John Stewart on Last Year's Financial Crisis

This afternoon I caught an interview on CNBC with John Stewart, who wrote an article, published this week in The New Yorker, on the days when "Lehman Brothers went under, the Federal Reserve bailed out A.I.G., and the global financial system nearly collapsed." It sounded really interesting with some tidbits that have never seen the light of day until now. As a preface to the article, here is the CNBC chat with Stewart.

If the video does not load below, click here..

The full article online requires a subscription to The New Yorker (or just go by a copy of this week's issue off the newsstand) but you can access here a few questions and answers from Stewart on his article and how Wall Street has changed since the meltdown. Here are two questions and responses.

TNY: Do you think there’s any evidence that the people and institutions that caused this crisis have learned their lessons? Or do you think we’re running the risk of another one?

Stewart: Some of the people and institutions that caused the crisis are gone. So they’re not really in a position anymore to wreak the kind of havoc that they did before. On the other hand, the regulatory structure that led to these massive amounts of leverage and poorly understood derivative products hasn’t really changed yet. And until you have sophisticated regulators with the power to oversee all these different firms, the risks are going to be there. It may not be mortgage-backed securities—back in the late nineteen-eighties it was junk bonds, and some new financial innovation that seems great at first will soon become a vehicle for massive profits and aggressive risk-taking. And another balloon will get out of control.

....

TNY: So we were close.

Sterwart: Very close. I heard from several people on the staff of Treasury and the Fed that they believed that things were going to collapse if they didn’t have legislation. They hastily drafted TARP legislation, which is why it was only three pages, and the seven hundred billion dollars number was plucked by Paulson out of thin air. It was roughly half the size of the market for mortgage-backed securities, and a number that would impress people. Of course, it got voted down at first, and there were various market convulsions for a few days until it finally passed on October 3rd. In the period from September 20th to October 3rd, they were scared to death that things were going to fall apart, and they didn’t have the capital to stop it.

Can Congress get the job done when it comes to regulation reform? It's not looking so good at the moment, but we'll see.

It's a great read. Nobody knew what was going on at AIG.

California Lawsuits Could Set Scary Precedents

Could this happen only in California?

On September 3rd a federal lawsuit was filed in the District Court for the Central District of California on behalf of buyers who purchased homes from Beazer Homes USA, Centex Homes, D.R. Horton, Lennar, Richmond American Homes, Ryland Homes, Shea Homes, and Standard Pacific Homes at the peak of the building boom.

The complaint was that these builders created neighborhoods where high foreclosure rates caused home values to plummet, wiping out the investments of many homebuyers.

I find this pretty unbelievable. Big Builder Online reports that “all eight lawsuits are seeking to become national class action cases, representing buyers who put 20% or more down on homes in the builders' neighborhoods across the country. The cases ask for compensatory and punitive damages as well as restitution and/or disgorgement of profits.”

Big Builder Online continues:

The allegations are that the eight builders and their mortgage companies violated two portions of California's Unfair Business Practices Act, “as well as fraud, negligent misrepresentation, and breach of the implied covenant of good faith and fair dealing.”

The general accusation is that the builders knew or should have known that by selling homes to investors who would not live in them and buyers who had credit issues and put little money down, they would create communities that could lose their value if home prices failed to climb and buyers with little investment walked from their purchases.

The lawsuits claim that the builders had the responsibility to disclose to buyers that they were selling to investors and buyers with poor credit and/or were investing little in their homes.

"What we believe is that, for the people who were qualified to buy these homes and were financed by the builder themselves through their mortgage companies, there is an obligation from the builder to let them know the facts that could materially affect the value of their homes," McCune (plaintiff’s attorney) said.

The lawsuits allege that the builders' practices in recent years of controlling every step of the home buying process, through appraisals and issuing loans through their finance companies, created an environment where there was no "neutral party" who didn't have a stake in the deal. Plus, McCune said, the fact that the mortgage companies knew the details of buyers' finances bolsters the allegations that the builder companies had to know there could be problems with foreclosures and buyers walking in the future.

"They certainly had knowledge that the house of cards had to come down," McCune said...

"Our local governments are in trouble because of the shrinking tax base," said McCune. "Life savings are gone, and these national builders came and built and then left us with this big mess. I know they feel like the market has affected them badly, but it's hard for me to feel sympathetic because they played such a big part in this."

Yeah, and I’d like to sue “Wall Street” as well. This could start a real pile-on.

This will be one to watch.

What Ever Happened to Long-Term Gain?

This is a must-read from the Washington Post:

Wall Street's Mania for Short-Term Results Hurts Economy
By Steven Pearlstein

It's been a year since the onset of a financial crisis that wiped out $15 trillion of wealth from the balance sheet of American households, and more than two years since serious cracks in the financial system became apparent. Yet while the system has been stabilized and the worst of the crisis has passed, little has been done to keep another meltdown from happening.

Even the modest regulatory reform effort launched with much fanfare back in the spring is now bogged down by bureaucratic infighting and special interest lobbying. And back on Wall Street, the wise guys are up to their old tricks, suckering investors into a stock and commodity rally, posting huge profits on their trading desks and passing out Ferrari-sized bonuses. The Wall Street Journal reports they've even cranked up the old structured-finance machine, buying up claims to life insurance proceeds and packaging them into securities.

All of which makes it particularly disappointing that so little attention was paid this week to a report by a panel convened by the Aspen Institute on the "short-termism" that has now become hard-wired into the culture of Wall Street and corporate America.

This wasn't just any blue-ribbon committee. Its members include billionaire investors Lester Crown and Warren Buffett; mutual fund pioneer John Bogle; Richard Trumka, the soon-to-be new president of the AFL-CIO; present and former corporate chief executives Jim Rogers of Duke Energy, Lou Gerstner of IBM and Henry Schacht of Cummins; retired Wall Street hands John Whitehead of Goldman Sachs, Pete Peterson of the Blackstone Group and Felix Rohatyn of Lazard Freres; Marty Lipton, Ira Millstein and John Olson, the deans of the corporate bar; and respected academics such as Bill George of Harvard and Lynn Stout of UCLA....

Read the entire article here.

Read the report referenced above from the Aspen Institute: Overcoming Short-termism. It begins like this:

We believe a healthy society requires healthy and responsible companies that effectively pursue long-term goals. Yet in recent years, boards, managers, shareholders with varying agendas, and regulators, all, to one degree or another, have allowed short-term considerations to overwhelm the desirable long-term growth and sustainable profit objectives of the corporation. We believe that short-term objectives have eroded faith in corporations continuing to be the foundation of the American free enterprise system, which has been, in turn, the foundation of our economy. Restoring that faith critically requires restoring a long-term focus for boards, managers, and most particularly, shareholders—if not voluntarily, then by appropriate regulation...

A nice companion piece on the subject of needed regulation based on Goldman Sachs is The Great American Bubble Machine published by Rolling Stone in July. But I'll warn you, it's a little scary, even if you only take the top 25 percent as the truth (that's for those who think Rolling Stone is still run by a bunch of pot smoking old hippies. Ahhh, those were the days.) In striking contrast it begins like this:

The first thing you need to know about Goldman Sachs is that it's everywhere. The world's most powerful investment bank is a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money. In fact, the history of the recent financial crisis, which doubles as a history of the rapid decline and fall of the suddenly swindled dry American empire, reads like a Who's Who of Goldman Sachs graduates.

Money Market Guarantee Ends 9/19

For what it's worth ... from ZeroHedge Blog:

The Treasury's Money Market Fund guarantee program, which was among the first to be instituted in the wake of Lehman's collapse, after the Reserve Primary Fund broke the buck (for a great description of what really happened, go here) is set to expire on September 19, after an extension had been granted on March 31 to postpone the initial April 30 expiration.

As a reminder, and as all money on the sidelines proponents will remind anxious bears, there is about $3.5 trillion in cash that is currently insured by the US Treasury. And speaking of the whole sideline money theory, which has been disproven over and over by those who don't actually have an agenda to push this stock or that on CNBC, here is another perspective on the issue courtesy of today's Rosenberg notes:

"The reality is that the mountain of money is no higher or lower than it was when the market was plumbing the depths through 2008 — money market mutual funds back then were $3.5 trillion and guess what? Today they are $3.5 trillion. Go figure."

Prof. Warren's Take on Geithner's Testimony to Oversight Committee

The following video from CNBC with Professor Elizabeth Warren is well worth the time and is a good recap of Treasury Secretary Timothy Geithner's testimony before a Congressional Oversight Panel reviewing the government's financial rescue efforts. Warren, a Harvard Law Professor, is the Panel chair.

The need for regulatory reform was very high on the "must do" list, least we end up at the threshold of another crises. With the Fed's track record of being asleep at the wheel, regulatory reform with greater transparency, accountability and risk control sounds like a minimum requirement for change.

If the video does not appear below, click here.

Foreclosure Pipeline Remains Full

It’s a real stretch to garner any good news from RealtyTrac’s August 2009 U.S. Foreclosure Market Report™ released today. Foreclosures remain steady at record levels.

The report reflects that there were 358,471 foreclosure filings — default notices, scheduled auctions and bank repossessions — for August which is a decrease of less than 1 percent from July but a nearly 18 percent increase year-over-year. Same old weary story with only slight variations.

“The August report demonstrates that there is still an ample supply of properties filling the foreclosure pipeline even while the outflow of bank-owned REO properties onto the resale market is being more carefully regulated,” said James J. Saccacio, chief executive officer of RealtyTrac. “After hitting a high for the year in July, REOs dropped 13 percent in August, but we also saw a record high number of properties either entering default or being scheduled for a public foreclosure auction for the first time.”

Nevada, Florida, California post top state foreclosure rates. Six states account for more than 60 percent of national total. Top 10 states with highest foreclosure rates are Nevada, Florida, California, Arizona, Michigan, Idaho, Utah, Colorado, Georgia and Illinois.

It is somewhat discouraging to note the expectations for future foreclosures that are sure pile on ...

Treasury (read yesterday's press release) expecting more foreclosures to come from borrowers not qualified for loan modifications and the unidentified underwater borrowers (h/t Calculated Risk):

Over 570,000 trial modifications have been offered under the program. Over 360,000 trial modifications are underway.
...
[W]e recognize that any modification program seeking to avoid preventable foreclosures has limits, HAMP included. Even before the current crisis, when home prices were climbing, there were still many hundreds of thousands of foreclosures. Therefore, even if HAMP is a total success, we should still expect millions of foreclosures, as President Obama noted when he launched the program in February.

Some of these foreclosures will result from borrowers who, as investors, do not qualify for the program. Others will occur because borrowers do not respond to our outreach. Still others will be the product of borrowers who bought homes well beyond what they could afford and so would be unable to make the monthly payment even on a modified loan.

Expect continued downward price pressure . Same song, different page.

From Bloomberg: Wealthy Families Succumb to Bankruptcy as Real Estate Crashes ...

Wealthy individuals' Chapter 11 bankruptcy filings jumped 73 percent in the second quarter from a year earlier, according to the National Bankruptcy Research Center, a research firm in Burlingame, California.

More individuals or families with at least $1,010,650 in secured debt and $336,900 unsecured are using Chapter 11 of the U.S. bankruptcy code typically associated with business reorganizations. Falling U.S. home prices leave them unable to refinance or sell properties when they drop below the value of the mortgage, said Chicago bankruptcy attorney Joseph Baldi.

... Wealthier people filing for bankruptcy typically have large homes, two car payments and children in private schools, said Leslie Linfield, executive director of the Institute for Financial Literacy in Portland, Maine ...

“There are a lot of people with real estate, and they can’t afford it,” said Baldi ... “They can’t make the payments, and they can’t sell the house.”

Hoping not to appear like piling on ... also noted from Calculated Risk on the danger of resetting interest only loans. We also know the high number of ARMs that will be resetting over the next few years.

From David Streitfeld at the NY Times: The House Trap

An analysis for The New York Times by the real estate information company First American CoreLogic shows there are 2.8 million active interest-only home loans worth a combined total of $908 billion.

The interest-only periods, which put off the principal payments for five, seven or 10 years, are now beginning to expire. In the next 12 months, $71 billion of interest-only loans will reset. The year after, another $100 billion will reset. After mid-2011, another $400 billion will reset.

There are a several fascinating anecdotes in the article, including a professor who teaches real estate finance. Here is one:

“I understand I took a risk,” said [Dean Janis, a Southern California lawyer who bought a $950,000 home in 2004] “But I did not anticipate that the real estate market would go down 30 percent.” He talked with Wells Fargo about his options, and the lender said he had none.

Click here to see individual state foreclosure data for August.

The Best of Times ... The Worst of Times

“It was the best of times, it was the worst of times …” Charles Dickens

“At the height of the Italian Renaissance, people believed they were living in an age of decline and even that the end of the world was imminent. Similarly, in the first decade of the 21st century, we believe we are living in a catastrophic time, a time of crisis – but if you compare life for the majority of people in the developed world with any other place or time, this looks like colossal self-pity.” Jonathan Jones, Guardian

There are big winners and losers loitering or littering the financial highways:

It was the best of times …

Some of the nation's largest banks could, in fact, emerge from the crisis stronger than they entered it. While they have suffered huge losses on complex financial products, and are still facing mounting loan defaults, they were stabilized with tens of billions of dollars of taxpayer money. In the second quarter, the seven largest commercial banks earned more than $14 billion, even as thousands of smaller banks were in the red.

Big lenders are currently enjoying an advantage in their "cost of funds" -- the raw material of a bank, which is in the business of borrowing cheaply and lending at a higher rate. The handful of banks with more than $10 billion in assets were paying 1.18% to borrow money in the second quarter, the FDIC said in data issued Thursday. By contrast, banks with $100 million and $1 billion in assets were paying 1.97%, a big difference in a business where tenths of a percentage point translates into millions of dollars in profits. Wall Street Journal

It was the worst of times …

For those not to big to fail, times seem particularly tough: The reality of excessive debt and falling asset prices have rendered the best efforts of the Fed impotent.

Burdened by costs associated with rising levels of troubled loans and falling asset values, FDIC-insured commercial banks and savings institutions reported an aggregate net loss of $3.7 billion in the second quarter of 2009. Increased expenses for bad loans were chiefly responsible for the industry’s loss. Insured institutions added $66.9 billion in loan-loss provisions to their reserves during the quarter, an increase of $16.5 billion (32.8 percent) compared to the second quarter of 2008. Quarterly earnings were also adversely affected by writedowns of asset-backed commercial paper, and by higher assessments for deposit insurance.

During the quarter, the number of institutions on the FDIC’s “Problem List” increased from 305 to 416, and the combined assets of “problem” institutions rose from $220.0 billion to $299.8 billion. This is the largest number of “problem” institutions since June 30, 1994, and the largest amount of assets on the list since December 31, 1993. FDIC Quarterly Banking Profile

And the biggest of big banks, Bank of America, Wells Fargo, and J.P.Morgan appear to be doing well thanks to bailouts and low costs of funds. Because those banks are regarded as "well capitalized" they pay a smaller insurance rate to the FDIC. "Regarded" is the key word. They can continue to be regarded as "well capitalized" but commercial real estate loans, credit card defaults, and pay option ARMs problems are the 800 pound gorillas in the room. Mish's Global Economic Trend Analysis

The multiple 800 pound gorillas that continue to hang around are becoming pretty darn tiresome. My purpose in these excerpts is to point up the overhanging uncertainty that continues to plague recovery.

Weekend At Bernie's Redux

The analogy to the hilarious 1989 movie, Weekend at Bernie's was obviously too much to resist. Does that sound caddy, or downright mean? It probably won't draw much criticism ... since we're talking about Bernie Madoff and his ex-beach house that is ready to hit the market.

Take a look at this Bloomberg video concerning Madoff's beach shack (estimated at $7-$10 million) and New York's Montauck's housing market in an interview with Johnathan Miller of Matrix fame. Click here to see video if it does not appear below.



The video is a presentation of the property by a gun-wielding U.S. Marshall cum real estate salesman. If you've seen the movie Weekend at Bernie's, you'll appreciate the similarity of settings, sans brilliant sunny weather.

The Loss of Mortgage-Interest Tax Deductions: Much To Do About Nothing?

In a column this week in the Washington Post, Ken Harney sets out the sinister plans of the Congressional Budget Office to disallow mortgage-interest tax deductions for a large segment of homeowners. Just when you need it the most.

Tax deductions for mortgage interest have been a mainstay benefit of homeownership that many of us have taken for granted - until now. As with many of the new rules coming out of Washington, the world as we know it is being set upon its ear.
Washington has some pretty big bills to pay these days and the Congressional Budget Office is in a cash-raising mode. How many millions in a trillion? Enter the taxpayer. Previously political “no-go zones”, like mortgage interest, may be invaded by Congress as it is forced to pay for their drunken sailor spending.

But we have to back up a moment. Is this a real cash-raising measure or is it just politics as usual? Is Congress going to come in on their white horse and save the mortgage-interest deduction for their constituents? It seems much to do about nothing. Remember the Alternative Minimum Tax that has already caught so many taxpayers who are the targets of the CBO’s dis-allowance of interest deduction? It seems as if the CBO is targeting the same group that they have already screwed with the AMT.

I’ll explain in a minute, but first here is the report on the CBO's proposal from the Washington Post:

Earlier this month, the nonpartisan Congressional Budget Office delivered its latest revenue-raising options for Senate and House consideration as they write this fall's tax and budget legislation.

Tucked away in the report are several incendiary plans that could -- if adopted -- cost homeowners billions of dollars. Though not formal legislative proposals, the CBO's options represent a handy fiscal menu from which legislators can pick and choose to reduce the deficit -- now at unprecedented levels -- or pay for new programs.

Tops on the CBO's hit list for housing: Slash deductions for homeowner mortgage interest from the current $1.1 million limit to $500,000, phased in with $100,000 annual reductions starting in 2013 and extending to 2019. Under current law, taxpayers can write off mortgage interest on their principal-home debt up to $1 million, and on home-equity debt up to $100,000.

Under the CBO's option, that maximum mortgage-debt amount would shrink annually until it hits $500,000. Over 10 years, this change alone would boost federal tax collections by an estimated $41 billion.How is this ominous sounding suggestion by the CBO much to do about nothing? Many reading this are already uncomfortably familiar with the Alternative Minimum Tax. To oversimplify a complicated matter, it is highly likely that anyone with a $500,000+ mortgage is already in the ATM tax box, rendering the mortgage-interest tax deduction a mute point.

Our Congressmen win either way this goes – and they still get their money. They win if they show their constituents and contributors they have fought to end the AMT. In that case the above proposal kicks in and snares the tax dollar. Or Congress wins by spouting their fight to prevent legislation that would disallow mortgage-interest tax deduction on the new CBO proposal. Either way, rest assured the affluent are going to pay. It’s a shell game. Nothing much changes. But it's a good PR play.

FYI: According to the CBO “Canada, Britain and Australia all have roughly similar homeownership rates as the United States, but none provides mortgage-interest tax deductions.”

Here is a very broad-brush explanation of AMT from Fairmark.com:

The AMT provides an alternative set of rules for calculating your income tax. In theory these rules determine minimum amount of tax that someone with your income should be required to pay. If you're already paying at least that much because of the "regular" income tax, you don't have to pay AMT. But if your regular tax falls below this minimum, you have to make up the difference by paying alternative minimum tax. Then you compare this tax with your regular tax. If the regular tax is higher, you don't owe any AMT. But if the regular tax is lower, the difference between the two taxes is the amount of AMT you have to pay.

Example 1: Your regular income tax is $47,000. When you calculate your tax using the AMT rules, you come up with $39,000. That's lower than the regular tax, so you don't pay any AMT.

Example 2: Your regular income tax is $47,000. When you calculate your tax using the AMT rules, you come up with $58,000. You have to pay $11,000 of AMT on top of the $47,000 of regular income tax.

Other housing-related items on the CBO's revenue-raising target list:

• Get rid of all write-offs for state and local taxes, including property taxes. That would pump $343 billion into federal coffers from 2010 to 2014, and $862 billion by 2019.

• Clamp a 15 percent cap on the value of all itemized deductions -- not just mortgage interest and property taxes but also charitable contributions, medical expenses and casualty losses. The revenue windfall: $1.3 trillion over 10 years.

• Revert to the capital gains approach that prevailed before 1987. Rather than taxing most gains at 15 percent as the current code does, the CBO plan would exclude 45 percent of gains from taxation and tax the remaining 55 percent at an individual's regular tax rate. New money raised: $48 billion over the next decade.

You can read the entire CBO Budget Options (all 248 pages) by clicking here. Advance to page 173 to get to the heart of the matter.

Get your checkbook out.

Banner Year for FHA Yields Increased Risk

It looks like fiscal 2009 will be FHA’s busiest year on record with one in four mortgages made over the last year being insured by the Federal Housing Administration. That’s a 50 percent increase with a count of 2.52 million loans.

Eighty percent of the FHA mortgages made for home purchases were to first-time buyers with low down-payments starting at 3.5 percent.

With the absence of subprime lenders, the FHA's market share grew from about 3 percent in 2006 to 23 percent this year. Also driving the numbers is the increased loan limits. The loan limit for FHA increased at the beginning of the year from $362,790 to $729,750 in some high-cost areas such as New York and Washington D.C.

But as FHA insures more loans, it is also assuming more risk. Defaults and foreclosures are up over last year. Mortgages 90 days or more delinquent are up 5.57 percent over last year.

With unemployment continuing to rise, the risk of default is very real although the borrowers are more solid than those receiving subprime loans in past years. Borrowers with FHA-insured loans now have average credit scores of about 690, compared with about 630 two years ago.

FHA also has tightened lending standards, requiring a 10% down payment for those with credit scores below 500.

Source: USA Today