Mortgage Future Now, Have One Later

This post first appeared on Minyanville.

If only home prices would stop plummeting, we could put this whole credit crunch nonsense behind us.

Unfortunately, a meaningful stabilization in property values is unlikely. Housing inventories are still at excessively high levels, unemployment is creeping up, consumers are stretched and mortgage underwriting guidelines are tighter than they've been in years. The outlook is bleak.

Left to the free market, these issues will take years to work through, as homeowners gradually scrape together the requisite finds to unbury themselves and banks grudgingly realize their losses. While this is the healthiest path economically, it’s also the least acceptable politically.

Short of immediate, full-scale nationalization of the mortgage market through seizure of Fannie Mae (FNM) and Freddie Mac (FRE), there's little the government can do to halt the decline and stem the knock-on effects rippling through the national -- and indeed the international -- economy.

Much of regulators’ efforts thus far have been aimed at solving the problem of negative equity, where a borrower owes more on his home than it’s worth. Congress's recent housing bill allotted $300 billion for the Federal Housing Administration and other taxpayer-backed institutions to shoulder the growing burden.

Progress has been slow; the nasty realities of the situation have impeded plans that were largely ill-conceived to begin with.

Each day, thousands more homeowners find themselves underwater. Unable to sell without coughing up the difference between the unpaid balance on their loan and the sale price, borrowers are left with few options: Continue paying for a losing bet, fall behind and hope their lender will modify the loan, or simply walk away.

Banks like JP Morgan Chase (JPM), Wachovia (WB) and Bank of America (BAC) don’t have many palatable choices, either. Loath to accept short sales (agreeing to a sale price below the loan balance and forgiving the difference) because their beleaguered balance sheets can’t handle the pain, or to modify loans lest they anger securities investors, lenders are hoping they can just ride it out.

Mark Zandi, chief economist at Moody’s Economy.com, estimated earlier this year that as many as 10% of all U.S. homeowners, or 8 million borrowers, are upside-down. With the median home price hovering around $200,000, this means the true value of housing stock (around $1.6 trillion) cannot be determined.

Thus far, home prices on a nationwide basis have fallen around 15% (depending on whose data you believe), which means roughly $240 billion in home equity is yet to be wiped out - despite the fact that it no longer exists.

Since the majority of upside-down homeowners live in California, Arizona, Nevada and Florida, where homes are more expensive, it’s not unreasonable to think this number is closer to $300 billion. It’s no mystery as to how Congress arrived at the total figure for their ineffective housing bill.

The challenge is to sop up negative equity without torpedoing the dollar, as would happen if the Treasury Department simply cut the mortgage industry a $300 billion check. But the money is out there; it’s just a question of tackling the prickly issue of exactly where it is.

According to data compiled by the Census Bureau, in 2005 the collective balance in Americans’ 401k accounts stood at $1.2 trillion. If homeowners were allowed to tap their retirement funds without penalty to pay for their negative equity, 75% of our retirement war chest would remain intact - and the economy could begin a real healing process.

That I’m even proposing such a solution shows how dire the situation is, and how few good options are left.

This may not be an entirely popular idea for a host of reasons.

Many would argue it’s unlikely borrowers who are underwater would have sufficient retirement savings for such a scheme to work. That argument is based on a common misconception, however: That subprime and being upside-down go hand in hand.

During the boom, many good-quality borrowers with good jobs and money in the bank were jammed into Alt-A or even Agency (backed by Fannie or Freddie) loans with high loan-to-value ratios. That means typical middle-class families that bought at the peak are in the same boat as their subprime brethren: A boat dangerously below the waterline.

Others may argue the cost of paying for our longer lives is already likely to bankrupt Social Security and endanger the retirement of millions.

Pilfering retirement accounts truly is mortgaging the future for the sake of the present. But consider the assumptions upon which current retirement cost expectations are based.

ING (ING) runs a snazzy ad campaign depicting concerned citizens toting around their “numbers,” toiling each day in hopes of reaching the net worth required to retire comfortably.

"Comfortably" -- as defined by our McMansions, SUVs, strip mall consumerism -- means a beachfront condo in south Florida, a 4000 square foot Toll Brothers (TOL) luxury track home in Scottsdale, or sweeping vistas from a custom-built manor on the Pacific. Your “number,” as determined by the investment advisors and stockbrokers at Merrill Lynch (MER), is based on pre-credit crisis consumption trends.

Social mood has shifted. We’re seeing the beginnings of a migration towards simplicity, minimalism and attendant revulsion at our past excesses. The future, in short, won’t be nearly as expensive as we think.

30 years from now, when today’s underwater homeowner becomes tomorrow’s retiree, the good life may be defined as a quaint bungalow on the Sea of Cortez, a loft in Buenos Aires’ Palermo district or a remote cabin perched on the edge of a Norwegian fjord. All these options provide just as much, if not more, opportunity for relaxation, peace and the quiet contemplation so many desire in their waning years - at a fraction of the cost.

Mortgaging a piece of our future may be our best bet to have one at all.

FDIC Passes Around Collection Plate

This post first appeared on Minyanville.

Poor, poor FDIC - ever the Treasury Department’s whipping boy.

The latter gets to smack the former around like a badminton birdie because the FDIC’s primary responsibility is to clean up the Treasury’s messes. And these days, there are messes aplenty.

It goes like this: The Treasury oversees a regulatory body called the Office of Thrift Supervision, or OTS, that’s tasked with keeping tabs on federal thrifts (which are just mortgage companies moonlighting as federally chartered banks).

Until recently, the OTS was responsible for monitoring IndyMac Bancorp, which collapsed last month under the weight of misplaced mortgage bets. The FDIC is now sorting out the mess. The OTS also oversees such thriving institutions as Washington Mutual (WM), BankUnited (BKUNA) and Downey Savings (DSL).

Since the OTS’s idea of regulation is apparently to wake up late, sip a latte and spend the day diligently ignoring the wildly unsafe lending practices of its member banks, the FDIC is up to its ears in barely solvent financial institutions.

The FDIC charges deposit-taking institutions fees about $0.05 per $100 in deposits to display the group’s goofy logo (which dates to its Depression-era roots). This is meant to assure customers their money's safe, even if the bank’s risk management policies aren't.

When banks go belly up, the FDIC steps in and covers depositors up to $100,000. In the case of IndyMac, this could cost up to $8 billion. The FDIC’s insurance fund stood at just $53 billion pre-IndyMac, and is now so low it’s been forced to come up with an action plan to raise more money.

The options aren't exactly palatable.

It could jack up the fees it charges member banks, but with so many teetering on the edge of insolvency, they don’t exactly have a lot of cash to spare. The FDIC also has a $30 billion line of credit from the Treasury Department, but it’s loath to tap into it, lest it appear desperate.

Finally, it could borrow from the Federal Reserve, and join other flailing institutions like Lehman Brothers (LEH) and Merrill Lynch (MER), both of which have submerged themselves the warm bath of cheap Federal money.

As the credit crunch migrates outward from its epicenter on Wall Street and infects Main Street, local banks and thrifts are becoming ensnared in troubles previously reserved for complex securities firms. Small banks are often heavily levered to construction firms, small businesses and individuals in their surrounding communities, and are particularly vulnerable to regionalized economic slowdowns.

Downey Savings (in Orange County) and BankUnited (in South Florida), for example, are at the heart of the housing bust. Their local economies are sagging under the weight of job losses in both the construction and mortgage industries, as well as fallout from plummeting home prices. Both banks bet heavily on ill-fated Option ARMs during the boom, and neither is likely to survive the current crisis.

Now, the FDIC's challenge is to raise sufficient funds to cover the coming wave of bank failures - without putting undue stress on the already shaky banking system or igniting fears that it would need to tap taxpayers' money to protect, well, taxpayers' money.

NY Real Estate Blows Its Top

This post first appeared on Minyanville.

Don’t tell Teva-toting Midwesternerns and flash-popping Japanese tourists there’s a recession on: They’ll call you crazy.

Despite souring economic conditions and evidence that consumers are cutting back, the peddlers of the non-essential that line Manhattan’s Fifth Avenue are battling to snap up pricey storefronts.

The New York Times reports rents on the prestigious retail strip are at an all-time high, and 2008 has already seen more new leases inked than in 2006 and 2007 combined. Landlords are literally paying existing clients to break their leases in favor of new, higher paying tenants.

Rents are up to $2,500 per square foot from $1,500 just a year ago, a jump many attribute to higher foot traffic generated by the weak dollar, which makes American goods attractive to foreign tourists.

Highbrow shops are giving way to mainstream chains looking to show off their more glamorous side. In just the last year, Tommy Hilfiger and Abercrombie and Fitch (ANF) signed leases on new office space, while Hugo Boss slinked away after its landlord ponied up big bucks for the retailer to vacate its prominent 56th street location.

Traditionally, opportunities to move into one of the most famous shopping areas in the world have been scant, so when space does become available, the gloves come off. Real estate agents auction off space to the highest bidder, a process one broker at CB Richard Ellis (CBG) described as “frenzied.”

One mass-market brand is bucking the trend, however, and trading down. Walt Disney (DIS) said it won’t renew its lease for the World of Disney when it expires in 2010. Mickey’s crew will be relocating to an undisclosed Manhattan location, likely close to Madison Park, to scoop up spillover traffic from yuppies descending on the Shake Shack.

And while American Express (AXP) may complain its wealthier clients are starting to crack under mounting economic pressures, the resiliency of high-end shopping is evidence of just how difficult it will be to loosen consumerism's grip on the US.

But there may be a more insidious cause for the rent explosion: Hysterical demand -- particularly when it defies all logic -- is often evidence of a blow-off top. A blow-off top is defined as a steep, fast spike in prices, followed by an equally sharp and rapid fall.

Rents that nearly double in the span of 12 months in the teeth of a recession certainly fit the bill. Especially when the battle is for the right to sell the world’s most overpriced pair of jeans.

Retailers, afraid they’d missed the boat on the weak dollar trade, have rushed into the game just in time to see their fortunes reverse. If the greenback catches a bid, an idea investors are increasingly warming to, merchants may see their well-hatched plans backfire.

Opportunistic international bargain hunters are already flocking to Dubai’s glitzy commercial centers and other trendy overseas bazaars, and a snappy dollar is only likely to accelerate this migration. Coupled with the shift in social mood away from the superfluous, the rush to relocate to 5th Avenue may be a contrarian indicator of consumerism's final gasp.

But it’s unlikely the wide promenade that stretches from Rockefeller Plaza to Central Park will become a ghost town any time soon. I mean, who can resist the allure of being lifted across 54th street on a sea of human traffic, wedged against dudes in painfully undersized I Love New York t-shirts and abrasive soccer moms dragging 8-year-olds to the American Girl Place?

With Fannie Falling, All Eyes on Paulson

This post first appeared on Minyanville on August 8th.

You can almost hear Treasury Secretary Paulson firing up his bazooka.

This morning, Fannie Mae (FNM) joined its smaller cousin Freddie Mac (FRE) in announcing losses that exceeded Wall Street's already dour expectations.

The company lost $2.3 billion in the second quarter and plans to slash its dividend to a paltry $0.05 per share, down from $0.25, according to Bloomberg.

All eyes now turn to Paulson, who just weeks ago asked for -- and received -- a blank check from Congress to support the beleaguered government sponsored enterprises, should the need arise. He had hoped the mere existence of the backstop would calm Investors' nerves such that he wouldn't need to step in.

Reality, it appears, had other plans: Shares of the 2 companies have slid back down to where they were when markets feared they'd collapse under the weight of their massive loan portfolios.

Fannie and Freddie are hopelessly levered to the U.S. housing market, which slides deeper into disarray every day. The 2 companies collectively back over $5 trillion of American mortgages, which are going sour at a record pace.

As I wrote earlier this week, after Freddie announced equally dismal results, it's no longer a matter of if they collapse, but when.

It turns out buying mortgages with nothing but a superficial glance at the paperwork -- something Fannie and Freddie excelled at during the housing boom -- just isn't good business.

Although the 2 firms only lightly dabbled in subprime loans, originators easily duped their automated risk engines into buying fraudulent or otherwise shoddy loans.

But since banks like Citigroup (C), Bank of America (BAC) and Wachovia (WB) are saddled with troubles of their own, Fannie and Freddie have been asked to expand their role in the market. They now provide the only liquidity left for new mortgages.

The government has little choice but to bail out their wayward children. If it doesn't, Hank will need a lot more than just a bazooka to save the ship.

Morgan Stanley Latest Band-Aid Over Fannie, Freddie's Bullet Hole

This post first appeared on Minyanville.

It looks like all those short-sellers might have been on to something.

Freddie Mac (FRE), the beleaguered mortgage giant that was just weeks ago on the brink of collapse, released second quarter results this morning that were nothing short of abysmal. Along with the financial backing of you, me and all the other US taxpayers, the government-sponsored enterprise now has:

• $831 million loss or $1.63 per share, compared with net income of $729 million a year ago.
  
• Revenue fell 28% to $1.69 billion compared to last year.
  
• $2.5 billion in credit loss provisions and $1 billion in mortgage-related writedowns.
  
• Board approval to slash dividends from $0.25 per share to “$0.05 or less”.
  
• The intention to raise $5.5 billion or more in fresh capital.

Although the company currently meets capital requirements demanded by its regulator, the Office of Federal Housing Enterprise Oversight, it may fall below those levels if the housing and credit markets continue to deteriorate.

Last month, shares plunged on fears that Freddie and its larger cousin Fannie Mae (FNM) would crumble under the weight of mounting losses in their massive mortgage portfolios. The Treasury Department tried to shore up confidence by demanding Congressional approval to support the 2 companies, should the need arise.

Treasury announced this week it had hired Morgan Stanley (MS) to help sort out the mess and assess the two companies’ financial positions.

It takes a very active imagination to think a company capitalized with just $37 billion to support more than $2 trillion in U.S. mortgage debt is anything resembling stable.

Although Fannie and Freddie managed to avoid buying the worst of the subprime mortgages originated during the housing boom, many equally toxic Alt-A and other non-prime loans made it onto their balance sheets. Even marginally savvy originators were able to exploit their automated underwriting and risk systems, resulting in the loss of billions of dollars from questionable loans.

Fannie and Freddie are now paying for their transgressions - or rather, the American taxpayer is paying, since Congress gave Treasury Secretary Hank Paulson what amounts to a blank check to bail out the two failed companies.

The only questions left are: When will Fannie and Freddie collapse, and what form will they take thereafter?

Many advocate for privatization, splitting the firms into several publicly traded companies. Others, mindful of the Federal government’s tendency to privatize profits and socialize losses, expect outright nationalization.

One near-certainty, irrespective of the outcome of their current crisis, is that Fannie and Freddie's ability to keep mortgages rates artificially low will be greatly reduced. That doesn't bode well for anyone considering buying a house in the next 20 years.

Investors Quietly Flee Credit Card Debt

This post first appeared on Minyanville.

The American consumer’s last bastion of cheap credit may finally have been overrun.

During the housing boom, it was easy to run up a big credit card bill, then pay it off with a cash-out refinance or home equity line. When banks ratcheted back loan guidelines following the collapse of the mortgage market, there was a reversal of fortune: Paying the mortgage with plastic was the only way to get by.

Now, the jig is up. A slumping economy and higher fuel prices have chewed through the last of consumers’ discretionary dollars.

Buyers of securities backed by credit card debt are becoming skittish and demanding higher returns on their investment. This depreciates the value of the investment and forces issuers to hold onto bonds longer, since deals take longer to sell.

Big lenders like American Express (AXP) and Bank of America (BAC) are having to fork over higher interest rates to keep investors happy. That means less profit for them - and less of a cushion as loans go sour. Just ask Citigroup (C), who reported a second-quarter loss on assets backed by credit card debt.

A common misconception about credit card securities is that they’re structured to handle high delinquency rates, and are therefore safer bets. Indeed, some argue that years of historical data show cardholders rarely default en masse, and that delinquency patterns are well understood. Of course, they said the same thing about mortgage-backed securities.

Asset-backed securities, or ABSs, are structured based on historical data and expectations of future cash flows. Since credit cards typically carry a higher default rate than, say, mortgages, their ABSs are designed to absorb these losses.

Deals therefore go sour not when delinquencies increase in an absolute sense, but instead when they deviate from historical norms. For more on this subject and the coming wave of prime mortgage-backed securities defaults, see The Next Subprime.

Lenders will be forced to cut back credit lines to stem the bleeding, and comprehensive new regulations will further inhibit consumers’ ability to borrow on the cheap.

Many are already calling this the dropping of the credit crisis' other shoe; in reality, this has been going on for a while. Credit card defaults have been inching up for months, as results from American Express, Capital One (COF) and Discover Financial (DFS) have shown. The only difference now is that it's getting mainstream media attention.

But here's the kicker: With mortgage debt, at least lenders can seize the house as a last resort.

Not so with credit card debt: Just try repossessing a flatscreen TV.

Who's Afraid of Recession?

This post first appeared on Minyanville.

I must not fear.
Fear is the mind-killer.
Fear is the little-death that brings total obliteration.
I will face my fear.
I will permit it to pass over me and through me.
And when it has gone past I will turn the inner eye to see its path.
Where the fear has gone there will be nothing.
Only I will remain.
- The Bene Gesseritl Litany Against Fear, Dune

We're taught from an early age how to deal with fear. We're told to face it, respect it, overcome it, lest it overcome us instead. Deny it, ignore it, push it away, or it will consume you.

Still, despite such a seemingly clear roadmap on how to deal with things that go bump in the night, the powers that be continue to fudge economic data. They adamantly declare we’re not in a recession, even when all reasonable information indicates otherwise.

Last Thursday, the Commerce Department quietly revised statistics on the U.S. economy: Rather than expanding, as the government had previously claimed, the economy shrank at the end of last year. The following day, the Bureau of Labor Statistics released its faulty employment numbers, using the cryptic birth-death model to magically create jobs out of thin air.

But what’s so terrifying about the word "recession"? It’s not possible to intelligently tackle problems if we don’t know what they are, so why this herculean effort to obscure the truth?

Recessions cleanse the economy, purging its excesses -- Countrywide, Bear Stearns -- as well as products that shouldn’t have been dreamt up in the first place (CDO-squareds, the pet rock). Inventory levels shrink, growth is reined in, and the whirring economic machine takes a well-deserved pit stop.

They’re usually short (recessions rarely last more than a year); growth then resumes at its normal rate. Risk management goes out the window, lenders loosen up and maverick CEOs expand into all corners of the globe until, ultimately, we have another recession. Lather, rinse, repeat.

The true fear caused by impending recessions isn’t diminished growth or an uptick in the unemployment rate; we know how to deal with that stuff. What keeps government officials up at night and drives them to statistical perjury is fear of the unknown.

The most worrisome aspect of recessions -- and this recession in particular -- is what might happen.

What if China’s economy slows down too. What if more banks go under. What if home prices keep falling. What if oil keeps going up. What if the Dream Team actually wins a gold medal.

For all their obfuscation before the credit crisis began, it's unlikely that Federal Reserve Chairman Bernanke or Treasury Secretary Paulson would have predicted credit losses approaching half a trillion dollars just one year into the malaise - even if they'd been given a military-grade truth serum. They probably wouldn't have imagined they'd backstop JPMorgan Chase (JPM) to the tune of $29 billion (in order to save Bear Stearns), or be forced to bail out Fannie Mae (FNM) and Freddie Mac (FRE).

But now, given the extremes to which they've been willing to go in order to prop up a faltering financial system, and indeed an economy, badly in need of some time to lick its wounds, there's one thing to be truly fearful of: What are they afraid of that they're not telling us about?

Chrysler Debt Stalls Out

This post first appeared on Minyanville.

If you think it’s hard to find a car loan these days, try borrowing $30 billion to finance a whole fleet.

Chrysler Financial, the finance unit of privately-held Chrysler LLC, spent the last month in intense negotiations to renew short-term debt such as that used for leases, retail car loans and loans to dealerships.

According to The Wall Street Journal, the company only managed to scrounge up $24 billion - just 80% of the $30 billion it wanted. And the money it did find was expensive: The debt cost Chrysler 1.10% to 2.25% more than the London interbank offered rate (or Libor), as compared to a spread of just 0.30% to 0.50% last year.

Chrysler will likely be forced to pass the additional expense on to customers, making cheap car loans increasingly hard to find.

JPMorgan Chase (JPM), Citigroup (C) and Royal Bank of Scotland worked on behalf of Chysler to renegotiate the loans, but in the end 2 major dissenters wouldn't budge: Bank of America (BAC) and Credit Agricole failed to renew a combined $3 billion in commitments.

Bank of America is already up to its eyeballs in lousy car debt, since it helped lead the refinancing effort for GMAC, finance arm of embattled General Motors (GM).

The financing struggle illustrates not only the lingering effects of the credit crunch, but the extent to which certain big industrial companies are, in Toddo's words, “financials in drag.” Included in this list are fellow automaker Ford (F) and massive conglomerate General Electric (GE).

With cheap credit flowing through the financial system, management found it expedient to squeeze income out of balance sheets with aggressive money management. Whether it was tapping the now-collapsed auction-rate securities market or relying on sketchy consumer debt as a profit center (GMAC for GM and WMC Mortgage, a subprime lender, for GE), these so-called industrial behemoths relied heavily on their finance arms for profits.

For carmakers, sales have long depended on cheap and easy financing for would-be buyers. Now those loans are more expensive and harder to come by; revenues are sagging and losses are mounting.

These firms will have to find new ways to turn a profit, or figure out how to do it for less. Of course, that's something their customers are already being forced to do.