Tag Archives: financial crisis

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.

John McCain, New Deal Democrat?

Meet John McCain, New Deal Democrat.

In the presidential debate this week, McCain shocked many of fellow Republicans by proposing the largest and most expensive government intervention in the housing market in U.S. history.

Specifically, McCain announced that he would tell his treasury secretary to spend $300 billion to buy the mortgages of homeowners in financial trouble and replace them with more affordable loans.  The program, which McCain calls the American Homeownership Resurgence Plan -– there’s that word “surge” again — would be available to mortgagors for whom the property is their primary residence, who can prove they were creditworthy when the original loan was made, and who made a down payment.

According to the McCain campaign:

“John McCain will direct his Treasury Secretary to implement an American Homeownership Resurgence Plan (McCain Resurgence Plan) to keep families in their homes, avoid foreclosures, save failing neighborhoods, stabilize the housing market and attack the roots of our financial crisis.”

“America’s families are bearing a heavy burden from falling housing prices, mortgage delinquencies, foreclosures, and a weak economy. It is important that those families who have worked hard enough to finance homeownership not have that dream crushed under the weight of the wrong mortgage. The existing debts are too large compared to the value of housing. For those that cannot make payments, mortgages must be re-structured to put losses on the books and put homeowners in manageable mortgages. Lenders in these cases must recognize the loss that they’ve already suffered.”

“The McCain Resurgence Plan would purchase mortgages directly from homeowners and mortgage servicers, and replace them with manageable, fixed-rate mortgages that will keep families in their homes. By purchasing the existing, failing mortgages the McCain resurgence plan will eliminate uncertainty over defaults, support the value of mortgage-backed derivatives and alleviate risks that are freezing financial markets.”

“The McCain resurgence plan would be available to mortgage holders that:

  • Live in the home (primary residence only)
  • Can prove their creditworthiness at the time of the original loan (no falsifications and provided a down payment).”

“The new mortgage would be an FHA-guaranteed fixed-rate mortgage at terms manageable for the homeowner. The direct cost of this plan would be roughly $300 billion because the purchase of mortgages would relieve homeowners of ‘negative equity’ in some homes. Funds provided by Congress in recent financial market stabilization bill can be used for this purpose; indeed by stabilizing mortgages it will likely be possible to avoid some purposes previously assumed needed in that bill.”

“The plan could be implemented quickly as a result of the authorities provided in the stabilization bill, the recent housing bill, and the U.S. government’s conservatorship of Fannie Mae and Freddie Mac. It may be necessary for Congress to raise the overall borrowing limit.”

This certainly doesn’t sound like a Republican plan to me.

In fact, it isn’t. 

As the New York Times has pointed out, “The mortgage renewal idea actually originated with Senator Hillary Rodham Clinton, said Charlie Black, a senior adviser to Mr. McCain. And Mrs. Clinton, who proposed the idea in a recent newspaper column, borrowed it from a Depression-era New Deal agency, the Home Owner’s Loan Corporation.”

How seriously should we take McCain’s plan?

First, we should appreciate what a stunning turn-around this proposal is for John McCain, who has previously railed against the “moral hazard” of bailing out homeowners who took out larger mortgages than they could afford.

Only last March, McCain declared — in response to the Hillary Clinton plan that McCain has now closely appropriated — that “it is not the duty of government to bail out and reward those who act irresponsibly, whether they are big banks or small borrowers.” 

As the New York Times then observed, “Mr. McCain’s remarks on Tuesday represented a stark tonal shift from the increasing calls for helping homeowners, as he faulted not only borrowers who engaged in risky lending, but suggested that some homeowners engaged in dangerous financial practices. ‘Some Americans bought homes they couldn’t afford, betting that rising prices would make it easier to refinance later at more affordable rates,’ he said. Mr. McCain argued that even during the ongoing crisis, the vast majority of mortgage holders continued to make their payments. ‘Of those 80 million homeowners, only 55 million have a mortgage at all, and 51 million homeowners are doing what is necessary — working a second job, skipping a vacation and managing their budgets to make their payments on time,’ he said. ‘That leaves us with a puzzling situation: how could 4 million mortgages cause this much trouble for us all?’”

Second, we should note that McCain’s point man for the plan is his senior economic advisor Douglas Holtz-Eakin.  Holtz-Eakin was the Chief Economist for the President’s Council of Economic Advisors under President George W. Bush and Senior Staff Economist for President George H. W. Bush’s Council of Economic Advisors.  He was, therefore, as responsible for the deregulation that lead to the mortgage mess as any single economist could be.  (He was also the person who claimed that McCain was responsible for the invention of the Blackberry phone.)   If we are to take McCain’s proposal seriously, then we must assume that Holt-Eakin has also had a Saint Paul-like sudden conversion and is now not a Bushite but a New Deal Democrat.

Third, we should look at the conservative reaction to McCain’s plan.  If they thought that McCain was serious about his plan, they’d be exploding with condemnation and accusations of betrayal.  But, so far, the National Review has nothing to say about it.  Conservative blogs mostly call it “pandering”  — and while they’re not happy about it, they understand it as an election ploy.  The Wall Street Journal doesn’t seem very upset either, taking an uncharacteristically wait-and-see attitude toward a proposal that would violate the foundational principles of modern Republican economics: “The idea must have puzzled many viewers and we’ll reserve judgment until we see the fine print,” the Journal said.” At a glance, it doesn’t sound like something Democrats would oppose — and elections are decided on differences.”

Our conclusion?

The McCain proposal isn’t serious, and few conservatives believe that either (1) McCain will win (and therefore be in a position to implement the plan) or (2) that McCain would implement the plan if elected.

We think that McCain’s new homeowner bailout program should really be called the “McCain Campaign Resurgence Plan.” 

Falling precipitously behind in the polls, especially in so-called “swing states” like Ohio, Florida and Michigan that have been hit hard by foreclosures and falling home prices, McCain has suddenly — and unconvincingly – decided that his favorite president is not Ronald Reagan but Franklin Roosevelt.

We’re not buying it.

Nevertheless, it is a watershed moment in American political history when the Republican candidate for President — and self-described foot soldier in the Reagan Revolution — attempts to outdo the Democratic candidate as a New Deal Liberal.

UPDATE:

Now that a few days have passed and the McCain campaign has repeated its call for a $300 billion bailout of mortgage holders at taxpayer’s expense, conservatives have taken the proposal seriously enough to lambast it.

CNN.com offers a good roundup of conservative commentary: 

” In a sharply worded editorial on its Web site Thursday, the editors of The National Review — an influential bastion of conservative thought — derided the plan as “creating a level of moral hazard that is unacceptable” and called it a “gift to lenders who abandoned any sense of prudence during the boom years.”

“Prominent conservative blogger Michelle Malkin went one step further, calling the plan “rotten” and declaring on her blog, ‘We’re Screwed ’08’.”

“Matt Lewis, a contributing writer for the conservative Web site Townhall.com, told CNN the plan only further riles conservatives upset with McCain’s backing of the massive government bailout plan passed last week.”

“‘Fundamentally, the problem is John McCain accepts a lot of liberal notions, unfortunately. There is somewhat of a populist streak,’ he said. ‘Most conservatives really did not like the bailout to begin with, and this was really kind of picking at the scab’.”

 

Morals, Money and the Bailout

We’ve heard lots of moralism about the economy recently from both ends of the political spectrum.  Wall Street is guilty of greed and homeowners in trouble are guilty of irresponsibility. Instead of offering a cogent systemic analysis of how we got into this financial mess, and the best way to change our economic and financial system in order to fix it, both parties seem to prefer preaching about the wages of sin. 

But while wagging a self-righteous finger while invoking the Seven Deadly Sins (in particular Greed, Envy, Sloth, and Pride, but we could also make a case for Gluttony and Lust) makes for good politics, it is a terrible way to approach the current crisis. 

We should not expect capitalists not to be greedy.  And we should not expect consumers to want fewer or less expensive goods, including fewer and less expensive homes and cars.

The desire for more, for bigger, and for better is not the enemy of capitalism. 

Unregulated capitalism is the enemy of capitalism.

What we should expect, and what we need, is for the economic and financial system to be structured by law and regulation to channel the desires of both capitalists and consumers for more, for bigger, and for better into productive, sustainable economic growth.

Moralism won’t get us there, and will distract us from seeing the problem for what it is: a matter of systemic, not moral or individual, failure.

Catastrophe Worsens for Housing Market — Home Prices and Home Sales Fall Again

As Congress meets to bailout the financial industry and George Bush vies with Freddie Krueger for the nation’s archetypal face of visceral terror, the latest report from the Census Bureau shows that the housing catastrophe continues to get worse. 

Here’s the summary of the bad news:

  • New homes sales in August dropped to the lowest level since January 1991.
  • Home prices hit a four-year low. 
  • Inventory continues to rise, creating more downward pressure for home prices.

And here are some of the ugly new numbers:

  • New home sales had a seasonally adjusted annual rate of 460,000, down 11.5 percent from a revised 520,000 in July and down 24.5 percent from a year ago.
  • Only 39,000 new homes were sold in July, the lowest level since December 1991.
  • Prices for new homes were at their lowest level since September 2004.
  • The median price of a new home sold in August was $221,900, down 5.5 percent from $234,900 in July and down 6.2 percent from $236,500 a year ago.
  • 166,000 new homes came on the market in August, bringing total inventory to a seasonally adjusted 408,000, equal to 10.9-month supply, up from a 10.3 month supply in July.
  • New home sales fell 31.9 percent in the Northeast, 2.1 percent in the South and 36.1 percent in the West. Only the Midwest showed an increase in new home sales, up 7.2 percent.
  • Three out of four builders reported having to pay buyers’ closing costs or offer other incentives such as expensive features for free in order to maintain sales.

The housing market is so bad that the main cheerleader for an I-can-see-the-light-at-the-end-of-the-tunnel approach to the real estate crisis – the National Association of Realtors (NAR) – has finally admitted, albeit with NAR’s typical understatement of the obvious, that “the pendulum in the mortgage market has swung too far.”

But if you’re looking for a bright side to the nation’s residential real estate fire sale, NAR’s number one Pollyanna-in-Chief, economist Lawrence Yun, still has a bromide to offer.

“August sales reflect higher interest rates before the government takeover of Freddie Mac and Fannie Mae, and the sudden drop in mortgage interest rates over the past couple weeks is improving housing affordability,” Yun said. “With higher loan limits and a beefing up of the FHA program, all the mechanisms have been falling into place to increase mortgage availability.”

Yeah.  Right.

Bankers Reject Free Market Ideology and Call for More Regulations and Protections for Investors

Free-market ideologues tend to blame most economic problems on government interference in the market.  And their response to economic crisis is invariably to call for the reduction or elimination of government regulations.

But free-market ideologues are usually pundits, professors, and politicians, and not capitalists themselves.

Real capitalists care less about ideology, and more about what is actually important — that is, capitalism.

That’s why it should come as no surprise that in the face of the potentially catastrophic crisis that is now gripping the banking industry, it is the bankers themselves who are calling for more, rather than less, government regulation.

As the Financial Times reports, “Many of the world’s biggest banks are proposing reforms that would limit the size and scope of their businesses in one of the most dramatic responses to the credit crisis. The proposals would hold down the number of investors who can buy complex financial products, bring large swathes of the derivatives markets into regulators’ sights and call on banks to spend more on technology and risk management.”

“Backed by banks including JPMorgan Chase, Merrill Lynch, Citigroup, HSBC, Lehman Brothers and Morgan Stanley, the proposals are being delivered to global regulators in the hope of producing rules for credit markets that would cut risk of contagion and restore confidence.”

Here is the story:  Last week, a panel of high-power bankers calling themselves “Counterparty Risk Management Policy Group III,” lead by Goldman Sachs managing director E. Gerald Corrigan, issued a report to Treasury Secretary Henry M. Paulson Jr. and Mario Draghi, chairman of the international Financial Stability Forum, calling for more regulation and governmental oversight of the banking industry and new standards for monitoring and managing risk.

The Washington Post reports that the bankers’ panel “suggested that big investment houses regularly perform ‘liquidity stress tests’ to measure their expected flexibility in the face of a crisis. It also urged firms to make sure they have accurate snapshots of their exposures to institutional trading partners, with the ability to compile detailed reports within hours.”

“In the current crisis, ‘some of the worst failures were in risk monitoring, which was before you even got to risk management,’ Corrigan, a former chief executive of the Federal Reserve Bank of New York, said in an interview.”

Included in the panel’s recommendations is a prohibition on selling high-risk and complex financial products to anyone except “sophisticated investors.” 

According to the Financial Times, under the panel’s recommendations “even pension funds and other institutional investors would no longer be automatically allowed to buy bonds backed by assets such as subprime mortgages. All but the wealthiest retail investors would be barred from buying structured products, such as auction rate securities, a $330bn market used by municipalities and student loan providers to raise funds.”

Corrigan said “the ‘markets had been sandbagged by complexity’ and suggested the new rules would help ensure sophisticated financial products were only sold to investors with the resources and skills to understand and monitor them.”

We agree with the panel’s report and recommendations. 

It is long overdue that investors in financial products have at least the kind of “qualified investor” protections that exist under the Securities and Exchange Act — both for the sake of the investors and the stabiliity of the financial markets.

And it is good to see that real capitalists care more about preserving the world’s financial markets than about preserving some ideologically pure notion of free-market capitalism.

On other hand, in the short term, it would not be good for the economy if the banks used these recommendations as a rationale to further restrict the availability of credit to qualified borrowers.

Are Our Economic Problems Just in Our Minds? John McCain’s Chief Economic Advisor Thinks So

Are the nation’s economic problems — the financial crisis, the mortgage meltdown, the tidal wave of foreclosures, soaring gas prices, increasing job losses, and a tumbling dollar — only in our minds?

It appears that Phil Gramm, John McCain’s chief economic advisor and co-chair of his presidential campaign, thinks so.

He also thinks that those of us who are seriously troubled by the state of the economy are “whiners.”

In an interview in yesterday’s Washington Times, Gramm said that “this is a mental recession. We may have a recession; we haven’t had one yet.”

Gramm says that Americans have “become a nation of whiners.” 

Americans, according to Gramm, are constantly “complaining about a loss of competitiveness, America in decline.”

“You just hear this constant whining,” he said.  “Misery sells newspapers,” Gramm said.  “Thank God the economy is not as bad as you read in the newspaper every day.”

What also sells newspapers are bone-head comments from key advisors to presidential campaigns.

We said last month that Gramm was on thin ice in the McCain campaign because of his ties to the mortgage meltdown and financial crisis

As a U.S. Senator from Texas, Gramm spearheaded sweeping changes in federal banking law, including the Gramm-Leach-Bliley Act in 1999, which repealed previous rules separating banking, insurance and brokerage activities, and which some analysts blame for creating the legal framework for the current mortgage meltdown and credit crisis.  For that effort, Gramm has been called “the father of the mortgage meltdown and financial crisis.”

In addition, Gramm is currently vice chairman of UBS, the giant Swiss bank that has been a major player in the U.S. subprime mortgage crisis.  While advising the McCain campaign, Gramm was paid by UBS to lobby Congress to roll back strong state rules that sought to stem the rise of predatory tactics used by lenders and brokers to place homeowners in high-cost mortgages.

Gramm’s leadership role in UBS — whose stock has fallen 70 percent from last year — also raises questions about his economic, and not just his political, judgment. 

As a recent article in Slate.com observes, “UBS’s investment banking unit made disastrous forays into subprime lending. Last December, having already announced a third-quarter loss, UBS raised about $13 billion to replenish its balance sheets, mostly from the Government of Singapore Investment Corp.  In the fourth quarter of 2007 and the first quarter of 2008, it racked up Mont Blanc-sized losses on subprime debt of nearly $32 billion. In May, it sold about $15 billion worth of mortgage-related assets to the investment firm BlackRock — but only after it agreed to finance most of the purchase price. In June, UBS raised another $15.5 billion in a rights offering. The credit losses — some $38 billion so far, according to UBS — caused the bank to replace its chairman and install new leadership at its investment bank.”

In addition, Massachusetts has charged UBS with defrauding customers who had purchased auction-rate securities. UBS is accused of “selling retail brokerage customers products that turned out to be profitable for the bank’s investment banking unit but caused the customers to suffer significant losses.”

UBS is also the subject of an ongoing federal investigation, in which Bradley Birkenfeld, an American UBS private banker who was busted on tax evasion charges, has plead guilty and is cooperating. 

UBS has also recently paid millions of dollars to settle a lawsuit with the victims of a 1031 exchange scam.  UBS was one of several defendants who were alleged to have participated with Donald Kay McGahn and and others in a scheme to steal the money that had been entrusted to them to facilitate tax deferred 1031 exchanges.

And most recently, the Financial Times, which called UBS “Europe’s biggest casualty of the US subprime crisis,” reported that UBS’s write-downs could total another $7.5 billion.  UBS’s stock fell 7 percent in trading on Monday.

With that resume, we think it would be best for everyone, not least John McCain, if Phil Gramm was no longer introduced to voters as “John McCain’s chief economic advisor.”

UPDATE:

As of July 18, Gramm has resigned as co-chair of McCain;s presidential campaign.

Foreclosure Activity Up 53% Over June 2007

Default notices, auction sale notices and bank repossessions were reported on 252,363 U.S. properties during June 2008, a 3 percent decrease from the previous month but still a 53 percent increase from June 2007, according to the latest RealtyTrac Foreclosure Market Report.

The report also shows that one in every 501 U.S. households received a foreclosure filing during the month.

“June was the second straight month with more than a quarter million properties nationwide receiving foreclosure filings,” said James J. Saccacio, chief executive officer of RealtyTrac. “Foreclosure activity slipped 3 percent lower from the previous month, but the year-over-year increase of more than 50 percent indicates we have not yet reached the top of this foreclosure cycle. Bank repossessions, or REOs, continue to increase at a much faster pace than default notices or auction notices. REOs in June were up 171 percent from a year ago, while default notices were up 38 percent and auction notices were up 22 percent over the same time period.”

Nevada, California and Arizona continued to document the three highest state foreclosure rates in June.  Florida, Michigan, Ohio, Colorado, Georgia, Indiana and Utah were other states that made the top ten.

For the third month in a row, California and Florida cities accounted for nine out of the top 10 metropolitan foreclosure rates among the 230 metropolitan areas tracked in the report.

RealtyTrac noted that “Foreclosure filings were reported on 8,713 Nevada properties during the month, up nearly 85 percent from June 2007, and one in every 122 Nevada households received a foreclosure filing — more than four times the national average.”

“One in every 192 California properties received a foreclosure filing in June, the nation’s second highest state foreclosure rate and 2.6 times the national average.”

“One in every 201 Arizona properties received a foreclosure filing during the month, the nation’s third highest state foreclosure rate and nearly 2.5 times the national average. Foreclosure filings were reported on 12,950 Arizona properties, down less than 1 percent from the previous month but still up nearly 127 percent from June 2007.”

“Foreclosure filings were reported on 68,666 California properties in June, down nearly 5 percent from the previous month but still up nearly 77 percent from June 2007. California’s total was highest among the states for the 18th consecutive month.”

“Florida continued to register the nation’s second highest foreclosure total, with foreclosure filings reported on 40,351 properties in June — an increase of nearly 8 percent from the previous month and an increase of nearly 92 percent from June 2007. One in every 211 Florida properties received a foreclosure filing during the month, the nation’s fourth highest state foreclosure rate and 2.4 times the national average.”

“Foreclosure filings were reported on 13,194 Ohio properties in June, the nation’s third highest state foreclosure total. Ohio’s foreclosure activity increased 7 percent from the previous month and 11 percent from June 2007. The state’s foreclosure rate ranked No. 6 among the 50 states. Other states in the top 10 for total properties with filings were Arizona, Michigan, Texas, Georgia, Nevada, Illinois and New York.”

“Seven California metro areas were in the top 10, and the top three rates were in California: Stockton, with one in every 72 households receiving a foreclosure filing; Merced, withone in every 77 households receiving a foreclosure filing; and Modesto, with one in every 86 households receiving a foreclosure filing. Other California metro areas in the top 10 were Riverside-San Bernardino at No. 5; Vallejo-Fairfield at No. 7; Bakersfield at No. 8; and Salinas-Monterey at No. 10.”

“The top metro foreclosure rate in Florida was once again posted by Cape Coral-Fort Myers, where one in every 91 households received a foreclosure filing — fourth highest among the nation’s metro foreclosure rates. The foreclosure rate in Fort Lauderdale, Fla., ranked No. 9. LasVegas continued to be the only city outside of California and Florida with a foreclosure rate ranking among the top 10. One in every 99 Las Vegas households received a foreclosure filing in June, more than five times the national average and No. 6 among the metro areas.”

“Metro areas with foreclosure rates among the top 20 included Phoenix at No. 12, Detroit at No. 13, Miami at No. 15 and San Diego at No. 17”

RealtyTrac does not expect foreclosure activity to ease up until 2009.