In this article we are going to examine 5 observations that only a market collapse like this, something we haven’t seen since the Great Depression can generate.  The Nasdaq now has a Government Relief Index so we can track the demise of our tax payer investments.  The index measures companies that receive over $1 billion in government relief.  This by current estimates is probably every single crony company on Wall Street.  Next, we will discuss how one of the government sponsored entities, from the two stooges camp of Fannie Mae and Freddie Mac are already back at the well for more money.  That was fast!  Again those calling for decoupling are being schooled once again by the unraveling of the Euro and British Pound while the U.S. dollar remains relatively strong.  There will be a slew of information next week so get ready with your swim goggles to drink water out of a fire hydrant.  And finally we will discuss the California unemployment numbers and will dig deeper into the report.  The news is not good and is even worse than the 9.3% headline number.

The Nasdaq Government Relief Index

I’m not sure if the Nasdaq Government Relief Index is a cruel joke of transparency since we all know that most of the money being dumped in these companies and failing banks is not coming back.  Too bad there wasn’t an easy way to short this thing when it opened on January 5^th, 2009.  Let us see what the index is about:

“(Nasdaq) This Index allows taxpayers and other investors to measure the performance of U.S. companies that are participating in the government’s financial relief plan,” said NASDAQ OMX Executive Vice President John Jacobs. “We believe the NASDAQ OMX Government Relief Index will be useful in helping investors evaluate the government’s investments and the impact of the relief plan on the economy during this period of historical significance.”

The NASDAQ OMX Government Relief Index consists of companies across multiple industry groups that have received a direct investment from the U.S. Government greater than $1 billion. The Index is the first of the Government Relief Index Series that NASDAQ OMX will be launching in the coming weeks.

The Index is calculated in real-time across the combined exchanges and is disseminated in dollars. The index began calculation with a value of 1000.00 on January 5, 2009.”

Why not call it the Bailout for Upper Management (BUM) index?  Let us now take a look at how things look on the index shall we?

A 34.5% drop in 3 weeks.  Glad our government money is being spent well!  If this is what we had in mind with transparency, maybe we should go back to simply thinking money is being flushed down the toilet and sticking our head back in the sand.  Maybe we don’t want to see the painful details of the actual money being eviscerated into the money shredder.  When I think of transparency, I hope we are talking about being open BEFORE we make the investment, not after.  This money is gone into the abyss.  Remember that small cadre of Kool-Aid drinkers who were telling us we were going to turn a profit on all this?  Maybe in a distant future but nothing in the short run.

Yummy – Can I have some more Government Cheese?

Mortgage giant Freddie Mac is now back looking for $35 billion from the government.  Let us take a trip down memory lane to July of 2008 when I talked about how we would be on the hook for billions of dollars if we went down the path of digesting the two giant mortgage organizations.  Remember this memorable quote from Paulson?

“I’m not here recommending putting taxpayer money into these institutions at this time. I am recommending we increase the backup facility temporarily to minimize the chance that the taxpayer will be involved,” he said. “If you have a squirt gun in your pocket, you may have to take it out,” he said. “But if you’ve got a bazooka in your pocket, you may not have to take it out.”

Not only have we taken out that proverbial bazooka but we’ve also added RPGs, ninja stars, ray guns, light sabers, F-16s, stealth fighters, nukes, tanks, and every other imaginable weapon of financial destruction.  The market was not impressed with Paulson’s bazooka.

In the Freddie Mac 8-K filing we get a glimpse of what they are looking for:

“Based on preliminary unaudited information concerning its results for these periods, management currently estimates that the Federal Housing Finance Agency, in its capacity as conservator of Freddie Mac (Conservator), will submit a request to the U.S. Department of the Treasury (Treasury) to draw an additional amount of approximately $30 billion to $35 billion under the $100 billion Senior Preferred Stock Purchase Agreement (Purchase Agreement) between Freddie Mac and Treasury.”

Awesome.  If you need any more reason to not use the government as a source for future projections, look at the CBO estimate which was released in July of 2008:

“NEW YORK (CNNMoney.com) — The Congressional Budget Office on Tuesday estimated that a government plan to stabilize mortgage giants Fannie Mae and Freddie Mac could cost government coffers an average of $25 billion.

The CBO said it thinks there is probably a better than 50% chance that the Treasury would not need to step in. It also said there is a 5% chance that Freddie and Fannie’s losses would cost the government $100 billion.”

Bwahahaha!  Don’t go betting with the government because they have a track record that is horrifically wrong.  We are already over that $25 billion mark and this $35 billion additional draw simply shows how off their estimates are.  That 5% chance is a lower end of the losses.  Fannie Mae and Freddie Mac will have significant losses because now, they are virtually the only game in town but also, many “prime” loans are going to start faltering given the economy and many analyst did not factor these things into their equations.

Currency Spaghetti – Decoupling meets eHarmony

If you need to understand why decoupling is a myth or what it is, please read the article “the Myth of Decoupling” which talked about this in detail.  Basically, the premise was that the U.S. would go under while the entire world flourished.  Little did many of these people realize that the balance sheet of most industrialized countries followed the same delusional crony capitalistic model and is in many cases, is worse off than the U.S.

Nothing highlights this more than looking at 3 major currencies over this economic crisis; the U.S. dollar, Euro, and Pound.  Let us look at this on a chart since August of 2007, when the gates of economic hell opened up:

Since August of 2007, when the U.S. bubble burst on the global stage, the following has occurred as you can see from the charts above:

U.S. Dollar:                +6%

Euro:                          -6.1%

Pound:                        -35.5%

The Euro’s demise is largely based on its emergence as a reserve currency trying to rival the U.S. dollar but once we found out that European banks acted in the same crony fashion, investors started returning to the “safe play” which is the U.S. dollar.  That is why since that time, the U.S. dollar has risen virtually the same amount as the Euro has fallen.  If you look at the chart of the Euro, it hit a peak of approximately 160 only in May of 2008 when the decoupling myth was going strong.  Since that time, the Euro has fallen 20% in less than a year.

But the currency that has taken it harder on the chin is the British Pound.  The Pound over this time has cratered nearly 35.5%.  As it turns out, the U.K. not only has a housing bubble rivaling the U.S., but they have banks that are running on a crony level as well.  Yet they don’t have the fortune of being a major reserve currency like the U.S. dollar or the Euro.  The 35.5% drop is simply astounding.  The currency markets tell a very different story from pundits and politicians.  That is, they believe this is going to be a long and extended downturn and people are seeking safety.

Week of Massive Information – Welcome Case-Shiller to Yahoo! Calendar!

I like looking at the week ahead and trying to get a sense of what to expect.  Next week will be a fun-filled week of earnings and major data releases.  Let us look at what to expect:

-Existing home sales

-Consumer confidence

-S&P Case-Shiller Composite

-FOMC Rate decision

-Initial claims

-New home sales

-GDP

-Chicago PMI

-Michigan sentiment

What does this mean?  Get ready for an extremely volatile week.  But one awesome thing that I am now seeing is the legitimacy of the Case-Shiller Index because it is now officially in the Yahoo! Finance calendar:

This is the first time I see it appear here so hats off to finally making it to the official economic calendar where Census, BEA, BLS, and other “official” reports make it.  It is hard to see how the market is going to react.  Expect reports to say a lot of “better than expected” since expectations are set so low.  GDP estimates are at -5.2% for the fourth quarter which if we come in or better than this, expect a bunch of spinning since the number is on the lower end.  If it misses however, expect major downward pressure but this is toward the end of the week so you won’t have much time to digest this data.

We can expect home price to be lower with the Case-Shiller Index and the FOMC report is pointless since we are already at 0.25 so expect the media to dissect the wording in the report.  Home sales are already expected to be in the crapper so any upside should expect a pop.  Consumer sentiment should come in higher simply because of a new administration and higher hopes.  Yet unfortunately, the data on the street is still very bad.

California Unemployment – Worse Than Reported

I have gone into painful detail regarding the California housing situation and need to reiterate that housing will not bottom in 2009.  The reason I continue to beat this drum is so people don’t drink the Kool-Aid (again) and go out buying a home simply because it is half-off and you saw a kid spinning a neon colored sign.  I’ve heard a few pundits going off this line of argument again and they are simply wrong.  After posting an article with the dire 8.4% number from November, we got a release telling us unemployment had shot up to 9.3% in December.  That number is stunning.  Keep in mind that since 1976 (data from the Census) the highest unemployment rate for California was 11%.  I expect us to break through that.  In fact, we are already there if we calculated the number accurately.

You need to remember that part-time workers looking for full-time jobs or those not working who have given up are not counted in the unemployment numbers.  I know personally many people that are working one or two part-time jobs but want full-time employment.  I’m sure you personally know of cases like this as well.  Basically 1 out 10 people in the state is without work.

What is more startling in the report is the massive amount of involuntary layoffs:

California unemployment data

December 2007 unemployed:             1,079,000

December 2008 unemployed:             1,732,000

November 2007 unemployed:             1,566,000

What that means is in one month, California saw 166,000 people added to the unemployment lines and in one year, the number has jumped a stunning 653,000!  That is simply jaw dropping.  And as I expect with our current budget deficit still in shambles with a $40+ billion budget deficit for the next couple of years, and the fact that we have yet to see the massive recasts with option ARMs, the state is in for a tougher 2009.  So we will break that 11% mark.
But if we dig deeper into the data, we realize even more deterioration:

Of the unemployed:

782,200 were laid off

125,300 left voluntary

Others:  new entrants or reentrants into the labor market or temps

The number leaving the workforce by choice is tiny.  This is an across the board cut down in the employment sector.  That is why the California 2009 forecast I put out will hold true since we’ve relied so heavily on the finance and real estate industries.  What is disturbing is the growing number of those on unemployment insurance:

“In related data, the EDD reported that there were 655,445 people receiving regular

unemployment insurance benefits during the December survey week. This compares

with 593,670 last month and 451,098 last year. At the same time, new claims for

unemployment insurance were 87,979 in December 2008, compared with 80,920 in

November and 56,984 in December of last year.”

Those filing for unemployment insurance is skyrocketing.  Some of you may be aware of this insurance but I think it is important to know what it is:

“The amount for benefits available is based on the claimant’s earnings in the base period. To qualify for benefits in California, a claimant must have (1) earned at

least $1,300 in the highest quarter of the base period, or (2) have earned at least $900 in the highest quarter and earned total base period earnings of at least 1.25 times the high quarter earnings. For example, if the claimant has $900 earnings in the highest quarter, he/she is also required to have earned a total of $1,125 in the base period ($900 x 1.25 = $1,125). The maximum amount of a regular UI claim is either 26 times the claimant’s weekly benefit amount or one-half of the claimant’s base period wages, whichever

is less.”

Just before leaving office, former President Bush did sign a law extending unemployment insurance by 13 weeks from the current 26 weeks.  So 39 weeks or three-fourths of the year will be covered.  The max anyone can receive is $450 per week in California.  So let us run the numbers to see how much is going out per week:

Number currently receiving unemployment insurance:  655,445

(max) Average $450 per week:                       $294,950,250

Average $300 per week:                                 $196,633,500
(lower end)  Average $250 per week:             $163,861,250

Keep in mind that unemployment insurance is financed by employer taxes who pay up to a maximum of $7,000 per year.  Do you think with the bottom line being hit with many companies that some can actually afford this?  Keep in mind when the extension was signed in November, many people had already started exhausting their funds.  The government had to dig deeper in to its pockets, money which it doesn’t have.

So think about it, I know many people criticize “make work” programs but already in a state like California, anywhere from $163 million to $294 million is going out a week to people who aren’t working.  Shouldn’t we at least put some of these people to work if they can’t find a job?  I think this would be a better use of money because at least folks will be working and generating an income and have a stake in helping the economy even if it means repairing roads or fixing up a school.  This is how things are going to be for some time.

Japan has many lessons for us with its lost decade.  It is probably more likely we will head down toward a Japan route instead of a Great Depression world if we do have a major economic calamity here.  The fact that we have already sunk trillions into the economy and zombie banks and now we are on path for a major fiscal stimulus program, we can expect a sluggish next 10 years.  Much of our future money is being spent right now.  Maybe a lost decade is better than a major Great Depression?  That seems to be our choice.  Any pundit that tells you we are going to have a second half recovery needs to be banned from ever appearing on the air again.  Really, do you think things will be shiny again by July?

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Alas, I wish it were so simple.  The market rallied on news that the government was going to buy mortgage backed securities which ironically is something it already said it was going to do.  Great.  However the caveat is the securities have to be fixed agency debt; that is, little help is provided to the ticking time bomb of pay option ARM mortgages which will engulf the country in the next few years.  The government is treading on a very murky line here.  First, the public is getting agitated that trillions of dollars are being thrown at the agents that caused this mess in the first place.  Little help is trickling down to the average person on shaky Main Street.  This perception is correct given that the unemployment numbers are looking worse and worse as each monthly number is dished out.  Why?  The unemployment rate usually peaks months into an equity correction.  And for most Americans, employment is the number one sign of a healthy economy.  Was November 20^th the bottom or only a head fake of things to come?

Even some areas in Los Angeles County are seeing zip codes coming in with five-figure prices.  Maybe a stunner for some but many have geared up for this kind of massive price destruction.  The bubble is in full burst mode.  Keep in mind historically December is kind to the markets but not this time.  Santa put a piece of coal in the stocking of most investment portfolios.

It is astounding that after all the money being hurled to banks and Wall Street institutions like NFL deep routes, not much has improved.  Sure some crony capitalist are now off with nice severance packages but nothing has improved for the lot of most Americans.  The housing market is still tanking.  Sticking money into your mattress would have outperformed the stock markets of the globe!  And to top it off we are now hearing echoes of a shopping tax-free holiday.  Wasn’t it shopping for big homes, big cars, and big TVs that got us here in the first place?

Case-Shiller 28 Months Down

*Click for sharper image

The number 28 may hold significance to you.  It is the atomic number of nickel, a lunar month is roughly 28 days, and there are 28 dominoes in a standard set.  Or it can also mean the number of months the Case-Shiller 20-City Composite Index has fallen.  That is right, the overall index is now down for 28 straight months.  Yet we still have people in the mainstream media with the gall to call for a housing bottom.  How about we first have at least a few up months before we even start discussing any bottom?

With the above chart I have also added the LA and Phoenix metro areas.  As you can see with Phoenix, the drop is almost a perfect vertical.  The correction has been so stiff that Phoenix is quickly approaching a trend line.  Los Angeles with a higher peak is still over priced and with 10 other reasons for a long-term housing correction, we are years away from a bottom in the state.

2008 has been the worst housing market on record.  With the employment picture deteriorating, why are we to believe housing will stabilize anytime soon?

Mattress Investing

*Source:  CBS MarketPlace

Take a long look at the above chart.  2008 has been horrific for global equity markets even after every imaginable government intervention known to humankind has been tossed at them.  We bailed out banks, insurers, nationalized our mortgage giants, and even gave a tiny helping hand to domestic automakers.  Even with this, global markets had one of their worst years on records.

Here is the real irony.  Ben Bernanke and Hank Paulson are determined to annihilate the U.S. Dollar.  Why?  Simple.  It is the only mathematical way we will ever work our way out of our massive debt.  Every action they have taken is inflationary although the market in the short-term is reacting with deflation.  The reason for this is you can’t force people to load up with more debt.  They are already maxed out.  Yet the one enemy of Bernanke and Paulson, the U.S. Dollar is one of the few areas up for the year!  Bwahahahaha!

How long this will last is unknown.  I assure you if you asked Americans if they are comfortable with a government policy that destroyed the U.S. Dollar’s value across the globe they would be in an uproar.  Yet I’m not sure how many people are aware that the policies currently being taken are direct affronts to our own currency.

Another curiosity is gold is up for the year.  Even after the massive fall earlier in the year, this is another glowing area.  People are fleeing to perceived safety.  This happens in all bubbles after they burst and the U.S. Dollar still has this reputation.  Give Bernanke another year and I’m sure things will be different.

Shopping Tax Free Holiday

I stand by my assertion of the Super Ignorant Investment Vehicle SIIV – each subsequent bailout is progressively dumber than the previous one.  The new idea making the rounds is being put out by the National Retail Federation (NRF), which is a sales tax holiday.  This fantastic idea is another knee-jerk reaction just like every other bailout we have seen.  First, spending and “shopping” is a reason we are in this mess.  As a country, we need to focus on production and move away from spending ourselves into oblivion.  Next, if any thought went into this they would realize that many states rely on sales taxes for revenues.  States like, oh, I don’t know, California:

27 percent of California’s revenue comes from sales taxes.  The state can barely stay afloat as it is and we are talking about removing one of the biggest line items for a few days?  Brilliant ideas once again!

You’ll love the wording in the letter:

“We urge you to act quickly on legislation to help stimulate consumer spending as one of the first priorities of your new administration,” the NRF said in the letter. “To be effective, any fiscal stimulus package must be enacted with great speed. It must be substantial. And it must be sustained. To accomplish this, the plan must include a longer-term investment designed to produce sustained economic growth through job creation as well as short-term economic stimulus aimed at increasing consumer spending.”

Don’t you love how they sneak in consumer spending a couple of times into the letter?  Who is going to argue with job growth?  Or sustained economic growth?  Yet what in the world does encouraging debt strapped Americans to spend more have to do with job growth or sustained economic growth?  It doesn’t.  Another fabulous idea that goes into the SIIV.

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“Mozilo likened the housing market to a gigantic ship needing to turn in the ocean. It will take time was his underlying point. I like to think of the housing market more like a NASA mortgage rocket with no turning back. Have you ever tried turning back a rocket-propelled vessel? His statement seems to offer some hope that housing will return even though he unloaded millions in his company stock. Maybe he forgot to mention that the ship he was referencing was the Titanic. Either way, housing is passed the shaky ground stage. I’ve shown countless examples in our Real Homes of Genius series that clearly highlights an outrageous bubble housing psychology. We also discussed a few months back the subprime implosion as credit suddenly tightened and subprime lenders started dropping like moths heading toward the light. In fact, I felt this was the watershed event and would set the tone for the summer.”

The idea behind a Minsky moment is that long periods of economic stability usher in demand for leverage which slowly begins to build into the system. This stability provides grounds for credit growth. In the initial stages, credit is given out in moderate portions, starts to expand, and finally reaches Ponzi like characteristics. Finally the market implodes on itself. I’m surprised how many are saying this is the true Minsky moment. No, the moment at least in reference to subprime happened last year and we are now facing the afterglow of the bursting. I wanted to sum up my sentiment in a poem and creative writing piece. I call it, Ode to the Housing Market:

Ode to the Housing Market

Housing always goes up!

Real estate is the best investment ever!

They’re not making anymore land.

What do you mean housing is down?

Speculating in housing is risky?

The US has other states besides California and Florida?

I’m surprised as to what is occurring.

My realm of understanding is now shattered.

But surely I’ll be able to flip my home because of granite countertops.

Alas! Granite countertops will save me.
That shimmering rock that allows me to display my 20 credit card bills all in one spot.

Are you not the true rock of Gibraltar?

HGTV told me that you were so it is written in stone.

Up, up, up…crash.

Jobs, jobs, jobs…no jobs.
Surprised I am.

SIV, CDO, MBS, CMO, VIE, and all I really want is to gas up my SUV.

The alphabet soup of confusion swimming in a sea of $100 barrel oil!

What do you mean my rate just doubled?

What do you mean a margin call requires me to come up with capital?
My HELOC is disappearing quicker than Chris Angel.

Credit cards are really freaking my mind.

Who’s this Alan Greenspan and Ben Bernanke?

First, they tell me adjustable rate mortgages are good.

Now they are telling lenders to cut my mortgage.

Deep in the pit of my stomach I like lower mortgages.

They lower rates every six weeks.

Ergo, I like these people.

Can we also slash the balance on my credit cards?

Raise the roof! Raise the caps! Alleluia!

Bigger is always better.

Bigger cars.

Bigger sodas.

Bigger homes.

Bigger bellies.

So why not bigger mortgages?

Maybe it is I who should be the next presidential advisor.

Monster hybrid loans are next.

Whoops, I just resigned.

Angry are the people!
They didn’t see this coming they cry.

Minimum wage and no million dollar home?

Living in a 500 square foot home with a 100-inch flat screen TV.

Best Buy is happy.
That wasn’t a best buy when the bill comes in.

Talking heads make sense of this all!

You genetically altered cyborgs.

They call you talking heads because we never see your body.

Reveal your full torso to us!

Disclose your torso by April 15!

We’ll trust you more if we can see your Docker khakis.

You open your mouth and the ticker moves up.

Conflict of interest, not today.

The US Dollar goes down like an elevator descending into the basement.

We arrive at the basement and find a sea of debt.

Take me back up!

I cannot stand the horror!
What do you mean we need $2 billion a day from foreigners?

In comes, toys, electronics, clothes, and all the things we buy.

Out goes raw materials and jobs.

Fair trade it is.

Housing has now bottomed!

Best time to buy!

Who cares about the economy because they aren’t making anymore economy.

Get in before rates go lower and home prices go lower.

I see that Snoop Dogg is teaching us about fatherhood.

We have a former Goldman Sachs CEO as US Treasury Secretary.

A presidential candidate tells us he doesn’t know much about the economy.

Economy number one issue for voters.

Wins party nomination.
Get in right now that things make perfect sense.

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“In an unprecedented move designed to save thousands of California homeowners from foreclosure, Gov. Arnold Schwarzenegger announced a deal Tuesday with four mortgage lenders to freeze adjustable interest rates for some of the state’s highest-risk borrowers.

The state’s agreement with Countrywide Financial Corp., GMAC Mortgage, Litton Loan Servicing and HomeEq Servicing covers more than 25 percent of California’s subprime mortgage loans, which generally involve homebuyers with weak credit and require periodic increases in payments after initial low-teaser rates.”

First, we need to clarify that this doesn’t begin to cover the majority of subprime loans in the state. According to the release, this may cover 1 out 4 subprime loans. There are other lenders that have offered subprime loans and they are not included in this deal. The false assumption made by the governor is that only people that took out subprime loans are facing trouble. Well we all know that people with high incomes and decent credit will also lose their homes. When you dig into the ambiguous details, you realize that this has more to do with political posturing and being ahead of others in the game:

“Schwarzenegger aide Sabrina Lockhart said his office negotiated an agreement with Countrywide Financial Corp (CFC.N: Quote, Profile , Research), GMAC (GMA.N: Quote, Profile , Research), Litton Loan Servicing LP and HomeEq Servicing Corp that will allow their mortgage borrowers in California to continue paying loans at initial rates if they live in their homes and make payments on time but are unlikely to afford higher payments when their mortgage interest rates reset.”

“Along with loan modification, the lenders have agreed to seek out borrowers before their loan terms reset and to improve the process of determining if borrowers can afford bigger mortgage payments when loan rates rise, Lockhart said.”

As the weeks unwind, as in our foreclosure story number 2, we are going to start seeing that many subprime loans were made under unbelievable pretenses. The lack of financial prudence was done by these lenders and the Governor is entrusting them in bailing out the same people they have put into financial peril? Where are the logic police? It would be different if they setup a third party to oversee the restructuring of debt but they are putting a group of people that have demonstrated that they should never be allowed near a mortgage again. Let us go through 4 reasons why this plan is an absolute ruse and will do nothing for the states financial problems.

#1 – Mortgage Investors will Kill Adjustable Rate Mortgages

You need to remember that lenders rarely hold mortgages in their portfolios. Rating agencies on Wall Street in collusions with large investment banks worked their financial alchemy and bought any kind of mortgage for the large part of the decade. They sold many of these mortgage backed securities to investors seeking higher returns. Silly labels such as AAA were given to loans that benefited from absurd inflated titles. This secondary market created and fueled the housing bubble. Many times, subprime loans paid investors a higher premium for the implied risk. Now if the loan can be modified at any time, how are investors going to be compensated? It is as if you purchased a 10 year Treasury note and suddenly state legislation tells you it is only a 1 year note with a much lower interest rate. This move if it spreads into other states and becomes common, will slam the door shut on subprime loans and also, other adjustable rate mortgages. Oh, and let us talk about adjustable rate mortgages in California shall we? According to DataQuick which tracks housing information:

“Most of the loans that went into default last quarter were originated between July 2005 and September 2006. The median age was 18 months. Loan originations peaked in August 2005. The use of adjustable-rate mortgages for primary purchase home loans peaked at 77.8% in May 2005 and has since fallen.”

So looking at this information, the vast majority of loans since August of 2005 were adjustable rate mortgages in California. Subprime is a tiny facet of the overall adjustable rate mortgage market which includes prime borrowers (the Alt-A category) loans that in fact, may have no ability to pay their mortgages when rates reset as well. We know that many lenders overlooked any semblance of ability to pay to push these products. With the height of irresponsibility showing when people making $14,000 a year taking out $720,000 mortgages. How is reworking this going to help? And we are going to give these same lenders the responsibility to determine who is able to repay and rework mortgages? Bwahaha! The fox is guarding the hen house folks. If you don’t believe this you need to read a scathing look at Countrywide written by the New York Times called Can These Mortgages be Saved?:

“To be sure, customers who borrowed from many lenders other than Countrywide are also experiencing difficulties with their loans. But because Countrywide was one of the most aggressive purveyors of adjustable-rate loans — the kind with interest rates that rise significantly after a low, two- or three-year teaser rate expires — it is not surprising, borrower advocates say, that overall problem mortgages are ratcheting up. The Mortgage Bankers Association said that adjustable-rate mortgages to subprime borrowers accounted for 44 percent of all new foreclosures in the second quarter of this year.

Even as Countrywide maintains that helping its borrowers modify their loans is its top priority, its investors have heard a slightly different story. In a conference call with analysts and investors in late July, Kevin Bartlett, Countrywide’s chief investment officer, counted about 2,000 loan modifications done in June. Most of those, he said, involved deferring overdue interest or adding the past due amount to a loan. The company rarely provides workouts that reduce interest rates on loans, Mr. Bartlett told investors.

Yet reducing rocketing interest rates is exactly the relief that many borrowers are seeking because, consumer advocates say, that is the only way they can afford to stay in their homes. Loan experts say that when workouts involve deferring overdue interest or tacking amounts owed onto the back of a loan, borrowers often wind up in trouble again in just a few years.”

This plan is more of an insurance policy guaranteeing lenders get their due even if they have to squeeze out every penny on people that have no potential of repaying an inflated mortgage. That is the true problem.  They would know this if they spent 10 minutes scrutinizing loans instead of trying to sell as many mortgage products as humanly possible. Sadly the Governor is not encouraging legislation for cram-downs and instead of aligning with these purveyors of the bubble, he should go after them forcing them to restructure loans at current market rates thus making them partly responsible for their mistake. Instead, he wants subprime borrowers to pay no matter what and make up for the financial irresponsibility of lenders:

“Borrowers need to do their part, too,” Schwarzenegger said in a statement. “If these lenders are willing to meet more than halfway, it’s important that consumers don’t run when they reach out. It was a two-way street that got us into this mess and it will be a two-way street that gets us out.”

I like this two-way street. I’ll give you a loan you have no financial way of paying off and you pay us even if you don’t have the money to begin with. Think about it folks! Subprime loans by default are loans given to people with bad credit and income ratios that are extremely risky. And these lenders are shocked that people are defaulting? In fact, losing their home may be a better solution instead of keeping someone in a home for 5 years, hoping the housing market inflates through asset inflation and a declining dollar and then all will be well. These people are gambling with a call option betting the entire house that housing prices will be up in 5 years. Well here is another view, what if housing isn’t up? What if incomes don’t rise? What will you do then? Will you allow rates to reset and amortize even at a higher rate for lost time? This is only buying time for lenders and make no mistake about it, this is not in the best interest of current subprime owners.

#2 – The Assumption is People in California Have Attachments to Homes

The assumption is that all people want to keep their homes. We’ve seen countless times on Flip this House or Property Ladder that many people in California have very little attachment to a home. In fact, there is a large segment that views a home simply as a commodity. There is no data on this but it would be interesting to see how many recent buyers in the last 3 years expected their homes to go up by 15, 20, or 25 percent in California? How bad is it here in California? Well it is good to look at a state that is one-year ahead of us in the housing bust to get a sense of how shady things really got:

“MIAMI (Reuters) – At first glance, the 43-story building in Miami’s international banking district seems little different from other high-rise condominiums overlooking the turquoise waters of Biscayne Bay.

But the 643-unit condo known as the Club at Brickell is a leader in mortgage foreclosures and it appears also to stand at ground zero in a blizzard of fraud that may lie behind many of the failed loans threatening to bury the U.S. property market.”

It gets even more interesting when the actual nuts and bolts of the deals are looked at under a microscope:

“Mortgage scams involve a cartel of inside players — colluding property appraisers, real-estate brokers and accountants willing to draw up fake income statements and tax returns — who recruit people with good credit histories to serve as a decoy or “straw buyer” in a real-estate deal.

The conspirators inflate the price of the property, to get the biggest loan possible, pay the sellers the original price and then pocket the excess loan money as “cash back” at the closing of the deal.

The decoy buyer is paid off — often with just $5,000 — and the property is quickly abandoned to foreclosure, said Theobald, a senior official with the Miami-Dade Police Department.”

I’m not sure about you, but I wouldn’t want the lenders or folks involved in the industry to have anything to do with a workout plan for this mortgage debacle. The story goes on:

“But Doug Dewitt, a real estate broker contracted to work with several lenders on the valuation and disposal of foreclosed properties, said nearly 70 percent of the sales or closings at the Club over the last 18 months were questionable.”

That works out to more than 200 possibly shady deals in a single building, he said.”

70 percent of the deals were under potential false pretenses. I wonder how many of these 200 shady deals are buyers that are going to worry about losing their home. This again is a play at the American ideal of owning a home. Many people in non-bubble states that lost their jobs and have modest mortgages that fall within current government cap guidelines do have options and the restructuring of debt should be available to them. But reworking a deal in California where an unscrupulous lender gave a $400,000 or $500,000 mortgage to a family making $40,000 or $50,000 a year is flat out criminal. And then to make them pay for the lender;s financial irresponsibility is nothing resembling a two-way street; it is asking the buyer to subsidize the lenders lack of judgment.

#3 – Prolonging the Inevitable

When you look at this information, do they really assume these borrowers will have a chance to repay the note after 5 years? Say the interest is deferred for a few years but then what happens when the note fully amortizes? This is a horrible move by the Governor because we have a second wave of resets coming in 2010 and 2011 of option ARM mortgages. So now, instead of dealing with one mortgage tsunami at a time we are pushing this current wave to the other wave and creating a mutant hybrid wave that will compound this mess exponentially. Not admitting a mistake is problematic and the Governor’s deal doesn’t face the reality of the matter. That housing was inflated by lenders, Wall Street, and the unscrupulous housing industry and instead of taking a stand against them, he’s joining their side. And why do we think that the Governor is prolonging this bubble? Take a look at a letter he sent to Congress about rate caps in September of this year:

“Accordingly, as you consider various legislative proposals related to home mortgages, I write to express my strong support for raising the current loan limits imposed on the Federal Housing Administration (FHA) and raising Government Sponsored Enterprises (GSE) loan limits in high-cost areas of the country.

Just when the safety and affordability of FHA-insured loans are needed most, they have virtually disappeared from the California marketplace. The current FHA loan limit is $362,790, well below the median-priced home in California. In testimony before the U.S. Senate Committee on Banking, Housing and Urban Affairs this summer, Brian D. Montgomery, U.S. Department of Housing and Urban Development Assistant Secretary for Housing, said California has “seen its [FHA] loan volume drop from 109,074 to just 2,599; that’s a decline of 98 percent and a loss of $13.6 billion.” This has been a significant factor in the increasing use of nontraditional mortgage products in California. The prospect of mounting losses on nontraditional mortgages has harmed the availability of home financing nationwide.

Increasing the FHA loan limit would have a positive impact on expanding financing options for hardworking Californians hoping to obtain a piece of the American Dream. In addition to increasing the FHA loan limits, consideration should be given to raising the conforming loan limits for the GSEs (Fannie Mae and Freddie Mac) in high-cost areas of the country. The current GSE conforming loan limit for lenders willing to originate conforming mortgage loans for median-priced homes in California is $417,000; however, according to the California Association of Realtors, the median price of a single family residence in July was $586,030. Again, this disparity makes these products practically irrelevant in California. This means that, for the majority of California homebuyers, the only option is to obtain a larger “jumbo” loan and pay higher interest rates and fees. Raising the FHA and GSE loan limits will help ensure that more financial resources are available to help facilitate lending in California.”

I wonder if he would have said this knowing the problems now facing Fannie Mae and Freddie Mac? Either way, you can see that he doesn’t see inflated prices as the problem but the lack of creative lending solutions as the main issue. In fact, him quoting the California Association of Realtors as his source for the incredible price of $586,030 is troubling since it doesn’t bother him that housing in California is completely unaffordable for the vast majority and these bubblicious products have created an unsupportable environment.

#4 – Who is Subprime?

Who really is subprime after all? The Governor’s office estimates that 500,000 subprime loans will reset in the next 2 years here in the state. Instead of asking why half a million loans were given to people that most likely should have never gotten a loan in the first place, he talks with lending institutions about methods of keeping troubled buyers longer in homes while they can bleed every single penny from them. Lenders are wising up that receiving one quarter instead of zero is much better than pushing for the full dollar. Unbelievably many of these lenders are pinching pennies and taking more money from these same people facing financial trouble. In another piece called “Dubious Fees Hit Borrowers in Foreclosure” we see that lenders are willing to kick owners when they’re down:

“In an analysis of foreclosures in Chapter 13 bankruptcy, the program intended to help troubled borrowers save their homes, Ms. Porter found that questionable fees had been added to almost half of the loans she examined, and many of the charges were identified only vaguely. Most of the fees were less than $200 each, but collectively they could raise millions of dollars for loan servicers at a time when the other side of the business, mortgage origination, has faltered.

In one example, Ms. Porter found that a lender had filed a claim stating that the borrower owed more than $1 million. But after the loan history was scrutinized, the balance turned out to be $60,000. And a judge in Louisiana is considering an award for sanctions against Wells Fargo in a case in which the bank assessed improper fees and charges that added more than $24,000 to a borrower’s loan.”

And these are the same people that will be in charge of determining who is subprime. They will also have reign over the details of the shady loans they have dished out. I’m not surprised. In fact, bringing in a third party would cause a stronger and faster decline in the housing market because the public will fully realize the extent of the financial imprudence in the industry. They claim that what is occurring is making the process more transparent when in fact, it is only sweeping more dirt under the rug out of the public’s vision. This mortgage restructuring plan sounds like a script out of Kindergarten Cop. Instead of terminating these lenders the Governor is jingling all the way to the mortgage bank.

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“Without doubt, 2007 has been an extremely difficult year for the country’s housing and credit markets and, as our third quarter financial results reflect, we have been impacted by the deterioration in these markets,”

The chief financial officer offers us another salient point of view:

“Weakening house prices and deteriorating credit have hurt Freddie Mac’s results, as well as those of other participants in the mortgage market,”

Weakening house prices are causing all this mess? Here I was thinking that rampant greed, financial alchemy, turbo charged mortgages, and credit standards [oxymoron alert]; in fact standards are so low, your cat can get a credit card. No seriously, a cat named Messiah got a $4,200 credit card in Melbourne Australia. The owner of the cat tells us:

“It’s a bit scary and it’s a big problem,” she said. “It was very easy to do and I’m not even a professional crook.”

When a person steals your identity and credit and charges $300 at a Target, they go to jail. When a shady mortgage outfit steals your life and leaves you with a $500,000 mortgage, you get an eviction notice. See how things work? If you think things couldn’t get any weirder, Fed Chairman Ben Bernanke announced two weeks ago a brilliant idea out of the Einstein playbook of physics:

“As Congress and the financial services industry struggle to cope with rising mortgage defaults and a deepening housing slump, Federal Reserve Chairman Ben Bernanke Wednesday proposed that the federal government guarantee so-called “jumbo” home loans worth up to $1 million.”

Let me get this straight. You want to give these two…:

…More access to funds? In his defense, how could he possibly see this coming? After all, Ben Bernanke did say this in May of this year:

“As the problems in the subprime mortgage market have become manifest, we have seen some signs of self-correction in the market. Investors are scrutinizing subprime loans more carefully and, in turn, lenders have tightened underwriting standards. Credit spreads on new subprime securitizations have risen, and the volume of mortgage-backed securities issued indicates that subprime originations have slowed. But although the supply of credit to this market has been reduced–and probably appropriately so–credit has by no means evaporated. For example, even as purchases of securitized subprime mortgages for collateralized debt obligations–an important source of demand–have declined, increased purchases by investment banks, hedge funds, and other private pools of capital are beginning to fill the void. Some subprime originators have gone out of business as their lenders have cancelled credit lines, but others have been purchased by large financial institutions and remain in operation. Importantly, we see no serious broader spillover to banks or thrift institutions from the problems in the subprime market; the troubled lenders, for the most part, have not been institutions with federally insured deposits.”

The bold is added to emphasize each wrong point. I would put more here but will spare you an entire page in bold. You can read the rest of the Nostradamus speech here. So I pose this question to you. Why would you trust a person that got it so wrong only three months before the August credit explosion to lead us out of this mortgage debacle? In addition, why would you give this person more power by increasing caps on government sponsored entities that are clearly facing trouble? His proposal was issued only two weeks ago and he didn’t see what occurred to Fannie Mae and Freddie Mac on Tuesday of this week. I’m not sure I would write a blank check to a company that just reported a $2 billion loss and is openly stating that the problem was home prices. Home prices were never the disease! Prices merely reflected the underlying cause which was that of mortgage and credit inflation. The issue about “jumbo” mortgages shouldn’t even be on the radar since the median home price across the United States is approximately $225,000 and GSEs guarantee loans up to $417,000 which are considered conforming loans. But Bernanke isn’t alone. We have a wise senator also backing this proposal:

“In response to a question from Committee Chairman Sen. Charles Schumer, D-N.Y., Bernanke suggested that mortgages eligible for government guarantees be capped at $1 million.

“I think that’s a very good idea,” Schumer said of the guarantees. “In fact, legislatively, it’s something that I would try to introduce and get passed.”

Schumer introduced a bill last month that would allow Fannie Mae and Freddie Mac to raise their total loan portfolios by 10 percent for six months. Bernanke suggested the new guarantees on jumbo loans should also be temporary.”

I wonder why Schumer has a sense of urgency to support this proposal? Let us take a look at his top contributors:

1. Goldman Sachs – $350,850

2. Citigroup Inc – $227,550

3. JP Morgan Chase & Co – $195,900

4. Credit Suisse First Boston – $191,294

5. Morgan Stanley – $186,500

6. Bear Stearns – $154,250

7. Merrill Lynch – $125,100

You can continue reading the list here. These names sound familiar, don’t they? The last thing that the current economy needs is a compounding of mistakes. Raising jumbo mortgages will essentially give Wall Street an exit from their massive credit gamble and a place to off load toxic mortgages that you and your family will have the pleasure of paying off. Doesn’t this make you feel all warm and fuzzy? If you think about it, raising the cap does nothing for the person facing foreclosure because what they are dealing with is payment shock. Many are on 2/28 mortgages or some other mortgage concoction that has no way of being paid off. Let us assume the cap is raised to $1 million for the sake of argument. A person in Los Angeles, let us call him John Subprime is facing a major reset in the next few months. His teaser rate is going to explode on his $500,000 mortgage. Thankfully, the government sponsored entities are their to help him. They’ll take the note off the lenders hands and securitize it over a 30 year conventional term. But guess what? Good old John Subprime is unable to make the payment because he now has to pay the entire amortize value of the note when before, he was paying an artificially low teaser rate on either an interest only or negative amortization loan. In fact, the reason he got subprime to begin with was because he didn’t qualify for the 30 year conventional mortgage! Why would you get anything but a conventional mortgage with multi-decade low interest rates? Most folks facing foreclosure in the majority of the country will fall under conforming loan limits; those that don’t are simply living in bubble states and raising the caps will institutionalize inflated prices at the expense of tax payers. Let us not even talk about a moral hazard here. As Will Ferrell so eloquently put it, “I feel like I’m taking crazy pills!” Or to paraphrase another movie this move of raising caps is simply wrong and wronger.

We do have a better option that has a better name to it. It is called a cram down and Tanta over at Calculated Risk does a great job explaining it. This was a viable option for Chapter 13 bankruptcies for over a decade. What occurred is lenders were instructed to restructure the debt to reflect the current market value of the home and any mortgage debt above the market value was treated as unsecured debt. Owner stays in home and lender is forced to write off charges on their books, not on the government’s books. However, this practice has taken a hit since 1993 and is facing stiff opposition by the Mortgage Bankers Association. Their argument is a fear of giving judges “free rein to rewrite” mortgages and this will create more mortgage instability in the markets. I thought the instability came from allowing these gurus to price the mortgages with complicit rating agencies? As you can see from our above example there is extreme lobbying going on right now and sadly, neither major political party is immune from these groups. Make no doubt about it, raising caps is not the solution. There are other more realistic options that should be put on the table. Just keep your ears peeled for a politician who has a backbone enough to stand up for the right solution. The housing debacle is gaining traction and if this credit crises sends us into recession, you can rest assured that politicians will be talking about it next year as a major issue.

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