a mess, earnings are deteriorating (2) Obama hasn’t backed off on his plan to increase capital gains rates.

The 2nd fear is the easiest to fix.  Eliminating the capital gains taxes on “new” stock purchases would tilt the risk-reward equation a bit.  Maybe enough to draw some capital off the sidelines and into the market — boosting stock prices, or at least providing some low-end support.

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Citi mulls replacing Chairman … what's wrong with this picture?

November 13, 2008

Excerpted from WSJ, “Citi Directors Mull Replacing Chairman”, Nov. 13, 2008

* * * * *

“The board of Citigroup  is growing increasingly dissatisfied with the financial giant’s performance, and some directors are considering replacing Sir Win Bischoff as chairman, according to people familiar with the matter.

One leading candidate is Richard Parsons, Time Warner’s chairman and a member of Citigroup’s board.

Mr. Parsons ran a New York thrift in the early 1990s and is one of the few Citigroup directors with experience in financial services.

He also is part of President-elect Barack Obama’s transition economic-advisory board.

While Mr. Parsons is a leading candidate for the chairmanship, no choice has yet been made. One potential wild card is whether Mr. Obama will ask Mr. Parsons to take a prominent role in his cabinet.”

Full article:
http://online.wsj.com/article/SB122652480535921911.html?mod=testMod

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Time Warner financial performance.  (Note: NI down 33% from 2006 to 2007; 2008 is worse !)

 image

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Time Warner stock is the blue line; S&P 500 is the red line

image

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Ken’s Take: Both Citi and Barack seem to have quite an eye for talent. Isn’t it time to stop rewarding under-performance (and abject failure?)

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Re: Fannie and Freddie – Who said what … and when did they say it ?

October 3, 2008

Excerpted from WSJ: “What They Said About Fan and Fred”,
October  2, 2008

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A special word is in order here for Congress. Today we’re running a collection of greatest Member hits in defense of Fannie Mae and Freddie Mac.

The guilty deserve such attention because those two government-sponsored enterprises did so much to turbocharge the credit mania. By providing subsidized rates of return to global investors, they helped fuel the bubble in housing and mortgage-backed securities that is now haunting so many financial institutions.As the quotes make clear, the Members fought furiously against any attempt to make Fan and Fred less dangerous.

The Bush Administration was on the right side of this debate for eight years, as was the late Clinton Treasury. This was a scandal in plain sight that all but a few ignored.

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Worst of the Worst

Rep. Barnie Frank: I do think I do not want the same kind of focus on safety and soundness that we have in OCC [Office of the Comptroller of the Currency] and OTS [Office of Thrift Supervision]. I want to roll the dice a little bit more in this situation towards subsidized housing. House Financial Services Committee hearing, Sept. 25, 2003

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Worth reading – the complete list of quotes:
http://online.wsj.com/article/SB122290574391296381.html

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Paying the piper …

October 2, 2008

Excerpted from WSJ: “Bailing Out Ourselves – Bankers weren’t the only ones who enjoyed the credit mania”, October 2, 2008

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“If banks, in spite of every precaution, are sometimes betrayed into giving a false credit to the persons described, they more frequently enable honest and industrious men of small and perhaps of no capital to undertake and prosecute business with advantage to themselves and to the community.”

So wrote Alexander Hamilton in 1790, amid an earlier populist backlash against American bankers. Hamilton didn’t hesitate to use the powers of the Treasury to calm markets amid a speculative panic for the good of the larger community. The U.S. is at another Hamiltonian moment, if Congress has the nerve to act in the national interest.

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We are told this is a “bailout for Wall Street.” But if Americans are honest with themselves, they will admit that bankers are far from the only cause of our current predicament.

The U.S. is living through the aftermath of a classic credit mania, one that all of us enjoyed while it lasted. We don’t remember many protests when home prices were rising by 15% a year, or when interest rates stayed at 1% for a year and real interest rates were negative for far longer.

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Our point isn’t to absolve Wall Street or Washington — far from it. The point is that credit manias are by their very nature societal, which is why the panics that follow can do so much damage to Americans outside the financial arena. They are part of a larger psychology that sweeps everyone up in euphoria for a time, only to send everyone into a defensive crouch when the credit stops.

The challenge at such a moment is to prevent a panic from becoming a crash that does far more extensive damage. This is where we are now, and this is why the House should pass the bill that passed the Senate last night, even with its flaws. The government needs the power to use public capital to defend and stabilize the financial system. In that sense, we are really bailing out ourselves.

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Credit markets are ceasing to function by any normal standard, with banks refusing even to lend to one another, much less to credit-worthy borrowers on Main Street.

Yesterday, the Institute for Supply Management’s manufacturing index reported its largest one-month drop in 24 years. While at 43.5 the index remains above the recession level of 41, the credit vise may soon guarantee one.

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Fannie Mae and Freddie Mac … those two government-sponsored enterprises did so much to turbocharge the credit mania. By providing subsidized rates of return to global investors, they helped fuel the bubble in housing and mortgage-backed securities that is now haunting so many financial institutions.

The Bush Administration was on the right side of this debate for eight years, as was the late Clinton Treasury. This was a scandal in plain sight that all but a few ignored.

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The Paulson plan isn’t what we would have drawn up. It will not by itself inject capital into troubled banks, and it carries risks in how Treasury will price toxic assets when it buys them. But it is one more policy tool at a time when something needs to be done, and it is the only one currently up for a vote. Passing it won’t by itself revive the banking system, but defeating it will guarantee far more damage to far more Americans.

In this sense, too, the votes this week in Congress are about bailing out our political class from its own embarrassing performance. Americans are anxious, even frightened, about the financial system. They are looking for leaders who will act to defend it.

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Full article:
http://online.wsj.com/article/SB122292003161497455.html

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Ken’s POV:

The bailout simply closes a loop.  The government ‘encouraged’ lower mortgage loan qualifying criteria with the Dem’s Community Reinvestment initiatives and Bush’e Ownership push.  Now, the government will be stuck holding the bad paper that it thought it was feisting off on the banks.  It would be poetic justice if the government weren’t playing with our money.

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Sticking with Your Strategy

October 2, 2008

Excerpted from Harvard Business Online, “Why the Mortgage Meltdown Hasn’t Burned These ‘Square’ Lenders”, by Bill Taylor, September 11, 2008

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How do you keep your head when all those around you are losing theirs? This has become a defining challenge for leaders in an age of technology bubbles, private-equity overreach, and, most recently, the mania (and meltdown) in the mortgage market.

What can we learn from this heartache and misery? The most valuable insights come from those few leaders who refused to be seduced by the promises of fast growth and easy profits.

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One case in point is Hudson City Bancorp, a 140-year-old company based in Paramus, New Jersey that has managed to avoid the mortgage meltdown and continues to post tremendous results. Business journalists have discovered this quiet little outfit and marveled at its strategic insights. Its shares are up 50 percent since last August, when the credit crisis really kicked in. (A leading index of bank stocks is down 40 percent over the same period).

“Hudson City banks the old-fashioned way,” Newsweek marveled. “It takes deposits and makes mortgages to people who buy homes in which they plan to live. And then it hangs on to” the mortgages, rather than sell them in the secondary market.

Imagine the brilliance! Take deposits. Make sensible loans. Repeat over and over again, until your market cap approaches $10 billion.

The New York Times tried to unpack the secrets of Hudson’s success and offered this analysis: “The bank carefully screened loan applicants to ensure they would be able both to afford a new house and reside there, rather than flip it. And the bank demanded hefty down payments…as a cushion against any sharp drop in home prices, because it planned to hang on to the loans.”

What a formula! Make sure borrowers can afford their loans. Insist that they make a big down payment. Favor owners over speculators.

Hudson City’s mindful approach to banking only looks remarkable because so many established banks lost their minds. ING Direct, a cutting-edge banking innovator, also managed to avoid the march of folly in its industry. The bank avoided the subprime meltdown because it stuck to simple, plain-vanilla mortgages rather than exotic instruments that sounded too good to be true (and were). The bank has written 100,000 mortgages worth $26 billion and has a grand total of 15 foreclosures. Not 15 percent, just 15 mortgages out of 100,000.

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These successes speak to one of the unappreciated elements of strategy and creativity:

Sometimes, the most important form of leadership is resisting an innovation that takes hold in your field when that innovation, no matter how popular with your rivals, is at odds with your long-term point of view. The most determined innovators are as conservative as they are unique. They make big strategic bets for the long term and don’t hedge their bets when strategic fashions change.

Edit by DAF

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Full article:
http://discussionleader.hbsp.com/taylor/2008/09/why_the_mortgage_meltdown_hasn.html?cm_mmc=npv-_-WEEKLY_HOTLIST-_-SEPT_2008-_-HOTLIST0929

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Lessons from the financial crisis

September 17, 2008

Excerpted from WSJ: “We Need Better-Capitalized Institutions”, Sept. 17, 2008

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That which does not kill us makes us stronger. Nietzsche may not have been aware of credit default swaps and subprime mortgages when he formulated that worldview, but so it will be with the current crisis. Like the 12 steps of recovery, the financial system is now purging itself of years of excess. How sad that it should have to come at such enormous human and institutional cost.

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Important Lessons

First, these losses were foremost a consequence of poor investment decisions. These decisions, driven by a virulent new strain of irrational exuberance, caused theoretically highly sophisticated firms to put hundreds of billions of dollars of poorly conceived and inadequately collateralized securities onto their balance sheets.

In a sense, that’s no different than other bouts of investing euphoria that ended badly, like the dot-com bubble. So for investors, this episode is an important reminder to stay true to conviction rooted in dispassionate analysis and avoid being swept along with the hype, even when it seems painful to watch others making money that you’re not.

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Second, risk management was equally poor. These financial institutions are (or were) in many ways giant hedge funds, except that they used far more leverage than almost any hedge fund (and made worse investments).

Stunningly, even with all the warning signs, the most fragile institutions shirked from sufficiently tough medicine — taking in ample new capital, selling off divisions, even merging their firms — that might have preserved value for their shareholders.

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Third, the systemic failure extended far beyond government oversight. Apart from experienced and highly paid in-house management, these institutions were each watched over by a flotilla of outside auditors, credit and equity analysts, and rating agencies. Virtually none of them accurately gauged the dangers.

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The market is loudly signaling that it wants larger, better-capitalized financial institutions. Even the vaunted Goldman Sachs and the venerable Morgan Stanley may prove too small to remain independent.

For those which emerge, both management and oversight will need to be far tighter. That will be reinforced by a dramatically changed business model.

Instead of highly leveraged banks providing a commodity — money — at razor thin margins, we will have less leveraged institutions providing a scarce resource — money — at more profitable pricing.

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Full article:
http://online.wsj.com/article/SB122161101467645853.html

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