The Credit Crunch and The Insolvency Arena

A global season of extraordinary things.

We all have become numb to dramatic statements.

‘Credit markets have frozen!’ or
‘Lowest rates in 40 years!’ or
‘Largest single day drop in history!’ or
‘The biggest xxxx since the Great Depression!’

When everyone is talking, only shouting rises above the din. When everyone is shouting, all we hear are shouts with hyperbole. When everyone is shouting hyperbole, it all fades into the white noise of an over-loud and frenetic world.

Such is our moment in this season of extraordinary things. When we could really use a shout. When a big statement really means a big thing. When we really need to know the severity and depth of our crisis, we can hear only the white noise of our exaggerated and overblown past. But our bank failures really are massive, and they happen overnight. Our credit markets really have seized in a manner no one thought possible. The global economic machine is grinding its gears into shards of metal.

I am surely not alone in my dislike of congressional bickering. It all seems so petty, so ridiculous, and so utterly tiresome. But now the congressional bickering is much more to me. It is profoundly sad and somehow almost shameful. They always seemed to act like spoiled children, but in this moment of national pain and urgency, the scene is somehow transformed.

I imagine a battlefield where are leaders are fighting a powerful enemy. And they look like small scared little people. Soft hands from never having worked. Golf suntans contrasting ridiculously with their unfitting armor. A fighting force with no leader, no vision, and no honor.

Extraordinary moments usually bring out the best in people; their genius, their leadership, their moral core. So it is with some sadness that we all must realize – their best is on display. In this moment of need, our leaders are showing their best and it is nowhere close to good enough.

The ferocity of this credit crisis is shocking. The speed of its unwinding is bewildering. The stakes are nearly unfathomable. This is no time for cowardice, no time for small minds, and no time for golf tan vanity.

The free markets should have been allowed to do all they could to correct the problem first with no monetary intervention and no fiscal intervention. Bernake failed in not letting them fail.

Once it was clear that the free markets could not heal themselves, which inevitably would have happened, several things should have happened simultaneously.

First, the Fed should have pumped money in the system at predictable moments, cut rates at a measured pace, extended credit and terms to other central banks and to our own system as they later did. The jerk and jitter of Bernake’s choices left markets guessing, pinched the net interest income of banks, and created an environment of uncertainty and fear at the highest levels of global finance.

Second, the Treasury should have acted quickly and decisively to buy up the toxic debt. It has to be purged from the system so we don’t fester for more than a decade like the Japanese. No add-ons by congress, no pet projects. Just the swift creation of a liquid market for the securities before they deteriorated so badly.

Third, mark to market accounting regulation should have been modified to a rational moment. There are multiple different suggestions on the best way to handle the modification. It is necessary for investor transparency, but it also was the wrong measure and the wrong time.

Fourth, Sarbanes-Oxley should have been revisted. A clear signal should have been sent to the world that we are open for business. Congress should have encouraged investment and small business with tax incentives of various kinds. The current mess has stripped hundreds of billions of current and future revenue from the Federal Government. All the tax incentives in the universe for businesses would never have cost what the credit seizure has stolen from us.

Fifth, affordable housing mandates should have come back to earth. Not everyone deserves a house as an American rite of passage. Risk and reward need to be realigned. Balanced. Congressional pet projects that send free money back to their districts through affordable housing programs gone mad are a mistake.

Sixth, credit default swaps should have been reined in as soon as the froth appeared. Reasonable disclosure and reasonable regulation should be introduced to this area of finance and to hedge funds.

Seventh, the FDIC insurance program should have been overhauled. Not simply by increasing limits or charging higher premiums to banks, but by thinking of ways to get rid of the perverse incentive for depositors and banks. Good banks are punished for good behavior in the current system. Bad banks are rewarded for recklessness. In a financial crisis, the imbalance sets off a firestorm of problems the FDIC program was intended to protect against.

Eight, the bailout of Fannie and Freddie should have taken a different path; one that demanded their reduction and privatization along with their handout.

Ninth, the government should have allowed for accelerated depreciation of different kinds of assets to jump start the flow of investment dollars. New factories, new business centers, commerical property of certain classes, etc..

It is a season of extraordinary things. One that will be talked about for decades to come. The words we all hear are not hyperbolic anymore. In fact, they are not enough.

More like 700 billion...

Like the Bear Stearns news, like the Fannie Freddie news, and like many other emergency actions in this season of extraordinary things, the agreement on the bailout plan will probably be announced today (Sunday) just before the opening on the Asian markets.

Without exaggeration, the entire political and economic world waits anxiously for news from our Congressional leaders. Few times in human history have so many people been connected to each other in so many ways. As we have all climbed higher by the interlocking steps of global commerce, so could we plunge and fall by the stumble of one.

Does something need to be done? Absolutely. Does it need to be done quickly? Absolutely. Is this bailout plan the best option? Maybe.

The stakes of never been higher. Paulson’s original request was said to be only a few pages long. The bullet points of the rumored deal today may only be a few pages more. Our concern? The DNA of America’s economic future will be written by bickering politicians (most of them trained as lawyers). The powers within the plan tinker with the deepest parts of our economic engine. The risk for devastating unintended consequences is too great to be ignored. A plan that pleases everyone will help no one. A plan that is diluted to the lowest agreeable denominator will allow holes into which demons will sneak.

Our main concerns? Hard as the politicians try to convince us otherwise, this plan will not turn a profit for the American taxpayer. The loans they will be forced to buy are too damaged, they are secured by property that has depreciated too far, and no healing of the markets will make them attractive enough in the future to be sold at a reasonable profit.

Even though the balance sheet of the Federal Government is the largest on the planet, this episode will leave the deepest of scars on her face. Of course the Congressional Budget Office let us know this weekend that they plan to zero out the whole episode like a simple credit and debit. We will borrow 700 billion and the value of what we have bought will be 700 billion – voila! – we are fine! But this ignores the fact that the Treasury will spend an obscene amount of money trying to administer this massive plan. It also ignores the fact that the valuation of the loans is not based on a real market value, it will be set by the Government itself when the purchase is made! Imagine this conversation with your CPA. “I borrowed 1 million dollars to buy this chunk of lead even though no one else on the planet would even pay a nickel for it. However, could you please value it at 1 million on my financial statement so I will not look so bad? Thanks – you are the best!”

Proud as we are of our American system, our government does not have the best track record of being a well oiled and efficient machine. To believe that they will be able to buy hundreds of thousands of bad loans, call those who are struggling and renegotiate their mortgage to a manageable level – it, well, it would be funny if it were not so painful. To put the size of this crisis into perspective, when Indy Mac failed, the FDIC owned 740,000 loans overnight. No less than 60,000 of those loans were in trouble and required a phone call. Indy Mac was a spoonful; this bailout is an ocean.

And last, this plan has placed our collective feet on the slipperiest of slopes. What will keep your neighbor from halting his payments so his loan will be bought up too? Shouldn’t everyone get a chance at a little renegotiation now and then? After all, his house depreciated just like yours.

Warren Buffet says that if we do not do something, the financial system will totally meltdown. Falling into chaos does not sound so good. But the ’something’ we should do stares at us like a giant question mark.

Our solutions come from lessons of the past. First, tempting though it may be, do not over regulate. Second, make sure the plan is temporary and has its own end written into the beginning. Third, stop the maniacal dedication to affordable housing mandates. And fourth, build a framework to better insulate politics from monetary policy, and pandering from fiscal policy.

Do not be tempted to over regulate.

Deregulation has been vilified; defending it is near heresy these days. We do need to modify our oversight. We do need to regulate better, but if we react to this grave crisis by introducing punitive regulation under the powerful thumb of Federal control, we will strike an irreparable blow to the core of our American soul. It is not a new argument to be sure. Jefferson and Hamilton could not agree, nor could Jackson and Clay. But the balance struck by their conflict build into our DNA the roadmap for prosperity. The middle road has given us decades and decades of unfailing economic power, unrivaled military power, and unparalleled ingenuity. It will be our national disgrace and our greatest shame if wade our American republic into the black waters of socialism.

Make sure the intervention is temporary.

The plan must have a self destruct timer. Historically, it is easy for a government to begin to provide a service or function. It is nearly impossible to take it away. Remember what happened to the Roman Emperors who gave out food to curry favor with the public in times of need. Taking the food giveaways back later proved a bit more difficult. The blank check to Freddie and Fannie should have been accompanied by this clear mandate. You will shrink quickly, your credit card will be cut up, and you will go to the private sector and work for your bread and butter. You may not slop at the public trough again. Ever. The same should be said to Wall Street wizards. Any failure of the monsters you create will be your failure too. You can keep all your winnings if you win, but you will suffer the same punishment and loss as the rest of us if you do not. Risk will no longer be decoupled from reward.

Affordable housing in small doses please.

Communities need socioeconomic diversity to be healthy. Home ownership lifts up communities in remarkable and mysterious ways. Our American dream is as much a human one as a cultural one. But politicians started handing out the American dream like a dime store trinket. They threw about down payment assistance programs and subsidies and tax breaks like gold coins in a mob. In their arrogance and in their ignorance, they cared more for their own reelection than for the potentially devastating consequences of their actions. If they were too stupid to know the peril of their choices, they deserve no more forgiveness or reprieve than those who ruthlessly ignored the signs. The stench of ill gotten political gain lingers all about our last three presidents and lays thick in the halls of our federal and state buildings. There are honorable people in politics – but tragically few indeed. We are all to blame for placing them there – for such is our right, and such is our folly.

Politics is a strange bedfellow of monetary and fiscal policy.

The founding fathers culled wisdom from thinkers all over the world to formulate our constitution. Hundreds of years of thought and political philosophy were hammered into our American bones and boiled into our American blood. Separating the functions of governance and giving each a glimpse and a hand into the other was the great genius of the age and the most precious of gifts to posterity. The remarkable connectivity of the modern world, more specifically the astounding economic interdependence of our modern world, demands that we author a new chapter. Monetary policy and fiscal policy are too near our political whim. No President should ever call a Fed chief and ask them to lower rates to please the American public. No tax break should ever be simply in return for support, or a contribution. No tax increase should ever be simply a matter of social engineering. Admittedly, financial levers move social wheels and vice versa; they always will be connected at the deepest level. But we must endeavor to design a new system of separation, with checks and balances, that will guide our decisions in a more diligent and careful manner.

This bird is extinct. So is WaMu. Do you think that is also the sound the bird used to make? WaMu?

WaMu was more than 100 years old and at $307 billion, it shattered the record set back in 1984 by Continental Illinois Bank at $40 billion and the IndyMac failure at $32 billion in July of this year. Looks like the FDIC insurance fund will not have to shoulder cash deficits for depositors because J P Morgan Chase will buy some to keep things from a disaster.

Last fall, in this economics column, we predicted WaMu would fail before Halloween 2008. We reiterated our prediction a few weeks ago. We also predicted a total of 50 bank failures by the same time. So far, there have been less than 20 in this cycle. Last fall, we also predicted the Dow would be at 9000 by Halloween. Looks like we might have been wrong about that too.

For bank failures, there were 3 last month and 3 this month:

Washington Mutual Bank September 25, 2008
Ameribank, Northfork, WV September 19, 2008
Silver State Bank, Henderson, NV September 5, 2008
Integrity Bank, Alpharetta, GA August 29, 2008
The Columbian Bank and Trust, Topeka, KS August 22, 2008
First Priority Bank, Bradenton, FL August 1, 2008

For a full list, and more information go to the FDIC site.

Look carefully at Wachovia, it may too go the way of the DoDo. Here in Tennessee, we are fortunate to have banks in good shape. However, there are two banks specfically that we believe have very dangerous fundamentals and are at risk of failure.

Manage your cash in this way – no more than $100,000 in any account. You can play the game of opening several accounts with the same bank under different titles (one for you, one for your spouse, one jointly, etc.), but it may be cleaner and easier to simply diversify your cash between banks. Do not hold your cash in money market accounts unless you specifically know that they are FDIC insured.

If you have a significant amount cash, consider the CDRS program. One your behalf, the program puts money in CD’s at the FDIC maximum amount in dozens or hundreds of different banks. Essentially, it makes certain that all of your cash is backed by FDIC insurance. The program is only available at community and regional banks (large banks are not allowed to participate because their size would create an imbalance with the reciprocity agreements in the CDRS program). You can insure up to $50,000,000 in cash this way. Good idea right now.

Our parent company, InsBank, has the program and we would be happy to talk with you about it. But many other banks offer the same thing. As always, we would love to earn your business, but we place a higher premium on you getting the information you need than us making a buck.

Make your mortgage a vault.

Over the last year, we have made several pleas to consumers to refinance. Each time it is the same thing – even if you do not use Finworth, please go ahead and take care of it. Don’t go to a dingy Countrywide office in a strip mall and use the loan officer who is still there because no one else would hire them when the ship began to sink last summer. Don’t call your cousin who just got a job at a bank. Underwriting guidelines are more complicated and more difficult than we have ever seen. One mistake in documentation, one mistake on an appraisal, one miscalculation as to when you should lock, and you could miss your opportunity.

But this plea is different. We are no longer begging you to take care of your mortgage, we are now fully convinced that if you do not do it now, you may not be able to do it at all.

If you have an ARM, get rid of it. Period. This is no time for reading the tea leaves with rates.

If you have a balloon, get rid of it. Period. You may not like your options down the road when the loan balloons and you are forced to refinance or sell.

If you have a significant amount of money that is on a variable rate loan (like a HELOC on prime or a monthly adjustable based on LIBOR), get rid of it if you have the equity in your house to refinance. Period. These benchmark rates could be very volatile in the gathering storm.

If you have PMI and need to refinance your loan to get rid of it, or if you have an FHA and have the equity to refinance it to a conventional without MIP, do it. Period. Your future options may be limited.

This is the time for sensible action; for a conservative posture. This is the time to work with someone who knows what they are doing, who has been doing it awhile, and who you can trust. Again, we would be delighted to earn your business. But more importantly, we want you to take action while the underwriting climate and the interest rate climate and the home value climate is still relatively strong. We think there is a significant risk for each of those things to move against us.

Respectfully and Sincerely Yours,

Steve Curnutte and the folks at
Finworth Mortgage, an InsBank Company

www.finworth.com
Borrow Wisely

Change this sign to Uncle Sam Mortgage Inc

Plenty to digest in the post below. But if you do not have time to read it – please remember this…Paulson’s move today (Sunday) makes it VERY LIKELY that 30 year fixed rates will FALL SIGNIFICANTLY for a few days then BOUNCE BACK UP. If you have a rate about 6.375% on a 30 year fixed, or if you have an ARM, you must act quickly. We have almost 8 million dollars of you already on a watch list and we will be calling you as you requested to go over your options. This is very likely to be short lived (if it happens at all) so please be prepared to make a decision quickly.

Now on the boring stuff. We did not try to put all of this info down in regular prose form. Tomorrow is likely to be loaded with work so we are favoring a bullet point format to get this to you – hope it helps some!

What will this do to my stock portfolio/mutual fund portfolio?

Foreign markets (proxy for Sovereign Wealth Funds and Foreignn Central Banks) will love it because they will see it as a small sign that the beginning of a US housing recovery is at least in sight. They will love it because it bolsters the confidence in their significant holdings of Treasuries and in Mortgage Backed Securities issued by Fannie and Freddie. Japan’s Nikkei for example gained 430 points (3.6%). Paulson’s Sunday announcement was timed for the Asian market opening. Domestic markets will like it too. The shares of Banks who are holding a lot of Fannie Freddie stock will improve because people now know they won’t be wiped out. Other equities will do well on a general relief that the other shoe has finally dropped AND the general feeling that this will help home owners in some way.

What will this do to the dollar?

Dollar will remain stable or gain. Currency traders have already priced in the fact that the 5 trillion of Fan Fred mortgage debt is on the government books. Before it was implied, now it is explicit. Lower oil and weaker foreign economies are powerful fundamentals that this news will not dislodge.

Who really wins and looses in this deal?

Republicans nudge up since they have hated Fan and Fred all along and wanted them smaller. This plan (although slowly) is supposed to make the giants smaller. McCain can take the moral high ground since he has resisted contributions from Fan and Fred Lobbyists

Shareholders win a little because even though they lose their dividends, at least now they know they are not going to get wiped out.

Homeowners with equity and good credit win a little – rates should fall some and they might be able to refi.

Banks who held a lot of Fan and Fred are glad their investments will not be wiped out – some worried that a wipe out would add to the pain in the banking sector – they will all feel better.

Paulson’s street cred will bounce – he finally stepped up with a solution that is ruthlessly middle of the road.

Bill Gross at Pimco is a happy man. His bonds in Fan and Fred are safe – and boy does he have a lot (just tripled his bet thinking this might happen)

Lobbyists take a black eye and get cut off. They have earned a170m in the last 10 years (3.5 of it in the first qtr this year alone!) protecting the indefensible. 42 lobbying firms are now cut off. And they deserve to be. Party is over.

Democrats will lose because they have provided shelter for Fan and Fred for years – and the strongest criticisms of their behavior have now come to pass. Obama has some explaining to do, he has received 105k from donors tied to Fan and Fred – the 3rd largest recipient in Congress.

What does ‘nationalize them’ mean?

Paulson and company have taken the least pernicious version of nationalizing. It is a conservatorship, not a receivership. One says I am going to take you over and make you do better, giving the exiting party goers at least some decent options. The other is – you are in bankruptcy, most people are going to get wiped out, this party is over.

Who are the people that are now in charge?

At the top, the brand spanking new FHFA (Federal Housing Finance Administration) and their Grand Poo Bah James Lockhart.

Behind the curtain, Henry Paulson and Ben Bernake.

At the helm of each Fan and Fred (taking orders from the top dogs) is Hebert Allison a 65 year old former Merrill guy, recently at TIAA CREF. And David Moffett, a 56 year old life time banker from Bancorp.

Mudd’s name is now really mud and Syron is gone too.

What does ‘cost the American tax payer mean?’

Some say the money the gov is putting up for the purchase of new stock and the money that the gov will lend Fan and Fred will never turn out to be a good investment and will never be paid back. Some say it might seem like the government is taking on several trillion more in obligations, but assets offset those obligations and one day all of this will be fine. The point is, the degree of loss to the American taxpayer depends on the length and depth of the housing problems. It could go either way.

What are each of Presidential candidates saying/not saying?

One of THE MOST fascinating things about this entire crisis is the neither of them talk much about it, and when they do they are extremely general. Part of the reason is that the problem is immensely complicated, is not yet worked out, and that neither of them understand it. Part of the reason is that both of them have been bragging about how important Fan and Fred are to the housing market, and that any rescue plan should not help greedy investors. However, the bailout plan makes government bigger, and costs the American tax payer (and it really was one of the only options!) So the candidates have a hard time saying, ‘it is critical’ and ‘don’t fix it’ at the same time. They also don’t want to be caught staking a claim on quicksand – and this world has been shifting a lot.

What will this do for home owners in trouble?

Nothing directly. Indirectly, one could argue that this will help the housing market some by making rates lower and lending easier (or at the worst make lending stop the slide of tightening standards).

What will this do to 30 year fixed rates for good borrowers like me?

It will help anyone with a 30 year fixed rate above 6.375%, and anyone with a conforming ARM with good credit who needs to refinance. In other words, this move should shrink the unreasonably high spread between the 10 year Treasury and the 30 year fixed rate. This should bring rates down into the 5’s and spark a mini wave of refi’s. This will only help Prime borrowers who still have reasonable equity and could potentially refinance.