Friday, August 31, 2007

Bush Home Mortgage Bailout Rewards Delinquents with Write-Offs and Tax Deductions

Bush will announce his bailout plan today:

Get a tax deduction for NOT paying your mortgage.

"A suspension of the debt-forgiveness tax could help people who are hoping to work out a reduction in their loan balance -- and payments -- as a way of avoiding foreclosure" (Los Angeles Times, via Bush aims to ease US mortgage woes - report (Forbes)).
Have you been doing things the hard way by paying your mortgage to get a tax deduction?

Update 3/29/08: "Bush Readies Mortgage Aid Plan: At-Risk Owners Could Get Cheaper Loans"

Wednesday, August 29, 2007

Federal Reserve Blind to Housing Bubble: BLS OER V. Case Shiller HPI

Flawed Fed Interest-Rate Policy Based on Rent Inflation, Not House Inflation, Causes Vicious Cycle

Fed Policy: First Identify a Problem . . .

Bloggers for years recognized the housing bubble because house prices diverged from rents. The Fed's John Krainer and Chishen Wei used Federal Housing Enterprise Oversight (OFHEO) data to document the inflated price-rent ratio in 2004 (before the mania of 2005-2006). They argued that expectations of future home-purchase returns drove the divergence but strangely added that "other factors, such as bubbles, do not appear to be empirically important for explaining the behavior of the aggregate price-rent ratio" (Federal Reserve Bank of San Francisco, FRBSF Economic Letter 2004-27, 10/1/04)--even though bubbles are driven by their identified cause, expectations of future returns.

. . . And then Ignore the Problem

The Fed likes to target "core inflation" (without volatile food and energy prices) which uses the Bureau of Labor Statistic's (BLS) Owners' Equivalent Rent (OER). The OER estimates the hypothetical rental value of an owner-occupied, non-rented home and therefore ignores the house's actual purchase price and PITI (Price, Interest, Taxes, Insurance) carrying cost.

Price-rent diverged and the Fed followed the red herring (rent, instead of purchase cost in an "ownership society").

Vicious Cycle of Inflation

The vicious cycle is that the Fed's loose monetary policy through low interest rates causes the housing bubble inflation, but the Fed watches a core-inflation statistic that ignores the house-price inflation it causes, so the Fed underestimates real inflation and keeps interest rates too low, which continues to feed the inflation that is invisible to the Fed.

The Fed is willfully blind because the bubble economy is government policy.

The Fed Is Always a Day Late and a Dollar Short

The Fed's recent bailout of speculators and buttressing of overpriced assets (by lowering the effective Fed funds interest rate and officially cutting the discount-window interest rate) shows that it still ignores the excess inflation that it has caused and is causing.

Wanted: Regression to the Mean

Tim Iacono at Seeking Alpha posted good background on how substituting the Case-Shiller Home Price Index (HPI) Composite 10 for the OER would expose some of the real inflation caused by Fed policy. Iacono however erred by suggesting that the Fed should cut the Fed-funds target rate now because of the recent decline in real-estate prices (deflation). Iacono looked at year-on-year rates but forgot about the magic of compounded inflation rates (like compound interest) from years of misguided monetary policy.

The graph below uses Iacono's chart data (including his core CPI reference, although the Fed tends to watch the Bureau of Economic Analysis' (BEA) core Personal Consumption Expenditures Price Index (PCEPI), which cuts the OER weight in half to 19% of the index) to show that the accumulated inflation from 2000 through 2006 is triple the level that would have occurred at the Fed's stated, desired target of annual 2% core inflation (even the PCEPI-HPI would show real inflation at double the Fed's target).

We now need real price deflation to counteract years of over-inflation and return the economy to a reasonable trend line. Cutting the benchmark Fed funds interest rate (or any other action to increase liquidity) would preserve or expand the over-inflation. If anything, today's monetary policy is still too loose and today's interest rates are still too low--as the markets keep trying to tell the Fed through rises in the effective Fed funds rate.

Friday, August 24, 2007

Ford Begs Bailout Rate Cut from Federal Reserve

That Ol' Black Magic for the Bottom Line

Ford Motor Company Chief Executive Officer (CEO) Alan Mulally pleaded the Federal Reserve to cut interest rates (the Fed funds target rate).

Ford lost $12.6 billion last year and Mulally wants the Fed to flood the economy with cheap credit again so that consumers temporarily feel wealthier and spend more freely.

Feeling wealthier on an inflated bubble economy is what put so many people in the current mess in the first place.

Ford's petition for corporate welfare might not be much of a strategic plan but otherwise it would have to build good cars at a good price.

Wednesday, August 22, 2007

Federal Reserve Pushing on a String

Fed Confuses Supply and Demand, Confuses Problems and Solutions

Federal Reserve Fed funds interest rate cuts are dangerous because Fed policy is based on an alleged credit-supply crunch when the actual condition is a credit-demand crunch. Moreover, the crunch is the solution, not the problem. These pressures are good and necessary for economic health (like your body’s pain signal to tell you to stop doing something harmful) so Fed policy to fight them, with the wrong tools, is doubly stupid.

Being unwilling to lend is completely different from being unable to lend. If the Fed has any concern, it should be the overall availability of credit in the economy as a whole and not how the markets allocate that credit. In other words, from the Fed’s view, banks are part of demand, not supply; the Fed is the supply and “the markets” (lenders and borrowers combined) are the demand.

Less wealth, higher risk premiums, and fewer buyers mean less demand for credit in the economy.

  • It is an information crunch, not a credit crunch: The uncertainty in asset prices limits demand for credit: Investors and lenders wisely do not trust current asset pricing. Junk assets will have a market too—at the right price—but it takes time to re-price. Meanwhile, tirekickers are not buyers.
  • It is a wealth crunch, not a credit crunch: Lower asset values (less wealth) limit the demand for credit: The housing bubble bust that has occurred so far means that, even under old loan-to-value (LTV) formulas, 100% of the house today is a lower credit limit than 100% of the house last year.
  • It is a collateral crunch, not a credit crunch: The limited supply of quality collateral limits demand for credit: There are plenty of people who will offer you junk for collateral but they will think twice before borrowing--and what they are borrowing for--when banks wisely demand the family silver (a known, good value). The banks are correct to demand the family silver and the Fed is exactly wrong to accept mortgage securities to send the opposite message.
  • It is a borrower crunch, not a credit crunch: The limited supply of quality borrowers limits demand for credit: Lenders are wisely not lending to all those people who “had no business getting a loan”—especially after the media and Congress pilloried lenders for lending too much to too many. Remove many fraudsters, gambling real-estate flippers, and other unqualified buyers from the buyer pool.
  • It is a savings crunch, not a credit crunch: Higher downpayment requirements limit demand for credit: A 0% interest rate would be irrelevant at 100% downpayment requirement (no financing allowed). In more realistic terms, lowering mortgage rates from 6% to 5% will have limited impact if minimum downpayments rise from negative 5% (cash back at closing) to positive 10% or 20%. A 0% downpayment on a $500k house creates demand for $500k of credit but a 20% downpayment on the same $500k house creates demand for only $400k of credit. A global move from everything at "zero down" to everything at "20% down" would reduce total credit demand by 20%. Demand for credit further decreases when buyers who lack the cash downpayment leave the buyer pool, regardless of the interest rate.
  • It is a re-pricing crunch, not a credit crunch: Narrower bands in loan pricing limit demand for credit: More accurate pricing of risk wisely includes different interest rates at smaller increments of downpayments (10%, 15%, 20%), which has the double effect of disqualifying bad borrowers (higher rates at the lower end) and giving good borrowers more incentive to borrow less.
  • It is a "beggar thy neighbor" crunch, not a credit crunch: The “debt for you, cash for me” impulse limits demand for credit: Some of the credit demand is the hope that someone will go into debt to finance a higher price for someone else (e.g. a seller does not want credit but wants his/her buyer to have unlimited credit, whereas the buyer would prefer less credit for a lower price). Let your neighbors stimulate the economy with their debt while you collect cash and save: "I wish you had more debt and I had less debt." This non-borrowing Mexican standoff is healthy, contrary to the usual "paradox of thrift" argument (with its absurd notion that, if everyone is smart, we all suffer--and its absurd conclusion that government must force individuals to behave foolishly so the aggregate foolishness will create propserity, somehow). Our current trouble resulted from people NOT being smart and NOT doing what was in their self-interest. In the long run, you want your neighbors to be responsible and thrifty.
  • It is a risk premium crunch, not a credit crunch: An increasing risk premium limits the demand for credit: All the reasons above suggest that lenders/investors are wisely demanding a higher marginal price spread for risk (e.g. a risky borrower who used to be able to get 3% over prime rate now can get only 4% over prime rate). To keep these borrowers/buyers, the Fed would have to cut rates faster than the risk spread rises.

People wrongly infer that “credit crunch” indicates a lack of available credit in the economy as a whole when actually there is a lack of known credit-worthy investments (information crunch).

The Fed, like most government, has little power to create good investments, so it panics and hits the button it does have, to increase credit, even if that makes the situation worse. Fed Chairman Ben Bernanke treats the wise solutions of market participants as problems to be stamped out with more of the loose monetary policy that caused the predicament. Bernanke seems to know that the issue is not the Fed’s supply of credit but the economy’s demand for credit, because he made a pitiful telemarketing call to increase the demand for Fed credit.

Fed interest rate cuts push on a string.

Many of these listed effects on demand for credit are inelastic to interest rate changes (not sensitive to small changes in the price of borrowing) or completely independent of interest rate changes (downpayment requirements), so small interest rate cuts are as ineffective as pushing on a string at stopping the seismic processes underway, despite psychological Wall Street rallies.

While everything has a selling price (ING bought Barings Bank for 1 British Pound (<$2) in 1995), and non-buyers will become buyers at a certain price, the genie is out of the bottle in so many regards that small cuts might have little lasting positive effect, yet large cuts could be disastrous in so many other ways.

Next: 10 Reasons Against Federal Reserve Rate Cut

Senator Chris Dodd's Housing Bailout Plans

The road to the White House is paved with your paychecks.

Senator Chris Dodd (D-CT) wants to do “everything possible” to pump more liquidity into the economy, according to his statement aired on NPR this morning.

Presidential hopeful Dodd had been telemarketing to give away your money by asking everyone he could find in the housing bubble bust what "he" could do for them.

Dodd now wants to "print" more money by loosening monetary policy further. He met yesterday in a closed-door meeting with Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson.

Of course, the powerful Senate Banking Committe Chairman Dodd asserted that he did not exert any political pressure on these guardians of our currency. He merely wanted to meet them personally in a closed room so the public cannot know what he said.

Opening up the printing presses (increasing liquidity) gives away your money in a sense because it devalues each dollar that you own, hence the term "inflation tax."

Dodd wants to do everything possible to increase your inflation tax to bailout mortgage delinquents, speculators, banks, and Wall Street.

Dodd updates:
Financial Homeland Security: Obama Tries Nationalizing Power Grab, Dodd Tries To Profit from Credit Crisis

NewDeal, SarbanesOxley, HomelandSecurity Recidivism: Financial Regulation Stupidity Roundup

Friday, August 17, 2007

Federal Reserve Pushes Debt in Conference Call to Banks

Federal Reserve Chairman Ben Bernanke reduces himself to an "easy money" telemarketer to push more debt onto the economy.

Did Bernanke remember to call when the banks were in the middle of dinner?

The Fed claims that it is pumping cash into the markets only because they need it for normal operations. However, if the markets truly needed extra money, they would not need a hard-sell telemarketing call from the Fed to get them to use the discount window (from which the Fed loans directly to financial institutions).

Is Fed policy a "solution" in search of a problem?

Investors first need to assess accurate asset value and the markets are trying to repair the misinformation of pricing that the Fed's loose monetary policy instigated. Yes, while Congress is running around like a chicken with its head cut off to dream up new regulations, the markets are trying to self-regulate for the simple reason that bad loans can lose money--except that the government (Fed and certain politicians) keeps trying to push the markets back into the same, bad decisions.

Fed Policy: When you are too far in debt, borrow more.

"Fed officials know the discount window action will only be effective if banks either use it, or the knowledge of its availability, to expand their own lending to high-quality counterparties such as high quality mortgage borrowers" (WSJ) (italics added).
The Fed apparently wants the discount-window's easy cash and its promise as a future bailout to encourage banks to go back out on a limb at the new, more indebted level. People who argue that the discount window's loans are limited overlook this ripple effect of relying on the promise of Fed money to "free up" and then "max out" lending of non-Fed money. It is the difference between handing credit cards to your teenagers, and handing credit cards to your teenagers while telling them not to worry if they go over their limits and cannot make their payments.

The Fed's "Refinance Now! Our records indicate that you qualify for our special rates!" telemarketing is a bad precedent. Is there any way that we can get the banks on a "Do Not Call" list?

Hat Tip: Calculated Risk

Federal Reserve Cuts Discount Rate 0.5%

The Federal Reserve announced a 0.5% cut to the discount rate, the rate it charges to financial institutions (whereas the more discussed Fed funds rate is the overnight rate which institutions charge each other). The Fed not only sprang this surprise cut to the less-watched rate, it doubled the bailout by the unusual action of extending the loan term to 30 days.

Should Ben Bernanke Resign? Who Should Be the New Federal Reserve Chair?

Should Ben Bernanke Resign? Who Should Be the New Federal Reserve Chair?

Bernanke’s Bailout Destroys His Credibility
in wrong response to banks incresing effective Fed funds rate toward 6%

Federal Reserve Chairman Ben Bernanke replaced Alan Greenspan and, like all new central bankers and substitute teachers, sought to establish authority and credibility immediately. However, Bernanke has been like a deer frozen in the headlights by freezing the official target Fed funds interest rate at 5.25% (the Fed declares a target and works to maintain it but the “effective rate” is what the market actually does).

The problem with 5.25% is that credit is still too cheap and risk is still too underpriced (the cost margin between low and high risk is too small). Worse, many special interests are lobbying to cut the rates back to the dangerous levels of easy (but depreciated) money that caused the bubble recklessness and put us in the current predicament in the first place.

Greenspan loosened monetary policy in the 1990s, organized the 1998 bailout of Long-Term Capital Management (LTCM) hedge fund, and began slashing the Fed funds target interest rate on January 3, 2001 (during the Clinton administration before 9/11, contrary to frequent punditry) through June 25, 2003's 1% rate and kept 1% for over a year until June 30, 2004, never since returning to the May 16, 2000 6.5% rate despite all the talk of a "Goldilocks ecocomy" prosperity, and meanwhile igniting the housing bubble and feeding the subprime beast a steady diet of loose credit. Greenspan was known to the markets as a soft touch because they felt that the infamous “Greenspan put” (his willingness to bailout the markets by pumping more cheap money into the system) always would postpone the day of reckoning yet again.

Fed Needed New Spine, Got New Face Instead

Bernanke has destroyed any potential authority he might have had by caving in to the first signs of volatility and pumping tens of billions of dollars into the markets in the last 2 weeks. One commentator argued that people are overreacting to the Fed’s actions because the liquidity is “temporary.” However, it does not matter that much of those injections have been returned to the Fed when (1) the Fed issued a “blank check” by stating that it was ready at all times to bailout whenever “necessary” and (2) the typical 14-day limit to each liquidity injection does not matter if the Fed is willing to refinance perpetually with fresh injections.

The markets “got” the message that “Helicopter Ben” Bernanke will come to the rescue and the party can continue: The effective Fed funds rate sank below the Fed’s target of 5.25% and some deals hit the basement of 0% interest. Further, the Fed-funds futures market responded by expecting a rate cut at the next Federal Open Market Committee (FOMC) meeting.

Fed Failure

  • Bernanke’s Fed claimed that it intervened last week because the always-fluctuating effective Fed funds rate was not at the target rate. However, the Fed’s overreaction to understandable market volatility, and to the desirable market correction in pricing (banks raising the effective rate to price risk better), left the effective rate still off target (not higher anymore but lower than the target rate, which is worse than the initial “problem”).
  • The Fed’s action also interfered with the market healing itself just as participants finally were trying to grapple with more-realistic prices.
  • Actions speak louder than words and Fed protestations that it will not bailout investors pale against its panicky interventions to stop panic. Traders can see who is panicky and they know an easy mark when they see one.
The Fed has increased moral hazard. The markets will expect more bailouts in the future. Each Fed bailout increases the pressure for the next bailout.

Meanwhile, each bailout placates only temporarily but at the cost of repeating the over-liquidity mistake that caused the mis-pricing problem in the first place.

The market initiated the solution and the Fed stepped in to sabotage the solution.

Friday, August 10, 2007

Federal Reserve's $38 Billion Binge Bails out Markets--for Today

The Federal Reserve cannot shake the easy-money monkey off its back.

The Federal Reserve slipped out and found its crack dealer again and burned up another $38 billion in emergency liquidity to prop up housing and stock prices even though they might still be overpriced at current levels.

Do you feel good now, Chairman Bernanke? You needed $24 billion yesterday. You needed $38 billion today. What about Monday? How much will you need on Monday?

"Fed funds climbed above 6% on Friday, reflecting uncertainty in the financial system, and the Federal Reserve Board said it was providing liquidity to facilitate the orderly functioning of financial markets" (Forbes).
If we all marched off a cliff, would it be OK if we did it orderly?

Has the Federal Reserve ever heard of Adam Smith and the invisible hand of the market?

The Fed funds climbing above 6% is the market trying to tell the government that politicians are trying to force an unnatural, unsustainable policy--i.e., not only should the Fed not cut rates, borrowing is still too cheap.

Hillary Clinton's Billion-Dollar Housing Bailout and Economic Illiteracy

Add Hillary to the bipartisan list

Your cost: $2 billion

Hillary Clinton showed that she has no idea what she is talking about but wants to spend at least $1 billion of your money doing it.

Hillary’s subsidy to the rich (tax cuts for rich bad, but subsidies for rich good?)

Hillary Clinton proposed a federal government $1 billion fund of your tax dollars to bailout home-mortgage delinquents, banks, and Wall Street investors (since the mortgage payment goes to the banks and investors).

Her website's 8/7/07 press release appeared to call for a second billion-dollar fund, for a total of at least $2 billion.

Hillary’s economic illiteracy

Clinton began to show her misunderstanding of basic economics in her CNBC interview by praising the recent tightening of lending standards as a way to prevent foreclosures, even though tightened lending standards do the opposite and will increase foreclosures in current conditions.

She announced in her website's 8/7/07 press release, "If I were President, I would . . . increase the supply of affordable housing." Apparently, she has no idea that (1) it is the currently huge housing inventory (supply) that contributed to the housing crash and foreclosure problem (lower home values, new homes available cheaper than an over-indebted seller's mortgage), and (2) market crashes automatically make housing more affordable (prices drop) but her bailout policies will prop up inflated prices and keep housing less affordable.

She apparently cannot decide whether she wants housing to be less expensive or more expensive because moments later her press release declared war on lower home prices, "To make matters worse, home prices are weakening."

Hillary’s elitism: “Let them eat cake”

Clinton started the patented family sob story in her CNBC interview but then showed more confusion by also stating that it was good that fewer low-income people can get loans because low-income people getting loans contributed to the housing bubble. She asserted that some people "just had no business getting into homeownership.”

It certainly was unwise for people at all income levels to take as much credit as anyone would give them but Clinton seems unable to decide whether she wants to increase the high liquidity that caused the housing problem (her $2 billion bailout) or decrease liquidity and restrict credit.

Hillary can’t spend your money unless you mail it to her

Clinton quickly followed her interview's “struggling family” routine with her other concern, “but it's also about the impact that this is having, and could very dramatically, have on our economy going forward." Remember that a bad economy decreases tax revenue to the government and many politicians do not like it when you send less money to fill their coffers--so stay at your galley oar.

Hat Tip: Another F#cked Borrower

Thursday, August 9, 2007

European Central Bank Bailout for US Housing Bubble

European Central Bank Throws Gasoline on the Liquidity Fire

The European Central Bank (ECB) injected 95 billion Euros ($131 billion) at low 4% interest rates in response to a $2.2 billion suspension crisis at France's largest bank, BNP Paribas SA, which is suffering from an inability to fairly value its US subprime mortgage securities.

Loose credit caused the subprime mortgage mess of bad housing bubble loans making some mortgage securities worthless, so the ECB's bailout repeats the causes of the problem, extends the problem, and magnifies the problem by telling lenders, borrowers, and investors to continue to make stupid decisions because the government will bail you out at the expense of others (i.e. creates moral hazard).

Governments' indecisive bailout policy creates uncertainty and impairs our rational decision-making ability.

The US Federal Reserve added $24 billion of liquidity even though its recent Federal Open Market Committee (FOMC) decision not to cut the federal funds target rate was a refusal to add liquidity.

The bailout attempts reignite the loose monetary policy (over-liquidity) problem, increase moral hazard, send confusing mixed signals to markets, and could backfire by creating a panic.