Saturday, December 29, 2007

Managing Expectations

I have a stump speech I give students going through my classes about expectations. I find many younger people have not yet developed sensitivity to the concept, and they often find it interesting (or entertaining). The concept is based on the premise that people do not like bad surprises, but good surprises are well received. It applies to personal relationships and business relationships. Here is what I tell them:

Suppose after class a few students ask me to go out and have a beer with them. Being the sociable type, I accept. It turns out we have a great time, and around midnight we break up and I go home. My wife greets me at the door at 12:300 with “WHERE HAVE YOU BEEN, I HAVE BEEN WORRIED SICK?!?” Well, lets just say I’m not getting any tonight!

Now, what if instead I called her after class and told her I was going out with a few students. I may be late, but if after one o’clock I’ll call. At 12:30 I come through the door with a big smile and a “hi honey I’m home.” Everything is fine. The simple difference, of course, is that I managed her expectations by calling her and there was no bad surprise (in this case a surprise when I did not come home at the usual time). The other point of this is that we are the ones who often set the expectations that others have of us. If we recognize this in advance, we can use it to our advantage.

Suppose you are in your first serious job after college and your boss calls you into her office. She wants you to review a stack of data, summarize it, and prepare a report for her. She asks when you can have it for her, and of course, you want to make her happy so you say “before I go home” or something like that. Your boss says thank you, and off you go back to your desk with this pile of data.

Once you start looking through the data, you realize that it will take you a considerable amount of time to analyze it and prepare a quality report. In fact, it will probably take you at least all day and most of tomorrow. Now what? You have several options, all bad. You can be late delivering the report, do a poor job but deliver it on time, or go to the boss and tell her it will take longer than you thought and ask for more time. Of course, the proper course of action is the last one, but what if your boss has relied on your estimate of time and made a commitment to someone else? Now she looks bad, and to her you look bad.

Now change the scenario. Instead of replying that you will get the report finished right away, try something like “I would like to look through this data and organize my thoughts to get an estimate of how long this will take. Can I call you in 30 minutes and let you know?” Any reasonable boss will say OK to that sort of reply. So, you go and review the assignment and you see it will take all day and most of tomorrow. You call your boss (in something less than 30 minutes) and let her know you believe you can make a good job of it by the end of the day tomorrow. Your boss says OK and thank you for getting back to her promptly. You are now inspired because you did something that worked and made you look good! So, you stay late and work on the report, and come in early the next day to finish it up. Around lunch time you deliver a quality report to your boss and say to her that you hope it is what she was looking for, and if she would like you to make any changes or additions you would be happy to do so. Now you look great! You delivered the report early, have time for her to review it before the promised deadline, and did a quality job. Go take a long lunch because you earned it.

Be careful, however, not to abuse this. If you believe the job will take you until the end of tomorrow, you can say that you think that it will be finished by then but you may need a little wiggle room. What you don’t want to do is say it will take you three days, even if you deliver it in two, when it should only take two. You can get a reputation as someone who manages expectations, and then the expectation will always be that you will deliver ahead of schedule. Now you have to manage that expectation too!

I am interested in any comments on this little stump speech. Is it a good one for college students who will be entering the job market? If you are in a supervisory role, are there any improvements/changes that you would make? If you are a young person, does it resonate with you?

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Friday, December 21, 2007

More Subprime From Schumer

I just posted the opinion piece below that relates to how Senator Schumer continues to ignore Wall Street's role in the current mortgage crisis. Apparently, Wall Street and other banks were so hungry to originate mortgages, 23 year old kids were able to defraud them of millions of dollars. The FBI has geared up dramatically to uncover and prosecute those responsible. Here is a quote from this December 21 Wall Street Journal page 1 article:

Fraud goes a long way toward explaining why mortgage defaults and foreclosures are rocking financial institutions, Wall Street and the economy. The Federal Bureau of Investigation says the share of its white-collar agents and analysts devoted to prosecuting mortgage fraud has risen to 28%, up from 7% in 2003. Suspicious Activity Reports, which many lenders are required to file with the Treasury Department's Financial Crimes Enforcement Network when they suspect fraud, shot up nearly 700% between 2000 and 2006.

Here is the article I posted last night:
Charles Schumer is at it again. On December 19, 2007 he presented "A Call to Action on the Subprime Mortgage Crises: Putting Common Sense Ahead of Ideology" to The Brookings Institution. I have read those remarks and find that I must discuss them in order to keep the record, as I see it, clear. If you are new to my blog, you may not know that in October I reviewed a report sponsored by Senator Schumer that set up his current proposals. This presentation is the next logical step in the progression of deflecting attention away from the Wall Street participants and moving the burden to mortgage brokers, non-bank lenders, shareholders of Fannie Mae and Freddie Mac, and taxpayers. There is so much to be said about this that I will first provide a summary and then review the Senator’s remarks. If you are not familiar with Wall Street’s role in the subprime mortgage market, I suggest you read my October post first.

Senator Schumer’s presentation contains some things I agree with. For example, I can’t argue against a plan that says borrowers should be informed about the loans they are taking, or that borrowers should have an advocate if they are in default (two of Senator Schumer’s proposals). The problem, however, is that Senator Schumer continues to ignore the primary causes of the crisis and tailors remedies that shift the burden to other parties. According to the Senator, the crisis was caused by homeowners who were duped by unscrupulous mortgage brokers into taking out bad mortgages. To fix the problem requires regulation of those bad brokers and refinancing hundreds of thousands of loans even if it means putting taxpayers on the hook and even if these borrowers were not first-time homebuyers. I’m sure there are unscrupulous mortgage brokers and that some borrowers didn’t fully understand the terms of their mortgage. But is it the root of the problem? The Senator completely ignores the role of Wall Street and the subprime mortgage fee-fest that fed many of his campaign contributors over the past five years. He also ignores the role of the Federal Reserve and its failure to do anything to prevent this long developing crisis. Of course, his political motives for this are obvious and I believe he really does understand the origins of this problem. If not, I suggest he read some of the recent reporting to educate himself. This Businessweek article would be a good place to start learning about Wall Street’s role (the link only goes to page two – click back a page to start). He can also read this Fortune article that discusses how the Federal Reserve ignored this problem for too long.

I will give the Senator credit for at last acknowledging the issues relating to credit rating agencies and the conflicts of interest that pervade the securitization of subprime mortgages (as well as everything else). Of course, Congress was warned of these problems in connection with Enron as far back as 2002 and again in 2006 but chose to ignore these warnings. We are now paying the price for Congress’ failure to act.

Finally, Senator Schumer claims that Chairman Bernanke supports his plan to raise the caps for loans made by Fannie Mae and Freddie Mac (the GSEs) to include jumbo loans. I have two problems with this. First, Senator Schumer believes that the GSEs should use their lending capacity to refinance subprime loans on homes that cost, potentially, seven figures. He believes they should do this even though the GSEs have said refinancing these subprime loans is not profitable for them. Of course, these entities were chartered to help provide affordable housing and are owned by shareholders, but apparently that no longer matters. Let the funds be used for the well off and the shareholders pay the price.

Second, Senator Schumer states that this proposal has the support of FED Chairman Bernanke. I am not sure about that. In fact, I wrote about the exchange between the Senator and the Chairman regarding this issue. What the Senator does not state is that the Chairman did not give his support to this plan of simply raising the caps. Rather he was asked if the government could do something like this and he said yes. He said the GSEs could make loans up to $1 million and have the federal government guarantee them. That could be done. However, it would require a large political price because these would be taxpayer guaranteed loans in order to protect the GSEs. You can read about that exchange here – click on “stupidity”. The Senator does not mention anything about the taxpayer guarantee part of the exchange. If this is the “support” from the Chairman that he is referring to then this is a shameful act of political maneuvering and misinformation, and Senator Schumer should, in my opinion, clarify this point. It was obvious when he set the Chairman up for this. So obvious that I wrote about it.

At the end of the day, Senator Schumer apparently believes that taxpayers and shareholders of the GSEs should pick up the tab for this Wall Street mess, mortgage brokers and non-bank lenders should be regulated, but the Wall Street banks need not even be mentioned. It makes me wonder who is actually running Congress. It’s as good as money can buy.

With that introduction and summary, here is my review of Senator Schumer’s remarks.

Senator Schumer’s remarks begin by bashing the Bush Administration’s economic policies as too ideological and irresponsible. I agree with him, especially when it comes to tax policy and saving for baby boomer health care. His next focus is on what he calls the “Four Myths Surrounding The Subprime Crises.”

His first myth is that subprime lending led to millions of brand-new, first-time homeowners. He states that according to the Office of Comptroller of the Currency, only 11 percent of subprime loans went to first-time buyers last year, so the majority of subprime loans were for refinance or buyers who had already owned a home. He then goes on to conclude: “Too many of these borrowers were talked into refinancing their homes to gain additional cash for things like medical bills.” He provides no support for this claim and implicates mortgage brokers as evildoers out to rip off poor desperate homeowners. He then goes on to say that “too large a percentage [whatever that means] went to investors and speculators.” This point is also without support, but is worth remembering because when Senator Schumer speaks about why we need to help out these poor subprime borrowers he is clearly not speaking to this “too large a percent” of subprime borrowers. What is really amazing is that Mr. Schumer goes on to spend an entire page of his presentation talking about how the Paulson rate freeze plan will not help enough borrowers. Which ones? He also ignores steps that have been taken already to help some 300,000 borrowers through FHA programs such as FHASecure and the pending FHA Modernization Act. The spin is so bad it hurts.

His second myth he calls “The Myth of the Unqualified Borrower”. I love this one. He claims that a study of credit scores clearly indicates that many subprime borrowers could have qualified for prime loans. He fails to consider, however, any debt-to-income or loan-to-value criteria (or any other criteria for that matter). So in fact we really don’t know whether these people could have qualified for a prime loan or not. All we know is that their credit scores were in a range that could possibly have qualified them for some mortgage amount. The other thing about this “myth” is how it is in direct contrast to all of the hype we have been hearing from HUD and the FHA. The FHA Modernization Act, supported by the Senate, lowers the underwriting criteria for FHA guaranteed loans. If all of these borrowers could qualify for prime loans, then why do we need to lower the underwriting standards to refinance all of them into FHA loans? Sounds like BS to me. You can get more details on the FHA Modernization Act from my post on it, but it is enough to understand that the thrust is to reduce the amount down from 3% to 1.5% and raise the size of the loan that can be financed. (The FHA role in refinancing hundreds of thousands of subprime loans is also a potential problem that could lead to a taxpayer bailout.) The Senator concludes this “myth” by stating “it’s clear that many subprime borrowers have the financial foundation for sustainable homeownership, but may have been tricked into unaffordable loans by unscrupulous brokers.” There we go again – it’s all the fault of those brokers. Did the Senator ever consider that maybe these borrowers wanted more home with less down and pressured the brokers to come up with a financing arrangement to satisfy their demands?

Myth three is “The Myth that Borrowers Can Easily Obtain Perfect Knowledge of The Terms of Their Mortgage Loans.” Well, if he is referring to the fact that the rate varies and the payments are likely to go up, borrowers can easily obtain and understand that information. The other thing borrowers generally understand is that if they cannot make their payment they will lose the home. According to Senator Schumer, however, most people are too stupid to understand this and so we must step in to protect them. Now, I wonder which people these are. Are these the ones who had to refinance to pay medical bills or the “too large a percentage” of investors and speculators? No, these must be the ones who were duped by the unscrupulous brokers. Yah, that’s it. How many of those are there again?

Myth four is that the free market will fix everything. I agree with his supposition that free markets do not fix everything, but stupid policy doesn’t fix everything either. If the Senate had listened to all of the warning signals it got about the housing bubble and leaned on the FED a little more, or about rating agencies and acted on that, then much of this mess probably could have been avoided. Instead, the politicians (pretty much all of them) stuck their heads in the sand because they didn’t want to throw cold water on a very popular housing boom (especially when their contributors were making a fortune from it). Glass houses and all of that.

The four myths are followed by warnings of impending doom. In fact, according to Senator Schumer “we are facing an economic downturn that we haven’t seen in this country since the Great Depression.” Yikes! If this is true I’m really glad I took most of my money out of long positions in equities! He goes on to point out that “a 10 percent decline in housing prices could lead to an overall $2.3 trillion economic loss…” That would be bad, but less than half of the approximately $5 trillion in losses from the dotcom bubble bursting. I agree this is not good for the economy, but the Great Depression? I hope not.

The presentation ends with seven policy options proposed by Senator Schumer to address the subprime mortgage crisis. Here they are, in a nutshell:

1) Provide more mortgage counselors to serve as borrowers’ advocates. OK, not bad.
2) Raise the portfolio limits for Fannie Mae and Freddie Mac so they can refinance subprime loans, even though these entities have said this would not be profitable for them. Also raise the cap on the loans they can make to include jumbo mortgages (no mention of the government guarantee part). I don’t like these, especially when the GSEs are saying they want no part of it.
3) Allow states to issue tax-exempt bonds to refinance subprime loans. As long as it’s not my state tax dollars guarantying the loans, fine.
4) Modify the bankruptcy code to change the protection mortgage lenders currently enjoy – mortgage loans are exempt from restructuring in bankruptcy without the consent of the lender. OK, but this could make mortgage loans more expensive in the future. Senator Schumer understands this, and acknowledges that this could be limited to only existing loans. This one gets a maybe and a ho-hum from me. If the lenders will be better off cutting a new deal they will.
5) Enact new regulations covering practices by mortgage brokers and non-bank lenders, including limitations on the types of loans they can make. Remember these brokers and non-bank lenders? They are the bad guys in all of this, according to Senator Schumer. Notice how these are mortgage brokers and non-bank lenders, and not banks or investment banks. If you didn’t click on that link to Senator Schumer’s top contributors you may not get this point as clearly. Here it is again. The Senator simply ignores the role of Wall Street and the investment banks in this crisis and makes no mention of any remedy targeted to them.
6) Create an easy to read summary of mortgage terms for borrowers so the big bad mortgage brokers can no longer dupe them into bad loans. OK.
7) Finally, Senator Schumer proposes to closely examine the role of rating agencies in all of this. Hooray! He is finally getting warm.

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Friday, December 14, 2007

Another Win for the Top

In another victory for the top 1% of income earners, The New York Times reported today that Representative Charles Rangel, Chairman of The House Ways and Means Committee, agreed to drop the carried interest proposal from the legislation that was passed by the House to adjust the AMT threshold.

The AMT was originally enacted to make sure high-income earners paid their share of taxes by limiting the amount of deductions that can be taken over certain income thresholds. The problem is that the thresholds were not inflation adjusted, so every year people with less real income get caught up in having to pay this tax unless Congress passes a law to provide relief. Now, instead of just fixing the problem by changing the law to index the income thresholds to inflation, every year Congress passes a law for the following year only, wasting many of the tax dollars the Treasury does collect in the process. The end result of increasing the income threshold is fewer taxes are collected and millions of taxpayers who don't quite make the top 10% are spared a very unpleasant surprise at tax time. In order to pay for this reduction of anticipated tax revenues, Representative Rangel had proposed a change in the carried interest rules that apply to hedge fund and private equity managers.

The carried interest proposal would have raised taxes on hedge fund and private equity fund managers who benefit from a tax gift, paying only 15% on much of their (often seven figure) income. Basically, these money managers have structured their businesses so they can claim that the income they receive from managing other peoples' money should flow through to them in the same way it flows to those investors. If the investors are getting capital gains, then the managers also get capital gains treatment on their income because their income is based on a share of the investors' income, even though it is not their own money that is at risk (the typical justification for capital gains treatment in the first place). So, hedge fund managers and private equity managers, many of who are in that top 1% of income earners, pay a 15% tax rate on much of their income. Now, if you work for a mutual fund you don't get this benefit. If you sell real estate and the owner receives a capital gain the broker doesn't get this treatment. But somehow, hedge fund and private equity managers do.

Well, there are all kinds of cerebral arguments and debates over this topic. One such argument made by the private equity and hedge fund group is the claim that because they provide such a necessary service to the economy by reallocating resources to their most efficient use they somehow deserve this special tax treatment. Teachers, firemen, and police apparently don’t contribute in ways that benefit society as much as hedge fund and private equity managers because they don’t get special tax treatment. I have written about this rule in the past and how I believe it is a sham on all other taxpayers. You can read that comment if you would like more detail.

All of these very complex and sophisticated sounding debates aside, my cynical brain boils it down to a very simple situation. These very wealthy people who do things that most of us don’t understand hide behind this complexity to gain a tax advantage over the rest of us. They take a portion of this tax savings and they donate it to their elected representatives to ensure that these representatives will not change their tax benefit. See how simple that is? Now, I don’t want to simply dismiss the plight of taxpayers, so lets take a look at the various groups of income tax payers and see how they have fared over the past few years since the Bush tax policies have been in effect.

The latest release to shed light on this issue is the Congressional Budget Office report Historical Effective Federal Tax Rates, 1979 – 2005 (the “Report”). The Report contains interesting data on the distribution of incomes since the Bush tax cuts, especially when combined with the same report from two years ago.

Here is a table of the percentage of all after tax income that went to households in the five quintiles by income (approximately 20% of households fall into each of these quintile categories):


The data make it clear that low-income households have been getting less of the total national after tax income than those in the highest quintile. In fact, the highest quintile is the only one that expanded its share of total after tax income over the period, from 48.2% in 2002 to 51.3% in 2005. Since these are expressed as a percentage of the total income, the gains come from losses to others. In this case the losers are those in the lower quintiles.

About 82.5% of the households in the highest quintile are also in the top 10% of households by income. Here is the trend in income share among those in the top 10%, 5%, and 1%:

Top 10%33.333.935.537.4
Top 5%23.524.225.927.8
Top 1%11.512.214.015.6

The top 10% did exceptionally well as compared to all others, gaining a minimum of 4% of the total national after tax income while all other groups lost share. But that’s not the whole story. Lets look at what has happened to the actual average after tax income in each group as opposed to group shares of the total. The data for 2002 are in 2003 dollars while the data for 2005 is in 2005 dollars. To compare apples to apples, I adjusted the 2003 dollars to 2005 dollars using the US Department of Labor Bureau of Labor Statistics Inflation Calculator to get inflation adjusted numbers for 2002:

Quintile20022005% Change

It looks like things have been pretty good for those in the highest quintile, with the average after tax income increase (21.7%) of 3.5 times the next best quintile. In the lower two quintiles things have been relatively stagnant with less than single digit gains in the lowest quintile. What about the top 10%?

Rank20022005% Change
Top 10%192,328246,30028.1
Top 5%269,811369,80037.1
Top 1%688,0081,071,50055.7

Now those are income gains!

The next time you hear any Republican talking about how Democrats engage in class warfare against the rich, remember these numbers. Looks as though it is the other way around, and the rich have been winning all the battles.

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Thursday, December 13, 2007


It’s the end of the semester and I am buried in grading, exams, etc. A lot has been happening over the past week, so I decided to write a quick update on a few topics and provide a few links. I’ll get back to articles when the smoke clears. Thanks for checking in.

Citi finally stepped up to the plate and announced it would consolidate the SIV assets on its books (my guess is this means no M-LEC). There are net assets of approximately $49 billion. The really important thing to me, however, is that there are finally details! Hooray Citigroup! You can find the announcement by Citigroup here, and the details regarding the SIV assets here. I note the absence of subprime mortgage exposure and that takes the wind out of my Subprime Conspiracy Theory (at least with respect to the SIVs).

According to this Reuters article Moody’s has already downgraded Citigroup senior unsecured debt to its fourth highest rating of Aa3, and

Moody's also lowered Citibank N.A.'s bank financial strength rating to B from A- and Citibank's long-term deposit and senior debt rating to "Aa1" from "Aaa."

It will be interesting to see if any of this impacts the ratings on other off-balance sheet conduits for which Citi provides credit enhancement.

The Credit Crises:
I highly recommend this related article in today’s WSJ Online Edition that provides a well written perspective on the de-leveraging we may be witnessing. If the author of this piece is correct, we could be in for some very bad economic times ahead as we unwind all of the leverage created by securitizations that investors don't want to purchase anymore.

There is a battle going on in Congress over the AMT fix and how to pay for it (although some argue that it need not be paid for as it was never supposed to be collected in the first place). The House Democrats want to increase taxes to pay for the loss of AMT revenue by taking the carried interest sham away from hedge fund managers. I like that idea, but I don’t think they have the votes to get it through the Senate and an almost certain veto by Bush, so righting that wrong will likely take a back seat for now. That’s too bad. You can get my opinion on that tax po$%#@icy here if you like.

With today’s headline year-over-year PPI inflation number of 7.2% (the highest since 1973) and continued concern over economic growth stagflation risk appears to be gaining some momentum, although retail sales came in stronger than expected. I note, however, that if we are about to witness massive de-leveraging (see the Credit Crises above), inflation is not likely to be a problem.

Back to grading.

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Friday, December 7, 2007

Subprime Conspiracy Theory

By now you have certainly heard that the Federal Government is taking steps to help those poor borrowers of subprime mortgages who were duped by banks and mortgage brokers. I’ll refer to this plan as the “Subprime Bailout Plan”. They plan to help as many as they can refinance into more “secure” fixed rate mortgages, and to freeze the adjustable rate for those who cannot refinance. This plan required many varied interests coming together, and they did so under the guidance of Treasury Secretary Henry Paulson.

At the same time and also with the help of Secretary Paulson, the major money center banks in the US are putting together a plan to finance the purchase of certain assets from Structured Investment Vehicles (SIVs). I’ll call this the “SIV Bailout Plan”. Word is that these vehicles were the repositories for pieces of mortgage securitizations, although finding any actual data on these has been an exercise in futility. The basic idea of this plan is to find a financing source for these assets other than the current structure because the current structure no longer works since these assets have been or may be downgraded by the rating agencies. Once they are downgraded, the SIVs liquidate selling the assets in the marketplace. Because the market for these assets is terrible and sales at current prices would produce large losses, the plan provides a purchaser (the MLEC or Super SIV) for these assets. With time, hopefully, the actual cash flows from these assets will be sufficient to repay the financing used to purchase them at above current market prices. The accounting for all of this raises serious questions in my mind, and if you are interested in that part of it you can read my previous post on that topic here.

To the conspiracy part:
Now, I am not making any direct accusations here, but I would like to point out an issue that I believe should be scrutinized carefully. If the assets in these SIVs are indeed mortgage backed securities or in any way tied to subprime mortgages, then the Subprime Bailout Plan is related to the SIV Bailout Plan because refinancing the subprime mortgages and/or fixing rates for a period of time provides both cash in the form of full repayment of these subprime loans to the owners of those loans, and time to work out the other loans that would default if the interest rates adjust. So, the Subprime Bailout Plan and the SIV Bailout Plan are related, and are both being structured with the assistance of the Treasury Secretary. This raises a potential conflict of interest regarding which subprime borrowers actually receive the assistance that the Subprime Bailout Plan is to provide because those whose mortgages are owned by SIVs or impact repayment on SIV assets could gain preference to aid the SIV Bailout Plan. I believe there should be a call for oversight and full transparency of this entire mess because there is the appearance of a potential conflict of interest here.

Unfortunately, that’s just the beginning of the “conspiracy”. Lets follow the mortgage refinancings to see where the risk of all of these defaults is going. Unfortunately, that road leads indirectly to the federal government and, ultimately, the taxpayer. HUD currently plans to refinance approximately 300,000 subprime mortgages raising serious questions about the ability of the Mutual Mortgage Insurance Fund to adequately cover potential future exposure. Any shortfall in the fund would result in a taxpayer liability. If you would like details about this, you can read my post on it here.

The other place many loans appear to be going is The Federal Home Loan Banks. These banks issue bonds backed by the full faith and credit of The United States (that would be us, the taxpayers) and use the proceeds to purchase mortgages from banks. How much do they purchase, you ask? Well, from December 31, 2005 to June 30, 2007, outstanding advances went from $619.8 billion to $640.0 billion. From June 30, 2007 to September 30, 2007, advances went from $640 billion to $824 billion, an increase of $184 billion. Humm. That would be an annualized rate of increase of ($184 x 4) $736 billion! Senator Schumer has recently questioned the quality of the loans being purchased in an open letter to Ronald A. Rosenfeld, Chairman, Federal Housing Finance Board. You can find that letter here.

Lets review. The Treasury Secretary has developed a plan with major financial institutions to move beaten down assets relating to subprime mortgages (we think) to a Super SIV to buy time to try to liquidate and recoup the value of these assets. At the same time, the Treasury Secretary has developed a plan to refinance and/or freeze the interest rate on some 1.2 million subprime mortgages. The refinance portion of this plan relies on FHA guarantees, and we don’t really know how many subprime mortgages are being refinanced through ultimate sales to The Federal Home Loan Banks. The United States taxpayers ultimately back both of these sources. So, is this really a plan to help those poor victims of the big bad banks that made these subprime mortgages or is this really a bank bailout disguised as a plan to help homeowners? I don’t know the answer, but I know I have serious doubts and there should be some oversight of this entire mess.

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Wednesday, December 5, 2007

Assisted Dying

I read Daniel Bergner’s article in The New York Times Magazine on December 2 and had a very negative reaction to it. Because I was writing about other issues at the time, I decided to ask my father for his input on this article. He and I feel very much the same about assisted dying, having faced the issue head on more than once, and he is very knowledgeable about the issues.

By way of background, my mother was diagnosed with cancer 11 years ago. She lived for about six weeks following the diagnosis. She had recently tended to her only sibling who had died following heart surgery. Her sister lingered for some time in a coma before expiring. My mother told me that she did not want that to happen to her. If she were ever in such a state, she would want an end to it. Unfortunately, I was unable to satisfy my mother’s wishes, and she lingered in a coma for week before her body finally gave out.

Whether my mother wanted to die before slipping into a coma is, to me, the only issue. Whether this was her desire because she did not want to be a burden, did not want to suffer, did not want the indignity of the process, or whatever is irrelevant. At the time of our death we are who we are and we should be allowed to determine our own fate based on that. If we need help to satisfy our wishes, help should be provided.

I want to make a couple of points before I get to my father’s response. The article struck me as the same old “we know better than they do” crap. When is it that children finally learn that they may know different things than their parents, but that doesn’t mean they know what is best or what is right? Finally, regarding Mr. Kervorkian, Mr. Bergner writes:

The first reported patient to seek him out and receive his aid was a 54-year-old woman with Alzheimer’s disease. His first eight such patients were women, and half of them had no terminal condition. Of the reported 75 suicides Kevorkian assisted through 1997, according to research by Silvia Canetto, a psychology professor specializing in the study of suicide at Colorado State University, 72 percent were women, and more than three-quarters of those women were not terminally ill. (Multiple sclerosis affected about 30 percent of them.) The disproportionate number of women could not be explained by the fact that women generally live longer than men and so might be more likely to want to escape life at its end. The average age of Kevorkian’s female patients was a year younger than that of his men. And, Canetto noted, Kevorkian’s women were more often middle-aged than elderly.

This all sounds like maybe we could conclude women are being victimized by Mr. Kevorkian. What Mr. Bergner fails to point out, however, is that MS strikes women at a rate of four times that of men. So, while age may not explain this ratio of women to men, the incidence of MS does. Seems to be pretty obvious.

With that introduction, here is my father’s opinion on Daniel Bergner’s article:

Daniel Bergner's article (Dec.2) on assisted dying was one of the most egregiously specious pieces of journalism I've ever encountered. The opinions of three people, each with a personal agenda that bears no relationship to the objective facts in this controversy, are put forth in great detail, while the Oregon studies, the only reliable indicia of the effects of legalized assisted dying, are virtually dismissed in a few sentences.

Doug Gardner, the born again tennis player, so deeply resentful of his father's neglect in his early years, thwarts the latter's humane concerns by adducing religious arguments about "God's Will." A hundred years ago, people died in great numbers, from diseases that are now routinely curable. Is "God's Will" then, predicated on medical technology?

As for the "scholar," Ms. Susan Wolfe, her radical feminist paranoia causes her to interpret statistics regarding the greater number of women than men helped by Kevorkian, as some kind of gender plot. So convinced is she that her fears are real, she ignores her dying father's pleas for help, and sits "stroking his hair," while he lingers on! What would Ms. Wolfe make of the fact that, among those in the general population, who are not seriously ill, the number of “successfully” completed suicides is overwhelmingly male?

Mr. Duane French's fears that voluntary assisted dying would somehow threaten the handicapped, are without foundation. The very essence of the assisted dying movement, is the belief that the right of those who are terminally ill or suffering, intractably, to seek a quiet, merciful, dignified end to their lives, is the most fundamental right of all; and, the decision to do so, is totally, and without any qualification, voluntary.

Because of the lobbying efforts of the Catholic Church, Oregonians voted, not once, but twice for assisted dying legislation, and voted against repeal of the law by a margin of 60 – 40, substantially higher than the 51% margin of original passage.

The Catholic Church is, indeed, the principal opponent to the legalization of assisted dying, and as such, it's own position is worth examining. It holds that, if a seriously ill person expresses a desire to die, all food, fluids, medication, and life support systems can be withheld, thus permitting that individual's death to be hastened; but, nothing may be provided to him, that would achieve the same goal in a faster, more merciful, and dignified manner. They may claim the moral high ground for such a distinction, I call it meaningless, Jesuitical casuistry.

We live in a society that provides a merciful death for dogs, cats, and serial murderers, but withholds that same mercy from its citizens. It's time that such issues are decided by those most affected by them, and not by religious fundamentalists, the Pope of Rome, gender fanatics, or the misinformed.

Thanks Dad:-)

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Tuesday, December 4, 2007

More On Taxpayer Bailout of Subprime

UPDATE: Congress is likely to pass the FHA Modernization Act. This will reduce downpayments from 3% to 1.5%, provide for wider use of risk-based premiums by FHA, and raise the maximum loan amount to the "conforming loan" amount for Freddie and Fannie of $417,000.00. The Senate passed this legislation last week and the House passed similar legislation in September. You can get details of the proposed legislation at this summary of the proposed legislation.

On November 13 I wrote an article about the beginnings of a taxpayer bailout of the subprime mortgage mess. I want to add to that article some new information I have found since then. This has nothing to do with the “Paulson” plan, except that his plan seems to be more of a diversion from what is really happening than anything else.

What is really happening? As I wrote in the article referenced above, the Federal Home Loan Banks have increased their exposure to banks by some $183 billion from December 31, 2006 to September 30, 2007. The FHLBanks obtain funds by issuing federally guaranteed securities, so ultimately this is a taxpayer guaranty. Freddie and Fannie have also substantially increased their portfolios over this time period. But there is more.

The FHA is now into the act in a big way. According to this press release yesterday FHA has now refinanced 33,000 subprime loans and plans to refinance another 20,000 by year end. Plans for 2008 are to refinance 240,000 subprime loans. This is all pursuant to the Bush FHASecure Plan. Of course, as with many Bush plans, the name is deceiving. If anything, I believe this plan makes the FHA less secure and more likely to ultimately require a taxpayer bailout.

Granted the FHA program is backed by an insurance fund – the Mutual Mortgage Insurance Fund (the MMI Fund), that is supposed to stand behind these mortgages. The fund is financed with insurance premiums paid by borrowers. The problem is that the health of the fund (which has a capital ratio around 6.4% of outstanding guaranteed loans based on May 31 2007 data that you can find here) depends upon underwriting standards. With all of the buzz around helping subprime borrowers, and based on some observations, I am very concerned that the fund will ultimately be in jeopardy and have to be bailed out by taxpayers. This is based on my reading of the threats to the MMI Fund.

According to this testimony by Basil N. Petrou, Managing Partner, Federal Financial Analytics, Inc. to the Housing and Transportation Subcommittee of the Committee on Banking, Housing and Urban Affairs, United States Senate, June 20, 2006. prepared and presented in consideration of FHA reform proposals in Congress, the primary sources of financial risk are identified as low or no downpayment loans and risk-based premiums.

Regarding risk-based premiums, the report warns that FHA is likely to get it wrong. FHA does not have the ability to accurately determine which borrowers are higher and lower risk thereby justifying a higher or lower premium. The current system of cross subsidization is a key part of why the MMI Fund has been successful (cross subsidization refers to the fact that all borrowers pay the same fee, resulting in higher quality borrowers subsidizing the lower quality borrowers).

Regarding low or no downpayment loans, it warns that such loans could result in high default rates and serious harm to neighborhoods where these loans would be prevalent. Adding to the risk, according to the testimony, would be a declining real estate market. Does this sound familiar? It sounds like the justification now being given by politicians for helping to stem subprime defaults. This testimony lays out the subprime problem quite clearly, and warns that FHA should stay away from these loans.

This reform that was in front of Congress was not passed. The Bush Administration has, however, authorized modifications to the HUD program that allow HUD to utilize risk based premiums. According to a HUD press release:

President George W. Bush today announced that HUD's Federal Housing Administration (FHA) will help an estimated 240,000 families avoid foreclosure by enhancing its refinancing program effective immediately. Under the new FHASecure plan, FHA will allow families with strong credit histories who had been making timely mortgage payments before their loans reset-but are now in default-to qualify for refinancing. In addition, FHA will implement risk-based premiums that match the borrower's credit profile with the insurance premium they pay-i.e., riskier borrowers pay more. This common-sense, risk-based pricing structure will begin on January 1, 2008.
“Common sense” – hummmm. Not according to congressional testimony. I also point out the spin. If riskier borrowers pay more, doesn't that mean "less risky" borrowers pay less?

Does HUD plan to implement these changes? Well, according to the Annual Management Report of The FHA:
This past year has seen an increase in interest rates and a decrease in house price appreciation, leading to the current mortgage credit crunch. Accordingly, FHA will expand its refinance program, FHASecure, to include those individuals and families who are in default as a result of an interest rate reset. With the inclusion of delinquent borrowers under the FHASecure umbrella, the government’s largest mortgage insurance provider will now be able to assist even more troubled homeowners. In addition, FHA will implement risk-based premiums that match the borrower's credit profile with the insurance premium they pay. This administrative risk-based pricing structure will begin in early 2008.
(Again the spin - "a decrease in home price appreciation" isn't really an accurate description of the current housing market.)
What about the downpayment issue? Well, according to the same press release announcing the FHASecure plan:
To qualify for FHASecure, eligible homeowners must meet the following five criteria:
1. A history of on-time mortgage payments before the borrower's teaser rates expired and loans reset;
2. Interest rates must have or will reset between June 2005 and December 2008;
3. Three percent cash or equity in the home;
4. A sustained history of employment; and
5. Sufficient income to make the mortgage payment.

Note the 3% cash or equity in the home. This is not much. If it is cash, it is most likely not equity given the decline in home prices (as opposed to a decrease in appreciation) so you are left with 100% (or higher) loan-to-value. The implementation of these requirements also concerns me. For example, here is what the FHA website says:
To qualify for FHASecure, and include the delinquent loan payments, homeowners wishing to refinance must meet the following requirements:
1. Have a non-FHA insured ARM that has reset;
2. Sufficient income to make the mortgage payment; and
3. A history of on-time mortgage payments before the loan reset.
Homeowners who are current on their conventional mortgages must have sufficient income to make the mortgage payment.
What happened to the “cash or equity” requirement? It isn’t there. Is this an oversight or a reflection of the implementation of this subprime refinance plan? What is this about refinancing delinquent payments? Doesn't this reduce the loan-to-value ratio (making it negative in many cases)? I am cynical, so you know what I think. Here comes the taxpayer bailout. Don't be surprised if sometime in the not too distant future you hear about a MMI Fund taxpayer subsidization plan. Want more? Here is a clip from the Congressional Testimony referred to above:
Key points to consider for FHA reform include:
• As a government program, FHA should serve its targeted borrowers if they are not already being adequately served by the private sector. It is not appropriate for FHA, as a government program, to launch initiatives to expand its “market share.”
• Recent General Accountability Office (GAO) and Department of Housing and Urban Development (HUD) Inspector-General reports, as well as the President’s FY 2007 budget raise serious questions about the Mutual Mortgage Insurance (MMI) Fund’s financial soundness. The most recent available MMI Fund data are for only mid-FY 2005, and these show a serious reduction in the economic value of the fund that undermines its capital adequacy. Mortgage-market trends since then have shown significant weakening, as evident by recent guidance from the federal bank regulatory agencies designed to protect insured depository institutions.
• The FHA should not seek to grow its way out of its current financial problems. Doing so is reminiscent of the actions taken by distressed savings-and-loans during the 1980s.
• The MMI Fund is already taking financial risks. For example, 50% of all FHA loans insured in 2004 had downpayment assistance, with nonprofit organizations that received seller funding accounting for 30 percent of these loans. GAO analysis indicates that these sellers raised the price of their properties to recover their contribution to the seller-funded nonprofit—placing FHA buyers in mortgages that were above the true market value of the house. The Internal Revenue Service (IRS) is curtailing these programs, but the significantly higher claim rates FHA has experienced from these loans will continue for those remaining on its books. Indicative of FHA’s problems is that its delinquency rates are higher than those associated with private subprime loans. Adding yet more risk means potentially profound FHA losses that will heighten the risk of calls upon the taxpayer.
• From a budgetary perspective, the MMI Fund now is only breaking even, but even this is based only on out-dated information. Any shift in the MMI Fund’s financial condition will convert the program into a net cost to taxpayers, increasing the federal budget deficit.

So why didn’t Congress pass this plan? Looks pretty obvious to me. Of course I hope I am wrong and there is no need for a taxpayer bailout of the MMI Fund. Time will tell.

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Sunday, December 2, 2007

Another Decade of Dependence

I was reading the Wall Street Journal Online Edition today and came across an article Sovereign Impunity (subscription may be required). The article points out that the Abu Dhabi fund that just purchased a stake in Citigroup (a convertible preferred that converts to approximately 4.9% of the company’s shares) is funded with oil dollars. This fund now controls an estimated $875 billion according to this article, which is approximately 25% of all of the $2-3 trillion of assets owned by all of the sovereign wealth funds. This is an entity that obtains its funding through the sale of oil which is controlled by the government, not through free market risk taking. The article concludes by stating that it is US monetary policy that is responsible for the growth of these funds:

These funds owe much of their current size from bad U.S. monetary policy. We were nearly as ‘dependent on foreign oil’ in the 1980s and 1990s as we are today. But with a responsible Federal Reserve and strong dollar, there was no boom in petrodollars.

Only in this decade, amid the Fed's dollar abdication, have we again seen the boom in commodity prices that is enriching Russia, the Arab kingdoms, Venezuela (read a related Review & Outlook) and other dubious corners of the globe. Our own monetary mistakes have made these funds richer than they would be under normal market conditions. The response should not be to restrict their investment, but to start protecting the value of the dollar so that the price of oil falls back down to where it reflects supply and demand, not a cheapening U.S. currency.

Now, I may agree that our monetary policy has contributed to the decline in dollar value, but this completely misses the point. Before even considering the real issue, however, I point out that without a declining dollar we never get to a balance of trade that we can sustain over the long term. That said, what is the real issue?

The real issue is energy independence and it has been energy independence since the very first oil shocks in the 1970s. I knew this even as a teenager waiting on line at the gas station to put gas in my car. When we were originally impacted by the oil shocks we learned that we have an issue that must be dealt with in the long term, and that issue is that we are dependent upon foreign resources for our energy needs. As we have supported globalization through our trade policies, we have also increased competition for these foreign supplies from the emerging economies we support, making us even more vulnerable. This is not the 1980s or even the 1990s, and we now have serious global competition for scarce resources. Finally, we are learning that we cannot continue to poor pollutants into our atmosphere without consequence, and burning more fossil fuel is probably a bad idea.

Just how dependent are we on foreign oil? Well, according to the Energy Information Administration, in 2006 we imported on average 12,390,000 barrels of petroleum products per day. Based on a price of $94 per barrel, that’s about $1,164,660,000 ($1.16 billion). So what is today’s value of 4.9% of Citigroup in terms of petroleum imports? It’s about ($7.5/$1.164) 6.5 days of imports. That’s right, 6.5 days of petroleum imports equals 4.9% of Citigroup in today’s market. (I note that prices of different petroleum products differ, and the price changes regularly.)

Is this a result of poor monetary policy? I argue it is not, and the same forces that have driven up the price of oil have driven monetary policy. These factors are primarily related to globalization and our reaction, as a country, to it. For one thing, we have relentlessly pursued the pools of lowest cost labor we can find. This has driven prices of imported goods down at the same time we have made tremendous productivity gains. These forces have placed downward pressure on prices, and even threatened us with deflation in the early part of this decade. (Unfortunately none of this applies to health care or education that, for now, require the actual presence of professionals.) In response, the Federal Reserve lowered interest rates according to its traditional mandate so as to maintain growth and price stability. In this case, price stability meant avoiding deflation so the reaction was to keep interest rates extremely low for a long period of time. The natural result of this action is an increase in the money supply and a decrease in the value of the dollar (as well as pricing bubbles in, say, real estate). Ultimately, then, our pursuit of cheap labor comes back to us in the form of higher import prices due to a falling US dollar and asset bubbles. A side effect of this policy is that with a declining dollar the dollar value of our raw material imports increase. Add to that scenario the fact that we are now competing with countries such as China for the raw materials to be found around the globe, and we see why the prices of oil and other raw materials are rising. To blame monetary policy for this is to say that we should have left interest rates higher in the early part of this decade and likely suffered a recession with a simultaneous deflation, something that could be devastating to any economy. So is monetary policy responsible or is it the overall trading policies of the United States? I don’t believe the monetary policy argument is the critical issue.

(For additional reading on the impact of higher oil prices on monetary policy and the economy, there is a good article here at the Federal Reserve Bank of San Francisco website.)

Now that we can at least question whether it is monetary policy that is responsible for rising prices or some other factors that resulted in our monetary policy, we can move to the true cause of our problem. Despite decades of advance warning, we have not pursued, together as a nation, alternative sources of energy. Surely this is a goal that almost every American supports, barring those whose livelihood flows from the vertical chain of the oil industry. Lets take a look at some estimated numbers.

If we take the daily barrels we import and convert that to an annual amount, we get 148,320,000 barrels per year. Multiplying that by $94 per barrel gives us an annual cost of about $424 billion. How much is $424 billion? To put it in perspective, it is over two times the projected 2007 fiscal budget deficit of The United States, and on a monthly basis over 60% of the $56.5 billion total US trade deficit in September 2007.

Of course, finding alternative sources of energy is not free, and the alternative energy itself will not be free (although some sources may turn out to be just that). What it would be is liberating for the United States and other oil importing countries around the globe, and possibly very profitable and stimulating to our economy. So, rather than pointing fingers at who or what is responsible for the current situation that leads to 6.5 days of oil imports = 4.9% of Citigroup and proposing ways to make oil cheaper (not that I have a problem with that), I believe we are ready for the national challenge similar to the Kennedy era challenge of reaching the moon. We should have been ready for it decades ago, but we were lulled into complicity by low oil prices. Think of the change in policies that could result from energy independence. Would we fight as many wars? Would the world fight as many wars? Would we be wealthier? Would we save the earth from global warming? Could achieving energy independence balance the budget? Provide for Medicare? Decrease our defense spending? Etc.

I am certainly not the only person advancing this issue these days, but I feel strongly that more people need to advance it and be heard. Certainly a goal of energy independence through alternative and environmentally friendly sources is worth our consideration, our investment, and our short-term sacrifice. Should this be left to the free markets or should we look at this like a system of highways – something we need to build together, combining public finance and the free market system in order to foster the ability of free markets to further our advancement in the annals of human history? I believe the latter, and hope that even if oil prices fall substantially, we have learned our lesson and will make the necessary investments. At this point in our national history I crave a positive issue to unite around. This sounds like a timely one to me. Of course, that’s just my opinion.

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Tuesday, November 27, 2007

Updates - SIVs, Citi, Social Security, Subprime, and Taxes

First thing to update is the status of this blog. I started it on October 2, not quite two months ago. Since then I have written 26 pieces for publication, but nothing substantial in the past week. The reason is that maintaining the level of publication I started out with has proved difficult as evidenced by the late payment notices I have been receiving (I have forgotten to pay the bills!). So I took some time off to catch up on the other pieces of life not reflected in the blog (bills, family, work, exercise, etc.). I will continue to post so long as I continue to have visitors, although there will be periods of quiet.

There have been some very interesting developments in the interim, and I am writing today to update the issues I have been writing about in November. If you have been following my blog (thank you) then these should be of interest to you. You can click on any of the topics below to go directly to that topic, or just read from the top.

Citigroup Subprime SIVs Social Security and Taxes Short Rant on policy and responsibility

On Citigroup:
It has been interesting watching this unfold. Citi announced today that it will receive a $7.5 billion capital investment from the Abu Dhabi Investment Authority. According to the press release

Each Equity Unit is mandatorily convertible into Citi shares at prices ranging from $31.83 to $37.24 per share. The Equity Units convert to Citi common shares on dates ranging from March 15, 2010, to September 15, 2011, subject to adjustment. Each Equity Unit will pay a fixed annual payment rate of 11%, payable quarterly.

11% seems high to me, about the same as Ford Motor Credit and GMAC high yield bonds give or take a point, and these are convertibles. Abu Dhabi ends up with a 4.9% interest in Citi post conversion.

Now the layoffs are coming in force, and there is a lot of speculation in the media about how many jobs. I heard today on MSNBC anywhere from 15,000 to 45,000. That could be a lot of layoffs and of course it comes just before the holidays.

The investment by Abu Dhabi reinforces the fact that America is currently on sale, as I wrote about in my first piece in November. Interestingly, this purchase is with dollars so the exchange rate is not the issue. Rather it is the price of oil.

Since I wrote that piece, the Fed chairman testified before Congress and released its (now quarterly) report on the economy. The report was pretty much as expected, as was the testimony. Of course some of the dialog during the testimony was simply amazing in that it will likely lead to a proposal by Congress to federally guarantee jumbo mortgages (just what we need – more obfuscation of the “market”). I believe I heard warnings of stagflation in the testimony as well. If you would like more detail on this you can find it here.

While on the subject of the overall economy, I have some anecdotal evidence of a slowdown. Each year my family drives 230 miles to visit relatives for Thanksgiving. Last year the trip took about 6 hours with traffic, each way being a very long drive. This year it took just over four hours each way with almost no traffic. I believe gas prices are beginning to have an impact.

On Subprime:
What is happening there? Well, for one thing the Federal Home Loan Banks have vastly increased their exposure over the past quarter to provide liquidity to the mortgage market. Freddie and Fannie did their part as well, although they have since disclosed problems of their own relating to poorly underwritten mortgages. I wrote abut these increased exposures here. In a pleasant surprise, Senator Schumer is onto this scheme and posted a letter to the Federal Home Loan Bank today. Details here. Other than that there have been increased calls for taxpayer help to bail out homeowners so as to avoid a real economic problem. I don't believe there should be any bailout, and you can read about my reasons for this here and here and here.

We now know that Citi has taken substantial assets onto its balance sheet relating to the SIVs, and HSBC announced that it is moving approximately $45 billion in SIV assets onto its balance sheet. I believe this is a blow to Citi and the whole MLEC plan because HSBC has taken the matter into its own hands and consolidated the problem. We should ask why Citi does not do the same, but the answer is likely to be one we don’t want to hear. Perhaps Citi does not have the equity to absorb such a move at this point. Whether Citi must consolidate these off-balance sheet entities is the subject of ongoing debate. According to a WSJ Online Edition article there MAY be a requirement to consolidate since Citi has taken over $32 billion in assets onto its balance sheet as of September 30 (as I discussed here). Sounds to me like a lot of intellectual wrangling over a pretty simple issue – if ultimately Citi will be forced to bail out these entities, whether for “reputational” or any other reasons, then they should be on the balance sheet. Of course that’s just my opinion.

The impact of all of this on the money markets is still uncertain. According to this WSJ article:

Efforts by HSBC to protect its SIVs are being watched closely by analysts and managers of money-market mutual funds, some of which have invested in debt issued by the two SIVs, called Cullinan Finance Ltd. and Asscher Finance Ltd. Janus Capital Group Inc. is estimated to have held about $606 million, or 2.7% of its money-market assets, in Cullinan and Asscher through the end of October, which has since been reduced. Federated Investors Inc. holds about $350 million in Asscher in its five largest money funds.

In other words, the mutual funds are still waiting to see whether they will be taking a hit on these. So far it appears they are winding down their exposure, but still have substantial assets tied to SIV structures.

On Social Security and Taxes:
I have been debating with people all week about my stance on Social Security, including the latest proposal by Fred Thompson to address the “crisis” we have. This Fox News Article reports his tax and Social Security plan as follows:

Thompson's proposal, announced on "Fox News Sunday," would allow filers to remain under the current, complex tax code or use the flat tax rates.
Asked whether the plan would cut too deeply into federal revenues, the former Tennessee senator and actor said experts "always overestimate the losses to the government" when taxes are cut.

"We've known for years any time we have lowered taxes and any time we've lowered tax rates, we've seen growth in the economy," Thompson said.

Thompson added that money would be saved by his Social Security reform plan. He proposed that workers younger than 58 receive smaller monthly Social Security checks than they are now promised. Individuals could contribute 2 percent of their paycheck to a personal retirement account, an amount that would be matched by the Social Security trust fund.

The retirement plan "faces up to the fact that Social Security is going bankrupt and we're going to have to do something about it," he said.

Well, first of all Social Security is only going bankrupt if the Federal Government decides not to honor its promise to repay what it borrowed from the Trust Fund (see my article on this topic here). If it does not, then it may be time to sell any treasury securities you have because they would no longer be “risk free”. (The Trust Fund does not own treasury securities, rather special IOUs from the federal government that are backed by the full faith and credit of The United States of America).

Next problem with this statement is the same old crap about the Laffer curve and taxes – if we can decrease taxes to grow the economy it will raise tax revenue. If this is true then why worry about Social Security? We can just cut taxes to pay for it! Ridiculous indeed. Now, to be fair, the article does not actually say that he believes a tax cut will result in higher tax revenue, but this is the argument we consistently hear from Republicans on this issue. I have yet to see any actual proof that the Bush tax cuts CAUSED tax revenues to increase. I have seen plenty of evidence that tax revenues have increased, but never any cause and effect proof. In other words, we do not know if it is the Bush tax cuts, fiscal stimulus from excessive borrowing, or normal economic growth from population growth and global growth that has caused tax revenues to increase. What we do know is that since the Bush tax cuts we are in a lot more debt and that is becoming a problem, especially when no one wants a tax increase to pay it down.

Finally, a flat tax has the potential to be regressive and could be another gift to the high-income population. In any event, a reduction in tax revenue is a problem at a time when we are at war (two wars, actually), and facing the need to begin repaying what has been borrowed from Social Security (not to mention the health care issues). At the end of the day, this boils down to paying for the Bush tax cuts and maybe even more tax cuts by reducing promised Social Security benefits relied on and paid for by lower- and middle-income retirees. It is a transfer of wealth from those with less to those with more. It is a sham. Again, that is just my (somewhat informed) opinion.

A short rant on policy and responsibility.
I think it’s about time we begin taxing to pay for our wars. Until now, we have fought this war in Iraq by borrowing the money and paying civilian warriors so as to avoid a draft and any tax increase. I wonder how long we would be in Iraq if we instituted a draft to get the soldiers we need and raised taxes to pay for it. I see uprisings on college campuses. I hear the cries of the high-income earners writing checks to the Treasury. My guess is we would already be gone. Isn’t this irresponsible? What happened to the party of personal responsibility? Isn’t keeping promises to taxpayers such as Social Security an act of personal responsibility? Isn’t managing the country in a fiscally sound manner an act of personal responsibility? How is it we get lectured on the values of personal responsibility by those who seem to ignore theirs? I shall continue to object.

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Schumer Gets It Right!

I have written a couple of articles that express a poor opinion of Senator Charles Schumer. In the interest of fairness, I want to also salute him for his attention to the taxpayer issues surrounding the Federal Home Loan Banks.

On November 13 I posted this article raising a red flag that the taxpayer bailout of the subprime mortgage debacle had begun through the Federal Home Loan banks. Today, Senator Schumer released this letter to the FHLBanks directly on point. I applaud Senator Schumer for his attention to this issue on behalf of all taxpayers and I hope that he continues to diligently protect taxpayer interests. Here is the letter:

November 26, 2007

Ronald A. Rosenfeld
Federal Housing Finance Board
1625 Eye Street NW
Washington, DC 20006

Dear Chairman Rosenfeld:

I write to express my serious concern over the lending practices of the Federal Home Loan Bank of Atlanta, specifically in regard to the significant volume of advances made to Countrywide Bank. I am concerned that the loans being pledged by Countrywide to secure these advances may pose a risk to the safety and soundness of the FHLB system as a whole. I urge you to conduct a careful review of FHLB Atlanta’s collateral evaluation policies, as well as Countrywide’s pledged collateral, in an effort to determine the risk that Countrywide’s collateral poses to the FHLB system. During the current market crisis, it is important that the FHLB system perform its critical mission safely without imposing additional risks on an already strained market.

According to the most recent SEC filings, FHLB Atlanta had made $51.1 billion in advances to Countrywide Bank, representing 37 percent of the Bank’s total outstanding advances as of September 30, 2007 and far exceeding advances made to the next largest borrower. Countrywide had pledged $62.4 billion of mortgages as collateral for the FHLB advances, representing 78 percent of its total mortgage loans held for investment at the bank.

I find these numbers alarming as reports continue to emerge about how Countrywide’s reckless and predatory lending practices were a leading contributor to today’s foreclosure crisis. Moreover, it is my understanding that Countrywide’s loans held for investment at the bank have been far from immune from the credit deterioration that has resulted from unsound lending. Countrywide reportedly held $27 billion of “pay option ARMs” as of September 30, 2007, accounting for over one-third of the loans held for investment by the bank. Countrywide’s option ARMs were (and may still be) often underwritten with less than full documentation – according to UBS Warburg data prepared for the Wall Street Journal, 91 percent of Countrywide’s option ARMs underwritten in 2006 were “low doc.” It has been reported that delinquencies on Countrywide’s pay option ARMS are skyrocketing, jumping nearly 75 percent in the last quarter.

Given this rapid deterioration in the credit quality of Countrywide’s option ARMs, I urge you to conduct a review of the loans that are being held as collateral for FHLB advances in an effort to determine if FHLB Atlanta has adequate collateral to secure these advances. I would also like an explanation of how any second lien mortgages during a time of property price declines could be viewed as adequate collateral for large FHLB advances.
Furthermore, I believe that you should consider preventing any further or continuing overnight advances based on collateral that does not meet the joint financial regulators’ guidance on nontraditional and subprime mortgage products (e.g., Interagency Guidance on Nontraditional Mortgage Product Risks and joint Statement on Subprime Mortgage Lending). This quarter, Countrywide reported that 89 percent of their 2006 originations of pay option ARMs did not conform to the joint regulators’ guidance, which increases the likelihood that Countrywide is pledging loans deemed predatory by the regulators as collateral for FHLB advances. Importantly, Fannie Mae and Freddie Mac’s safety and soundness regulator has specifically prohibited any new direct or indirect investment in loans that do not meet this guidance. As the mortgage crisis threatens to get worse from here, it is critical that the FHFB do the same.
Thank you for your prompt attention to this matter, and I look forward to working with you on these issues in the coming weeks and months. If you should have any questions, please contact David Stoopler on my staff at 202-224-6542.


Charles E. Schumer
United States Senator

You can view the original here.

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Sunday, November 18, 2007

The Social Security "Debate"

Revised November 29 - see additional information at end.

I am furious about this "crisis" in Social Security "debate" going on among politicians today, and here is why:

1. There is no immediate crisis in Social Security, yet the politicians keep arguing over how to fix it. I am really tired of this “debate” and I am very concerned that it will lead to higher taxes on my income. Social Security was “fixed” in 1983. The fix included an increase in the payroll tax that I have been paying virtually my entire professional career. In addition to that tax, the self-employment tax on small business and professionals was increased to over 15%, and I have paid that on many occasions as well. (Next time you hear anyone talking about how Democrats are against small business ask yourself how that can be true when it is the Republicans that placed this burden on these sacred cows.)

Here are some of the changes from the 1983 law from the Social Security Administration’s summary of the legislation:

Advances scheduled increases in Social Security tax rates. Social Security tax rates (which include the Hospital Insurance tax rates) for employers and employees will increase to 7.0 percent in 1984, {1} 7.05 percent in 1985, 7.15 percent in 1986-87, 7.51 percent in 1988-89 and 7.65 percent in 1990 and thereafter.

Provides for cost-of-living increases based on prices or wages--whichever is less--if the trust funds fall below a specified level.

Increases tax rates on self-employment income equal to the combined employee-employer rates and provides credits against tax liability to offset part of the increase.

Beginning in 1984, includes up to one-half of Social Security benefits as taxable income for taxpayers whose adjusted gross income, combined with half their benefits and any tax-exempt interest they may have exceeds $25,000 for a single taxpayer and $32,000 for married taxpayers filing jointly. Benefits received by married taxpayers filing separately are taxable without regard to other income. Appropriates amounts equal to estimated tax liability to the Social Security trust funds.

Raises the age of eligibility for unreduced retirement benefits in two stages to 67 by the year 2027. Workers born in 1938 will be the first group affected by the gradual increase. Benefits will still be available at age 62, but with greater reduction.

(Yes, it was RONALD REAGAN who first taxed social security benefits, NOT Bill Clinton.)

This is the deal we made, and the deal we have paid for dearly over the past 24 years. This is the deal we should get, and if we don’t get it then the funds we have paid in for our future benefits will have been confiscated and used for some other purpose. In other words, we will have actually had a regressive tax system placed on many of us for 25 years while taxes on high incomes have been cut (sold to us via the trickle down theory). In the end, those who went for the high incomes will not need social security and those who did not (the teachers and such) will be living in substandard conditions. This is the primary reason I am furious about this “debate”. There should be no debate. I have paid for my Social Security benefits and I want what I paid for, and if it means bringing tax rates on high incomes back to where they were because we have some larger fiscal problem then that’s exactly what we should do. (You can read my opinion about why tax increases should be on higher incomes here.) This means I want the payments I should get at the age I am entitled to get them under the current rules (the ones in effect while I have been paying for them).

2. There is no immediate crisis in Social Security and I am tired of the fear mongering being used to scare more tax revenue out of the middle class and upper-middle class. There is plenty of surplus in the Social Security system, and the only reason it would be in “crises” is if the United States Government decided not to repay the treasury securities owned by the Social Security fund. In fact, according to Social Security Administration data the combined OASI and DI funds have run a surplus since 1984. Here is what the OASDI Trustees Report has to say about the short term situation:

Both the OASI and the DI trust fund ratios under the intermediate assumptions exceed 100 percent throughout the short-range period and therefore satisfy the Trustees' short-term test of financial adequacy. Figure II.D1 below shows that the trust fund ratios for the combined OASI and DI Trust Funds reach a peak level in 2014 and begin declining thereafter.

In fact, in 2016 the fund represents 400% of the annual need. It should decline thereafter because us boomers will be dying off.

What about in the long term? This is what those using Social Security to scare us always point to. Here are some of the details:

Another way to illustrate the financial shortfall of the OASDI system is to examine the cumulative value of taxes less costs, in present value. Figure II.D4 shows the present value of cumulative OASDI taxes less costs over the next 75 years. The balance of the combined trust funds peaks at $2.6 trillion in 2017 (in present value) and then turns downward. This cumulative amount continues to be positive, indicating trust fund assets, or reserves, through 2040. However, after 2040 this cumulative amount becomes negative, indicating a net unfunded obligation.

If you count boomers to include all of those born between 1946 and 1963 (which is stretching it), then the youngest boomer alive in 2040 will be 77 years old, and the vast majority of us will be long dead. In other words, the Boomers will have paid for their benefits. How big a problem is the projected deficit for future generations? If all of the assumptions of The Social Security Administration turn out to be correct, then the total deficit after the fund “runs out” will be 0.7% of GDP through the end of the projected period ending in 2081. Now, until we fixed the system in 1983 we ran deficits all the time (that’s what happens when you have a large population of kids relative to working adults). In addition, one has to question the assumptions of the Social Security Administration that project increasing costs AND declining tax revenue after the boomers are all dead (go figure that one). So I don’t care about these projections of future deficits because (i) they are small, and (ii) they are unlikely. If the boomers will have saved and paid for their benefits through 25 years of payroll taxes, then the next generation can figure out how to do it for themselves. Does this sound like a crisis to you?

It seems to me that the crisis is a figure of someone’s imagination. If there is a crisis, it has to do with the overall fiscal health of our economy, and not Social Security. I want all politicians to stop using Social Security as a “crisis” that is in need of fixing as a way of garnering support from lower and middle class voters. We have real issues right now, including things like health care costs, deficits, wars, dismantling of constitutional protections, and so on. The real crisis for boomers is in health care costs, and we need to be doing more about that. So the next time you hear any politician campaigning on a Social Security plan, send them an email asking why they are spending time solving a problem that does not exist while ignoring the true problems we face. If enough people do this, then perhaps the politicians will think it’s a movement (a Thanksgiving reference for the boomers out there).

For those who are looking for clarity on the political obfuscation front, you can get a list of the changes to Social Security under the Clinton Administration by going here. Some changes include:

Contract With America Advancement Act of 1996 (P.L. 104-121).

This bill, signed by the President on March 29, 1996, made a change in the basic philosophy of the disability program. Beginning on that date, new applicants for Social Security or SSI disability benefits could no longer be eligible for benefits if drug addiction or alcoholism is a material factor to their disability. Unless they can qualify on some other medical basis, they cannot receive disability benefits. Individuals in this category already receiving benefits, are to have their benefits terminated as of January 1, 1997. Previous policy has been that if a person has a medical condition that prevents them from working, this qualifies them as disabled for Social Security and SSI purposes--regardless of the cause of the disability. Another significant provision of this law doubled the earnings limit exemption amount for retired Social Security beneficiaries, on a gradual schedule from 1996 to 2002. In 2002, the exempt amount will be $30,000 per year in earnings, compared to $14,760 under previous law.

The Personal Responsibility and Work Opportunity Reconciliation Act of 1996.

This "welfare reform" legislation, signed by the President on 8/22/96, ended the categorical entitlement to AFDC (Aid to Families with Dependent Children) that was part of the original 1935 Social Security Act by implementing time-limited benefits along with a work requirement. The law also terminated SSI eligibility for most non-citizens. Previously, lawfully admitted aliens could receive SSI if they met the other factors of entitlement. As of the date of enactment, no new non-citizens could be added to the benefit rolls and all existing non-citizen beneficiaries would eventually be removed from the rolls (unless they met one of the exceptions in the law.) Also effective upon enactment were provisions eliminating the "comparable severity standard" and reference to "maladaptive behavior" in the determination of disability for children to receive SSI. Also, children currently receiving benefits under the old standards were to be reviewed and removed from the rolls if they could not qualify under the new standards.

More data on SS:

The shortfall to "pay back" the trust fund: according to the Trustees Report referenced above, the largest annual amount required between now and 2040 is approximately $150 billion (see the link from "Figure II.D4.-Cumulative OASDI Income Less Cost, Based on Present Law Tax Rates and Scheduled Benefits"). That really isn't a problem for two reasons. First, the Office of Management and Budget projects fiscal 2008 total receipts of $2,574 billion, so the $150 billion is not a lot. But, it gets better. The OMB also projects that the budget, including all of these transfer payments, will be balanced by 2012. So, if the White House is correct, there is absolutely no issue.

The issue is health care, not SS.

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Wednesday, November 14, 2007

More Crap about Incomes

The United States Treasury – funded by your tax dollars – released a report (the “Report”) yesterday that is, in my opinion, a propaganda piece in the war against the middle- and lower-income classes being waged by the current administration and its allies. In my opinion the Report is crap.

That may sound like strong rhetoric to some, but it is well deserved. This report is being mischaracterized in the media with reckless abandon. For example, see this opinion piece in yesterday’s The Wall Street Journal Online Edition titled “Movin’ On Up”. Sounds cheery! Unfortunately it is the usual crap that I regularly read by those afraid of tax increases on higher incomes.

What the right is saying about the Report:

Based on the WSJ article above (the “Article”) as well as a quick search of the Internet, the Report is being referred to as proof of the success of the Bush tax policies and as evidence there is not really a growing income gap in the US. For example, the Article ends with these words of warning:

“All of this certainly helps to illuminate the current election-year debate about income ‘inequality’ in the U.S. The political left and its media echoes are promoting the inequality story as a way to justify a huge tax increase. But inequality is only a problem if it reflects stagnant opportunity and a society stratified by more or less permanent income differences. That kind of society can breed class resentments and unrest. America isn't remotely such a society, thanks in large part to the incentives that exist for risk-taking and wealth creation.

“The great irony is that, in the name of reducing inequality, some of our politicians want to raise taxes and other government obstacles to the kind of risk-taking and hard work that allow Americans to climb the income ladder so rapidly. As the Treasury data show, we shouldn't worry about inequality. We should worry about the people who use inequality as a political club to promote policies that reduce opportunity.”

Oooohhhh – better beware of the tax boogie person! He (or she) is coming to get you and will cause our economy to crash!

What the Report says:

In (my) summary, the Report says that if you look at a group of people in 1996, and then look at the same group of people in 2005, many of those people moved up in real income and many moved down. This demonstrates that there is plenty of income mobility in The United States, and is contrary to the many reports about a growing income gap. The Report points out that “Nearly 58 percent of households … in the lowest income quintile in 1996 had moved to a higher quintile by 2005” and “more than half of the top 1 percent of households in 1996 had dropped to a lower income group by 2005…Put differently, more than half of the households in the top 1 percent in 2005 were not there nine years earlier.” Sounds impressive.

What the report does not say:

I find it amazing that purportedly educated people can read the Report and come to the conclusions they do. I guess our educational system really is as bad as people say it is.

To get to the point, ask yourself a simple question. How many of the people that you know in the top 1% of income earners today will be retired in ten years? Ask yourself another question. Of all the people you know in the bottom quintile who are at least 25 years of age, how many are younger and should achieve substantial income growth over the next ten years of their careers? That’s right, these factors are NOT considered in the results. As noted in the Report, “The data also conclude that the incomes of many taxpayers at the highest income levels are very volatile.” Retirement can do that to your income. The report concludes “Economic growth resulted in rising incomes for most taxpayers over the period from 1996 to 2005. Median incomes of all taxpayers increased by 24 percent after adjusting for inflation. In addition, the real incomes of two-thirds of all taxpayers increased over this period. Further, the median incomes of those initially in the lower income groups increased more than the median incomes of those in the higher income groups.” Now I didn’t see a definition of “economic growth” but if it means the economic growth over time of individual households as they mature from young people to accomplished professionals then this makes sense. Unfortunately that is not the context in which it reads. There is a footnote, however, that says "By comparison, in the U.S. Census data (2006), median household real income increased by 5.4% from $43,967 to $46,326 over this time period in 2005 dollars." How much do you want to bet you will read the 24 percent number in the press and not the 5.4% number?

Now to be fair, the report does compare incomes within the group and to all taxpayers. Here is one line of what it says about the intra-group only comparison: "Nearly 60 percent of taxpayers in the top 1 percent in 1996 dropped out of the top 1 percent by 2005, although 87 percent of them remained in the top quitile." I wonder what percent of them retired? We don't know that from the report. It also makes one wonder what the results would look like if they were expressed in quartiles instead of quintiles.

I would have recommended that this report be used as a starting point for actual research into the movement among income categories by families in the United States. Unfortunately it is so biased it warrants nothing other than a trip to the trashcan.

I really hate it when my tax dollars are used to produce propaganda like this. It’s a disgrace, and it’s bi-partisan (both parties do it).

PS: For a good article about bipartisan reports on this topic, you can go here. Michael Gerson does the topic justice even from the conservative perspective.

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Tuesday, November 13, 2007

Taxpayer Bailout Act 1?

I was reading the WSJ today and came across an article here about how the Federal Government is putting up more of the cash for home mortgages. Now, if you have been reading my column up to this point you know that I have been warning of this for a while and that I am concerned that the taxpayers will ultimately pay for the mortgage meltdown (see my October 7 article and here and here).

I decided to do a little homework and I looked up the portfolio and guarantee growth of Fannie Mae, Freddie Mac, and the Federal Home Loan Bank portfolios from December 2006 to September 2007 (I can’t wait for the October numbers). What I found is that on a combined basis, these three entities (the Federal Home Loan Banks are considered one for this) increased their portfolios (for Federal Home Loan Bank this includes portfolio mortgages and investments) by over $640 billion in that nine-month period. Is this a lot? Well, it is an annualized compound growth rate (compounding monthly) of approximately 16%. In 2006 the growth rate was 7.7% for Fannie Mae, 8.4% for Freddie Mac, and 1.8% for the Federal Home Loan Bank. In September Freddie Mac's portfolio grew at a 23.3% rate, Fannie Mae's portfolio grew at approximately 14%, and the Home Loan Banks grew almost 30% from June 30 to September 30. Add to that the fact that total mortgage originations are expected to be down this year by 15%, and we see the massive shift to government program mortgages.

Of particular note is the Federal Home Loan Bank. Federal Home Loan Bank advances have grown from $619.8 billion at December 31, 2005 to $640.7 billion at December 31, 2006 to $824 billion at September 30, 2007. WOW! Just what are “advances” from the Federal Home Loan Banks? "FHLBank Advances. Advance lending is the FHLBanks' main business line. It currently represents about two-thirds of all the FHLBanks assets. These loans, known as advances, are well-collateralized loans used by members [that would be the banks as we know them] to support mortgage lending, community investment and other credit needs of their customers.” That quote is from here. In other words, secured loans to the banks backed by mortgage related collateral (I think). Now, I know critics will say that these are not subprime mortgages. This is just the government utilizing its tools to get the mortgage market liquidity machine running again. Unfortunately, I could not find any detail describing exactly what collateral is backing those additional $183.3 billion “advances” from the Federal Home Loan Banks or the FICO scores of the recently added GSE (Fannie and Freddie) loans, so for now that is open for uninformed debate. What is clear, however, is that the federal government has funded and/or guaranteed, either implicitly or explicitly, approximately $640 billion of mortgage loans since the 2006 year-end.

(Note: None of this includes Ginnie Mae which as of year-end 2006 had total outstanding government guaranteed mortgage backed securities of $410.5 billion. I have been unable to find any quarterly data on Ginnie Mae exposure. And according to HUD, the total dollar amount of single-family home mortgages guaranteed by the FHA was $342.6 billion at the end of September, up from $336.6 billion at the end of December 2006. Not a substantial increase but lets keep an eye out for the October report. You will find it here when it is published.)

The taxpayers are propping up the mortgage and real estate markets and could well be the ultimate big loser in the subprime mortgage meltdown. The data is not available yet to figure this out (at least not to someone with a computer and internet connection). The really scary thing is that most of the problem loans have yet to refinance. Even worse still (if you can believe it) is the idea floating around the halls of the Senate to back jumbo mortgages of up to $1 million with taxpayer guarantees. This is an outrage in my book, and a complete waste of taxpayer dollars even to be considering such a proposal (not to mention the distortions that such a program would create in the market). If you would like more information on this, go here and click on “stupidity”.

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