Posts filed under “Really, really bad calls”
It is a very hot August and the heat seems to be getting to people on Wall Street. In Washington the greater heat stems from fears about the impact of the economy and housing on the mid-term elections. As a result, Wall Street is expecting a big “surprise” in the form of a massive GSE refinancing plan, an unbridled expansion of the unsuccessful HARP program.
Don’t hold your breath.
Ongoing rumors of a streamlined GSE induced refi wave began last week with notes from Morgan Stanley and Bank of America. Folks at these firms proposed that borrowers could benefit, resulting in increased consumer spending, if only the GSE’s initiated a streamlined and broad program to allow those of their mortgagees who are current on their mortgages to instantly refinance from their higher rate mortgages to current market rates.
The argument is, since the GSEs own the credit risk anyway, they should change the refinancing requirements and lower or eliminate appraisal requirements and LTV requirements for refinancing. Doing so would, it is suggested, lower the burden on borrower cash flows, as they would benefit by lowering their rates by about 150bp. The pitch was ‘it would be a costless plan with real benefits’. Nice theory, too bad it doesn’t work and isn’t possible.
Beside the small consumer stimulus there could be another argued benefit to such a plan. By increasing the ability of borrowers to pay their primary mortgage, the plan would appear to help Treasury’s ongoing process of creating disparate benefits to second lien holders.
There are several and significant problems with this plan:
- As a result of another prepayment-shock and the inability to model future prepayment shocks, investors would become even more unwilling to invest in MBS gong forward, or would begin to demand higher yields going forward; unwilling to invest in MBS going forward, or would begin to demand higher yields going forward;
- The interest rate risk that this would cause, as banks and the GSEs themselves all had to re-hedge their books at the same time, could precipitate a systemic risk issue;
- The prepayments would cost investors more than half a trillion in lost interest income;
- Such a “streamlined” refi program would cost state and municipalities billions of dollars in transfer fees that they would normally be able to charge on a refinancing;
- Keeping borrowers in their homes with rate reductions could be argued to be consistent with maximizing value under conservatorship. A streamlined and across the board refi program that treats all borrower LTVs and other features the same would appear to violate the conservatorship;
- The GSEs, according to their trust agreements, are prohibited from soliciting prepayments. If they were in receivership these agreements could be abrogated but they would still have to pay value on the contracts; and
- Servicer’s could solicit borrowers to prepay on the program but it would be a nightmare to operationalize and oversee such a massive program.
We have heard absolutely no serious discussion of this hare-brained idea in regulator or policy circles. While we do not expect the GSE rumor to prove correct that doesn’t mean the situation is static.
We will soon see the implementation of their previously announced HAMP and FHA short-refinancing programs. Even though initial HAMP results will not be reported until you can expect the Administration to “sell it hard” and play it up. The Principal Reduction Alternative in the “new” HAMP is voluntary1 but does state “participating 2MP servicers must forgive an amount of principal on 2nd liens in equal proportion to the amount forgiven on the first lien loan by the 1st lien servicer.”2 The fact that about half of all second liens and HELOCS are owned by the same banks that service the firsts on behalf of mortgage investors, and that those banks continue to hold the value of their seconds at prices that far exceed a fair mark, you can expect that this voluntary approach will be generally left unused.
Also, as early discussions on the FHA short-refi program were happening, there were questions of whether the GSEs would be involved. At the time we were hearing the GSEs were developing their own short-refinancing program. It remains unclear am what that would be but it is important to remember that the Federal Housing Finance Agency is acting as “conservator” to the GSEs. “The FHFA, as Conservator, may take all actions necessary and appropriate to (1) put the Company in a sound and solvent condition and (2) carry on the Company’s business and preserve and conserve the assets and property of the Company.” This suggests any short refi program would have to be narrow, as drawing it too broadly would cause the dissipation of assets from the conservatorship.
Those who would suggest this view of the conservatorship ignores that politics will trump legality in a difficult mid-term election cycle should remember that politics are a two way street and the Republicans would make hay with any significant violation of the conservatorship. It is in large measure the public’s weariness from random interventions into market function and ineffective programs which continue to advantage banks ahead of market participants and the real economy that have caused so much unhappiness with this Administration. A new and massive program that crams losses onto investors rather than addressing fundamental problem3 will not be well received.
Morgan Stanley: More Irresponsible Mortgage Lending, Please (July 28, 2010)
1 Note: The Special Inspector General for TARP, in his Quarterly Report to Congress states “PRA does not require servicers to forgive principal, even when doing so is deemed to offer greater financial benefit to the investor.”
Over at Economix, Harvard economics professor Ed Glaeser looks at the ultra-low interest rates of the aughts, and does not find them to be much to blame for the US Housing boom and bust: “The most common explanation for the great surge in prices is the availability of easy credit, which took the form of…Read More
Whenever a company’s executives get caught doing something stupid/illegal, and are forced to pony up a hefty fine, a hue and cry go up: You are only punishing the shareholders. Well, yes, you are. That is, in fact, the purpose of these fines: To punish the companies engaging in violations of SEC laws, and to…Read More
“Our problem, basically, is that we have a very distorted economy in the sense that there has been a significant recovery in a limited area of the economy amongst high-income individuals who have just had $800 billion added to their 401(k)s and are spending it and are carrying what consumption there is. Large banks, who…Read More
Over the years, I have described myself politically as a “Jacob Javits* Republican.” For those of you unfamiliar with the Senator from NY, Javits was a social progressive, a fiscal conservative, “a political descendant of Theodore Roosevelt’s Progressive Republicanism.”
After he “retired” in 1980, the GOP took a very different turn: The emphasis on Fiscal conservatism was lost. Balanced budgets were no longer a priority. In terms of electoral politics, the embrace with the Religious Right was a deal with the devil. It married the party to a backwards combination of social regressiveness and magical thinking. Ideology trumped facts, and conflicting data and science was ignored.
In short, the party became more focused on Politics than Policy.
I bring this up as an intro to David Stockman’s brutal critique of Republican fiscal policy. Stockman was the director of the Office of Management and Budget under President Ronald Reagan. His NYT OpEd — subhed: How the GOP Destroyed the US economy — perfectly summarizes the most legitimate critiques of decades of GOP economic policy.
I can sum it up thusly: Whereas the Democrats have no economic policy, the Republicans have a very bad one.
The details are what makes Stockman’s take so astonishing. Here are his most important observations, of which I find little to disagree with:
• The total US debt, including states and municipalities, will soon reach $18 trillion dollars. That is a Greece-like 120% of GDP.
• Supply Side tax cuts for the wealthy are based on “money printing and deficit finance — vulgar Keynesiansism robed in the ideological vestments of the prosperous classes.”
• Republicans abandoned the belief that prosperity depended upon the regular balancing of accounts — government, trade, central banks private households and businesses.
• Once fiscal conservatism was abandoned, it led to the serial financial bubbles and Wall Street depredations that have crippled our economy.
• The Nixon administration defaulted on American obligations under the 1944 Bretton Woods agreement.
• Who is to blame? Milton Friedman. In 1971, he persuaded President Nixon to unleash on the world paper dollars no longer redeemable in gold.
• According to Friedman, “The free market set currency exchange rates, he said, and trade deficits will self-correct.” What actually occurred was “impossible.” Stockman calls it “Friedman’s $8 trillion error.”
• Ideological tax-cutters are what killed the Republicans’ fiscal religion.
• America’s debt explosion has resulted from the Republican Party’s embrace, three decades ago, of the insidious Supply Side doctrine that deficits don’t matter if they result from tax cuts.
• The GOP controlled Congress from 1994 to 2006: Combine neocon warfare spending with entitlements, farm subsidies, education, water projects and you end up with a GOP welfare/warfare state driving the federal spending machine.
• It was Paul Volcker who crushed inflation and enabled a solid economic rebound — not the Reagan Supply Side Tax cuts.• Republicans believed the “delusion that the economy will outgrow the deficit if plied with enough tax cuts.”
• Over George W. Bush 8 years in office, non-defense appropriations gained 65%.• Fiscal year 2009 (GWB last budget): Tax-cutters reduced federal revenues to 15% of GDP — lower than they had been since the 1940s.
• The expansion of our financial sector has been vast and unproductive. Stockman blames (tho but not by name): 1) Greenspan, for flooding financial markets with freely printed money; and 2) Phil Gramm, for removing traditional restrictions on leverage and speculation.
• The shadow banking system grew from a mere $500 billion in 1970 to $30 trillion by September 2008 (see Gramm, above).
• Trillion-dollar financial conglomerates are not free enterprises — they are wards of the state, living on virtually free money from the Fed’s discount window to cover their bad bets.
• From 2002 to 2006, the top 1% of Americans received two-thirds of the gain in national income.
I find it fascinating that the most incisive criticism of the irresponsible GOP policies has comes from two of its former stars: Bruce Barlett and now David Stockman. Sure, Krugman, Stiglitz, DeLong and others have railed against Bush policies for years. But it seems to take an insider’s critique to really give the debate some punch.
Its funny, but when I criticize Bush, I get accused of being a liberal Democrat (I am not). I am simply giving my honest perspective of an utterly ruinous set of irresponsible policies that did lasting damage to America. The critiques of Obama does not generate the same sort of reaction. I suspect brain damaged partisans of the left suffer from somewhat different cognitive deficits than brain damaged partisans of the right.
Here’s to hoping that reality-based economic policies are somewhere in our future.
Note: Brain damaged partisan comments will be unceremoniously deleted
Four Deformations of the Apocalypse
NYT, July 31, 2010
Today’s must read MSM piece is a brutal takedown on irresponsible tax and spending by Larry Kudlow’s former boss in the Reagan admin, David Stockman. Four Deformations of the Apocalypse DAVID STOCKMAN I’ll have more on this later, but go read what he wrote . . .
(Invictus here, kids. Don’t go bashing BR.) I learned two interesting things last week: Erick Erickson told me the following (bold font is mine, bold claim is Erickson’s): Likewise, after the 2003 tax cuts, the unemployment rate fell to the lowest level since World War II. Let me repeat that: the Bush economic program created…Read More
Yet another economist who dines at the restaurant of the free lunch: David Greenlaw of the US Economics Team at Morgan introduces what he calls a “Slam Dunk Stimulus” of sorts: “If it were possible to inject a significant amount of stimulus into the US household sector, and this stimulus had zero impact on the…Read More
We interrupt the George Bush reputation rehabilitation tour for this brief reminder: “For most of the past 70 years, the U.S. economy has grown at a steady clip, generating perpetually higher incomes and wealth for American households. But since 2000, the story is starkly different. The past decade was the worst for the U.S. economy…Read More
There is a BusinessWeek article that notes “Shares of companies whose CEOs dine with Obama outdo the S&P.” I have a quote in that I would like to clarify: “Just a coincidence? Only partly, says Barry Ritholtz, CEO of equity research firm Fusion IQ. Losers don’t get asked to hang out with the President, he…Read More