The Housing Chronicles Blog: 9/1/08 - 10/1/08

Tuesday, September 30, 2008

House to vote for revised bailout plan Wed.night

The House is expected to vote again on a slightly revised bailout plan soon after sundown on Wednesday night. From a story (hat tip: Calculated Risk):

The Senate plans to vote on the $700 billion bank rescue plan Wednesday evening - two days after the House failed to pass it.

The bill adds new provisions - including raising the FDIC insurance cap from $100,000 to $250,000 - and will be attached to an existing revenue bill that the House also rejected Monday, according to several Democratic leadership aides.

The vote is scheduled for after sundown, in observance of the Jewish holiday. Republican presidential nominee John McCain and Democratic nominee Barack Obama and his running mate Joe Biden confirmed that they would be present for the vote...

The revised bailout bill also includes a "Mental Health Parity" provision, which would require health insurance companies to cover mental illness at parity with physical illness.

Because the bill must originate in the House, the Senate is attaching the rescue plan to a bill that deals with renewable energy tax incentives. This would allow the Senate to vote before the House.

We shall see...

60 Minutes interview with Treasury Secretary Paulson

This season's premiere of 60 Minutes included an interview with Treasury Secretary Paulson, which tagged along with him over the last two weeks as the financial crisis unfolded. Definitely worth a look:

Watch CBS Videos Online

Blame the Community Reinvestment Act?

There's been a lot of noise lately on the culpability of the Community Reinvestment Act (CRA), which reportedly encouraged (some say forced) lenders to make subprime loans to those who couldn't afford it in the name of increasing homeownership.

So what is the CRA? First, from a Wikipedia entry:

The CRA was passed by the 95th United States Congress and signed into law by President Jimmy Carter in 1977 as a result of national grassroots pressure for affordable housing, and despite considerable opposition from the mainstream banking community.[1] Only one banker, Ron Grzywinski from ShoreBank in Chicago, testified in favor of the act.[2] The CRA mandates that each banking institution be evaluated to determine if it has met the credit needs of its entire community. That record is taken into account when the federal government considers an institution's application for deposit facilities, including mergers and acquisitions after the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 repealed restrictions on interstate banking.[3] However, until 1995 the Act was laxly enforced and banks only were required to advertise in local minority newspapers or sit on the boards of local community groups.[4] The CRA is enforced by the financial regulators (Federal Deposit Insurance Corporation ("FDIC"), Office of the Comptroller of the Currency ("OCC"), Office of Thrift Supervision ("OTS"), and the Federal Reserve System.[citation needed] It also charged the Federal Reserve System to implement the CRA through ensuring banks and savings and loans met their CRA obligations.

So what's the controversy? Again, from Wikipedia:

Some economists and financial experts have wondered if the CRA was - or at least had become - irrelevant, because it was not needed to force banks to make profitable loans to a variety of lenders.[11][12] Economist Howard Husock writes that a CRA-connected community group The Woodstock Institute found in a survey in the Chicago-area that even banks not subject to CRA tended to loan in a variety of neighborhoods. He also criticized as an "amateur delivery system" community groups' involvement in marketing loans.[4] Federal Reserve chairman Ben Bernanke has stated that an underlying assumption of the CRA – that more lending is always better for local communities – is questionable.[3]

Economist Stan Liebowitz notes that the Fannie Mae Foundation singled out Countrywide Financial as a "paragon" of a nondiscriminatory lender who works with community activists, following "the most flexible underwriting criteria permitted." The chief executive of Countrywide is said to have "bragged" that in order to approve minority applications, "lenders have had to stretch the rules a bit." Countrywide's commitment to low-income loans had grown to $600 billion by early 2003.[13] On the other hand, Professor of Law Michael S. Barr stated in congressional testimony that a Federal Reserve survey showed that affected institutions considered CRA loans profitable and not overly risky.[14]

Congressman Ron Paul has partially attributed the ongoing subprime mortgage crisis to legislation such as the Community Reinvestment Act.[15] A Wall Street Journal editorial argued that the law compelled banks to make loans to poor borrowers who often could not repay them and that this contributed in part to the subprime crisis.

So what's the story? Are these charges true? An blog post in BusinessWeek says no:

Fresh off the false and politicized attack on Fannie Mae and Freddie Mac, today we’re hearing the know-nothings blame the subprime crisis on the Community Reinvestment Act — a 30-year-old law that was actually weakened by the Bush administration just as the worst lending wave began. This is even more ridiculous than blaming Freddie and Fannie...

Not surprisingly given the higher degree of supervision, loans made under the CRA program were made in a more responsible way than other subprime loans. CRA loans carried lower rates than other subprime loans and were less likely to end up securitized into the mortgage-backed securities that have caused so many losses, according to a recent study by the law firm Traiger & Hinckley (PDF file here).

Finally, keep in mind that the Bush administration has been weakening CRA enforcement and the law’s reach since the day it took office. The CRA was at its strongest in the 1990s, under the Clinton administration, a period when subprime loans performed quite well. It was only after the Bush administration cut back on CRA enforcement that problems arose, a timing issue which should stop those blaming the law dead in their tracks. The Federal Reserve, too, did nothing but encourage the wild west of lending in recent years. It wasn’t until the middle of 2007 that the Fed decided it was time to crack down on abusive pratices in the subprime lending market. Oops.

Better targets for blame in government circles might be the 2000 law which ensured that credit default swaps would remain unregulated, the SEC’s puzzling 2004 decision to allow the largest brokerage firms to borrow upwards of 30 times their capital and that same agency’s failure to oversee those brokerage firms in subsequent years as many gorged on subprime debt. (Barry Ritholtz had an excellent and more comprehensive survey of how Washington contributed to the crisis in this week’s Barron’s.)

There’s plenty more good reading on the CRA and the subprime crisis out in the blogosphere. Ellen Seidman, who headed the Office of Thrift Supervision in the late 90s, has written several fact-filled posts about the CRA controversey, including one just last week. University of Oregon professor and economist Mark Thoma has also defended the CRA on his blog. I also learned something from a post back in April by Robert Gordon, a senior fellow at the Center for American Progress...

Bankruptcies, not bailouts

Remember those nearly 200 economists who signed a treatise against the bailout? One of them, Jeffrey Miron from Harvard, speaks out on the reasons why in a CNN editorial:

This bailout was a terrible idea. Here's why.

The current mess would never have occurred in the absence of ill-conceived federal policies. The federal government chartered Fannie Mae in 1938 and Freddie Mac in 1970; these two mortgage lending institutions are at the center of the crisis. The government implicitly promised these institutions that it would make good on their debts, so Fannie and Freddie took on huge amounts of excessive risk.

Worse, beginning in 1977 and even more in the 1990s and the early part of this century, Congress pushed mortgage lenders and Fannie/Freddie to expand subprime lending. The industry was happy to oblige, given the implicit promise of federal backing, and subprime lending soared.

This subprime lending was more than a minor relaxation of existing credit guidelines. This lending was a wholesale abandonment of reasonable lending practices in which borrowers with poor credit characteristics got mortgages they were ill-equipped to handle...

The obvious alternative to a bailout is letting troubled financial institutions declare bankruptcy. Bankruptcy means that shareholders typically get wiped out and the creditors own the company.

Bankruptcy does not mean the company disappears; it is just owned by someone new (as has occurred with several airlines). Bankruptcy punishes those who took excessive risks while preserving those aspects of a businesses that remain profitable.

In contrast, a bailout transfers enormous wealth from taxpayers to those who knowingly engaged in risky subprime lending. Thus, the bailout encourages companies to take large, imprudent risks and count on getting bailed out by government. This "moral hazard" generates enormous distortions in an economy's allocation of its financial resources.

Thoughtful advocates of the bailout might concede this perspective, but they argue that a bailout is necessary to prevent economic collapse. According to this view, lenders are not making loans, even for worthy projects, because they cannot get capital. This view has a grain of truth; if the bailout does not occur, more bankruptcies are possible and credit conditions may worsen for a time.

Talk of Armageddon, however, is ridiculous scare-mongering. If financial institutions cannot make productive loans, a profit opportunity exists for someone else. This might not happen instantly, but it will happen...

The costs of the bailout, moreover, are almost certainly being understated. The administration's claim is that many mortgage assets are merely illiquid, not truly worthless, implying taxpayers will recoup much of their $700 billion.

If these assets are worth something, however, private parties should want to buy them, and they would do so if the owners would accept fair market value. Far more likely is that current owners have brushed under the rug how little their assets are worth.

The bailout has more problems. The final legislation will probably include numerous side conditions and special dealings that reward Washington lobbyists and their clients.

Anticipation of the bailout will engender strategic behavior by Wall Street institutions as they shuffle their assets and position their balance sheets to maximize their take. The bailout will open the door to further federal meddling in financial markets.

So what should the government do? Eliminate those policies that generated the current mess. This means, at a general level, abandoning the goal of home ownership independent of ability to pay. This means, in particular, getting rid of Fannie Mae and Freddie Mac, along with policies like the Community Reinvestment Act that pressure banks into subprime lending.

Why did the bailout fail?

Voter anger. Politicians up for re-election in just over 30 days. It's no wonder the bailout -- in its current incarnation at least -- failed. From an LATimes story:

The surprise defeat of the Bush administration's financial rescue plan was a product of the waning influence of a lame-duck president and the nervousness of members of Congress, whose institution is even less popular and who faced a flood of angry messages from constituents. McCain and Obama are more popular, but neither candidate embraced the bailout measure enthusiastically before the vote....

"We're all worried about losing our jobs," Rep. Paul D. Ryan (R-Wis.), who voted in favor of the plan, said in a speech in the House. "Most of us say, 'I want this thing to pass but I want you to vote for it, not me.' "

The rescue plan, which would have allowed the Treasury to spend as much as $700 billion to buy distressed investments from troubled financial institutions, was always going to be a hard sell.

No grass-roots constituency supported the idea. Instead, conservative Republicans protested the bill as a huge federal intrusion into private enterprise, and liberal Democrats complained that it rescued wealthy investors but didn't give homeowners a refuge in bankruptcy to avoid foreclosure....

In the face of that storm, members of Congress in tight races walked away.

All seats in the House are up for grabs this year. But many members who voted no are in safe districts -- where voters are overwhelmingly conservative or liberal. That's partly because, over years of redistricting, many districts have become politically polarized, and members from those districts have less incentive to compromise with the other party....

Pleas from a president may not work either -- especially if the president's public standing has fallen to record lows. White House spokesmen said Bush called dozens of GOP members of Congress. His efforts appeared to bear little fruit. Rep. Joe L. Barton (R-Texas) said the president called him, but the lawmaker explained that he preferred to listen to his constituents.

In such a situation, even a powerful vice president such as Cheney can no longer command votes from members of the House. "Cheney lived up to his reputation as Darth Vader . . . talking about all the terrible things that were going to happen," said Rep. Christopher Shays (R-Conn.). "People weren't afraid of Darth Vader."...

Strangely, perhaps, some House members on both sides said the pressure from their leaders for a yes vote was milder than they had expected.

So what might happen without a bailout?

So let's say that Congress can never agree on a bailout package, and free market forces are allowed to correct the excesses the deleverage the economy on its own. What might that look like? From an LA Times story:

If the House vote against the $700-billion financial rescue proposal stands, Americans may be in for a test of free-market economics the likes of which the country hasn't seen since the early 1930s.

With the Treasury Department hobbled by the rejection of its plan, the Federal Reserve and Federal Deposit Insurance Corp. are the chief government institutions standing between the nation and the brutally Darwinian process that could unfold if the panicky financial markets are left to sort their problems out alone...

That's something the United States last experienced in the early 1930s, when Herbert Hoover was in the White House. Some conservatives believe that's still the best long-term solution to the problem, though none has gone so far as Hoover's Treasury secretary, Andrew Mellon, who said: "Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate. . . . It will purge the rottenness out of the system."...

For now, the Fed and FDIC are doing what they can.

Early Monday, the Fed pumped an extra $630 billion into banks around the world. Its goal: to keep money flowing through the financial plumbing that's hidden from view but is crucial to the global economy's operation....

For the Fed, the problem is that with business confidence so shaken, the banks on the receiving end of its latest flood of cash are parking the money in their vaults rather than lending it out to keep the economy functioning. Bankers worry that they might need the money if conditions keep getting worse....

Little cash is available for growth and job creation. But there's a more immediate danger: To an extent little appreciated by most Americans, businesses today no longer pay for their day-to-day operations with their own money but do so with borrowed funds.

Making next week's payroll or buying the supplies workers need to do their jobs tomorrow depend on loans. Without those loans, companies and the economy as a whole begin to grind to a halt.

The slowdown is feeding other problems that plague the nation: plunging home prices, the imploding value of mortgage securities and collapsing confidence. Among other things, that's all but certain to push more financial firms over the edge.

When that happens, the Fed and the FDIC have only one course of action: to pick and choose among collapsing firms, deciding which ones get a soft landing and which ones crash....

If Washington's rescue resources were to run out, the nation's investors, traders and lenders could discover that it was up to them alone to right the financial system.

That's a situation that has not occurred in more than three-quarters of a century, during the Great Depression.

"This is smacking more and more of the late 1920s and early 1930s," said New York University economic historian Richard Sylla.

In fact, in a less disastrous manner than during the Depression, something like Mellon's prescription of across-the-board liquidation is now underway.

And without a big, new program like the one rejected by the House on Monday, there is only so much the existing institutions can do.

Monday, September 29, 2008

Royce Homes now history

Houston, TX builder Royce Homes, once #44 on the Builder 100 list for 2007, has officially shut its door. From a story:

Houston builder Royce Homes, which acknowledged this summer that it was liquidating, has closed its doors, according to its Web site.

"After 24 enjoyable years, Royce Builders is no longer in business," the Web page announces.

It proved to be a fast unwinding for the large Texas builder, which closed as many as 1,280 homes in 2007, placing it 44th on the most recent BUILDER 100 list.

Lender tries to recoup losses from builder: the other side

Since I've already told the story of builder bankruptcies from the side of the homebuilders, I thought I should also do the same from the POV of the lender, in this case KeyBank. From a story:

KeyBank has sued Legend Homes' CEO David Oringdulph to try to recover $32.5 million in troubled loans that the homebuilder and its affiliated companies owe the bank.

Cleveland-based KeyBank sued Oringdulph and his trust on Sept. 18 in Multnomah County Circuit Court. Like most homebuilders, Oringdulph personally guaranteed he would repay the debts from KeyBank's seven loans.

With the guarantee, lenders can sometimes force builders to repay debts from their personal assets, including homes and personal bank accounts.

Oringdulph said he expected the suit after his company -- one of Oregon's largest homebuilders -- filed Chapter 11 bankruptcy in June. "I've taken steps to protect myself," he said. "My personal assets are limited and not in jeopardy."

KeyBank is Legend Homes' largest creditor and has pushed hard to recover its money...

The bank lent Legend or its affiliated companies millions of dollars to buy land for home lots, then land values plummeted in the housing slowdown...

KeyBank reappraised the land value and asked the company to pay back $7.7 million to meet its loan-to-value ratio, which was not disclosed in the lawsuit. The company could not make the payment and defaulted on the loan. That loan carries a $9.7 million balance, according to the suit.

KeyBank also started to foreclose on the property, company officials said.

Earlier this month, Legend Homes won court approval to restart home construction on some subdivisions, and executives hope to re-emerge from Chapter 11 next year.

Of course no one forced the builder to sign a personal guarantee...

Housing market to worsen without bailout plan

So what happens if there is no consensus on a plan to unfreeze the credit markets? For starters, a frozen real estate market. From an AP story:

The recession in the U.S. housing market is expected to be deeper, longer and scarier if lawmakers continue to be deadlocked in their effort to pass a $700 billion bailout of the financial industry...

U.S. home prices have already fallen about 20 percent since their peak in early 2006 and are expected to sink another 10 percent over the next year, according to Mark Zandi, chief economist with Moody's New data for July out Tuesday from the Standard & Poor's/Case-Shiller home price index will likely show more price declines in cities coast to coast.

Without a broad government response to the credit crisis, the economy, which many believe to be in recession or near it, would certainly worsen, analysts say. Unemployment, currently at a five-year high of 6.1 percent, could rise to double-digit levels as credit dries up.

"Businesses are going to begin shuttering operations and laying off workers," Zandi said. "That will hammer all consumer spending and housing demand."

Existing home sales were down almost 11 percent in August, compared with a year ago, while new home sales tumbled almost 35 percent. There's more than a 10-month supply of homes on the market.

Making matters worse, many potential homebuyers are having a hard time qualifying for a mortgage. Lenders, burned by record defaults and foreclosures, are only giving loans to borrowers with the best credit.

One silver lining, however, is that falling home prices have made homes more affordable for working families. And nervous investors helped push down the average rate on a 30-year, fixed rate mortgage to 6.12 percent on Monday, down from 6.22 percent on Friday, according to financial publisher HSH Associates.

But plunging stock markets and epic bank failures are bound to have a negative impact on home shoppers' psychology...

The credit crunch has crippled many homebuilders' ability to stay in business, and the industry has been among those calling on lawmakers to pass the financial rescue measure.

Most of the large, public homebuilders have been hoarding cash and aren't facing funding problems. But many smaller, private builders have seen their access to credit choked off, leaving the fate of building projects in limbo, said Nishu Sood, a Deutsche Bank analyst.

Private companies are "in a terrible condition right now," Sood said. Their ability to conduct business has been "effectively shut off."

Builders have lobbied in favor of the bailout in hopes it will ease the sector's access to financing and lift worries about the economy.

Industry groups said the House's failure to pass the bill Monday was a grave mistake, and the action shocked Wall Street, sending the Dow Jones industrial average down 777 points. House lawmakers were planning to reconvene Thursday to try again instead of adjourning for the year as planned...

Still, many Americans were baffled by the need to bail out Wall Street banks. And consumer groups -- which long warned about reckless lending practices -- were irate about the bailout, saying it didn't do enough to stop foreclosures and rewarded the institutions that fueled the boom in risky lending practices.

"The financial institutions that got us into this crisis are asking to be bailed out," said Michael Calhoun, president of the Durham N.C.-based Center for Responsible Lending, who called the government's actions a "textbook case of how not to manage a crisis."

Plus, consumer advocates said, if the Bush administration had been more aggressive last year in requiring loan modifications for homeowners in default, the crisis could have far less severe.

What? You mean to say the voluntary plan to initiate work-outs with borrowers didn't work? Well, when was the last time any business did anything voluntarily that wasn't in its own short-term interest. 1400?

Grassroots rage building over the federal bailout

It's one thing to see "no bailout" tags at the end of blog comments, but with a growing backlash against a federal bailout of the financial industry -- which is apparently trying to add everything but the kitchen sink in with failed mortgages -- it's easy to see why Congress can't seem to agree on a solution. Columnist Lou Barnes takes it on:

Any large-scale federal financial rescue was certain to face political chaos. However, within hours of rollout last Thursday this rescue collided with two linked and disastrous forces that may yet defeat immediate rescue...

Most grown-ups know that it's a mistake to ask a group to vote on an important proposal without prior discussion. You wouldn't spring something big on your PTA, your HOA or your book club and demand an immediate approval. You wouldn't ask a Cub Scout troop to vote on a field trip without some testing of the water.

Hank Paulson would. Hank has had 13 months to prepare a contingency plan in case market solutions to this crisis failed, and quietly to explore alternatives with Congress. Instead, he dumped on Congress a three-page sketch of a highly technical and questionable proposal. Tuesday's hearings in the first minutes revealed bipartisan, confused, angry and incredulous Senators, and an ill-prepared Paulson...

Over last weekend another force erupted all over the country: native, grassroots rage at a bailout that would leave all the big institutions in place -- officers, directors, stockholders, all -- and offer to taxpayers the absurd promise of payback from hundreds of billions of trash that the institutions couldn't unload on anyone else.

You tell me your precious markets will melt down without this? Why do I care? Your stock market can go to goddamn zero on Monday, and then you can come down here with me to find out how it feels not to be able pay the bills. More than half of Americans have no stake in these markets, no savings at all; and there is a political price to be paid for extreme inequality of income.

This bailout, incomprehensible to civilians and many experts and senators, should have taken ownership in the institutions involved. Proper vetting to Congress months ago would have gotten that done. Instead, the same ancient American forces that ignited the Palin phenomenon, Jefferson-Jackson-Bryan-LaFollette populism, have mobilized an anti-bank, anti-smarty-pants, street-level riot not seen in modern times.

Completing the scene: President Bush's nasty little speech on Wednesday, assigning blame and taking no responsibility; Senator McCain's grandstand play on economic issues he's said for decades he's not any good at; and Senator Obama's silent tip-toeing along.

Anatomy of the bailout failure

Interested at all in the minutiae of how the House voted down the bailout bill? The L.A. Times has that here.

So what was it exactly that they voted down? You can find the text of the bill here.

And what was the reaction on Wall Street? It wasn't good! From an L.A. Times story:

Stocks plunged today as the House of Representatives shocked Wall Street by voting down the government's proposed $700-billion financial-system bailout, ensuring a continuation of the anxiety and uncertainty pervading Wall Street. The Dow Jones industrial average tumbled 777.68 points, or 7%, to 10,365.45. Broader indexes hemorrhaged even more: The Standard & Poor's 500 index sank 8.7%, and the Nasdaq composite index plunged 9.1%. Financial stocks in the S&P 500 fell more than any other broad industry group, plummeting 16%. The next-worst-performing sector was energy, which tanked 11%...

The vote threw another monkey wrench into an already chaotic stock market, prompting investors to speculate about when and whether the rescue measure would be resurrected and how the troubled credit markets would fare in the meantime. "The financial markets are in panic, and until politicians realize that, and until Main Street America realizes it's not a Wall Street problem -- it's a Wall Street and a Main Street problem -- the financial markets are going to be volatile and the decline is going to be hard to arrest," said John Spinello, Treasury market strategist at Jefferies...

Stocks around the world fell hard overnight as news of the European bailouts raised fear that the financial crisis is increasingly infecting banks outside the United States

Finally, how does the bailout plan stack up against other federal spending? Below, a graph from the L.A. Times illustrates (hat tip: Andrew Sullivan):

Did Lehman's failure cause the global cash crunch?

Although the federal government defended its refusal to bail out Lehman Brothers, a story in the Wall Street Journal asserts that the consequences of that decision have been much more dire than predicted. That's the thing with predictions -- they're just GUESSES:

Two weeks ago, Wall Street titans and the government's most powerful economic stewards made a fateful choice: Rather than propping up another failing financial institution, they let 158-year-old Lehman Brothers Holdings Inc. collapse.

Now, the consequences of that decision look more dire than almost anyone imagined.

Lehman's bankruptcy filing in the early hours of Monday, Sept. 15, sparked a chain reaction that sent credit markets into disarray. It accelerated the downward spiral of giant U.S. insurer American International Group Inc. and precipitated losses for everyone from Norwegian pensioners to investors in the Reserve Primary Fund, a U.S. money-market mutual fund that was supposed to be as safe as cash. Within days, the chaos enveloped even Wall Street pillars Goldman Sachs Group Inc. and Morgan Stanley. Alarmed U.S. officials rushed to unveil a more systemic solution to the crisis, leading to Sunday's agreement with congressional leaders on a $700 billion financial-markets bailout plan...

In hindsight, some critics say the systemic crisis that has emerged since the Lehman collapse could have been avoided if the government had stepped in. Before Lehman, federal officials had dealt with a series of financial brushfires in a way designed to keep troubled institutions such as Fannie Mae, Freddie Mac and Bear Stearns Cos. in business. Judging them as too big to fail, officials committed billions of taxpayer dollars to prop them up. Not so Lehman.

"I don't understand why they didn't understand that the markets would be completely spooked by this failure," says Richard Portes, professor of economics at London Business School and president of the Centre for Economic Policy Research. Rather than showing the government's resolve, he says, letting Lehman fail only exacerbated the central problem that has afflicted markets since the financial crisis began more than a year ago: Nobody knows which financial firms will be able to make good on their debts...

The government's decision to let Lehman go marked a turning point in the way investors assess risk. When the Fed stepped in to engineer the takeover of Bear Stearns by J.P. Morgan Chase & Co. in March, Bear's shareholders lost most of their investments, but bondholders came out well. In the financial hierarchy of risk, this wasn't surprising, since bondholders have more contractual rights to get their money back than equity holders. But it created a false impression among investors that the government would step in to rescue bondholders when the next bank ran into trouble. By letting Lehman fail, the government had suddenly disabused the market of that notion.

The reaction was most evident in the massive credit-default-swap market, where the cost of insurance against bond defaults shot up Monday in its largest one-day rise ever. In the U.S., the average cost of five-year insurance on $10 million in debt rose to $194,000 from $152,000 Friday, according to the Markit CDX index.

When the cost of default insurance rises, that generates losses for sellers of insurance, such as banks, hedge funds and insurance companies. At the same time, those sellers must put up extra cash as collateral to guarantee they will be able to make good on their obligations. On Monday alone, sellers of insurance had to find some $140 billion to make such margin calls, estimates asset-management firm Bridgewater Associates. As investors scrambled to get the cash, they were forced to sell whatever they could -- a liquidation that hit financial markets around the world...

To make matters worse, actual trading in the CDS market declined to a trickle as players tried to assess how much of their money was tied up in Lehman. The bankruptcy meant that many hedge funds and banks that were on the profitable side of a trade with Lehman were now out of luck because they couldn't collect their money. Also, clients of Lehman's prime brokerage, which provides lending and trading services to hedge funds, would have to try to retrieve their money or their securities through the courts...

Spooked that other securities firms could fail, hedge funds rushed to buy default insurance on the firms with which they did business. But sellers were hesitant, prompting something akin to what happens if every homeowner in a neighborhood tries to buy homeowners insurance at exactly the same time. The moves dramatically drove up the cost of insurance on Morgan Stanley and Goldman Sachs debt in what became a dangerous spiral of fear about those firms.

At the same time, hedge funds began pulling their money out of the two firms. Over the next few days, for example, Morgan Stanley would lose about 10% of the assets in its prime-brokerage business...

To some, the government's decision to resort to a bailout represents a tacit admission: For all officials' desire to allow markets to punish the risk-taking that engendered the crisis, banks have the upper hand. "Lehman demonstrated that it's much harder than we thought to deal effectively with banks' misbehavior," says Charles Wyplosz, an economics professor at the Graduate Institute in Geneva. "You have to look the devil in the eyes and the eyes are pretty frightening."


With all the banking mergers, someone should really come up with an online game to help name these new behemoths. For example, Citigroupovia or CitiWach? JPWamu or JMutualMorganWashington? On a more serious note, however, there are concerns that the costs for all types of lending products will likely rise with so much money concentrated in few hands.

Sadly, I remember talking with a Senior Economist from Wachovia about 18 months ago who was pretty confident that the worst was behind us. His wife is an investment banker, so I'm sure there's some stress in that household! From a New York Times story:

Citigroup will acquire the banking operations of the Wachovia Corporation, the Federal Deposit Insurance Corporation said Monday morning, the latest bank to fall victim to the distressed mortgage market.

Citigroup will pay $1 a share, or about $2.2 billion, according to people briefed on the deal.

The F.D.I.C. said that the agency would absorb losses from Wachovia above $42 billion and that it would receive $12 billion in preferred stock and warrants from Citigroup in return for assuming that risk.

“Wachovia did not fail,” the F.D.I.C. said, “rather it is to be acquired by Citigroup Inc. on an open-bank basis with assistance from the F.D.I.C.”

Under the deal, Citigroup will acquire most of Wachovia’s assets and liabilities, including $400 billion in deposits and will assume senior and subordinated debt of Wachovia, the F.D.I.C. said. Wachovia Corporation will continue to own the retail brokerage firm AG Edwards and the money management arm Evergreen...

The sale would further concentrate Americans’ bank deposits in the hands of just three banks: Bank of America, JPMorgan Chase and Citigroup. Together, those three would be so large that they would dominate the industry, with unrivaled power to set prices for their loans and services. Given their size and reach, the institutions would probably come under greater scrutiny from federal regulators. Some small and midsize banks, already under pressure, might have little choice but to seek suitors.

Wachovia has been hurt badly by its 2006 purchase of Golden West Financial, a California lender specializing in so-called pay-option mortgages. The bank also faced mounting losses on loans made to home builders and commercial real estate developers, and its acquisition of A. G. Edwards, a retail brokerage firm, turned out to be problematic. In June, Wachovia’s board ousted G. Kennedy Thompson, the bank’s longtime chief executive...

As the credit crisis has deepened, a consolidation in the financial industry that analysts have predicted for years seems to be playing out in a matter of weeks.

The impact will be felt on Main Street, Wall Street and in Washington. While the tie-ups may restore confidence in the industry, they also could leave a handful of big lenders to determine fees and interest rates on everything from home mortgages to credit cards to checking accounts. Some small and midsize banks may be unable to compete with these behemoths...

Both Citigroup and Wells Fargo were deeply concerned about absorbing Wachovia’s giant loan portfolio, which is littered with bad mortgages, these people said. Bankers had little time to assess the risk.

Citigroup executives considered Wachovia a make-or-break deal for their consumer banking ambitions. With Wachovia, Citigroup would gain one of the pre-eminent retail bank operations after struggling to build one for years. It will also give Citigroup access to more stable customer deposits, allowing it to rely less heavily on outside investors for funds.

I've been banking with Wells Fargo since 1994 and, in general, have been very happy with their services and ATM network. Plus, once you have enough accounts you can tap a personal banker to help get rid of those pesky fees!

House says "no thanks" to bailout bill

The stock market hates uncertainty, and reacted even before the news that the House of Representatives has narrowly defeated their vote on the bailout bill. From an AP story:

The House on Monday defeated a $700 billion emergency rescue for the nation's financial system, ignoring urgent warnings from President Bush and congressional leaders of both parties that the economy could nosedive into recession without it.

Stocks plummeted on Wall Street even before the 228-205 vote to reject the bill was announced on the House floor...

Ample no votes came from both the Democratic and Republican sides of the aisle. More than two-thirds of Republicans and 40 percent of Democrats opposed the bill.

The overriding question for congressional leaders was what to do next. Congress has been trying to adjourn so that its members can go out and campaign. And with only five weeks left until Election Day, there was no clear indication of whether the leadership would keep them in Washington. Leaders were huddling after the vote to figure out their next steps...

Lawmakers shouted news of the plummeting Dow Jones average as lawmakers crowded on the House floor during the drawn-out and tense call of the roll, which dragged on for roughly 40 minutes as leaders on both sides scrambled to corral enough of their rank-and-file members to support the deeply unpopular measure.

They found only two.

Bush and his economic advisers, as well as congressional leaders in both parties had argued the plan was vital to insulating ordinary Americans from the effects of Wall Street's bad bets. The version that was up for vote Monday was the product of marathon closed-door negotiations on Capitol Hill over the weekend...

The fear in the financial markets send the Dow Jones industrials cascading down by over 700 points at one juncture. As the vote was shown on TV, stocks plunged and investors fled to the safety of the credit markets, worrying that the financial system would keep sinking under the weight of failed mortgage debt...

Several Republican aides said House Speaker Nancy Pelosi, D-Calif., had torpedoed any spirit of bipartisanship that surrounded the bill with her scathing speech near the close of the debate that blamed Bush's policies for the economic turmoil...

Rep. Barney Frank, D-Mass., scoffed at the explanation.

"Well if that stopped people from voting, then shame on them," he said. "If people's feelings were hurt because of a speech and that led them to vote differently than what they thought the national interest (requires), then they really don't belong here. They're not tough enough."

More than a repudiation of Democrats, Frank said, Republicans' refusal to vote for the bailout was a rejection of their own president.

"The Republicans don't trust the administration," he said. "It's a Republican revolt against George Bush and John McCain."

Builders taking on the banks

With large investment banks a thing of the past, more bank failures on the horizon, the American financial system in disarray and lenders hoarding cash, it’s hard to predict what the future holds for the building industry. But if the recently formed Coalition for Responsible Bank Behavior ( has anything to say about it, the chaos in financial circles certainly shouldn’t be taking down developers and homebuilders with it.

The coalition, formed earlier this year in San Diego by a collection of builders, attorneys and work-out specialists including Barratt American President Michael (Mick) Pattinson, hopes to force lenders to play by a consistent set of rules versus what the group’s members say have been a series of contrived defaults that have led not only to foreclosed projects, but hibernating or bankrupt development companies. At the same time, the coalition’s 85 members – whom are now geographically dispersed across the country – are focused on assembling the type of intelligence required to warn other builders about to face similar circumstances.

“The banks aren’t straightforward with customers regarding bank policy or decision making, so we’re left to piece together the jigsaw puzzle, and now can forewarn other builders who aren’t yet in the process but know what’s coming,” explained Pattinson to me in a recent phone interview.

The short-term goals of the coalition are quite specific, intending to leverage the political power of a key economic sector and put pressure on a banking industry that’s already proven itself to be less than responsible. These goals include raising the consciousness of both banks and builders about an entire industry in peril, encouraging builders to fight banking abuses, enlisting the media to tell the builders’ stories, contacting federal and state agencies and carefully documenting any patterns of poor and unethical bank behavior.

At the heart of the issue are inconsistencies between banks in their work-out dealings with builders. Citing regulatory issues that tie their hands, many banks are reportedly forcing their clients into defaults when other banks continue to work in tandem with builders to maximize the return of assets. And the stakes are significant: according to the coalition’s website, many lenders are selling foreclosed properties at 30 to 40 cents on the dollar when they could be getting twice that amount by avoiding the foreclosure process in the first place. Moreover, by forcing builders into default or bankruptcy, an entire supply chain of subcontractors, suppliers and consultants don’t get paid, leading to more layoffs and exacerbating the housing recession.

In many cases, these defaults aren’t due to the natural progression of a transparent series of steps but the contrived inventions of banks desperate to hold onto as much cash as possible. “In many cases, the banks encourage the builder to continue with the hope of potential loan renewal,” states the coalition’s website. “The banks seek to be made whole while the builder exhausts its cash. When the cash is depleted, the bank informs the builder they will not continue funding.”

So how does the lender justify such decisions? By relying on a ‘made to order’ deflated appraisal that backs up its findings – which, in a twist of irony, is the polar opposite of the puffed-up appraisals that helped mortgage lenders justify lending on $600,000 homes really worth closer to $500,000 during the boom years. In both cases, the true victims seem to be analytical objectivity, and eventually, the U.S. taxpayer.

Over time, the coalition also has other solutions it’s exploring to help an industry avoid similar scenarios in the future, such as eliminating the personal guarantee and making construction loans, like many purchase mortgages, non-recourse. Another major goal is to revamp the current commercial appraisal process so the process is transparent to the borrower, halting ‘mark-to-market’ rules that include panic-stricken sales comps and which don’t adequately reflect stabilized values, and initiating a three-appraisal rule to compete against sole in-house appraisals which tell the lenders exactly what they want to hear in order to declare a technical default.

Finally, the group suggests that the timetable required for a work-out on a multi-million dollar development should be expressed not in weeks or months but three to five years, and future loans should last the life of the project. Given the list of half-finished projects strewn across the country, I’d imagine that a host of cities, counties and homebuyers would certainly agree that the current solutions simply aren’t working.

While it’s undoubtedly sad that long-standing relationships between banks and builders have deteriorated to this point, it’s understandable that part of the conditions of a $700+ billion taxpayer bailout should have required both mortgage and commercial lenders to act with objectivity, fairness and transparency. Concludes Pattison, “We need every state and Washington, D.C. to ask lenders to explain themselves. If this isn’t the biggest fraud in the history of the world, then I don’t know what is.”

Sunday, September 28, 2008

Housing bust moves to the luxury segment

Due largely to the chaos on Wall Street, sales of luxury homes not just in Manhattan but around the country are finally starting to tank after showing some past resiliency. From a Wall Street Journal article:

For months, as housing values were falling for midsize ranch houses in Stockton, Calif., and Las Vegas high-rises, sales of high-end properties in financial centers like London, New York and San Francisco continued to percolate along.

But that was before last week, when turmoil in the credit markets brought down Lehman Brothers Holdings and imperiled thousands of high-paying jobs. While those rare properties priced at $20 million or more are still holding up, there are signs that the crisis is exacerbating a downturn that was already plaguing properties in the $2 million to $10 million range, a market often sought by Wall Street workers...

So far, the strongest part of the high-end market are the few "trophy" properties -- penthouses and other apartments with one-of-a-kind features that rarely come up for sale. "There are always people with money. Somebody's always on the other side of these crises," says David Ogilvy, a broker in Greenwich, Conn., who this year sold a $30 million house -- the second-most-expensive house ever sold in the area...

Just a few weeks ago, San Francisco saw one of its priciest listings ever, a 20,000-square-foot penthouse topping the St. Regis Residences. Encompassing two floors and featuring four terraces as well as a two-story waterfall, the still-unfinished unit has an asking price of $70 million.

So far, places like New York and San Francisco are still faring better than many other areas of the U.S., particularly areas of Southern California and Florida. "I think everyone is taking a hit," says Suzanne Perkins of Sotheby's in Santa Barbara, Calif., where prices have fallen 20% in the last year. "I still have buyers in the $20 million range, but they're looking for deals and they're looking for sellers who will negotiate."

In the run-up to the real-estate boom, brokers sometimes slapped headline-grabbing asking prices on highly desirable homes just to drum up interest and create buzz. Now, many of the tricks brokers are using to sell properties at the high-end are the same ones used with their more modest counterparts. The first and foremost: persuading the seller to list the home at an attractive price...

Amid the financial crisis, agents say many buyers are also more reluctant to buy splashy properties for reasons other than the cost. "I don't think anybody is going to be bidding for at least the next several weeks," says Kirk Henckels of Stribling Private Brokerage. "You'd feel pretty silly walking into a cocktail party today and saying you bought an apartment today."

L.A. Mayor to announce $5 billion housing plan

At MetroIntelligence, we're right in the middle of producing a market study for more low-income housing on the eastern border of Hollywood, so L.A. Mayor Villaraigosa's plan to be announced on Monday to spend $5 billion on housing for the poor and middle class caught my eye. You'd think it'd be easy to get managers of affordable apartment projects to cooperate with market analysts who are producting state-mandated reports, but nothing could be further from the truth.

Even if they do know the details of the apartments they manage, most managers or owners of existing tax credit, bond-financed and other types of affordable apartments treat information on rents and vacancies like a state secret. So when it takes a phone call to a councilman's office to get these people to cooperate, I'm not sure another $5 billion will fix the problem. The dirty secret in affordable housing? That private companies make a ton of money from tax credits and below-market financing and don't want any competition in the marketplace. So who loses? Everyone else. From an L.A. Times story:

Los Angeles Mayor Antonio Villaraigosa on Monday will unveil a $5-billion, five-year plan to build housing for the poor and middle class. The blueprint, which calls for thousands of new homes along subway and bus lines, and developments with people of all incomes living together, would, according to the mayor's deputies, alter the look and feel of the city forever.

But the plan, which many City Council members and business and housing groups said they had not yet seen, is being released while the housing market is a shambles, the state is facing a massive budget shortfall and the economy is teetering -- challenges that lead some to wonder whether it is feasible...

Others were more skeptical when they were presented with the broad brush strokes of the plan. Some developers object to a so-called mixed-income provision that would require affordable housing to be included in new housing developments. They say that such a policy -- which labor and housing groups have been pushing for years -- would cast a pall over entrepreneurial efforts...

Other elements of the plan, such as preserving existing affordable units and building near transit centers, are things the city already has pledged to do.

Housing has become an increasingly pressing political issue in Los Angeles. Last month, the Los Angeles Business Council released a report saying that the high cost of housing, especially in places like the Westside, "threatens the region's continued economic growth."

Los Angeles was designated the least affordable metropolitan area in the country last year, according to the Business Council report, because so many people pay so much of their incomes for housing. The city also has the largest homeless population in the nation. In addition, although private developers have built many high-end apartment units and condos over the last few years, there has not been a similar increase for households earning less than $75,000 per year...

Under the mayor's plan, the city would pledge $200 million a year for five years from various sources, including the city's Housing Authority, its affordable housing trust fund and its Community Redevelopment Agency, to build affordable housing.

Most, if not all, of that money would have been used for housing already, but by setting out a comprehensive plan the city hopes to use its money more efficiently and to be more competitive in winning grants, tax credits and bond funds from government and private sources. In all, the plan depends on raising an additional $4 billion over five years.

Villaraigosa acknowledged that in the current climate of economic uncertainty, some of the money the city is counting on may not come through, but he said he was confident other sources might open up. Federal dollars may flow to the city because of the foreclosure crisis, for example. He said he "sat down with three economists yesterday" and they assured him the plan was sound...

Other elements of the mayor's plan include:

* A "Sustainable Communities Initiative" to encourage the development of 20 pedestrian-oriented, mixed-income neighborhoods along the Gold Line in East Los Angeles and the Exposition Line in South Los Angeles.

* Building 2,200 units of permanent supportive housing to get homeless people off the streets and provide them with mental healthcare, drug treatment and other rehabilitation services, as well as making more Section 8 rental assistance vouchers available for homeless people.

* Redeveloping the Jordan Downs housing project in Watts into a mixed-income housing development with some units for very poor people and some units of market-rate housing. Already, the city has purchased 21 acres adjacent to Jordan Downs.

* Buying and rehabilitating foreclosed homes and turning them into affordable housing. On Friday, the federal government announced that the city was getting $33 million for that purpose.

* Preserving existing affordable housing by taking an inventory of all the affordable, rent-controlled and Section 8-eligible units in the city and finding ways to keep them affordable.

Could taxpayers make money on the federal bailout?

Could taxpayers actually make money on the federal bailout of distressed assets when the market unfreezes? An L.A. Times story asks the question:

...some economists say that the mortgage-backed securities the Treasury proposes to buy from crippled banks have been so beaten down in price that taxpayers could actually profit once the market for these securities -- now virtually nonexistent -- unfreezes.

"It's entirely within the realm of possibility that we'll make money on this deal," says J. Bradford DeLong, professor of economics at UC Berkeley.

DeLong observes that several government bailouts of the past have ended up in the black, including the 1994 rescue of the Mexican peso. The U.S. government eventually recorded a $500-million profit on its share of Mexico's $50-billion international loan package.

Of more immediate relevance, the government's takeover of stricken insurance company American International Group may have already produced a paper profit, and could produce more gains as AIG's asset portfolio is sold off or recovers its value...

No one is yet sure how the Treasury Department intends to set a price for its asset purchases, assuming Congress grants its request for $700 billion in buying power. Treasury officials have said only that the price might be set in a so-called reserve auction, in which each bank hoping to sell mortgage bonds to the government would state the lowest price it would accept and the government would buy first from the banks offering the lowest price.

"The devil is in the details," says Sandeep Dahiya, a finance professor at Georgetown University. "The government would pay something between the current market price, which is effectively zero, and the full fair value. But we've heard very little about how the auction would work out."...

One uncertain question is whether the government purchases will entice private investors to start bidding again for mortgage securities, creating an active market that could relieve the Treasury of the need to spend its entire fund.

Bailout plan details unveiled

Details of the $700 billion bailout plan of Wall Street were unveiled today as a rancorous Congress continues to debate the issue. From an L.A. Times story:

Congressional and administration officials unveiled their $700-billion rescue plan for Wall Street today, setting up the largest government intervention in the economy since the Great Depression.

The plan includes a program to purchase bad assets and an insurance program to underwrite others. It would also require the government to gain an equity stake in companies that benefit from the rescue, ensuring that taxpayers would make money once the assets regained some value. And the deal would require curbs on executive pay and the $700 billion to be released in installments...

The 110-page bill is posted on the website of the House Financial Services Committee. It is expected to be voted on by the House as soon as Monday and by the Senate on Wednesday...

But the plan faces fierce opposition from Republicans and Democrats angry at what they say is a taxpayer bailout of Wall Street "fat cats." As the House opened for an unusual Sunday session, lawmakers from both parties rose, one after another, for one-minute speeches denouncing the agreement -- and signaling a continuing struggle as policymakers and their staff work out the final details...

Both caucuses will be meeting in the afternoon, including a Democratic offshoot called the "skeptics caucus," at which members will hear from economists who oppose the bailout plan.

In separate appearances on the Sunday talk shows, both presidential nominees said they were inclined to vote for it.

"I'd like to see the details, but hopefully yes," Sen. John McCain of Arizona, the Republican candidate, said on ABC's "This Week." "And the outlines that I have read of it, that this is something that all of us will swallow hard and go forward with. The option of doing nothing is simply not an acceptable option."

Sen. Barack Obama of Illinois, the Democratic nominee, told CBS' "Face the Nation," "Ultimately, I believe that we have to get something done. And so if I feel that those are meaningful provisions that provide some constraints on how the Treasury operates, and this is not going to be welfare for Wall Street, then my inclination is to support it because I think Main Street is now at stake. This could affect every sector of the economy."

The rescue plan, which grew from a three-page proposal sent to Capitol Hill by the Treasury secretary a week ago to more than 100 pages, would allow the federal government to purchase bad debts from ailing financial institutions in an effort to stave off more bankruptcies and provide cash for new loans to ease the credit market freeze-up.

The plan is expected to call for the money to be made available in installments instead of one enormous lump sum. It is also expected to include additional oversight of the government's spending, limits on the pay of executives of firms that receive government aid, help for homeowners at risk of foreclosure and a provision that taxpayers share in any profits from the sale of distressed assets...

"I think the devil is in the details," Rep. Eric Cantor of Virginia, the GOP deputy whip, said on CNN's "Late Edition." "And, as you know, in Washington there may be a tentative deal, but oftentimes when the writing starts, the renegotiations begin. . . . I think the important thing that the Republican members in the House want to see is that taxpayers are not the ones left holding the bag."...

House Republicans, who have been critical of the growth in government spending under Bush, have been pushing to reduce the cost of the bailout. Unlike the president, they must stand for reelection this fall, and are willing to break with Bush as they try to reclaim the mantle of fiscal responsibility.

Bailout still ignores all of those pesky vacant homes

It's the empty houses, stupid.

So starts a blog post from the's "The Red Tape Chronicles" (no relation to this blog other than smartly selecting the generic term "Chronicles") on how the bailout of Wall Street mortgage junk still does nothing to address the problem of empty homes across the land. More from the blog post:

In case anyone has forgotten the core of the current economic crisis, here's a reminder: empty homes, both present and future. Empty homes are behind all the supposedly worthless mortgage-backed securities that no one wants to buy on Wall Street. Fear of the coming avalanche of empty homes -- what the Center for Responsible Lending calls the “tsunami of foreclosures” -- has made Wall Street’s mortgage-related paper nearly worthless.

It seems that filling those empty homes by dealing with foreclosures and stoking demand to buy homes should be the first order of business. So why -- as we discuss the most dramatic government intervention in nearly a century -- is there only passing mention of all these vacancies?

By every industry measure, foreclosure is a huge problem. Earlier this year, the financial services giant Credit Suisse estimated that there will be 6.5 million U.S. foreclosures during the next five years.

And even if you pay your mortgage on time, foreclosures will likely hurt you, too. Each time a family is kicked out of a home, there's collateral damage to the value of nearby homes. The Center for Responsible Lending says that the closest 50 homes lose an average of $3,000 in equity every time there’s a foreclosure. The organization estimates that 40 million families will lose nearly $350 billion in equity due to foreclosure collateral damage during the next five years...

There are really two related but distinct economic crises facing America right now. There’s the liquidity crisis on Wall Street, which has us all breathlessly watching CNBC, and there’s the housing crisis, which is kicking 6,000 families per day out of their homes and is draining equity from the rest of the nation’s homeowners...

“This was kind of a game of chicken and I'm afraid it looks like the consumer advocates in Congress are the ones who blinked ,” said Adam J. Levitin, a bankruptcy expert at the Georgetown University Law Center.

Details of the not-quite-completed-bailout-plan are still emerging, but by all accounts it will not include the most obvious and direct tool to stem the empty house problem: adjustments to bankruptcy law that would allow judges to modify the mortgages of at-risk homeowners.

Such assistance could still materialize in Congress, but the Senate voted to reject the idea in April, spurred on by agressive bank lobbying. By agreeing to this bailout deal without fixing bankruptcy law, Main Street’s advocates have surrendered nearly all their leverage...

"The only way to stop the free-fall of housing prices is to stop foreclosures," Kathleen Day, spokeswoman for the Center For Responsible Lending, warned. "If you don't do something for consumers, this is going to be unfair and ineffective."

The proposal to amend Chapter 13 bankruptcy law (the kind where debtors repay their loans, but buy time and get some discounts) is hardly revolutionary. Under Chapter 13, filers can rework all kinds of loans: car loans, vacation home loans, investment/rental property loans. But primary residence loans are exempt. Struggling homeowners face two choices in current bankruptcy law -- pay every penny or walk away. The limitation stems from a 1970s law that was intended to encourage banks to lend more money to would-be homeowners.

The simplest way to prevent the coming avalanche of additional empty homes -- and thereby make those asset-backed-securities have some real value -- is to prevent people from getting kicked out. It's stunning that $700 billion is about to change hands with no direct plan for keeping them in their homes.

Friday, September 26, 2008

Public simply doesn't trust federal government on bailout

Considering what's happened in American politics over the last generation (and not just the last 8 years), it's certainly understandable why the public simply doesn't trust anything that comes out of Washington, including the proposed federal financial bailout. From an LATimes story:

As congressional leaders struggled to craft a bailout plan for the nation's troubled financial system Thursday, angry protesters mobbed Wall Street, telephones rang off the hook in House and Senate offices and a group of prominent economists sent off e-mail blasts critiquing the proposal.

Numerous opinion polls taken this week came to wildly varying conclusions about the level of support among Americans for the Bush administration's $700-billion plan. But the increasingly loud roar coming from all corners of the nation shows that the idea of a bailout has touched a particularly sensitive nerve among the public...

"It's getting really controversial," said Peter DeMarzo, a professor of finance at Stanford who was among 166 academics who signed a letter sent to House and Senate leaders calling on lawmakers not to rush deliberation on the plan. Sen. Richard Shelby (R-Ala.) held a copy of the letter as he attended a meeting on the bailout negotiations at the White House. Shelby cited the letter as support for his stance against the Bush plan...

Polls taken in recent days have found little consensus among the American people on the Bush plan, which would provide funds to purchase huge quantities of mortgage-backed securities and other bad debt from troubled financial firms.

A poll by Rasmussen Reports early in the week found that 44% of Americans opposed the plan and 25% supported it. However, a USA Today/Gallup poll released Thursday showed more than 75% favored congressional approval of the bailout. A Bloomberg/Los Angeles Times poll conducted Sept. 19 through Monday showed 55% opposed to government bailouts of private companies.

More than 1,000 protesters clogged the street in front of the New York Stock Exchange on Thursday, bearing signs calling the bailout a "class war crime." A quartet dressed in business attire contrasted with the mob, holding up signs asking Congress to "have a heart, save a hedge fund," as other demonstrators jeered and shouted obscenities at them.

Meanwhile, some online conspiracy theorists think that a move by the military to bring back the 3rd Infantry Division’s 1st Brigade Combat Team from Iraq to focus on the homeland for 12 months beginning October 1st is intended to keep the masses in line should public protests get out of control. From the (hat tip:

The 3rd Infantry Division’s 1st Brigade Combat Team has spent 35 of the last 60 months in Iraq patrolling in full battle rattle, helping restore essential services and escorting supply convoys.

Now they’re training for the same mission — with a twist — at home.

Beginning Oct. 1 for 12 months, the 1st BCT will be under the day-to-day control of U.S. Army North, the Army service component of Northern Command, as an on-call federal response force for natural or manmade emergencies and disasters, including terrorist attacks...

The command is at Peterson Air Force Base in Colorado Springs, Colo., but the soldiers with 1st BCT, who returned in April after 15 months in Iraq, will operate out of their home post at Fort Stewart, Ga., where they’ll be able to go to school, spend time with their families and train for their new homeland mission as well as the counterinsurgency mission in the war zones...

The 1st of the 3rd is still scheduled to deploy to either Iraq or Afghanistan in early 2010, which means the soldiers will have been home a minimum of 20 months by the time they ship out.

In the meantime, they’ll learn new skills, use some of the ones they acquired in the war zone and more than likely will not be shot at while doing any of it.

They may be called upon to help with civil unrest and crowd control or to deal with potentially horrific scenarios such as massive poisoning and chaos in response to a chemical, biological, radiological, nuclear or high-yield explosive, or CBRNE, attack...

The 1st BCT’s soldiers also will learn how to use “the first ever nonlethal package that the Army has fielded,” 1st BCT commander Col. Roger Cloutier said, referring to crowd and traffic control equipment and nonlethal weapons designed to subdue unruly or dangerous individuals without killing them.

“It’s a new modular package of nonlethal capabilities that they’re fielding. They’ve been using pieces of it in Iraq, but this is the first time that these modules were consolidated and this package fielded, and because of this mission we’re undertaking we were the first to get it.”

The package includes equipment to stand up a hasty road block; spike strips for slowing, stopping or controlling traffic; shields and batons; and, beanbag bullets.

Wow, I feel better already.

Thursday, September 25, 2008

200 economists sign petition against quick bailout plan

Lately most of the anti-bailout rhetoric I've seen has been from people commenting on blogs, with most economists quoted in the MSM in favor of it. So why haven't the 200 economists who have signed a petition against the existing bail-out plan been widely quoted? I guess that's a question for the media. From a member's website:

To the Speaker of the House of Representatives and the President pro tempore of the Senate:

As economists, we want to express to Congress our great concern for the plan proposed by Treasury Secretary Paulson to deal with the financial crisis. We are well aware of the difficulty of the current financial situation and we agree with the need for bold action to ensure that the financial system continues to function. We see three fatal pitfalls in the currently proposed plan:

1) Its fairness. The plan is a subsidy to investors at taxpayers’ expense. Investors who took risks to earn profits must also bear the losses. Not every business failure carries systemic risk. The government can ensure a well-functioning financial industry, able to make new loans to creditworthy borrowers, without bailing out particular investors and institutions whose choices proved unwise.

2) Its ambiguity. Neither the mission of the new agency nor its oversight are clear. If taxpayers are to buy illiquid and opaque assets from troubled sellers, the terms, occasions, and methods of such purchases must be crystal clear ahead of time and carefully monitored afterwards.

3) Its long-term effects. If the plan is enacted, its effects will be with us for a generation. For all their recent troubles, America's dynamic and innovative private capital markets have brought the nation unparalleled prosperity. Fundamentally weakening those markets in order to calm short-run disruptions is desperately short-sighted.

For these reasons we ask Congress not to rush, to hold appropriate hearings, and to carefully consider the right course of action, and to wisely determine the future of the financial industry and the U.S. economy for years to come.

Click here to see the list.

The story behind the bailout discussions

There's a very interesting story on the website (hat tip: Drudge Report) that discusses in some detail exactly what happened at the White House on Thursday:

A high-profile White House meeting on Treasury’s $700 billion Wall Street rescue plan ended on a sour, contentious note Thursday after animated exchanges among lawmakers laced with presidential politics just weeks before the November elections.

Treasury Secretary Henry Paulson came up to the Capitol hours later to revive talks, but House Republicans did not participate, and Democrats warned that the whole process could collapse unless President Bush gets them to come to the table...

Both McCain and his Democratic rival, Sen. Barack Obama, would leave the White House without comment, and the meeting was described as among the wildest in memory. A beleaguered President Bush had to struggle to maintain order and reassert himself. And when Democrats left to caucus in the Roosevelt Room, Paulson pursued them, begging that they not “blow up” the legislation...

It was McCain who had urged Bush to call the White House meeting but Democrats made sure Obama had a prominent part. And much as they complained later of being blindsided, the whole event turned out to be something of an ambush on their part—aimed at McCain and House Republicans.

“Speaking professionally,” said one Republican aide, “They did a very good job.”

When Bush yielded early to Pelosi and Senate Majority Leader Harry Reid (D- Nev.) to speak, they yielded to Obama to speak for the assembled Democrats. And it was Obama who raised the subject of the conservative alternative and pressed Paulson on what he thought of the idea.

House Republicans felt trapped—squeezed by Treasury, House Democrats and a bipartisan coalition in the Senate. And while McCain spoke surprisingly little after asking for the meeting, he conceded that it appeared there were not the votes for the core Paulson plan without major changes...

The wild White House meeting may have the effect of uniting Democrats more. And only hours before, Dodd, Frank and bipartisan set of prominent senators had reached a bipartisan agreement Thursday on the framework for legislation authorizing the massive government intervention.

But passing the Treasury plan is still an uphill climb, and Pelosi will be reluctant to expose her members if House Republicans are sitting out the process. And the whole sequence of events confirmed Treasury’s fears about the decision by Bush, at the urging of McCain, to allow presidential politics into what were already difficult negotiations...

Paulson was left feeling bruised on two fronts. He was not part of the Capitol discussions in the morning, which stretched to nearly three hours and will now require extensive follow-up with Treasury. This process began last night and will continue Friday morning, while the leadership takes the political temperature for going forward.

At the same time, Frank, a strong Paulson ally, feels the secretary is being undercut in front of the president.“McCain and the House Republicans are undercutting the Paulson plan, talking about a wholly different approach,” Frank said prior to the meeting. And this was very much the line of attack at the White House: “This is the presidential campaign of John McCain undermining what Hank Paulson tells us is essential for the country.”...

There is a greater emphasis on efforts not just to relieve Wall Street firms of their bad debts but also to help homeowners threatened by foreclosure. Companies that benefit from the plan would be expected to limit pay and severance packages for their executives, and community banks are expected to benefit from a new $3 billion tax break as a result of their stock losses in the government takeover of the two mortgage finance giants, Fannie Mae and Freddie Mac...

Paulson had asked for the $700 billion funding authority as part of his initial bill, arguing that the large number is an important signal to the markets of the government’s commitment. Nonetheless, the administration has since paid a heavy political price for not better explaining its initiative as an “investment” by taxpayers — and one which will surely be repaid to some level as the economy improves.

The whole debate has exposed an angry anti-Wall Street cultural divide, and Paulson, a former Goldman Sachs CEO, has been the target of critics who argue that “Main Street” taxpayers are being asked to aid other wealthy bankers. Getting the full $700 billion, without any encumbrances, has become almost impossible politically in Congress.

The proposal agreed to in the Capitol meeting would allow $250 billion, immediately followed by another $100 billion, for a total of $350 billion. What happens to the second $350 billion is sure to be the subject of intense bargaining still with Treasury. But lawmakers signaled that Congress would have the authority to deny any more money through a joint resolution — but that it would have to overcome a presidential veto to do so...

The cost debate illustrates just how nuanced the massive intervention will be. Paulson has often stumbled this week when trying to describe its intent, and the clearest voice has been Bernanke, a former college professor who casts the whole effort as an unprecedented experiment in “price discovery” that will add not just capital but also precious knowledge to jump-start the credit markets.

With the bursting of the U.S. housing bubble, mortgage-related securities are caught in a vicious downward cycle, commanding only “fire sale” prices, Bernanke says. The government purchases, through a series of novel auction mechanisms, will help the market value these assets, he says. And this could be the spark needed to get markets working and the economy’s engine turning over again.

This explanation is very different from the “bailout” imagery that surrounds the debate. And the great challenge for both sides has been to find some path in between these two poles — able to satisfy the anger voters feel toward Wall Street but also leaving enough room for Bernanke’s experiment to function.
One issue where this comes up is the question whether Treasury should demand warrants or options to hold stock in the companies — a way, perhaps, to turn a profit for taxpayers in the future. Many Democrats argue that this is only fair given the risk the Treasury is assuming by buying up the bad debts. But Bernanke worries that it will be seen as a punitive step and discourage companies from participating — and thereby reduce the competition in the market.