WONKESS

Plus ca change, plus c'est la meme mortgage...

I really enjoyed this op-ed piece in the NYT today.  Written by two professors, it discusses some of the problems that are preventing the renegotiation of mortgages.  To summarize the problem, many mortgages are no longer held at a single bank, but have been pooled with other mortgages, packaged into Mortgage Backed Securities (which may have been further packaged into Collateralized Debt Obligations) and sold off to a wide array of investors.  The problem with this is that rather than a single mortgage holder, a mortgage now has many thousands of holders, each with a legal claim to a piece of the mortgage payments.  However, this problem has been addressed in the securitization contracts: a party called a “master servicer”  is assigned to manage the pools of loans.

Now under any functioning free market system, when you get into these default situations, it usually behooves the lender and the borrower to rework the debt.  Absent the situation where the borrower has absolutely no means to meet their obligations, the lender is usually better off reducing the debt payment by adjusting the interest rate or reducing the principal due (compare to the alternative in foreclosure, which involves a complex and costly legal process, with an auction that may not give you very good returns).  However, it looks like these master servicers have a very unique set of incentives to do the opposite:

Most anything a master servicer does to rework a loan will create big winners but also some big losers among the security holders to whom the servicer holds equal duties. So the servicers feel safer doing nothing. By allowing foreclosures to proceed without much intervention, they avoid potentially huge lawsuits by injured security holders.

On top of the legal risks, reworking loans can be costly for master servicers.

Last, some big master servicers are part of, or have now been bought out by, the very companies that own the securities that can be affected by the reworking or foreclosure decisions the master servicer makes. This conflict [because there is now the hint that the master servicers may make decisions that will disproportionatley favor their owners] further increases the chances of litigation and contributes to inaction.

So the profs propose the following:

To solve this problem, we propose legislation that moves the reworking function from the paralyzed master servicers and transfers it to community-based, government-appointed trustees. These trustees would be given no information about which securities are derived from which mortgages, or how those securities would be affected by the reworking and foreclosure decisions they make.

Instead of worrying about which securities might be harmed, the blind trustees would consider, loan by loan, whether a reworking would bring in more money than a foreclosure. The government expense would be limited to paying for the trustees — no small amount of money, but much cheaper than first paying off the security holders by buying out the loans, which would then have to be reworked anyway. Our plan would also be far more efficient than having judges attempt this role. The trustees would be hired from the ranks of community bankers, and thus have the expertise the judiciary lacks.

Well, I'm hating the TARP and the various central bank interventions.  And McCain's random n-th hour proposal to spend $300b in TARP money to simply buy out flailing mortgages at cost was a bit looney-tunes.  This?  I'm Ok with this. 

It's using the government as facilitator, rather than government standing in for a trading partner.   Warms the cockles of that part of my heart which is not dead.

On a related note, I was thinking about the tax consequences of debt forgiveness while I was reading this article.  Generally speaking, I believe that if a debt is canceled, that gives rise to ordinary income (which is taxed then at ordinary income rates).  So if there is an adjustment of principal, the difference would immediately become ordinary income for the borrower, which he would have to report on his yearly income tax filing.  Obviously, with the government playing facilitator, it would be kinda hard to evade this.  There are some exceptions to the rule that cancellation of debt gives rise to ordinary income, mainly in situations of bankruptcy and insolvency.  Maybe the borrower might get some leeway on insolvency, but it seems that if you are qualify for loan modification, you are probably not insolvent (just cash flow problems). 

This can kinda suck, and the borrower could get stuck with a large tax bill.

So even if the mortgage trustee program is not implemented, and we continue to rely on master servicers or judicial cram-down, it seems a predecessor step would be to fix the tax code so that the cancellation of debt income would either book at some later date, or that it could be booked in yearly installments over a period of years.

Link of the date: Discussion of the Fed's Balance Sheet (Scary in honor of Mischief Night)

And Now for Something Completely Different...

Found this site today:

It is a chart showing the number of REOs (Real Estate Owned by bank) on Countrywide's balance sheet.  That's 19,618 foreclosed upon homes held by Countrywide as of 10/17/08.  It's interesting that there's a bit of a dip in the spring.  Probably b/c there were some who thought that we had hit bottom, and were beginning to take advantage  by buying up REOs (from what I've heard, Spring is also usually the strongest months for sales).  Either that, or its just that at this point, the number of foreclosures are so high and coming so fast, that Countrywide can get them sold in sufficient quantities to offset new foreclosures.

Our old mortgage was held by Countrywide (even though they were not the originators).  Boy, am I glad not to be associated with that company in any way shape or form anymore.

Also, I mentioned in a previous post that I'm trying to take some actions to hedge against a dollar collapse.  We took a moderate stake in Yen, which was doing great until friggin' yesterday.  (Aaargh!  I can't be a friggin' day trader, I've got a friggin' job.)  And I knew I should have switched out of the Yen b/c the Japanese will not let the Yen strengthen that much - y'know, hurts exports, yadda yadda yadda.  I was going to switch out into commodities and *shazam* wouldn't you know it, oil goes and shoots up today.  Guess what I'm not going to be doing.

But, wishful thinking aside, here's some really weird and frightening numbers: the five-year TIPS yields have crossed up and over the conventional five-year treasury yields.  TIPS are Treasury Inflation Protected Securities.  Basically, the principal of your investment in a TIPS is inflation protected: it will be adjusted in case of inflation to match inflation.  The fact that TIPS yields are going up means that it has become more valuable to hold TIPS, which means either there is either irrational panic buying going on or that the market is signaling that it believes inflation is on the horizon.  (h/t Jesse's Cafe Americain)  [NOTE!  UPDATE BELOW]

Update:  Steve Waldman from the wonderful blog Interfluidity has corrected my misreading of the TIPS yield.  He is absolutely correct.  The reason the yield on TIPS are going up is because people no longer think it's valuable to be protected against inflation, so the securities have to offer higher returns in order to entice people to purchase the securities.  This is clearly an example of one of those behavioral economics phenomenons, where people tend to see data to support their point of view.  LOL, I'm such a cliche! 

Anyways, I still think we're in for inflation/dollar weakening, and though we saw some of it yesterday, apparently, this is NOT an indicator.  Tks Steve.

You Can Vote However You Like...

Wouldn't you know it gets busy right around election time.  I was going to try to get to PA to help out, but with the extra hours I've been pulling, I don't think I can fill the childcare gaps.  Damn.

But THIS, THIS is awesome.  And yeah, don't forget you CAN vote however you like.  Just VOTE.

h/t Andrew Sullivan

Random Link Love...

This is Scary Spice.  (Fed's imminent implosion.)
This is Angry Spice.  (Bailout money not for saving the economy, just for greedy bankers.)
This is Crazy Spice.  (Look, it's just not hard-hitting journalism to randomly start quoting Marx, k? Tks.)

Laid-Off by Lehman...

Not so timely, but still funny.

H/T Madame X

I Saw the Dow Today, Oh Boy...

Aw, man, I love Yves:

[E]ven though we have very strong opinions, we do not give investment advice. What we provide (aside from commentary) might be regarded as investment hazard warnings. You may nevertheless decide to go ahead after reading what we offer, but we hope you will proceed with caution. One thing most investors fail to realize (and we have made this mistake ourselves) is the warning from mathematician and market maven Benoit Mandelbrot: ""Markets are very, very risky – more risky than the standard theories assume."

The thought for today is that oversold does not necessarily mean undervalued. And a second thought is that the stock market increasingly seems to serve as a quick proxy for how the economy is doing, when it has a strong propensity to give false positives.

Even perennial bear Marc Faber, who has only 7-8% of his portfolio in stocks (and by the sound of it, not US ones either), thinks the market was primed for a technical rally but is not keen on the long-term prospects for the US economy:

"The governments in this world have no other option but to print money. That will lead down the road to inflation,'' Faber said. "You don't need to be an economist graduated from Harvard to know we're already in a recession. They will just put white paint on a crumbling building...."

"To rebuild economic health in the United States, you need a serious recession that will last several years,'' he said. "The patient that got drunk on credit growth needs to go into rehabilitation. To give him more alcohol, the way the Fed and the Treasury propose to do, is the wrong medicine.''
So whether or not the market signal is correct, we don't see the credit/economic crisis as close to resolution. The fact that we averted a systemic meltdown is not the same as saying the powers that be found a cure.

The dollar has remained unexpectedly strong (that view is based on disgruntled sounds I have heard from various sources). Most expected continued dollar weakness, although a minority saw the euro taking a big hit before a dollar slide resumed. An orderly fall in the dollar would hopefully not discomfit our trade partners unduly, but a disorderly slide would.

The big unresolved issue now is that even though we appear to have avoided a financial meltdown (even Nouriel Roubini thinks that risk has passed), we are still going to see considerable deleveraging, due primarily to the fact that lenders are in no mood to take risk, but compounded by the fact that consumers and businesses are feeling plenty shell-shocked.

We have noted before that even if the Fed gets Libor and the interbank risk measures associated with it down to less stressed levels, that does not mean we are back to status quo ante. First, rates could improve at diminished levels of activity. Second, even if banks do lend to each other, that does not mean that they are going to resume extending credit on anything other than very cautious terms to customers.

Remarkably, Anna Schwartz, who with Milton Friedman, was the author of the pathbreaking monetary study of the Depression that concluded the worst would have been averted had central banks injected more liquidity, said in an interview with the Wall Street Journal that the Fed was using the wrong remedy to this crisis, and was treating it as a liquidity crisis when it is in fact a solvency crisis.

So not surprisingly, with an economy on the downturn, even if banks do decide to become freer with lending to their peers, evidence is mounting that they are not going to be as accommodating with their customers. From Andrew Ross Sorkin at the New York Times:

But Mr. Paulson is making a big assumption about confidence, because until the real economy recovers — which could take more than a year — lending to Main Street is unlikely to return rapidly to normal levels.

"It doesn’t matter how much Hank Paulson gives us," said an influential senior official at a big bank that received money from the government, "no one is going to lend a nickel until the economy turns."

From Robert Reich:

The Dow is see-sawing but the reality is that the Bailout of All Bailouts isn't working. Credit markets are largely still frozen. Despite all the money going directly to the big banks, despite all the government guarantees and loans and special tax breaks, despite the shot-gun weddings and bank mergers, despite the willingness of the Treasury and the Fed to do almost whatever the banks have asked, the reality is that credit is not flowing. It's not flowing to distressed homeowners. It's not flowing to small businesses. It's not flowing to would-be homeowners with good credit ratings. Students are having a harder time borrowing for their tuition. Auto loans are drying up.

Why? Because the underlying problem isn't a liquidity problem. As I've noted elsewhere, the problem is that lenders and investors don't trust they'll get their money back because no one trusts that the numbers that purport to value securities are anything but wishful thinking. The trouble, in a nutshell, is that the financial entrepreneurship of recent years -- the derivatives, credit default swaps, collateralized debt instruments, and so on -- has undermined all notion of true value.

Roubini now foresees a deep recession of at least two years' duration. That does not appear to be part of the newfound stock market cheer. Given Roubini's success in calling this credit crisis, I'd be loath to take a long-term bet against him.

I've been thinking about the gyrating market over the past few weeks, and really, the more it gyrates, the more upset I get.  Not so much because of my personal losses (I am one of those who tosses my quarterly statements under the bed) but because I hate how much importance we've begun to attribute to it.  It has become the holy grail: the path to great financial wealth, the source of easy money, and an oracle to policy-makers.  It's like really bad one-stop shopping.

For example, the whole bailout thing.  It's become a monstrous cacophony of "huzzah for government intervention" because the Dow climbs 500 points to "no, if you don't pass this we'll all DIE!!!" as the Dow drops 700 points when in reality, the stock market reflects nothing more than a bunch of trader's day to day belief of whether they can make short term gains on this day.

You know, I wouldn't even care so much if the insanity of the market was just self contained.  I just hate how much it's leaked into every other aspect of life.

Link of the Day: The Broker with Hands on their Faces Blog.  There are moments when you discover something and you wonder how you ever existed without it.

You Betcha Doggonit

Break In Case of Emergency...

My favorite Personal Finance (PF) bloggers have all recently done segments about what everyone should be doing right now to prepare for the recession (that we are absolutely in, frak what some number watchers might be saying).  The advice has been pretty consistent, and good, namely:

(1) Don't pull your money out of retirement accounts if you have a longer than 10 year timeline and keep investing IF YOU CAN so as to take advantage of dollar cost averaging.  However, see (5) in the second list below.
(2) Pay off any debt (except mortgage debt) that is costing you more than 3-4% in interest.
(3) Build up a 8 month - 1 year emergency fund.  Keep that liquid, in a bank that is FDIC insured.
(4) Cut spending.

These are great suggestions if you can keep your job (or for dual income families, if both of you can keep your jobs) or, at the very least, see no more than a 30% decrease in earnings.  But what do you do if you are afraid that you might be down-sized out of your job(s)?  J and I have begun to plan for that possibility, seeing how his contract is up at the end of this academic year, and the law rag, Above the Law, keeps reporting stealth layoffs at law firms (with 2006 year associates being prime targets).

(1) First, I have been keeping track of every penny we've spent for the past six months.  (Yes, I'm due to report my September spending, but whereby I am religious in keeping track of the spending, I'm not so good with entering things into Quicken and making my monthly charts.)  That has allowed me to figure out how much of my spending can be done away with if J and I both lose our jobs.  Right off the bat, childcare and commuting costs zero out.   It has also given me a good sense of the bare minimum we need to survive.  For our family of four, we can make it on about $3000/month (w/o health coverage) if we BOTH lose our jobs (see #2).  From my experiences with Cobra, we would have to add an extra $800/month to be on Cobra.  What scares me here is that Cobra expires after 6 months, and I have no experience with what health insurance costs when you are buying it yourself.  Having 2 kids, having health insurance is non-negotiable.

(2) As I mentioned in my last post, J and I have been certain that this economic shit-storm was coming.  We had actually projected that it wouldn't hit for another 3-5 years, which sux for us because we were counting on that time to build up our net worth, but we predicted that it would start with real estate and would accelerate because of leverage.  This is the reason that despite my very good salary, we have been renting instead of buying.  We have also held off on pretty much any sort of furniture, home improvement, etc.. purchasing in order to save and keep ourselves mobile (my daughters sleep on mattresses on the floor... srsly).  So, the second part of our contingency plan, which will be much harder to swallow for some than others, is that we will move in with my mom, who lives in NY.  We have already talked about it with her, and she's completely in agreement.  There are several reasons that this makes sense for us: her home is paid for in full, she is near retirement and will be able to provide some amount of free childcare, she would love to have us near, it is near a major (though now bad) job market, and we would be able to consolidate a lot of our expenses.  It also gives us some time to ride out the real estate market, so that we can buy when prices hit rock bottom.

(3) Third, we have been diversifying for the changing economic environment.  J has some assets (which are not "mine" b/c of our prenup - I know, TMI, but it is why it doesn't count toward my net worth) that he inherited from his grandparents.  It's not much, but it is our emergency/college backup fund (see, we're crazy, we have backups on our backups).  In other words, it's not our emergency fund (nor our college fund), b/c it is not as liquid as our emergency fund, but it is what we will fall back on if our emergency fund runs out.  It used to be all in Fortune 500 stock, but J got out of half of that before things got really bad (back when the Dow was still above 10,000.  He's converted it to: physical gold, Japanese currency, Australian currency, Canadian currency, and Swiss currency (don't know how to do this?  Go to etrade or whatever brokerage you use and look for currency funds).  These have not been great choices, because gold has been erratic, and the dollar has gotten stronger, and Australia is falling apart.  (We're good at seeing big macro trends, not so good with micro trends or directing our money to the right investments,  For J, this makes him the perfect academic.)  Of course, these are NOT investments for growth, they are hedges for in case the dollar collapses.

(4) I know this will sound stupid, but I throw all my change and an occasional $20 bill into a large jar + coin purse that I keep in our room.  When the jar gets full, I throw all of that money into a separate bank account.  I've been doing this for about 5 years.  The account at this point has over $4000 in it.  This is our "garden" fund.  If one of us gets laid off, we will have the time (and money) to convert some piece of land (either a community plot here, or my mom's own garden in NY) into a vegetable producing garden.  Neither of us have had any experience at this, which is what makes this a kinda stupid idea, but you never know until you try.

(5) Both J and I reduced our retirement fund contributions over the summer.  J is now just at matching (5%) and since my firm does not match at all, I'm down to 3% from 5%.  We're ignoring the additional net income that this has brought, the extra amount goes straight to our emergency fund.  The reason for this is simple - we decided that we need the emergency fund more badly than we need to save for retirement right now.  We are still woefully behind in our emergency fund, and have nowhere near the 8 months of salary that I would like.  But we have now a few months of expenses (per #1) saved up, and J's job is guaranteed at least until next June, so we still have some time to save.

(6) Finally, we have cut some our fixed expenses.  I've let all but 2 of my magazines expire, I'm finally out from under my 2 year gym commitment which I've cancelled, I've lowered my netflix subscription, I've changed my cell phone plan, and I've changed our cable/internet plan.  All told, I believe this adds up to a $200 monthly saving.  We are also not entering into any longterm commitments that either require payment upfront or have penalties to exit (like classes for the girls).  We are trying to be as flexible as possible.

Does anyone else have an Emergency Plan in place?  If you do, please let me know in the comments!

Link of the day: Prime Rate explained (cool)

The Sky is Falling...

So, I know that there's no reason for anyone to believe me, but J and I have been predicting this economic collapse for a while now.  I wasn't as into econ back then (in fact, it was our discussions which lead to our mapping out of the scenarios which spurred my interest in economics and finance) so I couldn't have told you the specific mechanisms by which the meltdown would have occurred.  I could have told you it would be related to the real estate bubble and by the financial sector, but, srsly?  Barbar the elephant could have come up with that.

It was part of the reason we were very anxious to sell our bfv property back in early 2006.  Prices had not yet dropped in that area, in fact, they were holding up reasonably well, but J had been just dying to get out of our mortgage, despite the fact that we had been in the house for less than 3 years.  Let's just say we saw the writing on the wall.  The day we sold our house (at a very slight loss once fees were taken into account) was a happy day indeed.

Of course, I didn't predict it the way Nouriel Roubini, the original Dr. Doom, predicted it (i.e. in precise, 12-step form), but y'know, he's like world-famous and trained and shit, and I picked up my economics by reading other people's blogs.  Yeah, I'm teh amateur.

But hey, I have a blog now, which means I can spew my stupidity for posterity.  So I thought I would play a game called, hey, let's predict where the economy is going.

Please, for my 5 readers out there, I am SOOOO very much an amateur, and I have always been a glass-half-empty kind of person to boot, so please don't read too much into this.  I just want to have a permanent record here, so in the off-chance I'm right, I can feel all righteous and shit.

I think that this economic fall-out will be severe and long.  But long as in 3ish years and not Great Depression-esque.  I struggle between whether it will be deflationary or inflationary, but I've decided that that is because I don't know enough about how the other, non-US economies are doing.  If they weather the downturn better than us, then it will probably be deflationary.  If not, then inflationary.  The reasoning behind this has to do with the ability of foreign governments to buy our debt.  Given the degree of loosening of monetary policy that has happened recently, the only way to "sterilize" (oooh, new concept that I just learned this weekend, aren't I teh bom?) all the excess dollars will be to sell some serious debt.  We had no problem doing so after 9/11, which turned out to be a very mild bump in America's economic progress chart, but 9/11 wasn't global, and this is.  If East Asia and the Middle East can't afford to purchase our debt (and things aren't looking so peachy keen right now), the inability to sell our debt will lead to significant inflation.

China's not doing well.  I get this first hand, and more terrifyingly, from this post at Naked Capitalism.  The Baltic Dry Index, something I HAVE NEVER HEARD OF, which is apparently a proxy for the outlook of global manufacturing, has been dropping almost as precipitously as the Dow did last week today (but which drop is not, apparently, nearly as historical given innate volatility in the Index).  It also jives with the fast dropping price of oil, which has been attributed to a drop of demand.  If demand from China was the driver of the upside, it seems reasonable to speculate the drop off in demand is driving the downside as well. [update: this just in from J, apparently, some portion of the drop can be attributed to speculation.]

China is not a stable country.  China is like an enormous stick of dynamite with an extremely short fuse that is just waiting to explode.  The disparity between the rural and urban areas of the country is obscene, and from what I can tell, there is quite a lot of resentment over the massive amounts of attention that has been focused on the economic development in the cities.  A point that is noted in YaSheng Huang's (MIT Professor) recent book on Chinese Capitalism.  Add to this volatility that can arise out of a severe imbalance in the male to female ratio.  The favoring of sons, and the one child policy, has produced a male to female ratio in China of around 120:100 (as compared to most societies, where the figure is closer to 106:100 [nb - these statistics are disputed.  There are census that show China's male-female ratios to be closer to the world norms].  Young, un-marriable men, can be of great benefit to a state that is desperate to keep its hegemony.

If China cannot grow, it will feel a lot of internal strife.  The Chinese Communist Party does not take well to internal strife, and one way to dissipate anger toward domestic government is to direct that anger outward.  As we have seen a couple of times this year (i.e. Olympics) there is no country that China loves to hate more than the United States.  The Chinese government will push a heavy form of anti-American Nationalism.  Which could lead to...

An armed conflict between the US (maybe the West) against China.  The government stays intact, they find use for all of those un-marriable men.

Armed conflicts though really really bad for people are not so bad for the economy.  It took World War II to pull us out of the Great Depression.  And it can't be like the Iraq war, which only had the US fighting, in an economically thankless war (b/c US govt is funding the reconstruction).  It has to be a conflict w/ lots of damage that someone will pay the US to come in afterwards to cleanup.

Now that I've expunged my psychotic inner-Palin, we now return you to our regular programming,

Banktron...

From Sinfest