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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