I see frequent commercials on TV with Muriel Siebert, the "First Lady of Finance," crowing that her firm has never invested in "derivatives" or "structured products." Well this is like a commodities trader saying he has never invested in futures.
We have all, except for perhaps Ms Siebert, come to realize that "securitized debt" has long since become the dominant source of credit for our very advanced economy. Without it, we falter. And we know this, because this is what is happening now, lack of credit has reduced consumption, reduced consumption has caused lower production, lower producton means people lose their jobs. Perhaps the best example is the auto market. GM is not the only maker in trouble, Toyota has also asked the Japanese government for help.
If everyone followed Ms Siebert and refused to invest in "securitized debt" there would be way too little credit to revive the economy. In sum following her lead would lead us to an even worse situation.
No, we must allow the Feds to put more funds into Fannie Mae and Freddie Mac to allow these engines of the mortgage industry to issue, collect and "securitize" more mortgages that will in turn revive the housing market. We must allow the Federal Reserve to implement its "TALF" program that will buy up non-mortgage loans including auto loans, student loans, commercial loans, credit card debt and so on. "TALF" will buy these loans, bundled them and sell them as "securitized debt." If this is not done, say goodbye to recovery, no matter how much stimulus President Obama puts into the mix.
Again, if we follow Ms. Siebert's lead we guarantee failure. Funny, while she eschews "securitized debt" she shills "tax-free" municipal bonds. As if not buying "securitized debt" does not do enough to frustrate the recovery, she wants to deny the Feds funds to do anything. I guess she was Herbert Hoover's advisor too.
Leo Cecchini
March, 2009
Friday, March 13, 2009
Thursday, March 12, 2009
GET A JOB
Perhaps my articles describing how the present economic slump is forcing the Federal Government to take an even larger role in the economy have been a bit too heavy on financial details for the average reader. But there is one lesson that all should understand.
Until now Uncle Sam has been the largest consumer of our economic output, central banker, and rules maker for economic activity. To this he has added becoming the largest investor in the private sector (he is already the largest investor in the public sector with state and local governments being the others). Uncle Sam now owns the core of our mortgage industry, the largest insurance company, shares in the principal banks, and shares in the auto industry. No doubt he will add more to his investment portfolio.
And if Uncle Sam was the largest consumer of our economic output before, the planned national budget will see his share of consumption rising from 20% of our output to 30% of our output. To put it in my quaint phrasing, “we all suck from the public trough, it’s just that some have longer straws.”
So what does mean for the most pressing issue of the day, how do I keep my job or get a new one? The answer is obvious, if you are in a federal government job, you are assured of continued employment. If not, then get one as soon as possible.
Contrary to the contraction in employment in the private sector and even state and local government, Uncle Sam is hiring like the straw boss at a new construction site. Who is he hiring? For starters he needs many more economists and financial people to oversee his new investment portfolio, restructuring of the financial regulations systems, handling his new “securitized” debt activities, and spending massive new amounts of money.
But expansion of the federal work force will go well beyond these. Uncle Sam will need people specialized in the arts to monitor and control the Stimulus Fund expenditures on the arts. He will need educators to guide his massive commitment to increased funding of schools. In my own bailiwick, Uncle Sam will hire 800 new diplomats, an increase of perhaps 20%. The list is virtually endless.
Any job seeker today will do well to check with federal government employment as soon as possible.
Leo Cecchini
March, 2009
Until now Uncle Sam has been the largest consumer of our economic output, central banker, and rules maker for economic activity. To this he has added becoming the largest investor in the private sector (he is already the largest investor in the public sector with state and local governments being the others). Uncle Sam now owns the core of our mortgage industry, the largest insurance company, shares in the principal banks, and shares in the auto industry. No doubt he will add more to his investment portfolio.
And if Uncle Sam was the largest consumer of our economic output before, the planned national budget will see his share of consumption rising from 20% of our output to 30% of our output. To put it in my quaint phrasing, “we all suck from the public trough, it’s just that some have longer straws.”
So what does mean for the most pressing issue of the day, how do I keep my job or get a new one? The answer is obvious, if you are in a federal government job, you are assured of continued employment. If not, then get one as soon as possible.
Contrary to the contraction in employment in the private sector and even state and local government, Uncle Sam is hiring like the straw boss at a new construction site. Who is he hiring? For starters he needs many more economists and financial people to oversee his new investment portfolio, restructuring of the financial regulations systems, handling his new “securitized” debt activities, and spending massive new amounts of money.
But expansion of the federal work force will go well beyond these. Uncle Sam will need people specialized in the arts to monitor and control the Stimulus Fund expenditures on the arts. He will need educators to guide his massive commitment to increased funding of schools. In my own bailiwick, Uncle Sam will hire 800 new diplomats, an increase of perhaps 20%. The list is virtually endless.
Any job seeker today will do well to check with federal government employment as soon as possible.
Leo Cecchini
March, 2009
Wednesday, March 11, 2009
MARK 2 MARKET
Yes, the title is a double entendre. Let me explain.
I have steadily called for junking the “mark to market” rule for valuing mortgage based assets or securitized debt, the so-called “toxic” assets. These include mortgages bundled and sold as bonds and the infamous credit default swaps, a type of insurance for the bonds. There is no market for these instruments at this time. In the absence of a market those doing the valuations use their various models and Quija boards to determine values. The most prevelent model is to value mortgage based assets to the depressed value of property in the most depressed markets. I have asked that these assets be valued at their long term value, i.e. the mortgages held to maturity, minus the still small foreclosure rate now at 3%.
Those insisting on “mark-to-market” rules base their defense in predicting that if the assets are not valued this way, investors will not buy any. Well investors are not buying them now, so what would be lost?
Well the “mark-to-market” defense has been hit with two big blows. Fed Reserve Chariman Bernanke now calls for “fine-tuning” the “mark-to-market” rule. He does not want to suspend the rule, but rather adjust it to give a more accurate value to the assets. I modestly suggest he use my proposal, mark mortgage based assets to their maturity value, minus actual foreclosures.
At the same time well known Congressman Barney Frank has come out forcefully to change the “mark-to’market” rule and restore the “uptick” rule for selling shares short, i.e. selling shares at today’s price that you will deliver later, when the prices are lower. This is the classic bear market strategy, i.e. it works when stock values are declining steadily. The uptick rule serves to prevent short sales driving stock prices down too fast and too far.
These calls to battle will lead to a quick overhaul of these, and other rules, causing the plummeting stock market, and the economy itself, to fall faster and further than they should. Bernanke also called for major new Federal control over the financial markets.
So now our financial market will operate under revised and new rules which will yield a much changed market that I call, “Market 2.” Clever title, no?
Leo Cecchini
March, 2009
Categorized in Uncategorized
I have steadily called for junking the “mark to market” rule for valuing mortgage based assets or securitized debt, the so-called “toxic” assets. These include mortgages bundled and sold as bonds and the infamous credit default swaps, a type of insurance for the bonds. There is no market for these instruments at this time. In the absence of a market those doing the valuations use their various models and Quija boards to determine values. The most prevelent model is to value mortgage based assets to the depressed value of property in the most depressed markets. I have asked that these assets be valued at their long term value, i.e. the mortgages held to maturity, minus the still small foreclosure rate now at 3%.
Those insisting on “mark-to-market” rules base their defense in predicting that if the assets are not valued this way, investors will not buy any. Well investors are not buying them now, so what would be lost?
Well the “mark-to-market” defense has been hit with two big blows. Fed Reserve Chariman Bernanke now calls for “fine-tuning” the “mark-to-market” rule. He does not want to suspend the rule, but rather adjust it to give a more accurate value to the assets. I modestly suggest he use my proposal, mark mortgage based assets to their maturity value, minus actual foreclosures.
At the same time well known Congressman Barney Frank has come out forcefully to change the “mark-to’market” rule and restore the “uptick” rule for selling shares short, i.e. selling shares at today’s price that you will deliver later, when the prices are lower. This is the classic bear market strategy, i.e. it works when stock values are declining steadily. The uptick rule serves to prevent short sales driving stock prices down too fast and too far.
These calls to battle will lead to a quick overhaul of these, and other rules, causing the plummeting stock market, and the economy itself, to fall faster and further than they should. Bernanke also called for major new Federal control over the financial markets.
So now our financial market will operate under revised and new rules which will yield a much changed market that I call, “Market 2.” Clever title, no?
Leo Cecchini
March, 2009
Categorized in Uncategorized
Monday, March 9, 2009
"TOXIC" ASSETS TO THE RESCUE
If you haven’t noticed by now it should be abundently clear that the private sector hasn’t a clue how to recover from the economic slump in which we now find ourselves. The only “White Knight” with a lance long enough to slay this “dragon” is Uncle Sam. You might ask, “How can the government solve the problem when the best minds in the private sector are not able to come up with a solution?”
To understand why the Feds can succeed when “market economics” fail you have to go to the fundamental difference in how the Feds hold assets and how the private sector holds assets. The private sector borrows money to make investments and the return from the asset must be at least enough to cover the cost of the borrowing in order to make a profit. If the assets decline in value to less than what one owes he is technically bankrupt, i.e. liabilities exceed assets.
“Securitized” debt,the so-called “toxic” assets that have led to the economic slump, are mortgages and other loans bundled and sold as bonds with each bond representing a share of the total group of loans. In this they resemble mutual funds where the fund buys a group of assets and sells a share in the total amount to investors. The theory of combining these investments into packages to sell in pieces is that it distributes your ownership over a large group of assets instead of just one or two. This increases your chances for gain and reduces the potential for loss.
However, while mutual funds are traded on open markets, ”securitized” debt does not have such a market. In the absence of a visible market, “securitized” mortgages, have been devalued to the depressed value of the property market. However, the mortgage is not the underlying property. While the home may have dropped in value by 30% or more, the mortgage has only lost value due to foreclosures and defaults. Since foreclosures stand at 3% of mortgages and defaults stand at 7%, valuing these mortgages to the property has greatly exaggerated the loss.
So much for how the private sector holds assets. The Federal Government has a different position. The Federal Government does not borrow against the value of its assets, it borrows against the “full faith and credit” of the country itself. Since his ability to borrow is for all intentions unlimited, Uncle Sam can afford to hold assets as long as he likes. In short Uncle Sam can hold these assets as long as he likes without having to watch market conditions, since he has no intention of selling the assets nor do their value affect his ability to borrow.
But Uncle Sam does have to watch his earnings from the assets, since if they do not pay his low costs of borrowing, the deficit will have to be made up by taxes or additional borrowing. Fortunately the average return on the assets he has acquired and expects to acquire is still higher than his cost of borrowing, so he will not have to raise taxes or increase borrowing in the future to pay for a shortfall in earnings.
Now that we see the difference between how the private sector and the public sector, meaning here Uncle Sam, view assets we can now understand why the Feds can now propose curing the economic malaise by cranking up “securitized” debt again. This crisis has made everyone understand that the only way we can obtain the vast amount of credit required to drive our massive economy in today’s world is through “securitized” debt. Say what you will about how these debt instruments are “toxic” and so on, they are needed to make the engine work. To state it bluntly, the so-called “toxic assets” that are blamed for our ecomoic slump are now required to make the economy revive.
To reiterate, private owners of the debt instruments have to match these holdings or assets against their liabilities in order to see if they are still solvent. They do this by seeing what price they fetch in today’s market. The market now tells them that these instruments have lost allot of value. Thus they are judged to be not “solvent.” Uncle Sam has a different test, he only has to show that the average return on the assets, NO MATTER HOW THEY ARE VALUED, covers his small cost of borrowing to buy the assets.
While Uncle Sam can hold “toxic” and other assets without regard to the market for these assets, private investors, under present valuations, cannot do this. This why I have asked to suspend the “mark-to-market” valuations while private investors are forced to hold securitized debt instruments because at today’s “maket prices” they would lose their shirts if they sell them. This would put private investors on the same footing with Uncle Sam, i.e. hold the assets without regard to the market and focus on long term earnings from the assets. In the case of mortgage based assets this means the balance due on the loans, times the interest rate, times the duration of the loan, minus a 3% loss to foreclosures. Unfortunately this has not been done.
If it were not such a terrible problem I could find some humor in the situation. The way to save the economy is to go right back to creating massive amonts of “secritized” debt or “toxic” assets, the very thing blamed for the chaos. However, this time it can work without the problems caused by market valuations because the “securitized” debt will be controlled by the Feds. No, Uncle Sam will not become the sole holder of “securitized” debt, he will simply be its nexus and thereby in a position to make it work better.
To conclude with my constant reference to the “New Economy,” or one in which the Federal Government will play a greater role, this new development will add to making Uncle Sam’s control over the economy even more complete.
Leo Cecchini
March, 2009
To understand why the Feds can succeed when “market economics” fail you have to go to the fundamental difference in how the Feds hold assets and how the private sector holds assets. The private sector borrows money to make investments and the return from the asset must be at least enough to cover the cost of the borrowing in order to make a profit. If the assets decline in value to less than what one owes he is technically bankrupt, i.e. liabilities exceed assets.
“Securitized” debt,the so-called “toxic” assets that have led to the economic slump, are mortgages and other loans bundled and sold as bonds with each bond representing a share of the total group of loans. In this they resemble mutual funds where the fund buys a group of assets and sells a share in the total amount to investors. The theory of combining these investments into packages to sell in pieces is that it distributes your ownership over a large group of assets instead of just one or two. This increases your chances for gain and reduces the potential for loss.
However, while mutual funds are traded on open markets, ”securitized” debt does not have such a market. In the absence of a visible market, “securitized” mortgages, have been devalued to the depressed value of the property market. However, the mortgage is not the underlying property. While the home may have dropped in value by 30% or more, the mortgage has only lost value due to foreclosures and defaults. Since foreclosures stand at 3% of mortgages and defaults stand at 7%, valuing these mortgages to the property has greatly exaggerated the loss.
So much for how the private sector holds assets. The Federal Government has a different position. The Federal Government does not borrow against the value of its assets, it borrows against the “full faith and credit” of the country itself. Since his ability to borrow is for all intentions unlimited, Uncle Sam can afford to hold assets as long as he likes. In short Uncle Sam can hold these assets as long as he likes without having to watch market conditions, since he has no intention of selling the assets nor do their value affect his ability to borrow.
But Uncle Sam does have to watch his earnings from the assets, since if they do not pay his low costs of borrowing, the deficit will have to be made up by taxes or additional borrowing. Fortunately the average return on the assets he has acquired and expects to acquire is still higher than his cost of borrowing, so he will not have to raise taxes or increase borrowing in the future to pay for a shortfall in earnings.
Now that we see the difference between how the private sector and the public sector, meaning here Uncle Sam, view assets we can now understand why the Feds can now propose curing the economic malaise by cranking up “securitized” debt again. This crisis has made everyone understand that the only way we can obtain the vast amount of credit required to drive our massive economy in today’s world is through “securitized” debt. Say what you will about how these debt instruments are “toxic” and so on, they are needed to make the engine work. To state it bluntly, the so-called “toxic assets” that are blamed for our ecomoic slump are now required to make the economy revive.
To reiterate, private owners of the debt instruments have to match these holdings or assets against their liabilities in order to see if they are still solvent. They do this by seeing what price they fetch in today’s market. The market now tells them that these instruments have lost allot of value. Thus they are judged to be not “solvent.” Uncle Sam has a different test, he only has to show that the average return on the assets, NO MATTER HOW THEY ARE VALUED, covers his small cost of borrowing to buy the assets.
While Uncle Sam can hold “toxic” and other assets without regard to the market for these assets, private investors, under present valuations, cannot do this. This why I have asked to suspend the “mark-to-market” valuations while private investors are forced to hold securitized debt instruments because at today’s “maket prices” they would lose their shirts if they sell them. This would put private investors on the same footing with Uncle Sam, i.e. hold the assets without regard to the market and focus on long term earnings from the assets. In the case of mortgage based assets this means the balance due on the loans, times the interest rate, times the duration of the loan, minus a 3% loss to foreclosures. Unfortunately this has not been done.
If it were not such a terrible problem I could find some humor in the situation. The way to save the economy is to go right back to creating massive amonts of “secritized” debt or “toxic” assets, the very thing blamed for the chaos. However, this time it can work without the problems caused by market valuations because the “securitized” debt will be controlled by the Feds. No, Uncle Sam will not become the sole holder of “securitized” debt, he will simply be its nexus and thereby in a position to make it work better.
To conclude with my constant reference to the “New Economy,” or one in which the Federal Government will play a greater role, this new development will add to making Uncle Sam’s control over the economy even more complete.
Leo Cecchini
March, 2009
Tuesday, March 3, 2009
BACK TO SANITY
Well now we have Uncle Sam borrowing up to $3 trillion to fund the TARP, TAFL, Financial Stabilization Plan, Stimulus Plan,and so on. The borrowed funds are being injected into the economy to stop the bleeding and start the rebuilding. But no matter what he does, the body economic seems to slough off the effort and continue its nose dive.
And the dive is steep. Our concern with home foreclosures due to bad mortgages has turned to foreclosures due to loss of job, a much more serious problem. The only hope to stem job loss is President Obama’s Stimulus Plan that will put people back to work. Keep your fingers crossed.
At the same time the players have now come to finally recognize what I have been saying since last summer, you cannot revive the financial sector without dropping the “mark-to-market” rules. The balance sheets of all financial institutions were damaged by marking assets to markets that did not exist. Instead of marking to markets they were marked to models that were no better than notional ideas. These models have devalued assets well below any realistic value. FDIC Chairman Sheila Bair complained that 98% of all banks holding 99% of all bank assets have sound balance sheets but all are being devalued by these notional ideas. This has been the crux of the financial meltdown.
Uncle Sam has sought to build markets to which assets can be accurately valued. However, this has proven to be a difficult process and in any case too slow to correct the situation soon enough. Now we hear a chorus of calls for temporary suspension or a hiatus in marking assets to the market. The importance of this is that suspending this practice will allow balance sheets of financial institutions to recover lost ground instantly.
So here we are some $3 trillion of new Federal debt and nine months of wandering in the wilderness coming back to the reality that we have to value our assets at more realistic values. My particular call is that we value all mortgages and mortgage based assets at the maturity value of the mortgages minus the actual foreclosure rate. In this one case the value of the assets would increase by an average of some 25%. The total value of mortgages on owner occupied homes is some $13 trillion thus a 25% up tick in valuation would add $3.3 trillion to the balance sheets of those holding those mortgages.
If you drop “mark-to-market” rules for ”securitized debt,” originally valued by various observers at some $15 trillion, and further, to the “credit swaps” issued to insure these securitized debt instruments originally valued at $55 trillion, we can see a massive upward valuation in balance sheets, on an order far beyond Uncle Sam’s ability to borrow and spend.
Perhaps even more important, the new efforts by the Feds revive the “securitized debt” industry depend on correctly valuing the new financial instruments that will be created. Uncle Sam is feeding $400 billion into Fannie Mae and Freddie Mac to issue new mortgages that the two now government owned operations will bundle into bonds and sell as “securitized debt.” As a complementary effort the Feds will open the new “TALF” plan to buy up and securitize other loans including auto loans, student loans, credit card debt, and certain commercial debt. No sense doing this if ”mark-to-market” rules make these new instruments crash and burn at takeoff.
I believe it is a damn shame that we have had to go through all this trauma brought about by erroneous valuations of assets. When there is no market, it is foolish to follow “mark-to-market” rules. All this does is allow “wunderkinds” to pull out their electronic Ouija boards to value assets and in the process destroy the economy. It is long past the time to get a firmer grip on valuations of assets. But maybe not too late
And the dive is steep. Our concern with home foreclosures due to bad mortgages has turned to foreclosures due to loss of job, a much more serious problem. The only hope to stem job loss is President Obama’s Stimulus Plan that will put people back to work. Keep your fingers crossed.
At the same time the players have now come to finally recognize what I have been saying since last summer, you cannot revive the financial sector without dropping the “mark-to-market” rules. The balance sheets of all financial institutions were damaged by marking assets to markets that did not exist. Instead of marking to markets they were marked to models that were no better than notional ideas. These models have devalued assets well below any realistic value. FDIC Chairman Sheila Bair complained that 98% of all banks holding 99% of all bank assets have sound balance sheets but all are being devalued by these notional ideas. This has been the crux of the financial meltdown.
Uncle Sam has sought to build markets to which assets can be accurately valued. However, this has proven to be a difficult process and in any case too slow to correct the situation soon enough. Now we hear a chorus of calls for temporary suspension or a hiatus in marking assets to the market. The importance of this is that suspending this practice will allow balance sheets of financial institutions to recover lost ground instantly.
So here we are some $3 trillion of new Federal debt and nine months of wandering in the wilderness coming back to the reality that we have to value our assets at more realistic values. My particular call is that we value all mortgages and mortgage based assets at the maturity value of the mortgages minus the actual foreclosure rate. In this one case the value of the assets would increase by an average of some 25%. The total value of mortgages on owner occupied homes is some $13 trillion thus a 25% up tick in valuation would add $3.3 trillion to the balance sheets of those holding those mortgages.
If you drop “mark-to-market” rules for ”securitized debt,” originally valued by various observers at some $15 trillion, and further, to the “credit swaps” issued to insure these securitized debt instruments originally valued at $55 trillion, we can see a massive upward valuation in balance sheets, on an order far beyond Uncle Sam’s ability to borrow and spend.
Perhaps even more important, the new efforts by the Feds revive the “securitized debt” industry depend on correctly valuing the new financial instruments that will be created. Uncle Sam is feeding $400 billion into Fannie Mae and Freddie Mac to issue new mortgages that the two now government owned operations will bundle into bonds and sell as “securitized debt.” As a complementary effort the Feds will open the new “TALF” plan to buy up and securitize other loans including auto loans, student loans, credit card debt, and certain commercial debt. No sense doing this if ”mark-to-market” rules make these new instruments crash and burn at takeoff.
I believe it is a damn shame that we have had to go through all this trauma brought about by erroneous valuations of assets. When there is no market, it is foolish to follow “mark-to-market” rules. All this does is allow “wunderkinds” to pull out their electronic Ouija boards to value assets and in the process destroy the economy. It is long past the time to get a firmer grip on valuations of assets. But maybe not too late
ROBBING PETER TO PAY PAUL
The Government has announced the details of the plan to bring home values more in line with the debt owed on them, you know, correct the many homes that are financially "underwater," (we used to use the term "upside down"). To be specific, the balance due on the mortgage is more than the value of the house on today's market. As I said before this is a very difficult process and there are few who are able to actually do it. But let's go through the numbers.
There are about 60 million homes in the USA that are owner occupied or some 68% of all homes. Of these two thirds have mortgages. The total value of these homes is estimated at some $20 trillion. Of the total about 8.3 million have negative equity, i.e. they are "underwater."
The latest plan is to reduce the monthly payment on the "underwater" loans to 31% of one's income. This can be done by reducing the interest rate or reducing the balance due. Reducing the interest rate is relatively easy, Uncle Sam can subsidize the interest rate to allow a reduction. But reducing the balance due is a goal just short of finding the "Holy Grail."
Using the numbers I cite above, and they are best estimates, not hard and fast facts, we can see the Government attempting to write down some $2.6 trillion in mortgage balances. The plan is to get the lenders to share this cost with the Feds. I fear, however, that any write down will require the Feds to compensate for the loss. Of course, there is a new Federal Law being considered to allow courts to mandate write downs of mortgage balances. The consequences of this are too dire to contemplate. Let's say for the moment that Uncle Sam will have to shoulder any write downs of loans. If the average write down is 30% that would mean an expenditure of some $800 billion. Still another big chunk of change for Uncle Sam to borrow.
I see two killer problems with this plan. First, just how does one insure that the cost of the home - mortgage, taxes and insurance - is less than 31% of income? I can see every Tom, Dick and Harry busily hiding income to show a lower income stream and thus force a loan write down. And if you think this doesn't happen, remember how many people created "phantom" income when they had to show sufficient income to get a mortgage in the first place. (The 31% rule is that used by the Federal Housing Authority, FHA, to give a loan.) The issue here is fraud and I see widespread fraud being committed to comply with this measure.
The second problem with this plan is that it will be seen as being inherently unfair to those who continue to pay their home costs without this relief. I can see Harry looking across the fence at Tom who gets his home costs reduced by one-third. Both bought their homes at the same price, at the same time with the same mortgage terms, taxes and insurance. However, Tom's income is less than Harry's, or at least that is what he is showing. Now the Feds will pay part of Tom's mortgage so that his house costs no more than 31% of his income.
Will Harry be mad, you betcha. Especially if Tom works alongside of Harry at the same job. The difference is that Tom and his mortgage advisor are smarter at hiding Tom's income. Harry will see this as a ruse to use his tax money to pay part of Tom's mortgage. And he will be right.
Of course I am simplifying the process. It is far more complex than any mortgage business done to date and is fraught with mistakes as well as the certain fraud. Moreover, if those granting mortgages got us into this mess, why turn to them to get us out? They don't have the capacity to do the job, so as far as I am concerned, the plan will be a dismal failure.
I fear that this plan could undermine the entire Obama recovery effort. I see the downside far outweighing potential benefits. I would urge the Obama team to reconsider this plan. Stay with working to prevent foreclosures, don't go to correcting personal balance sheets.
Leo Cecchini
March, 2009
There are about 60 million homes in the USA that are owner occupied or some 68% of all homes. Of these two thirds have mortgages. The total value of these homes is estimated at some $20 trillion. Of the total about 8.3 million have negative equity, i.e. they are "underwater."
The latest plan is to reduce the monthly payment on the "underwater" loans to 31% of one's income. This can be done by reducing the interest rate or reducing the balance due. Reducing the interest rate is relatively easy, Uncle Sam can subsidize the interest rate to allow a reduction. But reducing the balance due is a goal just short of finding the "Holy Grail."
Using the numbers I cite above, and they are best estimates, not hard and fast facts, we can see the Government attempting to write down some $2.6 trillion in mortgage balances. The plan is to get the lenders to share this cost with the Feds. I fear, however, that any write down will require the Feds to compensate for the loss. Of course, there is a new Federal Law being considered to allow courts to mandate write downs of mortgage balances. The consequences of this are too dire to contemplate. Let's say for the moment that Uncle Sam will have to shoulder any write downs of loans. If the average write down is 30% that would mean an expenditure of some $800 billion. Still another big chunk of change for Uncle Sam to borrow.
I see two killer problems with this plan. First, just how does one insure that the cost of the home - mortgage, taxes and insurance - is less than 31% of income? I can see every Tom, Dick and Harry busily hiding income to show a lower income stream and thus force a loan write down. And if you think this doesn't happen, remember how many people created "phantom" income when they had to show sufficient income to get a mortgage in the first place. (The 31% rule is that used by the Federal Housing Authority, FHA, to give a loan.) The issue here is fraud and I see widespread fraud being committed to comply with this measure.
The second problem with this plan is that it will be seen as being inherently unfair to those who continue to pay their home costs without this relief. I can see Harry looking across the fence at Tom who gets his home costs reduced by one-third. Both bought their homes at the same price, at the same time with the same mortgage terms, taxes and insurance. However, Tom's income is less than Harry's, or at least that is what he is showing. Now the Feds will pay part of Tom's mortgage so that his house costs no more than 31% of his income.
Will Harry be mad, you betcha. Especially if Tom works alongside of Harry at the same job. The difference is that Tom and his mortgage advisor are smarter at hiding Tom's income. Harry will see this as a ruse to use his tax money to pay part of Tom's mortgage. And he will be right.
Of course I am simplifying the process. It is far more complex than any mortgage business done to date and is fraught with mistakes as well as the certain fraud. Moreover, if those granting mortgages got us into this mess, why turn to them to get us out? They don't have the capacity to do the job, so as far as I am concerned, the plan will be a dismal failure.
I fear that this plan could undermine the entire Obama recovery effort. I see the downside far outweighing potential benefits. I would urge the Obama team to reconsider this plan. Stay with working to prevent foreclosures, don't go to correcting personal balance sheets.
Leo Cecchini
March, 2009
NATIONAL DEBT - HOW HIGH CAN IT GO?
I am watching the Senate grill Fed Chief Bernanke about his injections of funds into the economy in an effort to restore bank balance sheets to a sound state and prime the consumer pump. I am appalled by the shallow understanding of the situation shown by most of the members of the Senate's banking committee. Here is one worrying about his local banks not having access to the TARP funds when they do. Another worries about banks receiving money but are keeping on their failed executives. And other such trivia.
In spite of their shallow knowledge of the subject in which they set the standards, the Senators did have one question that was worth answering - how large a Federal debt can we support? Bernanke responded by pointing out the familiar fact that our federal debt to national income ratio at the end of WWII was debt amounting to 120% of GDP. He said we now have a ratio of 60% and said that we should try to keep it at that level. But he also said there is no way to know what the maximum debt could be since it depends on willingness to buy our debt, which means essentially Treasury Bills.
Bernanke did not mention it, but the debt is now owned in the main by the US Government itself, mainly through Social Security purchase of T-Bills. Foreign ownership accounts for about 25% of the debt, with China and Japan owning about 20% each of that 25% and the UK about 10%. The rest is owned by various investors.
The question of how large a debt we can support may be answered in several ways. First, the US central government debt as a share of national income ranks 23rd among the major national economies of the world. Using this yardstick, and it is the IMF's ruler, we have a long way to go to reach our limits to borrowing.
Another way to measure national debt would be to compare it to personal debt. The average American family has a debt to income ratio of over 100%, thus the national debt has not yet reached the level of personal debt. One should also note that the standard rule for issuing a new prime rate mortgage is that the home should not cost more than three times the buyer's income, e.g. someone with $100,000 income can buy up to a $300,000 home.
The rule I use in assessing a company's cash flow is that the firm's indebtedness should not exceed one year's gross income, e.g. a million dollar a year cash flow means you can borrow up to one million. I do not know if others use this same rule but it has served me well in providing accurate cash flow analysis.
Using the available measures - historical, international comparisons, personal indebtedness, business indebtedness - it would appear that the national debt can be 100% of GDP without causing alarm. Adding the expected up to $3 trillion that the Obama administration plans to spend this year to revive the economy to the current $11 trillion in national debt, we should wind up with a national debt to national income ratio of about 85%, which is within the 100% guideline.
But there is a dimension to this debate that transcends the debt to income ratio. The national debt is backed by the "full faith and credit of the Republic." This is the same backing for the bucks in your pocket. Does the "full faith and credit" of the USA mean one year's GDP, or more? The critical question here is, how long will the debt holders hold the debt? If they hold it ad infinitum, there is theoretically no limit to what Uncle Sam can borrow.
The other relevant question is how much does it cost Uncle Sam to carry his debt? I have pointed out that at present the Treasury is issuing bonds that pay less than the inflation rate, some with 1% interest. In other words it will cost Uncle Sam probably less than $200 billion a year to carry this expected debt of $14 trillion, a small part of the Fed's budget expected to be some $3 trillion in 2009.
There is another factor to consider. What are the alternatives for foreign holders of US national debt? Fortunately for the USA, unfortunately for the investor nation, there are insufficient alternative instruments available in which to place these funds. They have to hold US national debt.
What does all of this mean? First, Fed Chief Bernanke was correct in saying it is hard to see how far US national debt can go. If one uses debt service ratio, i.e. how much does it cost to pay the debt, Uncle Sam has a very long way to go since he is only paying 6% of his current income to pay the debt. Assume we let debt service reach 12% of the national budget we could have a national debt of twice what it is expected to be in 2009 or $28 trillion.
If I were the Fed Chairman I would respond that we are at a high debt level now, but we can support a much higher debt. I believe President Obama should keep this in mind as he presents more programs to save the economy.
Leo Cecchini
March, 2009
In spite of their shallow knowledge of the subject in which they set the standards, the Senators did have one question that was worth answering - how large a Federal debt can we support? Bernanke responded by pointing out the familiar fact that our federal debt to national income ratio at the end of WWII was debt amounting to 120% of GDP. He said we now have a ratio of 60% and said that we should try to keep it at that level. But he also said there is no way to know what the maximum debt could be since it depends on willingness to buy our debt, which means essentially Treasury Bills.
Bernanke did not mention it, but the debt is now owned in the main by the US Government itself, mainly through Social Security purchase of T-Bills. Foreign ownership accounts for about 25% of the debt, with China and Japan owning about 20% each of that 25% and the UK about 10%. The rest is owned by various investors.
The question of how large a debt we can support may be answered in several ways. First, the US central government debt as a share of national income ranks 23rd among the major national economies of the world. Using this yardstick, and it is the IMF's ruler, we have a long way to go to reach our limits to borrowing.
Another way to measure national debt would be to compare it to personal debt. The average American family has a debt to income ratio of over 100%, thus the national debt has not yet reached the level of personal debt. One should also note that the standard rule for issuing a new prime rate mortgage is that the home should not cost more than three times the buyer's income, e.g. someone with $100,000 income can buy up to a $300,000 home.
The rule I use in assessing a company's cash flow is that the firm's indebtedness should not exceed one year's gross income, e.g. a million dollar a year cash flow means you can borrow up to one million. I do not know if others use this same rule but it has served me well in providing accurate cash flow analysis.
Using the available measures - historical, international comparisons, personal indebtedness, business indebtedness - it would appear that the national debt can be 100% of GDP without causing alarm. Adding the expected up to $3 trillion that the Obama administration plans to spend this year to revive the economy to the current $11 trillion in national debt, we should wind up with a national debt to national income ratio of about 85%, which is within the 100% guideline.
But there is a dimension to this debate that transcends the debt to income ratio. The national debt is backed by the "full faith and credit of the Republic." This is the same backing for the bucks in your pocket. Does the "full faith and credit" of the USA mean one year's GDP, or more? The critical question here is, how long will the debt holders hold the debt? If they hold it ad infinitum, there is theoretically no limit to what Uncle Sam can borrow.
The other relevant question is how much does it cost Uncle Sam to carry his debt? I have pointed out that at present the Treasury is issuing bonds that pay less than the inflation rate, some with 1% interest. In other words it will cost Uncle Sam probably less than $200 billion a year to carry this expected debt of $14 trillion, a small part of the Fed's budget expected to be some $3 trillion in 2009.
There is another factor to consider. What are the alternatives for foreign holders of US national debt? Fortunately for the USA, unfortunately for the investor nation, there are insufficient alternative instruments available in which to place these funds. They have to hold US national debt.
What does all of this mean? First, Fed Chief Bernanke was correct in saying it is hard to see how far US national debt can go. If one uses debt service ratio, i.e. how much does it cost to pay the debt, Uncle Sam has a very long way to go since he is only paying 6% of his current income to pay the debt. Assume we let debt service reach 12% of the national budget we could have a national debt of twice what it is expected to be in 2009 or $28 trillion.
If I were the Fed Chairman I would respond that we are at a high debt level now, but we can support a much higher debt. I believe President Obama should keep this in mind as he presents more programs to save the economy.
Leo Cecchini
March, 2009
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