News&Views 20:Jul14

Summer has arrived and the economy has slowed from lukewarm to tepid as unemployment figures tick up again for the second consecutive month after a small pullback earlier this year. The cautious optimism of April and May has deflated with the realization that there is no "there" there, with regard to our recovery, the pitiful jobs data from May and June being only the first clue. Criticism regarding the management of the crisis has manifested itself in a steady parade of speculation about the demise of the dollar, the Bond Market bubble, the question of QE3, the threat of inflation, and a double dip in housing is that may take the entire economy down with it.

False Hopes

Against that backdrop, Fortune Magazine last week published an optimistic article entitled "Surprise! The big bad Bailout is paying off". The article asserts that the much disparaged Federal "Bailout" is actually about to pay off to the tune of a $42 billion profit to the American taxpayers by the end of 2012. Perhaps in their eagerness to paint a rosy picture, the authors overlooked the fact that the Congressional Budget Office's cost of $317 billion for Fannie and Freddie bailout is very different from the $130 billion "official White House figure" that was used in their analysis. Or, perhaps the CBO information came out after the article was written, but, in either case, the CBO data blows their profit theory out of the water. The fact that the profit figure is also based on projections aside, the article leaves the reader with more questions than answers; such as how taxpayer exposure ever got to be that large in the first place? With heavy focus on TARP, which was actually only about 3% of the $14 trillion bailout exposure, most people were not aware that the risk was anywhere near that amount. It also included Fannie and Freddie, asset purchases, the nationalization of corporations and a variety of global obligations through our participation in the International Monetary Fund. While the authors acknowledge that the dynamics of the Bailout did little to help the public at large, they argue that it was necessary to prevent a complete economic meltdown. Yet, the notion that you need to reward the perpetrators of the debacle for mismanagement and corruption in order to protect the American public seems preposterous, especially in light of the severe hardship that resulted for so many and with up to 40% of American homeowners at risk of foreclosure.

Witness to Corruption

In the course of back room deal making, only the deal makers have come out ahead while the Taxpayers have routinely gotten the shaft. As Americans struggle to pay their bills and mounting debts, there is an uneasy feeling that many of those who are benefitting the most are not playing by the rules. Goldman Sachs, for example, is the poster child for Institutional corruption on Wall Street. Corruption articles on Goldman Sschs on the internet would make your head spin. As part of the "gang" who created the bubble and then bet against the housing market it made immense profits. From stock market improprieties, to the sale of US debt funded by the bailout, to the collapse of Greece's economy, Goldman Sachs is implicated in wrong doing. With close ties to the US Treasury, it influenced the fall of its competitors, and, as one of the "chosen" then secured its position in line to receive a big share of the spoils, not to mention bailout funds.

While much of the corporate corruption was blatant, there was also considerable corruption at other crossroads of money and power. The old adage "Power corrupts; absolute power corrupts absolutely" can be applied universally as people in a leadership position exercise their influence in getting things done, and in doing so delude themselves that most of what they do is for the greater good. Public trust in Congress is at an all time low and stories abound on ethics violations of various members. Of particular interest is how many members of Congress have increased their wealth significantly during the recession. One study claims that "Senators on average beat the [stock] market by 12% a year." Much of this may result from the fact that insider trading is perfectly legal for our Representatives due to a loophole in the law which Congress refuses to correct. Having the scoop on legislation that might affect a company or sector economically, and then being able to act on that through the purchase or sale of stocks is apparently one of the perks. The reality is that those that have benefitted directly from the collapse of the economy clearly have a different perception of the seriousness of the Recession, and one can only assume that they may very well feel a different level of urgency in ultimately solving the problem.

What Next?

If the sheer magnitude of this Recession hasn't fully registered to some, talk of a double-dip Recession has increased recently, with estimates that it could conceivably drag out recovery for another 10 years - a terrifying thought to those who have already been hit hard and have spent the past 4 years hunkering down in survival mode. Yet, the forecasts are erratic enough to have people confused. The truth is that economists don't agree on where the indicators are leading us. Will the recovery ebb and flow in an anemic way inching up over time, or will it move sideways? Or, could we be facing something worse? Mark Zandi at Moody's Analytics believes that things are beginning to stabilize, while Nouriel Roubini, professor of economics at NYU's Stern School of Business and Chairman of Roubini Global Economics, says that by not unilaterally addressing the core issues, Europe and the US are facing the perfect storm in 2013.

Housing is the Key to Recovery

Most economists seem to agree that until the housing market stabilizes, recovery is unlikely. Wall Street insider and "master trader" Shah Gilani calls the housing market "our single-most important generator of gross domestic product (GDP) and, ultimately, national wealth." Recent data indicates that banks are sitting on nearly 2 million homes. Yet the government has set up, and is fostering, a condition wherein stabilization cannot happen. In their effort after the collapse to take pressure off the banks which were deemed at the time to be vulnerable to collapse, the government ultimately gave the banks their cake and let them eat it too in the hope that things would stabilize. In doing so, they established a system that makes the banks whole for every foreclosure or shortsale. In many cases the banks actually even come out ahead on the deal. Shielding banks from all risk, has effectively removed any incentive for them to work with homeowners on saving their homes and lies at the heart of a problem that may have catastrophic consequences if nothing is done to correct it.

If the rationale was to protect the financial institutions from collapse, then now that the danger is past, it's time to change a policy that is undermining the recovery process. If the rationale was to speed up the foreclosure process to clear away bad debt and thereby hasten recovery, it has had the opposite effect. It has set up a potential cycle where in property values have logically eroded after the first wave of subprime foreclosures, but they will inevitably continue to be undermined as long as banks are subsidized for doing so, leading to even more people becoming upside down on their mortgages and a new wave of foreclosures for as long as the reward dynamic continues. Uncertainty in the housing market has prevailed, and as property values drop, unless someone has a lot of equity in their home, there is a point at which paying a mortgage that is considerably higher than its value, is just irrational. Many solvent homeowners are coming to that realization and are walking away from their mortgages rather than continue to overpay when there is no likelihood that the property values will ever return to the point of breaking even, much less giving them a profit. If cash flow is an issue, the property becomes an albatross. How low could home values drop? Hypothetically, they could continue to fall until equilibrium is reached between rental value plus the income tax burden and the mortgage price minus the mortgage tax deduction.

Loan Mod, Not An Option

In short, the government over-corrected and there is simply too much money to be made from short sales and foreclosures for the banks ever to take Loan Mods seriously. That being the case, there is nothing to arrest the steady devaluation of property values. In addition to guaranteed loss protection, the banks get paid $1000 for every delinquent customer that they refer to HUD, so foreclosure is often preceded by a government work out process for a Loan Mod. Since the Home Affordable Modification Program (HAMP) has a cap of $700,000, homeowners with higher mortgages do not qualify. In California where property values are so high, banks are routinely making homeowners that they know don't qualify, go through HAMP process anyway, just to collect the easy money before they start any Loan Mod or foreclosure process in earnest. Understaffed and overwhelmed by applications, the process is cumbersome and lengthy and with the new government regulations, it has slowed even more. In addition, the bank may just be servicing the loan and, in that case, paperwork ultimately must be forwarded to the lien holder. From what we understand, since the too-big-to-fail banks are under no obligation to consider it, the Loan Mod process is primarily a courtesy to customers that keeps up appearances and maintains bank credibility, but amounts to little much more than a hoax. Before one is summarily denied, they may be granted a "trial" loan mod. One Loan Mod specialist that we interviewed said that even for those that complete a trial successfully, the permanent Loan Mod is usually denied in the end without explanation. Some of the reasons for bank reluctance may stem from their long time prejudice against people who have defaulted or have bad credit, and, in fact the Loan Mod failure rate is over 65-75%. The HAMP failure rate is 88%. So, with rare exceptions it appears that the entire system again favors the banks and not the American public.

Sorting Out Our Problems

The sad thing is that spiraling property values hurts everyone. However well intentioned, it's hard to make the case that government meddling is doing much good, for there are always unintended consequences that result. And, unfortunately, memories are shockingly short when it comes to learning lessons from the past. Take the subprime mortgage fiasco. Front Page Magazine reports that the Department of Justice is again intimidating banks into lending to unqualified minorities and they are acquiescing for fear of being labeled racist. The article claims that welfare recipients are being considered with banks being pressured to apply irresponsible lending criteria which include welfare payments and unemployment benefits as "valid" sources of income.

In his article "How to Fix the U.S. Housing Market", Gilani says that one way to get the housing market back on track is for the government to offer viable tax incentives to homeowners. While not a panacea, his message is really deeper. He states that "Unless the government is providing direct-and-transparent tax incentives to bolster homeownership," "it has no business being in the mortgage business - especially when that "business" ultimately puts taxpayers at risk." Susanne Trimbath, CEO and Chief Economist of STP Advisory Services, shares that perspective in her interesting article "Solving the Financial Crisis: Looking Beyond Simple Solutions". She makes the point that Americans have a basic fear and distrust of all things financial. And, politicians respond to the public reaction to economic events by passing legislation du jour, which creates "regulatory chokeholds that make failures of financial institutions almost inevitable". What is needed, she says, is to enforce existing laws rather than continually create new ones. She claims that financial crisis didn't result from too few laws, "it resulted from not enforcing the laws we already have." She uses the Bernie Madoff example to stress the absurdity of all the hearings that resulted from that scandal as if we don't have any laws on the books to prevent Ponzi schemes.

Conclusion

To ordinary people, economic theories and balance sheet perspectives don't provide much comfort midst rising food and gas prices. The economic uncertainty is like Chinese water torture as we wait for the next shoe to drop. The only thing that is clear right now about the future is that it will be very different for our children. Paradigms are changing, and one new one to consider is that, as an investment, the house is overrated and in the future may not be the cornerstone of success and independence that it once was. "A Home Is a Lousy Investment", by Robert Bridges, the USC professor of clinical finance and business economics provides a surprising analysis that concludes that we have over-emphasized the importance of home in our personal finances as well as in our economy.

As the congress fights over coming to grips with the debt ceiling, it is clear that the only real plan at hand is the fallback of kicking the can down the road. How's that for denial? At a time when we should be coming together to solve our problems, polarization seems to be escalating, with name calling and demonization of the other side the norm. It doesn't seem like it should be that hard for a group of bright and responsible people, elected and paid handsomely to do a job, to meet in a room and develop a plan for the common good. Common sense would indicate that to tackle any problem where expenses exceed income, any reasonable person would reduce expenses and increase income. The problem is that simple. While a great place to start would seemingly be by taxing the very long list of those who received windfalls and bonuses during the crisis at taxpayer expense, anyone knows that when personal or business finances become top heavy, the first thing you look at is how to cut overhead. American overhead is beyond unreasonable, it is downright absurd. In all practicality, that is the first place to start. This process should not, in all fairness, be pain free for anyone.

"How's The Government Progressing" is the first of a two part series. In our next edition, Part 2 will focus on the Cost of Regulation, Entitlements and Solutions by Experts.