Begging the Banks

Treasury Secretary Henry Paulson today called on the banks that the federal government has just given $250 billion dollars to make that money available to others in the economy.

“We must restore confidence in our financial system,” Paulson said. “The needs of our economy require that our financial institutions not take this new capital to hoard it, but to deploy it.”

The “needs of our economy” might require that the banks not hoard the money that the government has given them, but the Bush administration isn’t requiring much of anything.

I agree with Paulson that the economy will not begin to recover until there is liquidity in the credit markets.  That, indeed, was the rationale behind the government’s massive and unprecedented bailout of the financial industry.

Why, then, is Paulson asking the banks to do the only thing that justified giving them those billions of taxpayer dollars?

If, as is apparent to just about everyone, the economy will not recover until liquidity is restored to financial markets, why doesn’t the federal government require that the banks not hoard the billions that the government is giving them?

The answer is that, despite the acuteness of the financial crisis, and despite the government’s belated decision to take large scale action, the basic approach of the Bush administration has not changed.

In fact, for the past year, the Bush administration has taken a consistent, and faulty, two pronged approach to dealing with the expanding economic crisis, and this approach has not changed with the latest bailout.

This two pronged approach is

• (1) make capital available at extremely low rates to banks and financial institutions with the goal of restoring liquidity, and then
• (2) beg and plead with these same banks and financial institutions to move this capital into the economy.

As the housing and mortgage crisis worsened, Federal Reserve Chairman Ben Bernanke announced a series of cuts in interest rates.  Each time, Bernanke repeated his call for lenders to voluntarily reduce the principal on delinquent loans to adjust them for the drop in home prices, rejecting the far more more forceful action proposed by Democrats favoring legislation that would require the refinancing of hundreds of thousands of mortgages.

Of course, the banks did not voluntarily do what Bernanke requested.

Now Treasury Secretary Paulson is following the same dead end path in asking the banks to voluntarily take the actions that are needed for the restoration of the market.

The Bush adminstration’s beg and plead approach did not work in the past, and it will not work now.

Of course, no one, except the apocalypticals of the far Left and Right, and Libertarians driven crazy by ideology or alcoholism, want to see the global economy collapse.  Sane people don’t want to see bread lines or live with their guns at the ready in a bunker in the woods.

But we can now longer expect that capitalists, driven by personal gain, will voluntarily act to save the system that sustains them.

What is needed is a comprehensive and mandatory overhaul of the entire banking and financial system and the credit markets on the order of the Securities and Exchange Act of 1934.

And for that, we’ll have to wait at least until a new Congress, a new administration, and a new political and economic philosophy take over in January 2009.

I hope we last that long.

Credit Markets are Frozen as Economy Stalls — The Fed’s Efforts to Increase Lending Fail Despite Billions to Banks

Federal Reserve Chair Ben Bernanke and his fellow monetary watchdogs have taken unprecedented steps in the past year to increase liquidity in the credit market.  They’ve cut the short-term interest rate seven times since September 2007.  They’ve committeded billions of public dollars to prevent the bankruptcy of Bear Stearns and other major financial institutions, and billions more to prop-up mortgage giants Fannie Mae and Freddie Mac.  The goal has been to stabilize the financial markets and increase liquidity — that is, to make more money available to more people and businesses.

What has been the result of the Fed’s efforts?

The answer is: Not much.

Despite the Fed’s efforts — and the billions of public dollars invested over the past year in the financial industry — the banking business has just about shut down.

In fact, it is harder now for most business to borrow money than it was before the Fed started its rating-cutting.

As the New York Times reports, “Banks struggling to recover from multibillion-dollar losses on real estate are curtailing loans to American businesses, depriving even healthy companies of money for expansion and hiring.  Two vital forms of credit used by companies — commercial and industrial loans from banks, and short-term “commercial paper” not backed by collateral — collectively dropped almost 3 percent over the last year, to $3.27 trillion from $3.36 trillion, according to Federal Reserve data. That is the largest annual decline since the credit tightening that began with the last recession, in 2001.”

The effect of the banks’ tight money policy could be devastating to the economy. 

Mortgage rates will continue to climb, further increasing foreclosures and heightening the housing crisis.  Those industries closely allied with real estate, such as construction, will continue to collapse.  Even successful businesses will be unable to expand, further increasing the jobless rate.  Smaller businesses, which provide a large percentage of American jobs, will be particularly hard hit, since they will be entirely frozen out of the credit market.  Bankruptcies, both large and small, will continue to spiral upward. 

What is the answer?

The Fed’s rate-cutting hasn’t worked, and the piece-meal approach being taken by Congress and the administration (including the new mortgage relief legislation) won’t work either.

What is needed is a comprehensive overhaul of the entire banking and financial system and the credit markets, including the securities laws.

And for that, we’ll have to wait at least until a new Congress and a new administration take over in January 2008.  Even then, comprehensive and systemic change is unlikely.

We need a 21st Century Franklin Roosevelt. 

Unfortunately, that’s probably impossible until we’re in the midst of a 21st Century Great Depression.

Top 10 Steps for State Governments to Tackle the Mortgage Crisis

The Brookings Institution, one of the nation’s most prestigious think tanks, has issued a new report on the mortgage crisis focusing on the role of state governments. 

The report, entitled “Tackling the Mortgage Crisis: 10 Action Steps for State Government,” was written by Alan Mallach, a Senior Fellow at the National Housing Institute and a Visiting Scholar at the Federal Reserve Bank of Philadelphia, and suggests “10 Action Steps” that can be taken by state governments to “tackle both the immediate problems caused by the wave of mortgage foreclosures and prevent the same thing from happening again.”

The 10 steps are:

• Help borrowers gain greater access to counseling and short-term financial resources.
• Ensure a fair foreclosure process.
• Encourage creditors to pursue alternatives to foreclosure.
• Prevent predatory and fraudulent foreclosure “rescue” practices.
• Establish creditor responsibility to maintain vacant properties.
• Make the process as expeditious as possible.
• Ensure that the property is ultimately conveyed to a responsible owner.
• Better regulate the mortgage brokerage industry.
• Ban inappropriate and abusive lending practices.
• Establish sound long-term policies to create and preserve affordable
  housing, for both owners and renters.

These seem like common sense steps to us — although the debate over what in fact are “inappropriate and abusive lending practices” and “sound long-term policies to create and preserve affordable housing” — will be where the reform process is likely to break down.

We’ve noted before that “while the federal government’s response to the mortgage and real estate crisis appears to be paralyzed by partisan politics, the States are taking the initiative in trying to protect homeowners facing foreclosure.”

The Brookings Institution agrees:

“Although most media attention has focused on the role of the federal government in stemming this crisis, states have the legal powers, financial resources, and political will to mitigate its impact. Some state governments have taken action, negotiating compacts with mortgage lenders, enacting state laws regulating mortgage lending, and creating so-called ‘rescue funds.’ Governors such as Schwarzenegger in California, Strickland in Ohio, and Patrick in Massachusetts have taken the lead on this issue. State action so far, however, has just begun to address a still unfolding, multidimensional crisis. If the issue is to be addressed successfully and at least some of its damage mitigated, better designed, comprehensive strategies are needed.”

As we’ve pointed out, “Unless a national consensus is quickly reached on dealing with the rising tide of foreclosures — and we believe this is unlikely to happen when presidential candidates are competing for votes based on whose plan is best for dealing with the mortgage and real estate crisis – we think lenders can expect to fight individual battles over foreclosure in all 50 States. Given the negative publicity that lenders have had in the media, and with a bitterly fought presidential election on the horizon, these are not battles that the lenders are likely to win.”

Since delinquent and at-risk borrowers have far more political leverage in many state capitols than they have in Washington, the Brookings Institution report not only provides a road map for individual state action, but also further increases the pressure on the mortgage industry and their supporters in the federal government to come up quickly with an effective national plan for dealing with the foreclosure crisis.

 

N.Y. Times Editorial Calls for Foreclosure Prevention Legislation Before the Next Mortgage Meltdown

The New York Times entered into the politics of the foreclosure crisis with an explosive editorial today accusing the Bush administration of failing to protect the economy and instead “sowing confusion and delay” in the face of the mortgage meltdown.

Here’s what the Times said:

“The housing bust is feeding on itself: price declines provoke foreclosures, which provoke more price declines. And the problem is not limited to subprime mortgages. There is an entirely different category of risky loans whose impact has yet to be felt — loans made to creditworthy borrowers but with tricky terms and interest rates that will start climbing next year.”

“Yet the Senate Banking Committee goes on talking. It has failed as yet to produce a bill to aid borrowers at risk of foreclosure, with the panel’s ranking Republican, Richard Shelby of Alabama, raising objections. In the House, a foreclosure aid measure passed recently, but with the support of only 39 Republicans. The White House has yet to articulate a coherent way forward, sowing confusion and delay.”

“[I]f house prices fall more than expected — a peak-to-trough decline of 20 percent to 25 percent is the rough consensus, with the low point in mid-2009 — financial losses and economic pain could extend well into 2011.”

“That is because a category of risky adjustable-rate loans — dubbed Alt-A, for alternative to grade-A prime loans — is scheduled to reset to higher payments starting in 2009, with losses mounting into 2010 and 2011. Distinct from subprime loans, Alt-A loans were made to generally creditworthy borrowers, but often without verification of income or assets and on tricky terms, including the option to pay only the interest due each month. Some loans allow borrowers to pay even less than the interest due monthly, and add the unpaid portion to the loan balance. Every payment increases the amount owed.”

“In coming years, if price declines are in line with expectations, Alt-A losses are projected to total about $150 billion, an amount the financial system could probably absorb. But until investors are sure that price declines will hew to the consensus, the financial system will not regain a sure footing. And if declines are worse than expected, losses will also be worse and the turmoil in the financial system will resume.”

“There’s a way to avert that calamity. It’s called foreclosure prevention. There is no excuse for delay.”

We agree with the Times that effective foreclosure prevention legislation is long overdue.  As the Times pointed out, unless Congress acts fast, it is likely that the economic consequences of the bursting of the housing bubble will be even more serious and widespread.

Even Fed Chair Ben Bernanke — who could not be called an advocate of government intervention in the markets — has stated that “High rates of delinquency and foreclosure can have substantial spillover effects on the housing market, the financial markets, and the broader economy” and that what is at stake is not merely the homes of borrowers, but “the stability of the financial system.” 

We also can not imagine a more self-defeating political strategy than that of the Republicans who have opposed foreclosure prevention legislation. 

We’ve already written about Senator Richard Shelby’s close ties to the apartment owners industry, which has aggressively opposed federal aid to homeowners in, or near, default.

Surely, with the presidential election only months away and their party in trouble, more Republicans — including Senator McCain — should see the need for coming to terms with the economic, and political, realities of the foreclosure crisis, even if it requires ideological compromise.

 

Has the Credit Market Thawed? Is it Freezing Up Again? And Are You Still Out in the Cold?

We’ve written before about the failure of the Fed’s policy of cutting short-term interest rates — seven times since September 2007 — to spur liquidity in the credit market. 

The good news today is that there is “significant improvement in the credit markets since late March,” according to the Wall St. Journal.

The bad news, also reported by the Wall St. Journal, is that this recent thaw in the credit market is not expected to last:

“‘Most of us are anticipating two steps forward, one step back and carefully watching where the markets can handle deals,’ said Tyler Dickson, who oversees capital raising at Citigroup.”

“‘There’s no question the tone in the market is getting better,’ says Jim Casey, co-head of leveraged finance at J.P. Morgan Chase.  He adds, however, that ‘there is some concern that this might be a short-term window of opportunity for issuers, since investors are still very focused on default rates and the potential severity of a recession.'”

“‘Risk tolerance is still pretty low,’ says Daniel Toscano, a managing director of leveraged and acquisition finance at HSBC Securities in New York.”

“Banks and debt investors are treading carefully,” the article said. “Investment banks, which incurred big losses after selling a lot of buyout debt at heavily discounted prices, are committing only to deals they can underwrite at a profit. And investors don’t want to be caught wrong-footed if corporate defaults spike.”

We think that the report of a credit thaw is premature.  For most businesses and individuals, the credit market is still frozen solid. 

Blackstone Group LP President Tony James appears to agree with us.  James told Bloomberg News that banks are mistaken if they think credit markets have begun a sustained recovery. 

Rather than a real break in the dismal credit forecast, James said that this little patch of sunshine may be “the eye of the hurricane.”

There is clearly no de-icing of the credit market that would significantly impact the housing crisis or allow Fed Chair Ben Bernanke to sleep without getting the chills at night.

 

 

Who is Still Against Federal Foreclosure Legislation?

As the Congress comes closer to passing legislation to help homeowners facing foreclosure, it is worth taking a look at the opposition to federal foreclosure aid.

Of course, there are those who strictly oppose nearly all forms of government intervention in the economy.  Congressman and presidential candidate Ron Paul and his free market libertarian supporters would be among this group.

Then are those who are opposed to market interventions in general, but will support some government interventions when the stability of the market is at stake.  Most Republicans fit into this group — including Federal Reserve Chairman Ben S. Bernanke.

That’s why it was significant that it was Bernanke who last week made the most convincing argument from a free market perspective for federal aid to homeowners facing foreclosure.

As we noted in an earlier post, Bernanke told an audience at the Columbia Business School that the foreclosure crisis posed the clear and present danger of wreaking economic havoc far beyond the housing market. “High rates of delinquency and foreclosure,” Bernanke said, “can have substantial spillover effects on the housing market, the financial markets, and the broader economy.”

What is at stake, according to Bernanke, is not merely the homes and financial well-being of hundreds of thousands of borrowers, but “the stability of the financial system.”  In this extreme circumstance, even staunch free market advocates, such as Bernanke himself, recognize the need for the government to intervene in the market.

We think, then, that the overwhelming vote in the House of Representives in favor of government intervention to stop the rising tide of foreclosures — legislation that now has the support of many free market Republicans — was rooted at least as much in the economic reality of averting catastrophe as the political expediency of government largess in an election year.

Who then is still opposed to foreclosure aid?

The answer is the apartment owners.

Behind any legislative process is a power struggle of conflicting interests, and very often these interests are economic.  In the case of foreclosure aid, there this now a growing consensus that the foreclosure crisis threatens not merely the borrowers and the lenders, but the economy as a whole and hence the economic interests of almost every sector of the economy.

Except apartment owners.

The National Multi-Housing Council (NMHC) and the National Apartment Association (NAA) have consistently argued that the blame for the foreclosure crisis is what they have called the “misguided” national policy of “home ownership at any cost” and that “People were enticed into houses they could not afford and the rarely spoken truth that there is such a thing as too much homeownership was forgotten.”

The fact is that in sharp contrast to other sectors of the real estate market, the apartment industry has not suffered as a result of the current housing crisis.  Rather, as we’ve noted before, the real estate crisis is forcing the lower end of the single-family housing market back into multi-family rental apartments.  People have to live somewhere — if they can’t afford to live in a house that they own, they will be forced to live in a house that someone else owns, such as multi-family apartment units. As homeowners suffer, apartment owners benefit.

The apartment industry has some very powerful supporters in Congress, including Senator Richard C. Shelby of Alabama, the ranking Republican on the Senate Banking Committee.   Senator Shelby,  who has opposed federal intervention to stop foreclosures, has made millions as a landlord and is the owner of a 124-unit apartment complex in Tuscaloosa called the Yorktown Commons. 

“I want the market to work if it can, and most of the time it will, but not without some pain,”  Senator Shelby has said.

This time, the pain appears to be too great, too wide-spread, and too dangerous, for most other members of Congress, as well as most important players in the economy, to allow it to continue unabated.

Indeed, Shelby has already signaled that he would support a version of the legislation — and that the White House would sign the bill into law.

“I think if we reach a compromise,” Shelby said, “it would be acceptable to the White House because, as a Republican and former chairman of the committee, I’m going to do everything I can, work with the administration, to make sure that the program works for those it’s intended to do and make sure we can afford it as a nation.”

In this crisis, even Senator Shelby has other, larger, and more important economic interests at stake than helping the apartment industry.

 

 

Fed Chair Bernanke Warns Foreclosures Could Sink US Economy — Is He Threatening Lenders?

In a speech today at the Columbia Business School, Federal Reserve Chairman Ben S. Bernanke issued his strongest warning to date about the danger of the rising tide of home foreclosures sinking the US economy.

“High rates of delinquency and foreclosure,” Bernanke said, “can have substantial spillover effects on the housing market, the financial markets, and the broader economy.”

Bernanke began by detailing some of the nasty numbers of the foreclosure crisis:

• About one quarter of subprime adjustable-rate mortgages are currently 90 days or more delinquent or in foreclosure.
• Foreclosure proceedings were initiated on some 1.5 million U.S. homes during 2007, up 53 percent from 2006.
• The rate of foreclosure starts is likely to be even higher in 2008.
• Delinquency rates have increased in the prime and near-prime segments of the mortgage market.

He then warned that the catastrophic effects of these millions of foreclosure proceedings will extend far beyond the parties to the mortgage:

“It is important to recognize,” Bernanke said, “that the costs of foreclosure may extend well beyond those borne directly by the borrower and the lender.  Clusters of foreclosures can destabilize communities, reduce the property values of nearby homes, and lower municipal tax revenues.  At both the local and national levels, foreclosures add to the stock of homes for sale, increasing downward pressure on home prices in general.” 

“In the current environment, more-rapid declines in house prices may have an adverse impact on the broader economy and, through their effects on the valuation of mortgage-related assets, on the stability of the financial system.”

The real threat that the foreclosure crisis posed to the overall economy, Bernanke said, was “the declines in home values, which reduce homeowners’ equity and may consequently affect their ability or incentive to make the financial sacrifices necessary to stay in their homes.”

The responses to the foreclosure crisis specifically endorsed by Bernanke were nothing new —  working with community groups trying to acquire and restore vacant properties; encouraging lenders and mortgage servicers to work with at-risk borrowers; developing new lending standards to prevent abusive lending practices; working with the Bush administration’s Hope Now Alliance; expanding the use of the Federal Housing Administration (FHA) and government-sponsored enterprises such as Fannie Mae and Freddie Mac to address problems in mortgage markets.

But we think that the tone and perspective of his speech signaled that he was far more ready than the current administration to endorse a wide-ranging federal program to aid homeowners who are in default.

Bernanke came close to saying as much:  “Realistic public and private-sector policies must take into account the fact that traditional foreclosure avoidance strategies may not always work well in the current environment.”

We think by “traditional foreclosure avoidance strategies” Bernanke meant voluntary procedures undertaken by the financial market itself; the “non-traditional foreclosure avoidance strategies” that Bernanke suggested might be necessary would then be mandatory procedures imposed on the market.

We therefore think that Bernanke’s speech contained a threat to the very financial institutions that the Fed has been so generous toward for the past six months.

So far, lenders have been asked to voluntarily help stem the foreclosure crisis by working with homeowners.  Now it appears that Bernanke may be close to supporting mandatory restraints on foreclosures.

We think Bernanke may have been saying this to the lenders and the leaders of the financial market: “We’ve made billions of cheap dollars available to you, so that you could stay afloat and so that you could make this money available for new borrowing and refinancing to prevent foreclosures.  You have not kept your end of the bargain.  If you don’t move much further along this path soon,  it is in the interest of the US economy overall to force you to do so.”

The lenders and financial institutions haven’t listened to threats from Congressional Democrats like Barney Frank or taken the voluntary actions requested by the Bush administration.

Maybe they’ll listen to today’s warning by Ben Bernanke.

We think they’d better.

 

 

The Fed Nears the End of the Rate-Cutting Line — Now its the Banks’ Move

After the Federal Reserve cut short-term interest rates on Wednesday for the seventh time since September 2007 — lowering the federal funds rate to 2 percent, from 2.25 percent, the lowest level since November 2004 — most analysts observed that the Fed’s move showed that it was more concerned with preventing recession than halting inflation.

We’re not so sure that it is a question of recession verses inflation that’s driving the Fed.

We think that the Fed’s real concern right now is neither inflation nor recession, at least not directly, but the lack of liquidity in the financial markets and the lack of funds that financial institutions are making available to borrowers.

So far, the Fed has pumped more than $400 billion into major U.S. financial institutions in the hope that these institutions would make this money available to borrowers. 

And, so far, they haven’t done so, and liquidity conditions in the credit markets have continued to deteriorate. 

Despite the Fed’s inceasing generosity for the past six months, it has been harder, not easier, for businesses (and individuals) to borrow money.

The Fed is nearing the end of its rate-cutting line.  If the financial spigot does not loosen for borrowers based on the latest cuts, there may be no more that the Fed can do, especially since, with rising fuel and food prices, fears of inflation are already starting to overtake fears of recession, in America’s living rooms as well as its Board rooms.

Two members of the Fed’s Open Market Commitee  — Richard W. Fisher, president of the Dallas Fed, and Charles I. Plosser, president of the Philadelphia Fed — which is charged under federal law with overseeing national monetary policy — voted against lowering the rates this time.  And the criticism of the Fed’s policy of lowering interest rates and providing cheap money for the banks is getting broader, louder and more influential.

The banks and major lending institutions have been waiting for the Fed to cut interest rates as far as it possibly would before they start lending.

That moment has probably arrived.

Now it’s the financial market’s turn to make a move.

 

 

The Government Offers Kind Words and Bandages

When we reported on Thursday on the continuing rise in foreclosures and the downward slide in homeowner equity, we concluded that “The political pressure on the States and the federal government to take sweeping and even desparate actions will also continue to mount, especially because this is a presidential election year.”

On Friday, The New York Times echoed our assessment, saying that “The [recent foreclosure] figures are expected to increase pressure on policy makers and the mortgage industry to move faster to contain losses and help homeowners. In recent days, regulators and lawmakers have begun suggesting that the federal government might need to take a bigger role in the mortgage business.”

While Federal Reserve Chairman Bernanke repeated his call for lenders to voluntarily reduce the principal on delinquent loans to adjust them for the drop in home prices, far more more forceful action was propsed by the Chairman of the House Financial Services Committee, Rep. Barney Frank (D-Mass.), who will introduce legislation that would require the refinancing of hundreds of thousands of mortgages, with the F.H.A. providing new loan insurance.

Our opinion is that the most signifiant cause of the mortgage and foreclosure crisis is the underlying disarry in the credit markets. Unless and until the credit markets are better regulated and rationalized (and not necessarily by the government), all that can be hoped for is first aid, not a cure.

Of course, if you’re bleeding badly, you’re grateful even for a kind word and a bandage.