Who's to blame for the economy?
It's not just a political question, it's an economic question as well. It is essential that this question be answered because without an answer we won't know what to do to fix it.
Remember 1999? The federal budget was balanced. The trade deficit was still manageable. The unemployment rate was low, as was the poverty rate. There were plenty of good paying jobs out there. Corporations were making record profits.
It was also the year that the economy was broken.
"Let's hope we are all wealthy and retired by the time this house of cards falters."
- email sent Dec. 15, 2006, from one rating agency to another
"If Congress again opens up banking to Wall Street speculation, as it opened up S&Ls and banks to real estate speculation, regulators will quickly lose control over the complex series of events that a pervasive marketplace will immediately set in motion. Insider abuse, self-dealing, and back scratching relationships between institutions will run rampant.
Almost immediately the predictable happened. The historical arms-length relationship that had existed between lender and borrower vanished, and with it went due diligence, common sense and, in too many cases, ethics. Thanks to facilitating that bit of synergy the taxpayer is stuck with $300 billion dollars worth of repossessed real estate from failed thrifts. If we sold $1 million worth of this stuff a day, it would take 300 years to sell it all.
Deregulated banks can look forward to a similar script, with some of the same bad actors. U.S. Attorney Joe Cage in Shreveport, Louisiana, told us, "Some of the same people who took down savings and loans, are out in the securities business and banking now, already in place. And they're just waiting for Congress to abolish the Glass-Steagall Act. If that happens I'm afraid they'll take the banks just like they did the savings and loans.""
This testimony happened several years before Congress deregulated the banking industry. They were warned, but they obeyed their corporate masters who were only interested in turning a quick profit.
So what is the condition of our nation's financial system now?
Bridgewater Associates has issued an apocalyptic warning to clients that bank losses from the worldwide credit crisis may reach $1,600bn (£800bn), four times official estimates and enough to pose a grave risk to the financial system.
If Bridgewater is anywhere near correct, governments alone have the wherewithal to rescue the system. This would mean the de facto nationalization of the banking systems in the US, Britain and Europe.
Belatedly the House is finally investigating the systemic risk in the financial system. What did Congress think was going to happen when they deregulated the banks?
Lending standards dropped to irresponsible levels as greed overwhelmed good sense on Wall Street, and regulation was nowhere in site. It's no coincidence that the housing bubble began right around the same time that the banking industry was deregulated (although it helped the bubble when the Fed dropped interest rates to irresponsibly low levels in 2001 - 2004). Wall Street repackaged all those mortgages, and with a good deal of fraud and unethical behavior, sold them to investors at inflated fees.
Now the housing sector is a complete disaster. Bank repossessions are twice the level of May of last year and there is no end in sight. What's worse, the foreclosure rates are so high that home sales aren't cutting into existing inventory.
In a nutshell and simplistically speaking if 10k people get a ‘great buy’ on REO, 100k home owners could have the value of their homes fall by 30-50% overnight. Of those 100k, 35% get thrown into a negative equity position, 35% of those experience loan default and 75% of those (9,200) go back the bank as REO. The banks sell at a 30-50% discount and the process repeats. Again, no inventory has moved. Values just continue to fall. It is a vicious cycle.
The big new problem is happening with the government-sponsored enterprises - Fannie Mae and Freddie Mac. These are the same organizations that Congress and the Bush Administration were using to bail out the housing market.
Shares of the two companies dropped Monday to their lowest levels in more than 14 years, and at one point, Freddie Mac had lost nearly 30% of its value.
Investors are so worried about these two giant entities (together they guarantee about $5.2 trillion of home mortgages, or roughly half of all home loans outstanding) that the price of insurance against default on their debt is hitting new highs.
These two mortgage giants have suffered about 11 Billion dollars in losses over the last nine months alone (as of March 31). Wall Street expects those losses to worsen in the coming quarters. How bad could it get?
FBR Capital Markets analyst Paul Miller believes each company needs to raise an extra $15 billion in common equity.
Not easy to do. Fannie, for instance, has a current market value of about $15 billion. That means that at its current stock price it would have to roughly double its shares outstanding to raise $15 billion.
And it isn't clear just how much new capital Fannie and Freddie need. Mr. Miller's $15 billion could prove optimistic. Each quarter, Fannie and Freddie release an estimate of the market value of their balance sheets and net worth. At the end of March, Freddie's net worth available to common shareholders was negative to the tune of $16.9 billion.
But even that number was inflated by a $16.6 billion deferred-tax asset, which has a questionable value. In other words, Freddie would have to issue more than $30 billion of stock to cover the $16.9 billion market-value deficit and the deferred-tax asset.
Adding to all this is a new fear: new accounting rules that could require Fannie and Freddie to take back onto their books investment vehicles that were used to sell off, or securitize, debt instruments such as mortgage securities.
A Lehman Brothers report suggested that this could require Fannie to add $46 billion of capital and Freddie, $29 billion.
The best outcome for the administration is that Fannie and Freddie manage to issue new stock and the balance-sheet fears subside. But if capital raises don't get done at the right size, the administration might have to do something drastic like take over Fannie and Freddie.
If that were to happen, shareholders would be left with pennies.
"We cannot imagine such an outcome occurring."
- Lehman analyst commenting on the chances of Fannie and Freddie's ability to raise that much capital
If you take all those numbers and look at them closely, they don't add up! The only way that this isn't a disaster is if you start making fantasy-land assumptions about the economy and the housing market.
CNN called it the trillion-dollar mortgage time bomb.
In fact, a bailout of Fannie and Freddie would be so large that it would cost America its AAA debt rating. Losing the AAA rating would mean foreigners would fly from our Treasuries, thus bringing to an end the dollar's status as world's reserve currency.
The important point to note here is that the GSE's didn't get themselves in trouble all by themselves. They didn't become the dominant force in the housing market, even while the market implodes, all by themselves.
They were instructed to bail out the housing market by the Bush Administration.
By reducing the extra cushion of capital the two companies have been required to hold since 2004, the regulator, the Office of Federal Housing Enterprise Oversight, is enabling the companies to invest $200 billion more in home loans. In essence, the companies are being allowed to take billions of dollars that had been used as a reserve against possible further losses and invest that money now in the housing market.
"It’s a toxic brew. All the ingredients are there for the problem to escalate."
- Howard Glaser, former HUD general counsel
Congress and the Bush Administration have also gotten the FHA involved in bailing out the housing bust, and with equally predictable and disastrous consequences.
The Federal Housing Administration expects to lose $4.6 billion because of unexpectedly high default rates on home loans, officials said Monday. The projected loss is the highest in the home loan program since 2004, and officials said the F.H.A. had to withdraw $4.6 billion from its $21 billion capital reserve fund in May to cover the costs.
He said the mortgages had foreclosure rates three times those of traditional loans and would push the F.H.A. to the brink of insolvency.
"Let me repeat: F.H.A. is solvent," Mr. Montgomery said on Monday in a speech at the National Press Club. "However, no insurance company can sustain that amount of additional costs year after year and still survive. Unless we take action to mitigate these losses, F.H.A. will soon either have to shut down or rely on appropriations to operate."
Like the GSE's, the FHA didn't get into this mess all by itself. It was put there by the Bush Administration.
The looming financial difficulties have not prevented the Bush administration from expanding the F.H.A.’s role to help ease the nation’s foreclosure crisis. Since September, more than 150,000 homeowners have refinanced through F.H.A. and officials hope that the number will increase to 400,000 by the end of the year.
If you think that the banks are going to pay their fair share to clean up this mess, I got bad news for you.
Here's a good example: the housing bailout bill that is making its way through Congress was written by Bank of America.