Every year millions of students are taught in their economics classes that Laissez-faire market capitalism is the best path to prosperity... well I'm here to tell you that Laissez-faire (unregulated) capitalism doesn't work! It's a patently flawed economic policy.
Laissez-faire capitalism is tantamount to having no lines, dots, stop signs/signals on the highway. Not only is it reckless and negligent for our government to endorse this economic policy, it is inefficient and doesn't achieve its sought-after goals of optimal resource allocation. Just like having an unregulated highway creates an environment for car crashes, Laissez-faire capitalism inevitably creates over and over again the same economic environment that leads to financial collapse and stock market crashes.
If the Bush Administration for example enforced the laws enacted by congress to regulate the stock market via the SEC and oil manipulation and speculation through the FTC and CFTC and regulated the mortgage-backed securities market for excesses and the mortgage brokerage industry they would have averted this whole financial mess we're in today.
And if the Bush Administration would have shored up the mortgage-backed securities market by buying as little as 10% of the outstanding mortgage-backed securities at par-value that had dropped from 100 to 27 cents on the dollar, the mortgage-backed securities market wouldn't have collapsed which was the catalyst that initiated this massive financial catastrophe we're now experiencing.
The justification the Bush Administration used to defend their negligent economic policies - Laissez-faire market capitalism and the "invisible hand" would solve these major systemic problems in the financial system. Well like any major problem we ignore... it doesn't get better on its own, it actually gets much worse.
Laissez-faire capitalism just doesn't work! It is totally irresponsible in a sophisticated economy like ours. It is supposed to be impartial/unbiased and yet it favors the powerful over the weak, the informed over the uninformed - it is impartial to the compassionate needs of humanity and the social goals of the citizens its supposed to serve. Markets are easily manipulated, information is censored/concealed and not evenly distributed, and except for supply/demand theories drafted on paper, in reality equilibrium is rarely ever achieved.
Laissez-faire capitalism leads to a phenomenon known as "creative destruction" that actually wastes valuable resources and productive capacity - where the total cost of the entire industry's production is calculated and attributed against the total value of the units sold and the results are a net loss for the entire industry. For example, when the auto industry was born there were 100s of automobile manufacturers all with extensive infrastructure startup costs. With all these manufacturers seeking to recover the costs associated with production as soon as possible, this led to the over-production of automobiles and 95% of the automakers went bankrupt - only 5% were profitable. If you took the sum total of the entire cost of manufacturing all the automobiles in the industry - even those unsold vehicles - and compared that cost against the total revenues of all the automobiles sold, you'd have a net loss for the entire industry! This phenomenon leads to a highly inefficient and an ineffective allocation of resources and use of vital capital. Even though there are individual winners in this and pretty much every economy, most of America's industries today looked at in their entirety are losing money!
Laissez-faire capitalism doesn't work and belongs on the trash heap of history... to be learned from but never used again.
For those of you reading this who are confused into thinking that if I'm not a Laissez-faire capitalist I must be a socialist or communist, I will state very clearly that I'm am neither. That is the propaganda of the ultra-elite who espouse Laissez-faire capitalism.
In closing - regulation is good. It keeps us from taking medication that is ineffective, makes people sick or with severe side-effects, or even worse kills. Regulation keeps our food supply safe for consumption. Regulation keeps utility companies from abusing their monopoly power. Regulation keeps the ordinary investor protected against fraud. Regulation keeps the environment clean. And regulation keeps the rich and powerful from abusing the economic rights of the under-privileged. Regulation is good.
Monday, March 2, 2009
CEO Pay
Why is it when we make an investment in a company's stock, the government doesn't care the CEO makes $10+ million dollars in annual compensation - they call it laizze-faire, yet when the government makes an investment in these same companies from their bailout reserves, they insist the CEO pay is reduced!
It takes 100,000 investors buying 100 shares each per year to pay a CEO's salary for each $ of stock sold to raise $10 million. That's like taking the members of Mariners Church multiplied by 10 investing 100 shares in a company just to pay the CEO's salary for one year.
Who will be in charge of setting CEO pay? None other than Treasury Secretary Henry Paulson who made $16 million per year (Source: Forbes) as CEO of Goldman Sachs - the investment bank who made a fortune selling short mortgage-backed securities which led to the collapse of the MBS market which has spread into collapsing the U.S. financial system. Yes, the wolf is guarding the hen house! The CEO who presided over the destruction of the U.S. financial system is the one in charge of repairing it! But I've written a lot about that already...
We don't need more laws from Congress - we need enforcement by the executive branch for the laws we already have.
It's similar to the issue of securing the U.S. border, we don't need more legislation... we need the Bush admin (i.e. Securities and Exchange Commission) to enforce the laws we already have on the books.
SEC Chairman, Republican Chris Cox (Newport Beach) advocated just 6 months ago the SEC be dissolved and yet their mission is to create stable and secure markets and to protect the rights of ordinary investors against wall street excesses. This shows how negligent those laizze-faire types at the highest levels of the Bush admin are. They have no clue how to govern this nation!
The SEC allows staggered boards (so only a potion of an entrenched board can be removed at a time), cumulative voting (where institutional investors can allocate all their voting shares towards one of their hand-picked board members guaranteeing their approval), closed-door compensation committees (without any visibility into the process or accountability to shareholders), etc.
The SEC has the power to stop this!
In addition, the SEC has the power through executive order to force publicly traded companies to open CEO compensation to shareholder approval. Instead, SEC Chairman, Republican Chris Cox keeps reiterating his laizze-faire rhetoric while his party accepts large CEO campaign contributions... with big smiles and cheers the Republicans and CEOs yell: "4 more years! 4 more years!"
This has to stop! They advocate laizze-faire free market capitalism and yet there are plenty of market mechanisms like the one mentioned above that help manage CEO pay and the SEC doesn't establish any of them! Why? It's called: "4 more years! 4 more years!" the Republicans want to get their candidates elected and CEOs are powerful and make large contributions to the Republican party.
It takes 100,000 investors buying 100 shares each per year to pay a CEO's salary for each $ of stock sold to raise $10 million. That's like taking the members of Mariners Church multiplied by 10 investing 100 shares in a company just to pay the CEO's salary for one year.
Who will be in charge of setting CEO pay? None other than Treasury Secretary Henry Paulson who made $16 million per year (Source: Forbes) as CEO of Goldman Sachs - the investment bank who made a fortune selling short mortgage-backed securities which led to the collapse of the MBS market which has spread into collapsing the U.S. financial system. Yes, the wolf is guarding the hen house! The CEO who presided over the destruction of the U.S. financial system is the one in charge of repairing it! But I've written a lot about that already...
We don't need more laws from Congress - we need enforcement by the executive branch for the laws we already have.
It's similar to the issue of securing the U.S. border, we don't need more legislation... we need the Bush admin (i.e. Securities and Exchange Commission) to enforce the laws we already have on the books.
SEC Chairman, Republican Chris Cox (Newport Beach) advocated just 6 months ago the SEC be dissolved and yet their mission is to create stable and secure markets and to protect the rights of ordinary investors against wall street excesses. This shows how negligent those laizze-faire types at the highest levels of the Bush admin are. They have no clue how to govern this nation!
The SEC allows staggered boards (so only a potion of an entrenched board can be removed at a time), cumulative voting (where institutional investors can allocate all their voting shares towards one of their hand-picked board members guaranteeing their approval), closed-door compensation committees (without any visibility into the process or accountability to shareholders), etc.
The SEC has the power to stop this!
In addition, the SEC has the power through executive order to force publicly traded companies to open CEO compensation to shareholder approval. Instead, SEC Chairman, Republican Chris Cox keeps reiterating his laizze-faire rhetoric while his party accepts large CEO campaign contributions... with big smiles and cheers the Republicans and CEOs yell: "4 more years! 4 more years!"
This has to stop! They advocate laizze-faire free market capitalism and yet there are plenty of market mechanisms like the one mentioned above that help manage CEO pay and the SEC doesn't establish any of them! Why? It's called: "4 more years! 4 more years!" the Republicans want to get their candidates elected and CEOs are powerful and make large contributions to the Republican party.
Republican Party is not by Nature Conservative
The Republican party is not by nature conservative, and yet conservatives keep promoting the Republican party. Go figure!
I've heard it all before... ya, ya, ya... gay marriage, dial #1 for english, illegal immigration, abortion, etc these are all over-used push-button emotional issues the Republicans tease us with over and over again but do nothing about. They want to blame it on the gridlock in Washington. They don't want to resolve these issues. It's these hip-pocket issues they pull out every 4 years that help them get elected. Ya, ya, ya... it's like a broken record.... remember the Republicans have had control of the White House, Supreme Court, Senate, and House of Representatives for 6 out of the past 8 years and what did they do?
Did they push forward a conservative agenda? No!
So how did they spend their political collateral? Deregulating the financial system (i.e. stocks, bonds, hedge funds, insurance, investment banking, and runaway commodities markets), and taking us to war in Iraq - a country who never attacked us. George W. Bush took the political risk. He knew that the Iraq war, or I should say, invasion and occupation, could cost us the House and Senate and sure enough it also brought Nancy Pelosi into power two years ago. Don't blame anyone but Bush and his awful presidency for destroying the Republican party and bringing those liberals into power. It's the war, high food and oil prices, and the laizzez-faire unbridled capitalism that is bringing Obama into the White House with absolute full control of our federal government going to the Democrats. Look, read your history, it happens every time! The pendulum always swings the other way - if you want unbridled laizzez-faire capitalism like we had in the 1920s, well get ready for some serious market-oriented socialism like we had in the 1930s.
I don't know why so many Republicans defend Bush #1 and Bush #2 so much when they have been the worst presidents in modern history. McCain spent the past 7 years fighting to defend Bush's policies and war agenda. Now he wants to distance himself. Americans aren't that forgetful. They associate McCain with the failed Bush Republican policies of the past 8 years. I believe the country would be better off with Ron Paul. However, he's not running.
Now the choice for me is Obama versus McCain - but these guys are surrogates. What people are really thinking is... Clinton versus Bush. And I know what people are feeling deep down in their hearts... Clinton left this country better off than when he took it over from Bush #1 - in spite of Jocelyn Elders, Janet Reno, Monica Lewinsky, and the two dozen or more scandalous pardons he issued to the highest bidders. Even still, I and millions of Americans believe the country is far worse after Bush #2 than it was 8 years ago under Clinton.
The tax issue is a real deal. But I figure I'll have to pay an additional 2% per year as my marginal tax rate of 35% goes to 39% on my earnings above $250,000. But it's very reasonable to conclude that the government deficit will be reduced or eliminated like in the Clinton Administration. NAFTA and the other free-trade agreements will be eliminated or renegotiated to help the hard working middle-class from the vicious cycle of unemployment, re-training (usually at their expense) and re-employment over and over again. And we'll get out of the war in Iraq costing us taxpayers $200+ billion per year.
These and the many other Obama policies have been formulated by great minds like Warren Buffett, Paul O'Neil, William Donaldson, Paul Volker, and Colin Powell - a dream team of responsible Republicans who care about America's future and want to have this country governed well. This mind trust will help Obama stabilize the economy and financial markets. I'm not worried one bit about paying more taxes in an Obama administration, I consider it an investment because I'm certain I'll get a good return on my tax dollars through greater financial opportunities and increased personal income.
I've heard it all before... ya, ya, ya... gay marriage, dial #1 for english, illegal immigration, abortion, etc these are all over-used push-button emotional issues the Republicans tease us with over and over again but do nothing about. They want to blame it on the gridlock in Washington. They don't want to resolve these issues. It's these hip-pocket issues they pull out every 4 years that help them get elected. Ya, ya, ya... it's like a broken record.... remember the Republicans have had control of the White House, Supreme Court, Senate, and House of Representatives for 6 out of the past 8 years and what did they do?
Did they push forward a conservative agenda? No!
So how did they spend their political collateral? Deregulating the financial system (i.e. stocks, bonds, hedge funds, insurance, investment banking, and runaway commodities markets), and taking us to war in Iraq - a country who never attacked us. George W. Bush took the political risk. He knew that the Iraq war, or I should say, invasion and occupation, could cost us the House and Senate and sure enough it also brought Nancy Pelosi into power two years ago. Don't blame anyone but Bush and his awful presidency for destroying the Republican party and bringing those liberals into power. It's the war, high food and oil prices, and the laizzez-faire unbridled capitalism that is bringing Obama into the White House with absolute full control of our federal government going to the Democrats. Look, read your history, it happens every time! The pendulum always swings the other way - if you want unbridled laizzez-faire capitalism like we had in the 1920s, well get ready for some serious market-oriented socialism like we had in the 1930s.
I don't know why so many Republicans defend Bush #1 and Bush #2 so much when they have been the worst presidents in modern history. McCain spent the past 7 years fighting to defend Bush's policies and war agenda. Now he wants to distance himself. Americans aren't that forgetful. They associate McCain with the failed Bush Republican policies of the past 8 years. I believe the country would be better off with Ron Paul. However, he's not running.
Now the choice for me is Obama versus McCain - but these guys are surrogates. What people are really thinking is... Clinton versus Bush. And I know what people are feeling deep down in their hearts... Clinton left this country better off than when he took it over from Bush #1 - in spite of Jocelyn Elders, Janet Reno, Monica Lewinsky, and the two dozen or more scandalous pardons he issued to the highest bidders. Even still, I and millions of Americans believe the country is far worse after Bush #2 than it was 8 years ago under Clinton.
The tax issue is a real deal. But I figure I'll have to pay an additional 2% per year as my marginal tax rate of 35% goes to 39% on my earnings above $250,000. But it's very reasonable to conclude that the government deficit will be reduced or eliminated like in the Clinton Administration. NAFTA and the other free-trade agreements will be eliminated or renegotiated to help the hard working middle-class from the vicious cycle of unemployment, re-training (usually at their expense) and re-employment over and over again. And we'll get out of the war in Iraq costing us taxpayers $200+ billion per year.
These and the many other Obama policies have been formulated by great minds like Warren Buffett, Paul O'Neil, William Donaldson, Paul Volker, and Colin Powell - a dream team of responsible Republicans who care about America's future and want to have this country governed well. This mind trust will help Obama stabilize the economy and financial markets. I'm not worried one bit about paying more taxes in an Obama administration, I consider it an investment because I'm certain I'll get a good return on my tax dollars through greater financial opportunities and increased personal income.
A Solution to the Mortgage Crises
A Solution to the Mortgage Crises
Please pardon the next several paragraphs as they are necessary to establish the basis of the analysis and solution to the mortgage crises. If these are of no use to you read the solution and go back to the assumptions afterward.
Assumptions used in the analysis.
U.S. Census data reports that there are 64 million home mortgages in the United States. However, the Mortgage Banking Association (MBAA.ORG) tracks only 45.4 million mortgages of those mortgages. Either number you go by you'll soon discover that the lower MBA number actually accentuates my case I'm making below.
According to the MBAA's National Delinquency Survey 3rd Quarter report released in December 2008, roughly 6.99% of all mortgages are 60 days late which is the predictor used by the mortgage banking industry to predict eventual foreclosure. In addition, 2.97% of mortgages are in foreclosure for a total of 9.96% of distressed mortgages. The 45.4 million mortgages used in their survey is a huge sample size and can easily be used to make inferences toward the total number of 64 million U.S. home mortgages.
With that said, we'll assume that the 9.96% percentages of distressed mortgages should be applied toward the total number of 64 million U.S. home mortgages. This provides us with approximately 6.37 million mortgages are in distress and either in foreclosure or heading that way.
The median monthly mortgage payment in the United States is $1,687. Although this number isn't an average (I couldn't find a current average figure), I'm assuming since the mortgage statistics are well distributed, I'll use this number as an average. The average number will probably be somewhat higher because the lowest quartile is a linear progression with a shallow slope from the mean, whereas the highest quartile is a hyperbolic progression with a steeper slope from the mean. ** if anyone can source the average home mortgage, please let me know ** After I receive this statistic for the average monthly home mortgage, I'll use this more accurate number for my future calculations instead.
So if you take the 6.37 million distressed mortgages and multiply them against the $1,687 median monthly mortgage payment, you arrive at a $10.75 billion monthly mortgage cash-flow loss upon the mortgage banking and mortgage insurance industry. That's a fraction of the magnitude the Bush/Obama Administration Treasury Department has portrayed. The reason is in how they look at the problem.
The problem in the great depression and now is how they looked at the problem. Like any problem, if you cannot see the problem correctly your solution set will either be absent, or seriously maligned or skewed toward ineffective or inefficient solutions.
I contend that the mortgage banking problem is a flow issue and not a capital issue. The Administration is focusing on and attempting to fix the capital issue. We are in a vicious de-leveraging cycle. As banks are having to fully capitalize their losses which have eroded past their loss reserves, and with mark-to-market accounting forcing banks to book assets below intrinsic values, they have to sell these and other distressed (presently illiquid) assets to satisfy their reserve requirements maintained against their deposit base.
The banks are in a de-leveraging squeeze as their non-performing home mortgage portfolios are pushed through vicious algorithms that reassess future value. To give you a rough idea, if a bank originates a 30 year 5.41% fixed interest loan of $307,000 for a $1,687 monthly payment with 360 payment coupons, that loan's future value is $607,320 (we're assuming the homeowner pays all his/her payments on time). When the payments are delinquent or not paid at all, the future value of the loan is greatly depreciated. What's 360 payments of $0.00 worth? Nothing, right? Well that's an over-simplification but hopefully you get my point. When assets become non-performing all of a sudden you are forced to arrive at the asset value through some sort of imprecise liquidation appraisal arithmetic. The depreciation of the future value of the loan contributes heavily to the bank's cash-flow losses and when extrapolated forward using future value algorithms that access loss capitalization, it greatly affects the banks deposit reserves and the solvency of the bank. As a bank becomes insolvent, the next step is nationalization of bank assets and the FDIC takes over like in the case of Washington Mutual, et al.
This outcome is very tragic and what's worse, it's totally unnecessary.
Using the basic arithmetic shown above, the total future value for all distressed U.S. home mortgages is $3.87 trillion. That's if the loans were to be reset and carried forward in a 30 year fixed starting today. I'm saying this only to illustrate that the problem is far less severe than it's being made out to be by the Bush/Obama Administrations. The current payoff values on these mortgages would be much lower, approximately $2 trillion. You heard that right, the federal government could payoff all delinquent home mortgages and home mortgages in foreclosure for less than $2 trillion. But that would be an extremely inefficient use of tax payer money. My solution would be far less expensive and involves the government providing 2nd tier public mortgage supplemental insurance.
Approach the Problem from a Cash-Flow Crises not a Capital Crises
If you factor a 2 to 5 year duration to this mortgage crises, you arrive at a $258 to $645 billion financial catastrophe, respectively. But that is much smaller than the federal government makes this crises out to be. When certain people can't afford to pay their mortgages but are remaining in their homes, that is a cash-flow crises. The Obama Administration Treasury Department needs to approach the problem where the problem exists - where the rubber meets the road. Americans and our banks are having a cash-flow crises, not a capital crises. It's the conversion and extrapolation from cash-flow to capitalization that is so exponentially damaging to the banks as the leverage dynamic is being applied against the banks reserves. The Bush and now Obama Administrations are approaching this as a capital crises as the banks are forced to fully capitalize these cash-flow losses on their balance sheets which affects the capital used for their bank deposit reserve requirements. The $700 billion TARP money is being used to shore up the banks' capital requirements when it should be used to cover their cash-flow losses and therefore temper this vicious cycle of loss capitalization and de-leveraging of the financial sector. The loss capitalization methodology is irrational and thus indeterminant, whereas the cash-flow deficiencies are far more precise and manageable. And that's exactly where the solution should reside.
A Forbearance Strategy
The solution to the mortgage crises is a forbearance strategy and would involve the government acting as a national public mortgage insurer. Let MBIA, AMBAC, AIG, MGIC, and others who offer Private Mortgage Insurance (PMI) remain as primary 1st-tier insurers with the federal government acting as the backstop or secondary supplemental mortgage insurer. However, the taxpayers must be protected – I'm not suggesting a free lunch for anyone. The federal government's public mortgage supplemental insurance should maintain an enforceable first lien position upon owner-occupied properties at a substantial premium commensurate with the risk of default and the banks should have the right to opt out of the program. Mortgages made to real estate speculators and vacation homeowners would not qualify except for mortgages made upon their primary residence.
Here are more details on the way the program should work. When a homeowner is late by 30 days, the participating lien holding banks with secured home loans would inform the homeowner of his/her rights to make payment on their delinquent balance within 30 days to opt out and remain unaffected. However, after 60 days late payment, the homeowner would again be notified of the government emergency public mortgage supplemental insurance program and the first position lien supplemental payment being made to the bank by the government on the homeowner's behalf. After 90 days of delinquency, the federal government emergency public mortgage supplemental insurance payment would automatically kick in and first reimburse the 90 days of back payment to the bank and continue in force to supplement homeowner delinquent mortgage payments at 6% above prime as published in the WSJ (currently 3.25%) for a total of 9.25% APR being attached to the lien. After the homeowner has satisfied payment to the bank for all delinquent back payments and fees, the bank keeps the processing fees and the prime rate of interest portion while the federal government would receive the remaining 6% APR.
It is important that the federal government should remain transparent to the homeowner. No relationship should be established between the homeowner and the federal government other than a first position lien is placed upon the property that would be satisfied at sale if not previously released prior to the sale and dispossession.
At anytime, the homeowner can reinstate all back payments to the bank with interest and government-regulated bank processing fees. The bank keeps the processing fee and the prime rate interest and pays the government the 6% APR interest associated with the supplemental mortgage insurance reimbursement. The first position federal government lien would promptly be removed with all liens appropriately reinstated to their respective positions. The homeowner is then made whole with his/her credit re-established in good standing with appropriate forbearance toward future institutional lending.
If the policy, as outlined above, was pursued by the U.S. Treasury Department the banks wouldn't be facing nationalization - as the great extent of their cash-flow losses stemming from this mortgage crises wouldn't need to be capitalized and additional assets acquired and collateralized to be held in reserve against their deposit base.
This policy isn't perfect and won't solve the mortgage crises entirely as there exist a substantial number of highly-leveraged real estate speculators who have sustained substantial depreciation in appraised values who are walking away from their least performing inventory of homes in foreclosure and the banks will have to capitalize those unavoidable losses. But this is a smaller percentage of the total number of homes in foreclosure.
RFC: I would appreciate your comments and any pertinent mortgage/housing data (please provide sources and date range covered by the research)
Please pardon the next several paragraphs as they are necessary to establish the basis of the analysis and solution to the mortgage crises. If these are of no use to you read the solution and go back to the assumptions afterward.
Assumptions used in the analysis.
U.S. Census data reports that there are 64 million home mortgages in the United States. However, the Mortgage Banking Association (MBAA.ORG) tracks only 45.4 million mortgages of those mortgages. Either number you go by you'll soon discover that the lower MBA number actually accentuates my case I'm making below.
According to the MBAA's National Delinquency Survey 3rd Quarter report released in December 2008, roughly 6.99% of all mortgages are 60 days late which is the predictor used by the mortgage banking industry to predict eventual foreclosure. In addition, 2.97% of mortgages are in foreclosure for a total of 9.96% of distressed mortgages. The 45.4 million mortgages used in their survey is a huge sample size and can easily be used to make inferences toward the total number of 64 million U.S. home mortgages.
With that said, we'll assume that the 9.96% percentages of distressed mortgages should be applied toward the total number of 64 million U.S. home mortgages. This provides us with approximately 6.37 million mortgages are in distress and either in foreclosure or heading that way.
The median monthly mortgage payment in the United States is $1,687. Although this number isn't an average (I couldn't find a current average figure), I'm assuming since the mortgage statistics are well distributed, I'll use this number as an average. The average number will probably be somewhat higher because the lowest quartile is a linear progression with a shallow slope from the mean, whereas the highest quartile is a hyperbolic progression with a steeper slope from the mean. ** if anyone can source the average home mortgage, please let me know ** After I receive this statistic for the average monthly home mortgage, I'll use this more accurate number for my future calculations instead.
So if you take the 6.37 million distressed mortgages and multiply them against the $1,687 median monthly mortgage payment, you arrive at a $10.75 billion monthly mortgage cash-flow loss upon the mortgage banking and mortgage insurance industry. That's a fraction of the magnitude the Bush/Obama Administration Treasury Department has portrayed. The reason is in how they look at the problem.
The problem in the great depression and now is how they looked at the problem. Like any problem, if you cannot see the problem correctly your solution set will either be absent, or seriously maligned or skewed toward ineffective or inefficient solutions.
I contend that the mortgage banking problem is a flow issue and not a capital issue. The Administration is focusing on and attempting to fix the capital issue. We are in a vicious de-leveraging cycle. As banks are having to fully capitalize their losses which have eroded past their loss reserves, and with mark-to-market accounting forcing banks to book assets below intrinsic values, they have to sell these and other distressed (presently illiquid) assets to satisfy their reserve requirements maintained against their deposit base.
The banks are in a de-leveraging squeeze as their non-performing home mortgage portfolios are pushed through vicious algorithms that reassess future value. To give you a rough idea, if a bank originates a 30 year 5.41% fixed interest loan of $307,000 for a $1,687 monthly payment with 360 payment coupons, that loan's future value is $607,320 (we're assuming the homeowner pays all his/her payments on time). When the payments are delinquent or not paid at all, the future value of the loan is greatly depreciated. What's 360 payments of $0.00 worth? Nothing, right? Well that's an over-simplification but hopefully you get my point. When assets become non-performing all of a sudden you are forced to arrive at the asset value through some sort of imprecise liquidation appraisal arithmetic. The depreciation of the future value of the loan contributes heavily to the bank's cash-flow losses and when extrapolated forward using future value algorithms that access loss capitalization, it greatly affects the banks deposit reserves and the solvency of the bank. As a bank becomes insolvent, the next step is nationalization of bank assets and the FDIC takes over like in the case of Washington Mutual, et al.
This outcome is very tragic and what's worse, it's totally unnecessary.
Using the basic arithmetic shown above, the total future value for all distressed U.S. home mortgages is $3.87 trillion. That's if the loans were to be reset and carried forward in a 30 year fixed starting today. I'm saying this only to illustrate that the problem is far less severe than it's being made out to be by the Bush/Obama Administrations. The current payoff values on these mortgages would be much lower, approximately $2 trillion. You heard that right, the federal government could payoff all delinquent home mortgages and home mortgages in foreclosure for less than $2 trillion. But that would be an extremely inefficient use of tax payer money. My solution would be far less expensive and involves the government providing 2nd tier public mortgage supplemental insurance.
Approach the Problem from a Cash-Flow Crises not a Capital Crises
If you factor a 2 to 5 year duration to this mortgage crises, you arrive at a $258 to $645 billion financial catastrophe, respectively. But that is much smaller than the federal government makes this crises out to be. When certain people can't afford to pay their mortgages but are remaining in their homes, that is a cash-flow crises. The Obama Administration Treasury Department needs to approach the problem where the problem exists - where the rubber meets the road. Americans and our banks are having a cash-flow crises, not a capital crises. It's the conversion and extrapolation from cash-flow to capitalization that is so exponentially damaging to the banks as the leverage dynamic is being applied against the banks reserves. The Bush and now Obama Administrations are approaching this as a capital crises as the banks are forced to fully capitalize these cash-flow losses on their balance sheets which affects the capital used for their bank deposit reserve requirements. The $700 billion TARP money is being used to shore up the banks' capital requirements when it should be used to cover their cash-flow losses and therefore temper this vicious cycle of loss capitalization and de-leveraging of the financial sector. The loss capitalization methodology is irrational and thus indeterminant, whereas the cash-flow deficiencies are far more precise and manageable. And that's exactly where the solution should reside.
A Forbearance Strategy
The solution to the mortgage crises is a forbearance strategy and would involve the government acting as a national public mortgage insurer. Let MBIA, AMBAC, AIG, MGIC, and others who offer Private Mortgage Insurance (PMI) remain as primary 1st-tier insurers with the federal government acting as the backstop or secondary supplemental mortgage insurer. However, the taxpayers must be protected – I'm not suggesting a free lunch for anyone. The federal government's public mortgage supplemental insurance should maintain an enforceable first lien position upon owner-occupied properties at a substantial premium commensurate with the risk of default and the banks should have the right to opt out of the program. Mortgages made to real estate speculators and vacation homeowners would not qualify except for mortgages made upon their primary residence.
Here are more details on the way the program should work. When a homeowner is late by 30 days, the participating lien holding banks with secured home loans would inform the homeowner of his/her rights to make payment on their delinquent balance within 30 days to opt out and remain unaffected. However, after 60 days late payment, the homeowner would again be notified of the government emergency public mortgage supplemental insurance program and the first position lien supplemental payment being made to the bank by the government on the homeowner's behalf. After 90 days of delinquency, the federal government emergency public mortgage supplemental insurance payment would automatically kick in and first reimburse the 90 days of back payment to the bank and continue in force to supplement homeowner delinquent mortgage payments at 6% above prime as published in the WSJ (currently 3.25%) for a total of 9.25% APR being attached to the lien. After the homeowner has satisfied payment to the bank for all delinquent back payments and fees, the bank keeps the processing fees and the prime rate of interest portion while the federal government would receive the remaining 6% APR.
It is important that the federal government should remain transparent to the homeowner. No relationship should be established between the homeowner and the federal government other than a first position lien is placed upon the property that would be satisfied at sale if not previously released prior to the sale and dispossession.
At anytime, the homeowner can reinstate all back payments to the bank with interest and government-regulated bank processing fees. The bank keeps the processing fee and the prime rate interest and pays the government the 6% APR interest associated with the supplemental mortgage insurance reimbursement. The first position federal government lien would promptly be removed with all liens appropriately reinstated to their respective positions. The homeowner is then made whole with his/her credit re-established in good standing with appropriate forbearance toward future institutional lending.
If the policy, as outlined above, was pursued by the U.S. Treasury Department the banks wouldn't be facing nationalization - as the great extent of their cash-flow losses stemming from this mortgage crises wouldn't need to be capitalized and additional assets acquired and collateralized to be held in reserve against their deposit base.
This policy isn't perfect and won't solve the mortgage crises entirely as there exist a substantial number of highly-leveraged real estate speculators who have sustained substantial depreciation in appraised values who are walking away from their least performing inventory of homes in foreclosure and the banks will have to capitalize those unavoidable losses. But this is a smaller percentage of the total number of homes in foreclosure.
RFC: I would appreciate your comments and any pertinent mortgage/housing data (please provide sources and date range covered by the research)
On Short-Selling
On Short-Selling
Although free markets find the equilibrium price between spot supply and demand, they are indeterminate towards establishing equilibrium outside this short-term scope. In the long run, supply, demand and the price level adjusts.
Trend trading creates hyperbolic market prices. That is a phenomenon that exists even without the advent short selling. You can look at stock chart after stock chart and see trading behavior quite clearly. People jump on the bandwagon. There is little rationale that correlates a stock’s trading price and its intrinsic value. Its price has very little to do with retained earnings, shareholder equity, assets, liabilities, book value, even expected future earnings. These two values behave asymmetrically as I have found that most stocks trade in a pattern disconnected to their basic fundamentals.
Trend trading behavior dictates that when prices continue falling, the natural response is to get out of the way. It creates a downward hyperbolic trend where prices fall exponentially until the price falls so far below its long-term trend line and/or intrinsic valuation. This phenomenon exists even without short-selling. When you add short-selling, the laissez-faire capitalists argue, it clears markets sooner - like when ripping a band-aid off fast it hurts less.
However short-selling doesn’t actually have that effect for several reasons. For one, the phenomenon known as hypothecation obfuscates the supply/demand dynamic. Short selling is supposed to involve borrowing someone else’s shares and selling them as if you owned them with the intention of profiting by buying them back at a lower price later. It implies locking those shares up so they are not available to the market until they are bought back. But this is not how it works under hypothecation. In reality the shares remain available. This appears to the market as more shares available for sale artificially pushing up supply.
In your basic supply/demand dynamic, hypothecation of short-sold shares can dramatically increase supply and therefore prices fall. When this phenomenon is added to an already existing downward trend, it serves to artificially fuel the downward momentum. The second problem with short-selling is that it’s too easy to leverage to zero. When a brokerage firm allows their clients to buy on margin, this creates leverage when used to buy shares – an important point is that it can be used to buy any shares. Moreover, in this scenario there is a finite amount of leverage that can be applied toward any stock whose price is potentially infinite. Remember, a stock price theoretically could go to infinity.
Whereas when leverage is used to short-sell stock, the stock price on the downside is finite at zero. In many cases the stock price of zero is more readily finite than the amount of leverage that can be obtained through re-hypothecation.
For example, if there are 100 million shares outstanding, and 100 million shares hypothecated and then sold short – because they are not locked out, there will soon exist 200 million shares – the original 100 million shares plus the hypothecated shares sold short. Eventually, those 100 million short-sold shares will be bought back and everyone’s happy right? No. In certain circumstances like what’s prevalent in today’s market, before that occurs the stock price will already have been driven to near zero with the stock in violation of its exchange mandated minimum price – this causing it to be delisted from the stock exchange. Coincident with that the company is driven toward declaring bankruptcy as companies typically float stock for emergency operating capital or use their stock as collateral for short-term debt obligations. A sub par stock typically cannot raise capital in the credit or equity markets.
The capitalists’ rationale is this: the market simply helped speed up the inevitable. However in most cases that just isn’t true without this additional hyperbolic momentum caused by the hypothecation and downside leverage.
In many cases, the short sellers operate under total secrecy and float false rumors that malign the company and destroy confidence keeping buyers out of the market until the rumors are proven to be false. By that time the stock price collapses under the panic selling making the false prophesy come true.
I like the analogy of a mob rushing a theatre full of people, borrowing their belongings, and then screaming “fire” shortly before locking them inside. In most cases the predators don’t even need to set an actual fire. In the mayhem and mad rush to the exit doors, fire is the least of their concerns as they trample over each other to death. The few who survive end up receiving their belongings, while the remainder becomes the mob’s treasure trove.
Although free markets find the equilibrium price between spot supply and demand, they are indeterminate towards establishing equilibrium outside this short-term scope. In the long run, supply, demand and the price level adjusts.
Trend trading creates hyperbolic market prices. That is a phenomenon that exists even without the advent short selling. You can look at stock chart after stock chart and see trading behavior quite clearly. People jump on the bandwagon. There is little rationale that correlates a stock’s trading price and its intrinsic value. Its price has very little to do with retained earnings, shareholder equity, assets, liabilities, book value, even expected future earnings. These two values behave asymmetrically as I have found that most stocks trade in a pattern disconnected to their basic fundamentals.
Trend trading behavior dictates that when prices continue falling, the natural response is to get out of the way. It creates a downward hyperbolic trend where prices fall exponentially until the price falls so far below its long-term trend line and/or intrinsic valuation. This phenomenon exists even without short-selling. When you add short-selling, the laissez-faire capitalists argue, it clears markets sooner - like when ripping a band-aid off fast it hurts less.
However short-selling doesn’t actually have that effect for several reasons. For one, the phenomenon known as hypothecation obfuscates the supply/demand dynamic. Short selling is supposed to involve borrowing someone else’s shares and selling them as if you owned them with the intention of profiting by buying them back at a lower price later. It implies locking those shares up so they are not available to the market until they are bought back. But this is not how it works under hypothecation. In reality the shares remain available. This appears to the market as more shares available for sale artificially pushing up supply.
In your basic supply/demand dynamic, hypothecation of short-sold shares can dramatically increase supply and therefore prices fall. When this phenomenon is added to an already existing downward trend, it serves to artificially fuel the downward momentum. The second problem with short-selling is that it’s too easy to leverage to zero. When a brokerage firm allows their clients to buy on margin, this creates leverage when used to buy shares – an important point is that it can be used to buy any shares. Moreover, in this scenario there is a finite amount of leverage that can be applied toward any stock whose price is potentially infinite. Remember, a stock price theoretically could go to infinity.
Whereas when leverage is used to short-sell stock, the stock price on the downside is finite at zero. In many cases the stock price of zero is more readily finite than the amount of leverage that can be obtained through re-hypothecation.
For example, if there are 100 million shares outstanding, and 100 million shares hypothecated and then sold short – because they are not locked out, there will soon exist 200 million shares – the original 100 million shares plus the hypothecated shares sold short. Eventually, those 100 million short-sold shares will be bought back and everyone’s happy right? No. In certain circumstances like what’s prevalent in today’s market, before that occurs the stock price will already have been driven to near zero with the stock in violation of its exchange mandated minimum price – this causing it to be delisted from the stock exchange. Coincident with that the company is driven toward declaring bankruptcy as companies typically float stock for emergency operating capital or use their stock as collateral for short-term debt obligations. A sub par stock typically cannot raise capital in the credit or equity markets.
The capitalists’ rationale is this: the market simply helped speed up the inevitable. However in most cases that just isn’t true without this additional hyperbolic momentum caused by the hypothecation and downside leverage.
In many cases, the short sellers operate under total secrecy and float false rumors that malign the company and destroy confidence keeping buyers out of the market until the rumors are proven to be false. By that time the stock price collapses under the panic selling making the false prophesy come true.
I like the analogy of a mob rushing a theatre full of people, borrowing their belongings, and then screaming “fire” shortly before locking them inside. In most cases the predators don’t even need to set an actual fire. In the mayhem and mad rush to the exit doors, fire is the least of their concerns as they trample over each other to death. The few who survive end up receiving their belongings, while the remainder becomes the mob’s treasure trove.
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