A Common – Sense Piece of Dodd – Frank

In 2010, Obama signed the largest overhaul to financial regulation since the 1930’s.  The Dodd – Frank Act is a 2,000 plus page cluster that imposes over 400 new regulations on the finance year’s industry.  The various special interest groups and political parties have reacted over the past couple on speculated benefits and harm that this monster would unleash on society.  If any of the policy details, rules and regulations behind the bill has been written, they have not been publically socialized yet.  The one thing we do know is that all regulation has winners and losers.

The Consumer Financial Protection Bureau is the most public of the agencies created under Dodd – Frank and is responsible for consumer protection.  Its web site is surprisingly still soliciting the consumer for ideas on simplifying the mortgage disclosure statement, ways to make your credit card agreement more understandable and ways they can make the student loan process smoother.

Additionally, expect a crack down on predatory lenders, high interest rate short-term (payday loans), and aggressive debt collection practices.

A much-needed and common sense reform that unfortunately needs to be regulated because of past abuse is the no income-qualifying loan.  In the past so-called “liar loans” enabled a borrower to obtain financing to a home based on their credit alone.  As long as you paid your existing bills on time, you did not have to prove your income.  The greed factor made this provision by loan officers and prospective homebuyers alike.

During most of the 2000’s I was employed by a major bank in their auto lending division.  Much of that time was spent in the credit department, underwriting or overseeing the underwriting of auto loans.  Working in the direct lending department, I saw loan applications from all over the county.

Beginning in 2005 and becoming widespread in 2006, we began to see auto loan applications from borrowers who also had mortgages on their credit bureaus that made no sense.  Historically the mortgage industry held your mortgage payment to 31 percent of your gross income on the front end.  Including other debt such as an auto loan, and credit cards would bump your back-end debt to income ratio up to 43%.  Higher risk non-conforming loans would take a back-end debt to income ratio up to 55%.

The first sign of a terrible wrong appeared in the credit bureau reports of our auto loan applicants.  How were these consumers able to secure mortgage loan in the $200 – $250K while paying less than a $1,000 per month. This was not only a fully amortized loan payment; this was not even an interest only payment.

The second sign of financial funny business was an alarming number of auto loan applicants with mortgage loan payments that were between 60 – 85% of their gross income.  I cannot remember how many loan applications I saw where the applicant had verifiable gross income of $3500 per month and on the hook for a monthly mortgage payment of $2,000 per month plus.  We are not talking about joint mortgages either.

My Credit Team and I had numerous formal and informal discussions regarding the insane mortgage loans that were popping up and we resolved to start interviewing the applicants who fell into this profile.  Our thinking was, if they pay their credit on time there has to be more income.  We will get another signer on the loan to take care of the excessive debt to income ratio.

We interviewed nearly a hundred applicants over an eight-week period.  The borrowers fell into three broad categories.

Let us call the first set of borrowers the wishful thinkers.  What they do not know does not hurt them.  They bought into the line of the time.  The market is different time.  Values are going to keep going up.  When it comes time for your teaser rate to adjust, either refinance into another teaser rate loan or quickly flip the house for a tidy little profit.  This worked well for many borrowers until it did not. Some of these people owned two to five rental properties and envisioned themselves as high rollers playing the game.

The second set of borrowers were naïve or inexperienced homebuyers. They heard it was easy to get a home loan and had dreamed of getting their own home but never thought it possible.  The loan officer checked their credit and as long as they paid their bills on time, the loan officer would congratulate the customer on their good credit and assure them they will be able to buy a home.  In fact we thing you are so qualified for a home that we are not going to even check you income.

Sadly, this borrower was taken advantage of by some in the industry and was the face of the new legislation.  The primary breadwinner took all the risk.  I remember talking to one person who could not believe I would not give him a car loan.  He made $3,500 per month and had a mortgage payment of $2,200 per month.  After adding up all the debt on his credit bureau, he had responsibility for $4,000 month in debt.  He said, “I pay my credit on time, how come you won’t give me a car loan.”  There were other income earners in the household, but the customer refused to add them to his auto loan application.

Group three were the opportunists.  Hey, everybody else is getting some. I want some too.  Why not live in style for as long as I can?  Some if these borrowers never made a loan payment.  Others paid some money to show, but wanted to see how long they could get away with it.  The funny thing is that some of this group began to believe their own hype and became the angriest at eviction time.

This change will not fix the future of mortgage lending, but it will reduce some easiest and most tempting avenues for fraud at the retail level.

Real Estate Rebound in 2012?

Many homeowners are wondering if 2012 will be the year that the value of their home finally starts to rise.  According to the National Association of Realtors, the median price for a home in the United States has fallen from a high of $230,000 in July 2006 to an estimated $162,500 in November 2011.  So what can we expect in 2012?

Positive news regarding manufacturing output and an increase in housing starts is encouraging.  However, the fundamental structure of the real estate market will support increasing values only in select markets, while the overall market will remain flat or slightly decline. Here are the reasons why.

Tight underwriting criteria has removed millions of would be homebuyers from the market.  Free market theory states that the price of a given commodity, such as a single family home, will arrive at an agreed upon price based on the supply and demand.  Remove some of the demand from any given market, and the price will be flat or trend downwards.

Interest rates on first mortgages are below 4 percent, which is an all time historic low, thanks to a monetary policy that is keeping rates artificially low.  Market theory would offer that the prices of homes should rise, since lower rates allow the consumer to purchase higher priced homes.

Beginning in 2007, mortgage lenders began to tighten their standards.  Gone are the days of widespread no-income qualifying loans, 2 percent teaser rates, and other financing gimmicks that allowed consumers to buy property that they would not have qualified for under conventional lending guidelines.  Remove buyers from the market and the price goes down. The real estate industry does not have the ability to reduce supply to compensate for falling demand

The census bureau shows homeownership rates have dropped from 69% in 2006 to 66% in the first quarter of 2011.  In spite of record low-interest rates and significantly lower home prices, tighter credit standards, and greater down payment requirements have reduced the percentage of American who can afford their own home.

The second reason prices will remain depressed is reduced mobility.  The ability to move freely about the country to seek the best financial opportunity is a vital component of a vibrant and healthy market.  Any hindrance to mobility limits capital from achieving its best use and results in lost production when the best and brightest for any given job opening is not filled because the best candidate is tied to an asset in another market.

In November 2011 Zillow Inc., released a report that found nearly 29 percent of the homes in the United States are underwater, the homeowner owes more on the mortgage than the home is worth. A market that finds nearly 30 percent of its potential customers facing a financial obstacle to selling one home and buying another reduces the total potential buyers, which according to market theory slows demand putting downward pressure on prices.

Reason number three is the shadow market.  This market consists of the inventory of all single-family homes that are in some stage of foreclosure but have not been made available to the market.  The exact number of these homes is not known.  CoreLogic estimated the shadow inventory to number 1.6 million homes in October 2011.

Real Estate investors have been hesitating to buy up homes at record low prices because they understand the affect the shadow market can have on prices in any given market.  The investor knows that the inventory of homes in market limbo, need to be strategically brought to market to avoid sudden drop in prices brought about by excessive supply. Historic market analysis models do not account for a shadow market of this size making near term investing extremely challenging.

Mortgage lenders know this also and are attempting systematically bring their properties to the market in order to minimize the downward effect on the pricing.  As the numbers of home foreclosures in most markets have peaked, lenders will be looking market more of their foreclosed properties.

The fourth factor is unemployment.  The Labor Department shows that in prior recessions since 1973, the economy has reabsorbed all workers who had been displaced during the recession within 48 months.  Comparing employment recovery this time around, the unemployment rate is still nearly 5% higher than it was when the recession began in December 2007.  This is where comparisons to the Great Depression are warranted

The extended unemployment and reduction in job opportunities has hit young adults particularly hard. Many of the jobs they would have secured in the past after graduating high school and college either have disappeared or never became available as more experienced workers held on to those jobs.

Young adults have traditionally looked to purchase their first home in their late 20’s or early 30’s and in doing so, kept a steady pipeline of buyers for lower end homes.  Disruption of this pipeline has disproportionately hurt the owners of starter homes.  A concern exists that the young demographic may become disillusioned with the process and opts out of homeownership until many years in the future.

The National Association of Realtors recently reported that first-time homebuyers made up 35 percent of all existing home sales, down from 50 percent in the early 2000’s.  High unemployment and tight lending standards are removing this demographic from the market adding further downward pressure on the low-end of the real estate market.

Home sales have increased and pent-up demand could move the market higher as could a new government program that funnels billions of dollars into the market.  Realistically the worst has past but the market has not yet returned to health.  Expect prices to stabilize but until unemployment drops significantly and the inventory of homes for sales drops below 6 months, any gains will be minimal.

What if the U.S. Government was a maxed out consumer?

Tune into the news and you cannot escape without hearing what will happen if the United States Congress does not increase the federal debt ceiling by the August 2 deadline.  Prevalent among all the voices is the refrain stating that the United States will default on its debt, plunging the world economy into deep depression, if the debt limit is not raised.

Is default a possibility? Sure, it is, but the probability of default in the near term is small.  The challenge of trying to assess the situation for yourself is that the complexity of the federal government,  the bond market, and the global economy make simple answers unattainable and open to a variety of interpretation and opinions;  Many of them slanted by political identification.

As a consumer lender for many years, I will look at the possibility of a United States’ bond default from the standpoint of a lender making a loan to an individual.  The moving parts of the world economy and the United States position within it make the comparison less than exact but may lend some perspective for making your own decision.

The federal government is presently spending $1.40 for every $1.00 it collects from taxes.  An individual in this circumstance would need to borrow from their credit cards or line of credit in order to maintain this ratio of spending to income.  Eventually, when the credit limit is maxed out, the individual will need to reduce spending, increase income or a
combination of both.  The federal government does not have a pre-set credit limit like an individual but it does have a debt ceiling, which is similar to a credit limit.  The federal government credit limit is currently set at $14.3 trillion.

If Congress does not increase the debt ceiling/credit limit by August 2, The U.S. government will need to cut spending, increase income or employ some combination of both in order to get spending aligned with revenue.  Federal government spending can be divided into three categories.  Mandated spending which includes Social Security and Medicare.  Discretionary spending which are items the Congress can increase or decrease.  Military spending is the prime
discretionary item as it makes up nearly 60 percent of all discretionary spending.  The third category of federal
spending is interest paid to the holders of its debt.  The debt of the United States is held in the form of U.S. Treasury notes and bonds and savings bonds.

The equivalent of mandated spending for the individual is the rent or mortgage payment.  You cannot stop paying the mandatory items without immediate repercussions.  Examples of discretionary spending for the individual are food and entertainment.  You have a choice where to spend your money.  The interest payment for the individual is the money paid to the credit card companies and the bank and finance company for your installment loans.

The U.S. government has a debt rating of AAA, which is the highest rating for a bond issuing entity.  The rating tells investors the investment is safe and the probability of default is very small.  A downgrade in the rating signifies that the risk of default is a little higher, entitling the investor a higher rate of return for taking on the additional risk.  A small increase in the interest rate that investors command for financing the debt of the United States government, may translate into hundreds of billions of dollars of additional interest paid annually.

A consumer lender will not change the terms of existing contracts, just because a customer has maxed out all available lines of credit.  If you max out your credit, your credit score will drop, making future borrowing more expensive.  Even if you pay me on time, I will charge you a higher rate of interest in the future, because a lower credit score indicates that your probability of defaulting on the next loan is slightly higher.  Fair or not, that is how things work.

If Congress does not raise the debt ceiling beyond the current limit of $14.3 trillion dollars, the U.S. government will be maxed out on its debt.  The federal government will be unable to borrow additional money.  Is that a good thing?

The government does not have a credit score but it does have a bond rating.  As with the individual, who finds that his or her credit score drops after maxing out the credit cards, the federal government will likely find its bond rating drop if it is unable to borrow additional money to continue operations.

You or I max out all of our credit; we will have a difficult time getting new credit.  If we do, the interest rate will be high.   The effect of a lower bond rating for the United States will be felt when current Treasury bonds become payable.  The investors of the T-bills such as China and U.S. mutual fund companies will require a higher rate of return when it renews the bond debt because the chance that the U.S. will default on the debt has increased.  If U.S. is currently paying $300 billion per year in interest to the bond investors, a lower credit rating for the U.S. may increase the annual interest payments to $400 billion or more.

The federal government being unable to create more debt to pay off the old debt would need to redirect spending from the military or maybe social security to pay for the increased interest payments.  The equivalent for the individual would be increased interest rates paid to the credit card companies after charging a purchase that pushed the credit card balance over the credit limit.  Money would need to be diverted from something else to pay for the increased credit card payments.  Default on the debt, the holder of the debt demands payment in full.

The probability of the U.S. defaulting on its debt is not a high probability, paying a higher rate of interest on its debt is a higher probability.

How else might the frozen debt ceiling scenario pay out?  The U.S. bond rating may not be lowered immediately, but if the federal government begins missing payroll or holds off reimbursing hospitals on Medicare payments, the investors will demand payment in full either when the bond becomes due or will require a higher interest rate to renew the debt.  As a consumer lender, if my customer comes to me to refinance their debt, after making their payments on time and I find they have been slow paying their other creditors, I will decline the request or if I approve the refinance, the interest rate will be higher.

The point can be further illustrated with a plausible example.  Let us say Japan has $100 billion in T-bills coming due in a two months and sees the U.S. government is not paying its bills.  The treasury department expects Japan to renew the bond but at the last moment, it states we fear you will default and we want our principal back.  The United States is faced with the option of possibly liquidating assets to pay its debt or paying a higher interest rate to renew the bond.  After intense negotiations, Japan agrees to refinance the debt but at a higher rate.  The U.S. now has to pay a greater percentage of its revenue towards interest on the debt.
I do not know what will happen to the United States if the debt ceiling is not raised, but I have been witness to hundreds if not thousands of consumers who became overloaded with debt and lost the ability to borrow additional funds.

I have observed approximately 40 percent of the individuals who end up in this situation file for bankruptcy.  A smaller percentage secures a second job or is awarded a timely promotion enabling them to get a handle on their
budget.  Some people rent a room for additional income.  Others cut back expenses to bare bones and struggle along until finally paying down enough debt to get back on their feet.  What path will the United States government follow???

Door-to-Door Sales on the Rise

Half way through yesterday’s dinner, a familiar rapping on the front door, interrupted our tranquil meal. Expecting to see one of the neighborhood kids looking to squeeze in a couple of hours of playtime with one of my kids, I was not expecting to see a
bearded man with a clipboard standing at my door.  I quickly realized it was a roof salesperson, hoping I would allow him time climb on my roof so that he could tell me my roof is in disrepair and must be replaced immediately.  Quickly I uttered, “Thanks, but no thanks”, and closed the door before he could utter a word.

In hindsight, I was not surprised at all by the roof peddler’s intrusion into my families evening meal.  My family asked who it was; I answered matter of fact, “another roof salesman”.  He was the third salesperson of the day. Around 9am, earlier the same day, a woman in Ford truck slowly trolled the neighborhood, behind a small girl, who I estimated to be six or seven years.  The girl was handing out business cards for the woman behind the wheel.

Around 3pm on the same day, I opened the door to a well-spoken, cleaning solution salesperson.  He was itching to come inside so he could show how well his secret solution would take care of my toughest stain, I did not bite. I allowed this person to go on with his sales pitch, because he spoke well, and he was naming off all of my neighbors who had purchased his miracle solution at $70 a pop.  Knowing he was not going to be invited in, the magic solution sales representative looked for alternative things to clean.  He cleaned a window, an ink stained washcloth, which he had marked himself.  He also cleaned the bumper of my truck parked
in front of the house and a small section grout.  My house has brick siding.  The cleaning solution rep. expressed visible surprise that I would not shell out $70 for his miracle cleaner.

Usually when there is a piece about door-to-door salespeople, somebody is railing about unlicensed sales people roaming the town or why does my town crack down on these sales people.  I have no problem with people selling door to door, it is a part American tradition that I would hate to lose.  If it really bothers you, do not answer the door.

What I have noticed is the dramatic increase in the number of people going door to door for business. In an average week, I find two to three business cards squeezed between my front door and the door frame for landscapers.  The same number of house cleaners attempt to sell their services.  Roofers stop by two to three times a week.  Less frequently are the mobile food service proprietors, house painters, insurance sales people, yes we have people occasionally trying to sell insurance.  Fortunately the magazine subscription sales force has been absent over the last couple of months.  Maybe due to the bad reputation they have developed over the years.  Also absent are the Fuller Brush man, Encyclopedia man, and vacuum cleaner salespeople.  Okay the last three have been waning for a number of years now.

This year I estimate the number of people knocking on my door has increased three-fold from last year and probably five fold from three years ago.  Why the sudden increase?  In the words of President William Jefferson Clinton, “It’s the economy stupid”.

The Bureau of Labor Statistics reported in April 2011, that employment in the construction industry is still down $2.2 million jobs from its peak in April 2006.  If you were in the construction industry or a related support industry and you were laid off in the past five years, and cannot find work, what do you do?  You find work related to what you know.

Unable to find work in construction, maybe you can find work as a landscaper.  Your spouse had a good job in construction five years ago; work has been sparse since then.  What do you do?  You find work doing what you know to help support the family by cleaning houses.  You have a roofing company, housing starts are so low that if you are in danger of losing the business.  What do you do?  Hit the streets and solicit homeowners to replace their roof.

You are a good sales person with a background in mortgage, but the few jobs there are do not pay anything close to what you made
before.  What do you do?  Try you hand selling high margin products door to door until the housing market picks up.

I have no evidence to back up my theory other than the large increase in people selling door to door.  I fully expect the number of people knocking on my door to drop off as soon as the employment picture in the construction industry turns around.  My neighbor in the heavy equipment rental business to the construction industry attests to the continued drought in new construction.  Next time someone knock on your door and tries to sell you something , don’t be too hard on them, they are doing the best they can in a tough economy.

Home Prices Likely to Fall in 2011

Something has been weighing on my mind the past month or so.  It has been rising to the conscious level of my mind two maybe three times a week.   I know I need to get a hobby, which is a fantastic idea, but unfortunately, I have not been able to find free time to indulge in a leisurely pursuit. 

So what has me worked up?  The Case-Shiller home price index showed nationwide home values fell 3.9% in the fourth quarter of 2010 when compared with the third.  The default explanation is demand fell off when the homebuyer’s tax credit ended last summer.  Okay I thought, this rather makes sense, but this is not what caught my attention.

Economist Robert Shiller, who created the index with Karl Case, made the comment, “My intuition rates the probability of another 15%, 20%, even 25% real home price decline as substantial. That is not a forecast, but it is a substantial risk.”

While Karl Case disagreed with Shiller’s assessment, I though how responsible is that, “your intuition tells you”?  Are you kidding me, you throw that out based on a gut feeling?  Don’t you know you are famous enough that your statements carry weight?   

What if it is true, that this home market has another 20% drop left in it.  I will attempt to answer that question in my non-scientific way that is informed by years in the financial services and banking industry and with information that I have gleaned over the years as a keen observer of the overall economic direction of this country.  In this two-part article, I will focus on factors that could push the real estate market lower, followed by a second article that will delve into what if consequences of such a drop. 

Discontinued Home-Buyers Tax Credit

The homebuyers tax credit focused on the first time buyer, but there was also a $6,500 tax credit for the repeat buyer that was meant to entice those who were looking to upgrade their property.  A buyer who owned and used the same home as a primary residence for at least five consecutive years of the eight-year period ending on the date of purchase of a new home as a primary residence would be eligible.

Orders for new homes dropped and contracts for purchases of existing homes fell immediately when the homebuyer’s tax credit expired.  Simple laws of supply and demand dictate that when demand drops, the pressure on the supplier (home seller) to lower the price increases. 

The impact of the tax credit coming into and out of the market has already been factored into prices and its effect going forward will be negligible.

The Foreclosure Affect

The number of new foreclosure filings is beginning to reverse itself; however, its impact on the market has not been fully realized. 

According to RealtyTrac, 26 percent of all homes sold in 2010 were foreclosed properties.  In the state of Nevada, the number was approximately 57%.  The buyer of a foreclosed property received, on average, a 28 percent discount to that of a non-foreclosed property.

In many of the hardest hit markets, the homes sold in foreclosure are not receiving the minimum bid as required by the loans investor and are, being held by the bank or the title is transferred back to the investor.  Huge inventories of foreclosed properties are not officially for sale on the market as they are in search of willing buyers.

Banks are beginning to step up the number of evictions, which will increase the inventory of foreclosed homes for sale.  Banks are slowly bringing these properties to market so as not to inundate the market with foreclosed properties, increasing downward pressure on prices.  Realty Trac is estimating that only 30 percent of the foreclosed properties are currently on the market.  Price recovery in the real estate market will be isolated locations until buyers are found for this inventory of homes.   Historically, only 10 percent of the homes on the market are foreclosures.

The foreclosure effects will be significant enough in most markets to push prices lower in 2011.

Market Reorganization

The real estate boom was fueled largely by Fannie Mae and Freddie Mac.  These quasi-governmental sources of capital that fueled the financing boom that in turn blew up home prices nationwide are now in the governmental cross hairs.

Richard Wolff – Professor of Economics Emeritus at the University of Massachusetts in Amherst (PhD in Economics from Yale) – where Wolff said that 97% of all U.S. mortgages are either written or guaranteed by the government.  Freddie and Fannie are estimated to have 70 percent of the market.

Obama is considering a plan that would phase out Fannie and Freddie over a 5 to 7 year period.    These government sponsored enterprises were instrumental in the affordable housing boom  that became corrupted by exotic  financing schemes that helped buyers get into homes that they could not afford.

With Fannie and Freddie gone, will the Federal Housing Administration (FHA) step in and back all the mortgages?  The most likely scenario is that the real estate market will see a shift from government to private backing.  Private money will not enter the market with any altruistic notions of propping up a battered market.  The major banks and other financing interests will step in to fill the void, but expect the size of the investment market to drop. 

Private money will expect a return on capital that would not be supported by the current historically low mortgage rates.  To meet the investment objectives of private money and factor in the increased risk of investing in home mortgages versus T-bills, the cost of loans will rise. 

The staple of the real estate market, the 30 year mortgage may be scaled back to 15 or 20 years.  Down payments will be 20 to 30 percent of the purchase price, not the 5 or 10% that helped cash poor individuals get into the market.  The 4.75% interest rate in today’s market may be 6 or 7%, higher with inflation, to make it worthwhile for private money to invest in the real estate market. 

The effect on the market will be to decrease the number of eligible buyers,  Going back to Econ 101 and the laws of supply and demand state that the fewer buyers you have for your product or service, the lower your price needs to be to attract the buyers that are out there.  Maybe Mr. Schiller is right.

  Mortgage interest deduction

A major incentive to purchase your residence instead of rent has been the mortgage interest deduction.  In the past, it has been said housing fuels the U.S. economy and the mortgage interest deduction made it attractive for the GI’s coming home from WWII to buy a home.  The home buying frenzy that began in the 1950’s has been an part of building the middle class in America.

The mortgage interest deduction does make a difference for first time buyers who can reduce their tax bill by thousands of dollars and that money usually circulates back into the economy.  Renters and individuals who have owned their homes for years do not receive benefits from the mortgage interest deduction.

Elimination of the deduction will provide additional revenue for the federal government and may dissuade some people from buying a home.  Eliminate the tax deductibility of the interest payments and the after tax costs increase, leading to a decline in demand for owner-occupied housing and ultimately reducing housing prices. It seems unlikely, in the near future that politicians will touch the mortgage deduction.  The mortgage interest deduction is unlikely to disappear in the near future.   

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Maybe Mr. Schller is right and we have yet to find the real estate bottom.  Maybe I need a hobby, but in any case, the downward forces outweigh the upward ones.   In the part two of this series, we will look at the impact of an additional 20 percent drop in home prices.

Foreclosure Gate’s Drag on the Market

The foreclosure freeze that began less than two weeks ago over improper signatures on foreclosure documents is already beginning to thaw.  A call to Bank of America’s home loan and insurance customer service line greets customers with an automated voice declaring that there is not a moratorium on foreclosures.  Bank of America, Ally Bank and JP Morgan Chase among other bank put a temporary freeze on foreclosures on revelations that the foreclosure documents were not reviewed before they were signed.

What initially seemed like a grinding halt to foreclosures has turned into a small bump in the road.  The foreclosure juggernaut will continue.  The toxic mortgages are working their way through the system and following in their footsteps are the homeowners who lost their jobs in 2008 and 2009 and have been unable to replace the income that enabled them to afford their mortgages.  Many of these individuals have been in their homes for 10 to 20 years in contrast to 2 to 5 years the homeowners who ended up with a subprime or Alt-A mortgage.

The banks are implementing follow-up procedures for reviewing foreclosure documents, making sure that sufficient oversight is in place.  While improper signatures have raised concerns, a much more problematic concern lurks below the surface.  You cannot foreclose on a property if you do not know who owns it.

Property ownership has traditionally been recorded by the county clerk and the records have been kept in a filing cabinet inside the county building.  Title insurance companies have had a reliable source from which property ownership can be established.  When a title insurance policy is written on a piece of property, the question of ownership rarely came up and if it did, fraud was usually involved.  This process has worked well for hundreds of years and no one questioned its authority. 

As the real estate boom took off in the 1990’s, many county clerks were unable to keep up with the sheer number of real estate transactions, not to mention the increase in home refinance and home equity lines of credit.  Closings were postponed and an anxious market looked for an escape valve to relieve the pressure.

The answer was to create an electronic clearinghouse that bypassed the cost and delays of recording the sale of a loan from one entity to another.  The Mortgage Electronic Registration System (MERS) was created in 1997 to expedite the transactions and enable ease in long distance transactions.  MERS helped the process move smoother, track ownership, and hold title as an agent of the owner.  It created efficiency in the system that paved the way for securitization and collateralized debt obligations, providing the capital necessary to fuel the real estate boom between 2004 and 2007.

The confusion in this system is that MERS is the mortgage holder regardless of the owner.  Let us say your mortgage loan was financed by Chase in October 2006. Chase, looking to raise capital for future mortgage lending, packaged the mortgages it originated in the fall of 2006 into multiple security issues.  These investment vehicles may have been sold through a hedge fund, Goldman Sachs, or Lehman Brothers to name a few, to pension funds, foreign governments and local municipalities looking to diversify their investment holdings. If a pension fund sells a portion of the issue purchased, ownership of specific piece of property can come into question, especially when there is not a paper document verifying ownership. 

Foreclosure gate’s signature problem has inadvertently brought to light the murky world of property ownership in the age of MERS and securitization.  The potential impact to the market is much greater than robo-signers.  How likely are you to make a bid on a foreclosed property if the property owner is a question mark? 

Capitalism is founded on transparency and trust.  If our trust in the market erodes, prosperity becomes more elusive.  Buyers in the foreclosure market go elsewhere reigniting the downward pressure on home values.  How does the market grow if you cannot trust the information?

Is the Government’s Spending Gusher Subsiding?

An uncommon word was heard echoing in the senatorial chambers the other day.  The Senate said NO to more stimulus spending by a 52 – 45 vote.  It seems the fear of being booted from office in the mid-term elections influenced more votes than the threat of the dreaded double-dip recession.  Did the Senate finally figure out the taxpayer is fed up with Federal Government spending it’s money faster than the oil spewing from BP’s Deepwater Horizon?

The real question is; is the Federal Governments spending gusher slowing down or is this just a blip on proverbial radar?  Are we in the midst of a grand social experiment testing the theory that there is no such thing as a credit limit when it comes to Federal Government spending?

Treasury Secretary Tim Geithner sounding vindicated in an interview with The Atlantic magazines Joshua Green in April of this year, he boasted the government had, “put in place the conditions and the foundation for a resumption of growth and recovery.”  Many economics agree that global financial collapse would have occurred without the federal government pumping trillions of dollars into the world economy.  That may be true but there really is no concrete way to test the theory.

The narrow-minded take on one’s own actions are definitive when you presuppose all other courses of action would have resulted in failure.  Parents commonly use this rational on their children.  If I had not forbidden you from hanging out with that group of kids in the park, you would have ended up in jail and your life would have been ruined.  Yes, jail may have been one outcome if the child hung out in the park, but so could have many other possible outcomes, some of which could have had a positive benefit on the child’s life. 

The bailout may have saved the economy but to set it up as the ultimate, best, highest course of action is insulting to millions of Americans.  The credibility gap is further solidified when undefined yet soaring rhetoric is not followed up with action.  Instead of counting jobs created, we count jobs saved.  The relief pitcher in baseball saves the game for the winning picture.  The taxpaying public can’t help but seeing Wall Street Banks, trial lawyers and public sector unions as the winners while the middle class is relegated to having a “kick me” sign taped to its back.

So what happens if the national debt exceeds 100% of the GDP?  Nothing special happens if the debt hits 100%.  It’s not a magic number.  Higher debt can lead to higher inflation, higher interest rates, and reduction in economic growth as more money goes to service the debt.

The Federal government would be under pressure to raise tax rates to increase revenue to pay for the debt.  Some believe raising taxes will lower revenue because of the disincentive to produce at higher tax rates.

The primary concern for today is the rate of deficit growth.  The Government Accountability Office (GAO) describes the current debt growth trajectory as unsustainable.  Under current laws, mandatory spending, Social Security, Medicare, and Medicaid will exceed the revenue collected in taxes.  Benefits will be cut, taxes raised and the unwashed masses will garner their pitch forks and march on Washington, or not.  By 2017 the Medicare Trust Fund is projected to become insolvent.  If all tax revenue collected is used to pay the deficit held in large part by foreign entities, the United States risks compromising its sovereignty.  Will the United States be transformed in less than two generations to a dead beat debtor from a beacon of light, time will tell? 

The transformation in a humorous take has already begun.  How does China view President Obama?  Obama is the fund manager of China’s largest offshore investment holdings.

All joking aside, the national debt is sure to be a factor in the mid-term elections.  The public mood puts the political football, deficit spending, in play during the next election cycle.  The politics of this deal is not about how much is spent, but how it is spent.  Deficit reduction, according to conventional wisdom is considered in the best interests of the taxpaying public, yet the party in power has yet to restrain its check writing prowess. 

Real deficit reduction will require public sacrifice.  Are we as U.S. citizens ready to make a sacrifice to get debt under control, maybe, it’s not that bad yet, things will fix themselves, and ultimately, somebody else needs to pay?

The Keynesian camp feels further deficit spending is necessary to keep the economy on its upward trajectory and provide funding for a jobs bill.  The budget crisis is contrived by the right as a wedge issue to split unity in the Democratic Party.  The deficit topped 100% of GDP during WWII; we’ll grow our way out. At the end of WWII, the manufacturing base was strong and provided a strong engine for GDP growth well into the 1970’s. 

The next economic engine is not readily apparent as the manufacturing base was at the end of the second war to end all wars.  Alternative energy is a long shot at this point.  Without government mandates, solar, wind, geo-thermal and the like are not likely to gain traction, much less drive the next generation of U.S. GDP growth.  The next economic engine for US growth has not emerged as of yet.  Good luck digging out of this debt hole, oh yeah deficit spending saved us all.

Whenever, signs of supposed real change appear don’t be deceived, the promise of a better way are but vapors of mist that evaporate when exposed to the light of day.  All kidding aside, is your elected official representing you or the high dollar donors who funded the campaign?  Voter vigilance is required, your children and grandchildren may ask you someday, why didn’t you do anything?

Financial Reform: High Hopes, Low Expectations

There was something anti-climatic about the recent financial regulatory financial reform passed by the Senate on May 20, I guess I expected more celebration instead we got a collective sigh.  Is there real reform or merely cosmetic changes in response a clamoring public?  Can the taxpaying public rest easy and feel confident that Congress has its back or does it need to look over its shoulder and keep a hand on its wallet because Uncle Sam is poised to pick its pocket again?

It wasn’t too long ago that financial regulation was a bad word.  Big money and its political patrons claimed we needed to even the playing field with the international banks, allowing U.S. banks to compete without unnecessary constraints imposed by government regulators.  In 1999 the slow repeal of the Glass Stegall Act was complete breaking down barriers that segregated bank activities.  The environment was ripe for risk taking, cheap money and increasingly complex financial instruments. 

Regulatory failures were a contributing factor to the financial meltdown.  Financial firms created complex financial products that governmental oversight agencies were unable effectively monitor.  The largely unregulated derivative market, lack of transparency and standards in the securitized loan market, deteriorating underwriting standards for mortgage loans, and credit rating agencies inability to rate the collateralized debt obligations consistently was obscured by rising home prices.  The convergence of these circumstances blew up in the perfect storm resulting in the great recession.   Adequate governmental oversight of banks and other financial and investment institutions might have thwarted or at least muted the severity of the recession.

It was not a matter of if we have regulatory reform, but what shape would it take.  The Senate bill will be merged with the House bill and signed by President Obama on July 4^th.  The Senate bill creates a nine-member Financial Oversight Council consisting of the treasury secretary, Federal Reserve chairman, a presidential appointee with insurance expertise, heads of regulatory agencies and a new consumer protection bureau that would monitor financial markets and watch for threats.

Consumer protections will be monitored and enforced by a newly created agency with a base of operations in the Federal Reserve, not the FDIC.  The group will have the authority to ensure American consumers get clear and accurate information needed to shop for mortgage loans, credit cards and other financial products and make sure hidden fees, abusive terms and deceptive practices are exposed and eliminated.

Large banks and financial institutions will not be broken up as some proponents had lobbied.  Taxpayers can take some consolation knowing their tax dollars will not be used to bail out financial firms deemed too big to fail.  A safe way to liquidate financial firms that threaten the economy will be established.  Capital and leveraging requirements will make the cost of getting too big more prohibitive.  The Fed will still have authority to allow system-wide support, but no longer bail out individual firms, Fannie and Freddie excluded.  This stipulation is a big step in the right direction, but without clear parameters stipulating when and how firms may be liquidated, the potential for regulatory overstep is high.

The advanced warning system is a council that will identify and assess risks posed by large companies, complex financial products and activities before they threaten the stability of the economy.  On the surface, the advanced warning system sounds like it will be the watch dog the U.S. consumer and the world financial system needs to calm jittery nerves and provide reassurance to those who lost faith in the system.  Once again, without clear parameters and definitions, the potential for governmental abuse is high.  What is the group’s mission statement and will it operate independently or will it be influenced by the politics of the day to put pressure on companies that have not been friendly to the party in power.

Reactionaries on the left wanted to completely reorganize the system, claiming the meltdown was proof Capitalism no longer works in the 21^st Century.  Sentiment such as, we need a governing body that has its hand in all private sector activities, is a misdiagnosis the problem.  The system, though imperfect, still works.  Create a hedge around financial activities and products and let the players have at it.  A system allowing operators to focus solely on the next quarter, churn securities for no reason other than generating income on a transaction and cloak activities in secret, needs some checks and balances.    The Transparency and Accountability for Exotic Instruments provision should be sufficient.  Regulating derivatives, asset back securities, mortgage brokers and payday lenders by putting process and procedures in place should eliminate many abuses.   Naked shorts should have been included, oh well.

The credit rating agencies failed by giving high ratings to collateralized debt obligations that were composed of sub-prime and Alt-A mortgages.  New regulations will protect investors by demanding transparency and accountability of the credit reporting agencies.  The banks will no longer be able to shop and choose the agency that gives their product the best rating.  A board will be created that will assign a rating firm to the bank.  Banks will be a large source of revenue of revenue for the ratings agency, so the potential for abuse will still exist.

Smartly, punitive taxes on profit and mandatory salary caps will not be implemented.  Shareholders will have a non-binding say on executive compensation which may be a lever for providing pressure.  Make it simple, your company makes money, exceeds expectations, compensation should be large.  If your company tanks, making bonus for leading a downturn doesn’t make much sense.

Language in the bill states the laws that are already in place will be enforced.  Oversight will be strengthened; regulators will be empowered to aggressively pursue financial fraud, conflicts of interest and manipulation of the system that benefit special interests at the expense of American families and businesses.  Herein lays the rub.  Who will define what?  The government does not have a stellar track record enforcing laws and regulations that are already on the books.  Will the laws be ignored someday because they will be deemed discriminatory because they happen to affect a one group more than another?

Government has become so large with so much overlap; various agencies had become uncertain about their lines of authority, allowing the system to become riddled with loopholes.  The Senates financial reform bill clearly delineates lines of responsibility.  The FDIC will regulate state banks, thrifts and bank holding companies with assets under $50 billion.  The OCC will regulate federal banks, thrifts and holding companies with assets under $50 billion.  The Federal Reserve will regulate banks, thrifts and bank holding companies with assets over $50 billion.  Banks with assets under $10 billion will be examined by the appropriate bank regulator and will be exempt for some of the higher fees larger banks will pay.

 Will anything change?  Future actions and behaviors can be predicted with a high degree of probability by looking at how individuals or organizations reacted in the past.  Anytime the spotlight is focused on an individual/department/organization, short-term activity increases and minor advances are made, but the test occurs when the klieg light of public attention is focused on a new target.  Laws will be updated, unethical but legal loopholes will be closed.  The Fed is assuming more power, but how well will new regulations prevent future bubbles or excessive risk taking, depends to a large extent on enforcement.  Look at past regulatory actions, the future ones will not be far off.  Hopes are high, expectations are low.

http://banking.senate.gov/public/_files/FinancialReformSummaryAsFiled.pdf

Another Reason for the Financial Meltdown

Over the last eighteen months, Washington politicians, Wall Street Bankers, world leaders, media pundits, special interest groups and millions of individuals like you and me have been playing the blame game.  Democrats blame Republicans lax regulatory policy for the recession, while Republicans blame Democrats for creating the Community Reinvestment Act (CRA) in 1977 to force banks to make loans to low-income families.  Some say the banks were too greedy.  World leaders blame the United States and Wall Street, while others still place blame on the repeal of the Glass-Steagall Act (GSA).

The GSA was enacted in 1933 in response the stock market crash in 1929 that triggered the Great Depression.  At the time, commercial banks aggressive underwriting of stocks and bonds, lax commercial lending policies and risky speculation were blamed for the stock market crash.  Depositors pulled their money from the banks in droves helping to push the number of bank failures to nearly 5,000.(1)

The purpose of the GSA was to bolster the public’s confidence in the U.S. banking system and begin to rebuild the crashed financial structure.  The GSA forced commercial and investment banks to separate.  Commercial banks primary purpose was to receive depositor’s money and make loans.  Investment banks primarily underwrite and market securities, facilitate corporate mergers and acquisitions, and broker transactions in the secondary market such as issuing corporate bonds. 

Additional measures to protect the system included granting the Federal Reserve added oversight powers to monitor national banks.  Also created was the Federal Deposit Insurance Corporation (FDIC) to insure bank deposits.  Banks would be required to set aside or reserve a percentage of their capital.  Member banks pay deposit insurance premiums or assessments to the FDIC.  In 1934, families had security knowing they could deposit their money with a member bank and it would be insured to $2,500 increased to $5,000 on July 1, 1934. (2) In 1956, The Bank Holding Company Act, placed further restrictions and companies owning two or more banks.

In the ensuing years, Congressional decrees and judicial rulings would circumvent and reinterpreting major provisions of the GSA culminating in the Gramm-Leach-Bliley Act (GLBA) that President Bill Clinton signed into law on November 12, 1999. ⁽³⁾ The GLBA also known as the Financial Services Modernization Act, ended depression area regulations established by the GSA by allowing commercial banks, investment banks and insurance companies to merge and create huge financial conglomerates.  The laws regulating how money could be used were replaced by laws regulating how information could be used. 

The law was hailed as a break though for competition allowing U.S. banks a level playing field for competition with foreign banks.  Some believe that repealing the GSA helped create conditions favorable to growth after the dot-com bust.  Remember in the year 2000 convention wisdom held that regulation stifled growth.  What a difference a decade makes, a Harris poll in February 2010 revealed that 82 percent of Americans want tougher bank regulation. (4) Effectively regulating a complex financial conglomerate like CitiFinancial would be like trying to untie a Gordian knot.  Apparently, the invisible hand that regulates the free market fell asleep on the job but the idea of free markets in the age of huge conglomerates buying Congress and the Oligarchs manipulating world markets makes the idea of free markets a myth.

After Lehman Brothers began the largest bankruptcy proceedings in history on September 15, 2008, and the credit market froze a couple weeks later, the blame game began.  The repeal of the GSA was the reason for the financial meltdown proclaimed many politicians and media personalities.  Sen. Russ Feingold, who, in a statement from his office, recalled, “Gramm-Leach-Bliley was just one of several bad policies that helped lead to the credit market crisis and the severe recession it helped cause.” Senator Feingold’s statement is well taken but does it overstate the case?  Would have the GSA prevented the credit meltdown had it not been overturned?

With real estate home values skyrocketing in the 2000’s, the GSA would not have stopped Countrywide Mortgage, Wachovia, Washington Mutual or Indy Mac bank from making ridiculous mortgage loans that helped fuel home values.  The GSA would not have prevented the banks from offering no income qualifying loans or from writing a $300,000 mortgage with low monthly payments of $875/mo for the first two years.  It is unlikely the GSA would have made a difference at bailout time for Fannie Mae and Freddie Mac that received over $100M in bailout funds.

Ludicrous lending policies and easy money that helped inflate residential real estate values nationwide could not have proliferated without a little help.  Banks had ready cash by selling their loan portfolios in the secondary market, courtesy of their friends in the investment banking industry.  GSA would not have affected investment banks Bear Sterns, Goldman Sachs, Lehman Brothers and Merrill Lynch from purchasing mortgage loans in the secondary market, slicing them into pieces and reselling them as mortgage backed securities and Collateralized Debt Obligations (CDO’s), creating more cash for the mortgage banks to lend.  The GSA would not have prevented these same investment banks from taking out insurance policies on these same securities and bond issues they sold on the secondary market.  These insurance policies known as Credit Default Swaps are a type of derivative that paid these investment banks if the securities default. 

Relating this to the consumer level, imagine you purchase insurance on your neighbor’s mortgage loan.  You have absolutely no vested interest in whether your neighbor makes his mortgage payments or not, yet you still insure against your neighbor defaulting on his mortgage loan.  Let us say your neighbor is unable to make his mortgage payment and loses his house to a foreclosure.  Because your neighbor was unable to make his mortgage payment and the bank was unable to sell the home for the amount owed on the mortgage, you being owner of an insurance policy on your neighbor’s mortgage get paid because your neighbor defaulted on his home loan.  As absurd as this sounds, trillions of dollars worth of derivative contacts are written on a similar premises.  In October 2008, the estimated value of all derivative contracts was $668 trillion, in contrast the total value of all the assets on the planet are less than $200 trillion.(5)

  The GSA would not have prevented the trillions of dollars worth of derivative contracts that are currently in force that have no more relevance to them than the above example of you taking an insurance policy out on your neighbor’s mortgage loan.  The GSA would not have restricted the insurance company AIG, from underwriting multiple insurance policies/derivatives on the same securities and bond issues backed by mortgage loans.

 When the housing market tanked and homeowners were no longer able to refinance their mortgages, they began to default on their mortgages in mass. The investments backed by those mortgages went into default.   The investment banks had insurance called Credit Default Swaps that paid them the estimated value of the security when it defaulted.  AIG underwrote many of those policies.  When the whole thing collapsed and AIG was unable to pay on the derivative contracts it had underwritten, the Federal Government came to the rescue with $140 billion in bailout funds which AIG in turn paid to the investment banks like Goldman Sachs which was the owner of the Credit Default Swaps AIG was unable to pay.  The rich got richer on the backs of the taxpayer.  Legal yes, ethical, you be the judge.  Would have the world economy collapsed without the bailouts, maybe so?

Okay so how did the derivative market become an albatross that has the potential to wipe out the world economy?  The Commodity Futures Modernization Act of 2000 said many derivative contracts like Credit Default Swaps could be traded in the Over the Counter Market (OTC).    The legislation of the act essentially eliminated capital and other requirements on banks that entered into OTC derivative contracts.  The informed parties entering these contract would regulate themselves.  The CFMA has allowed parties to enter contracts where the holder has no interest in the underlying security, in fact, the contract holder in many cases finds the failure and misfortune of others is a very lucrative business.  Like a parasite, attaching itself to a host, the bank that owns the derivative contract will nourish itself financially until the underlying security is dead.  However, this parasite has the ability to attach itself to another host and root for its death to enrich itself further.

The slow repeal of the Glass-Steagall Act did not cause the recession but its dissolution helped create the atmosphere where an unregulated derivatives market could flourish.  Someday historians may look back at the global economy and blame its collapse on, The Commodity Futures Modernization Act of 2000. 

(1)    http://topics.nytimes.com/topics/reference/timestopics/subjects/g/glass_steagall_act_1933/index.html

(2)   http://www.fdic.gov/bank/analytical/firstfifty/chapter3.html                                                                                                                                                                                                                                                                                              

(3)   http://banking.senate.gov/conf/

(4)   http://www.msnbc.msn.com/id/35817048/ns/business-stocks_and_economy/

(5)    http://www.newsweek.com/id/164591

GDP Gains, Belay State and Local Pains

Jamie Dimon, Chairman of JP Morgan Chase caused quite a stir in the investment community when he warned American investors should be more worried about the risk of default of the State of California than of Greece’s current debt woes.  Dimon told investors at the bank’s annual meeting that, “there could be contagion” if a state the size of California, the biggest of the United States, had problems making debt repayments. “Greece itself would not be an issue for this company, nor would any other country,” said Mr. Dimon. “We don’t really foresee the European Union coming apart.”  (1)

As a temporary California resident, I was aware of California’s budget shortfalls but wanted to find out why the state was in so much trouble.  The latest report on the Gross Domestic Product (GDP) of the United States for the last quarter of 2009 grew by a revised second estimate of 5.9 percent. (2)  Why should state and local governments have fiscal woes when the federal government is growing at such a brisk pace?

The short answer is revenue is down and expenses like unemployment compensation are up.  States and local governments get revenue from state income tax on individuals and corporations, sales tax, property tax, death and gift tax, and various other licensing and transfer fees.  High unemployment equals less people paying state income tax.  Sales taxes are flat or growing at rates less than projected as individuals cut back on spending.  Property tax collections have decreased in many markets nationwide as county tax assessors have reassessed property values to reflect the depreciation in home values.  In summary, state and local governments are hurting for income in ways they never would have imagined in 2007.

The stimulus package Congress voted on a year ago to stimulate the economy has primarily gone to buoy financially troubled states.  The state extensions of unemployment insurance are federally funded.  Stimulus cash has allowed state governments to prevent or delay letting go public employees under their jurisdiction.  As the federal funding of states dries up in 2011, the gap between obligations and revenue will widen. 

The Center on Budget and Policy Priorities projects that an increasing number of states will struggle to balance their budget in 2010.  The total budget shortfall for all states in the fiscal year could reach $196 billion or 29 percent of the state’s budget – the largest gap on record.   Revenue gaps for 2011 will continue, leading to a combined budget shortfall of $375 billion. (3) 

 Boiling this scenario down to a household, imagine taking home income of $100,000 on expenses of $129,000.  You need to borrow $29,000 to make ends meet.  Now blow this scenario back up again to include all fifty states in aggregate and the gravity of the combined budget shortfall becomes painfully clear.  After a few years of living like this, you would consider bankruptcy to remedy the situation as your total debt exceeded your total assets.  State governments do not have the luxury of this option.

Media outlets in the states of Arizona, California and Illinois have cried our states will go bankrupt if we do not solve our fiscal problems.  The headlines have overlooked one pertinent fact.  States cannot legally file bankruptcy.  Chapter 9 bankruptcy is for municipalities like Vallejo, California, which filed bankruptcy in 2008 because it could not afford its pension obligation. (4)

However, states can default on their bond obligations.  In the 1841, the state of Mississippi defaulted on a bond issued on its behalf by the Planters Bank in 1833.  The bonds were never paid.  If one of our fifty states defaulted on its obligation in 2010, in the near term, it is unlikely the Obama administration would allow that state to stiff the bondholders.  The political implications would outweigh fiscal realities and the federal life-preserver would land on the front steps of the afflicted states’ capital building. 

The financial implications of default would cause the states bond rating to flirt with junk status and make the possibility of borrowing additional money prohibitively expensive.  The dilemma might effectively freeze all state business but the essentials until a viable strategy is enacted.  I see the miss-guided masses marching on the streets demanding their personal bailout benefits. 

Defaulting on debt obligations is the nuclear option, state and local jurisdictions make up budget shortfalls by raising taxes and fees and cutting services.   The majority of services we receive as citizens come from our state and local governments, not the federal government.  As the revenue or income that states receive decline, the state needs to reduce the amount of money it spends.  The cuts in spending may show up as layoffs or reductions in salary for state workers such as schoolteachers.  Many medical and health professionals as well as state police and highway maintenance personnel are other state employees who are affected by fiscal contractions.  Lower and middle-income workers are disproportionately affected when local and state municipalities cut services and raise taxes.

Shifting gears and going national, the GDP growth in large part resulted from the federal governments stimulus spending.  State governments do not have the luxury of printing money through the Federal Reserve and monetizing the newly created debt as the United States Treasury Department does.  The federal government creates money when a commercial bank like Goldman Sachs borrows money from the Federal Reserve at .25% and uses the money to purchase Treasury Bills paying three or four percent interest, presto change, money is created out of thin air.  The resulting increase in the GDP was not a result of organic growth from expansion in the private sector but a further escalation of the federal deficit.

At the city and county level, pay and benefits consume the majority of local budgets.  Bloated pensions will be the downfall for cities all over the country.  Vallejo California filed bankruptcy in 2009 to get out of paying retroactive pension boosts.  Bankruptcy hurts all concerned.  City employees are laid off, budgets are trimmed and the hit to the cities credit rating makes borrowing money for infrastructure and building improvements much more expensive.(5)  According to the Pew Center state pensions are underfunded by almost $1 trillion. (6)  Can you say bailout!

The Dirty Little Secret

In the 2000’s before the Great Recession money managers in small municipalities wore many hats including managing the pension fund.  Riding into town on the white horse was the investment advisor of a prominent investment bank promising returns 2 or 3 percent higher if the money manager only invested a portion of the pension fund into an exotic security backed by so-called quality mortgages.  The exchange was similar to a high school aged kid telling a third grader I will give you three baseball cards for the Alex Rodriguez rookie card in your collection.  The over matched third grader said three for one, of course I will trade, are you crazy?  The pension manager, like the third grader, said of course, the county employees and pensioners will not believe I got them such a good deal.  We all know how that exchange turned out for the pensioners and their municipal money manager.

Do not ask me how things will turn out; my crystal ball is clouded over.  Things do not look brighter on the horizon.  Taking positive GDP figures and letting your guard down is an act of willful ignorance or self-deception at best.  Taking your financial future into your own hands is the prudent course.  In this bloggers opinion, rising revenue in concert with reduction of national debt would be a good start.  Everything else is smoke and mirrors.

Have a nice day! 

 (1)                 http://www.telegraph.co.uk/finance/financetopics/financialcrisis/7326772/California-is-a-greater-risk- than-Greece-warns-JP-Morgan-chief.html

(2)                 http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm

(3)                http://www.cbpp.org/cms/index.cfm?fa=view&id=711

(4)                http://www.iddmagazine.com/news/189081-1.html

(5)                http://money.cnn.com/2008/06/02/pf/retirement/vallejo.moneymag/index.htm

(6)                http://www.reuters.com/article/idUSTRE61H13X20100218