Tuesday, March 31, 2009

Foreclosures Are Mostly NOT Good Deals

Many people believe that foreclosures equal good deals and that good deals can be had by searching a market only for foreclosures. Nothing could be more wrong in our experience, especially in and around Houston, where most foreclosures are some of the worst deals on the market.

We have found that foreclosures, while they may look okay in photos or on the outside, most often a) need more work than an occupant can take on, b) require expertise and cash beyond what a homestead buyer normally has, and c) are often anything BUT good deals in the end.

The most effective way to find a good deal is simply to look in good neighborhoods for low prices and then figure out why the price may be low. An elderly person may be moving to elder care, it could be an estate sale, someone may just need to move quickly, perhaps a house needs updating that most will not want to do but you don't mind doing in time, etc.

Foreclosures per se are not good deals.

And don't rely on foreclosure "specialists" or workshops or special public auctions or lists you have to pay for. Remember also that almost any property can look good in a photo (think "online dating"). Nobody gets all good listings and nobody corners a market, so using the Multiple Listing Service in an area is still the best and most comprehensive way to search for prospective properties.

Some firms like mine only do foreclosures with investors. That way, we know the investor knows what they're getting into (foreclosures are riskier deals than traditional resale/new) and typically will not encounter underwriting issues and can accommodate the bureaucracy involved -- another huge disincentive for homestead buyers -- the timing can vary wildly from expectations on foreclosures and there's really nothing you can do.

Why are foreclosures often rotten deals? Well that's a trip down the rabbit hole we'll save for another time. Just know foreclosures often equal "beasts." Finding good deals takes standard old fashioned knowledgeable research and professional advice.

Monday, March 30, 2009

This Is American Capitalism At Work

Well Wall Street is nervous this morning, but since Wall Street is driven by greed and fear and not much else, this is a very healthy sign. There has been too much optimism recently that fueled the 1000 point rise in the Dow. Clearly the economy is not going to turn around on a dime (or ten trillion dimes), even with policy on the right track. So to see Wall Street renewing its fears about banks and cars is a positive sign today -- capitulation is a necessary precursor to any turnaround. And capitulation on the scale required will not happen in a day.

The auto plan announced this morning, which includes the ouster of Rick Wagoner from GM, is an extremely serious but positive sign.

Yes the administration is catching flack this morning from Wall Street and the talking heads -- the same breed really -- but the plan is a master stroke, and I don't mind saying so.

The president said that the car industry is not doing enough to restructure seriously or quickly enough. While the prospect of the government forcing out a CEO is indeed breathtaking, it is concurrent with the needs of the time. It has been all too obvious since last fall that the auto companies have been thinking that if they can just get through this economic turbulence, then they can return to whatever course they thought they were on.

This morning the president ended that thinking.

What the auto executives have not been considering is that as many as 1 in 7 jobs in the country are connected to the auto sector. What must precipitate any economic turnaround in this nation? Answer: a turnaround in the jobs market. Therefore, without significant reform in the auto industry to stoke financial confidence in the industry that will lead to renewed investment, renewed demand at the producer level, and renewed jobs, there will be little chance of a robust economic turnaround.

The auto sector helped make the middle class in this country. It can help save it.

So what the administration has announced this morning is a bold statement that clarifies this moment in economic history: the government represents the taxpayers as the shareholders, and not instead of the shareholders. This is the correct and only correct concept.

Where taxpayer money is used as a lifeline for private companies, then those companies have a fiduciary responsibility to the taxpayers as shareholders, and in turn the administration correctly understands that Treasury's fiduciary duties are to taxpayers, the American public. In other words, this is capitalism at work.

This is a brand new phenomenon, make no mistake. It's provocative and maybe a bit frightening because it marks a sharp departure from historic economic policy. We have not seen this before. But then we haven't seen economic conditions like this before.

This morning the administration shows that it understands the lay of the land. It understands that it can use policy to help shape and encourage an economic recovery - not socialist policy, but shareholder policy.

It understands that Wall Street must see that the taxpayers are these companies' primary shareholders right now -- not because we are a socialist nation, but because the taxpayers have paid for their shares.

American capitalism is in a crucible no doubt. But there can also be no doubt today that American capitalism is still very alive. Today's policy shows the administration's commitment to America's system of democratic capitalism.

Let the socialist meme die an undignified and ugly death.

Friday, March 27, 2009

Seller Financing: Seller's Advantage

It used to be that financing was so easy, seller financing as a concept fell to extremely distressed properties and the shadows of usury. But no more.

Nowadays, the slightest credit blip could prevent someone from receiving an affordable, reasonable loan by a bank or other mortgage lender. In this case buyers and sellers may turn to some type of seller financing in order to buy a home. While this post is in the context of homestead purchases, seller financing is a well-known concept in entrepreneurial finance, and its distant cousins are all over typical large corporate finance.

Anyway, in a home seller financing arrangement, the seller would agree to sell her or his property to a buyer of the seller's choosing, but not accept payment at closing. Instead, the seller issues a debt instrument in the amount of the sale to the buyer / "borrower." Done correctly, this can create a first lien position for the seller just like any other mortgage lender, with the sole right to foreclose on the property as collateral.

The debt instrument is actually a mortgage issued by the seller to the borrower, or wherein the buyer is the mortgagor and the seller is the mortgagee. The seller in most every case will not be able to pass on or sell that mortgage to third parties easily, but it can be an important source of income if the seller does not need the lump sum at closing - similar to an annuity.

The seller-financed mortgage will contain all the terms of a regular mortgage as the parties agree, and it should be drafted by an attorney in the state of the transaction. Terms can include required down payment, interest rate, payment schedule, amortization schedule, term (15, 20, 30 years, etc.), and perhaps most importantly, the default terms and foreclosure procedures in line with state law. In "Deed of Trust" states like Florida and Texas, the seller will hold the Deed of Trust, which gives the seller the right to foreclose on a loan in default. In such a case where the seller believes the buyer to be in default, the seller most likely would hire a foreclosure attorney to handle the foreclosure.

But here's where things get very interesting: in the event of a foreclosure in most DT states including Texas, the foreclosing lien-holder (in this case, the seller) gets to reclaim the property and re-sell it while keeping past payments including the down payment of the defaulting borrower. Whereas foreclosures are mostly a quagmire for large financial institutions, the opportunity to charge an attractive interest rate to someone who can't or doesn't want to get a private loan along with the opportunity to reclaim the property to re-sell it in the event of default - it can create a substantial financial advantage for the seller and a fair opportunity for a buyer.

Sellers can do short-term loans to help a buyer through a rough credit patch - the 30 year mortgage is not the only arrangement. A seller could offer a buyer 2 to 5 year financing with a 30-year amortization schedule (payments based on a 30-year loan) but requiring a balloon payment of the balance in 2 to 5 years or 7 or 10 or whatever. Most buyers will not have the cash for a balloon payment at that time, but the implication is that the buyer will have to refinance in order to pay off the balance to the seller. Notice, if the buyer does not successfully refinance, then they may trigger default / foreclosure terms and lose all their past payments and equity to the seller/lender.

Sellers with an existing mortgage most always cannot do this because traditional mortgages usually have terms that do not allow it. But even for sellers who do not have their property paid in full, they may be able to tap other funds to pay off their mortgage so they can take advantage of a seller-financing opportunity.

This post is meant merely as a framework for an idea and is not financial or legal advice or legal opinion. Any seller considering this opportunity in today's market should consult real estate brokers, financial advisers, accountants, and most importantly, a trusted real estate attorney.

Frankly I am surprised we don't see more seller financing in this market.

Saturday, March 21, 2009

Optimism Is Creeping Back

The following chart is from Pollster.com, a polling outfit that averages most major polls and then regresses the plot to show trend lines. Averages of averages are a relatively good measure for broad indicators. Fortunately, this broad indicator measures American economic optimism!

After long stagnation of relative pessimism, the gap is starting to narrow between those who believe the economy is worsening and those who believe the economy is getting better. Of course, no good analyst will confuse opinion polls with reality, but to the extent that optimism may reflect future spending patterns, this is really great news.

FYI, interestingly, the famous "right track/wrong track" number about the country's direction is continuing a sharp narrowing trend after a long wide gap that started a marked turn-around after the election last fall. It may reinforce or correlate with the above. Regardless, still great news.

Friday, March 20, 2009

When Liability Insurance Attacks: For Home Sellers

Our insurance adviser tells us that one of the highest liability risk periods for any home owner is when they market the home for sale. This makes sense because hopefully a lot of interested buyers will be coming onto the property to see it -- most of them strangers. If someone falls, etc., it's like any other time basically -- there could be a liability claim against you. A standard Listing Agreement with any real estate broker should cover this in some further detail, however your best protection on all of these issues is to speak with your insurance agent.

We have even been advised that some home owner insurance carriers will not even establish a new policy while a house is on the market for sale because of the increased risk. Also, as with any insurance policy, the beast is in the exceptions listed in the policy, not to mention insufficient coverage compared to the likely liability cost a covered incident provides for in the policy. (For example, if you only have $5,000 for injury liability but someone breaks a leg, you could well be on the hook for way more than $5,000.)

Cheap insurance quotes are like discount real estate brokers in my opinion: you think you're saving money (and most times you're really not) -- and you better hope you never need them.

Another scenario: I have a pit bull and so am very aware that many home owner liability policies will either a) not cover pets, or b) not cover certain breeds from the liability policy. So every pet-owning home owner must be clear on that aspect of their policy. Even if your pet's actions are covered, you want to be sure the coverage is sufficient for any likely claim scenario - as with the above example, a dog bite could put you on the hot seat for way way more than $5,000 if that's the limit in your policy. Nothing stops anyone from suing you for more than your insurance coverage. If that person were to win in court, the plaintiff can pursue your other assets. Anyway your insurance agent can speak to all of this, and if anything in this post is news to you, you should call that agent right away.

Other critical items in my view to discuss with your insurance agent:

  • Whether you need a business rider on your car insurance. Without it, if the insurance adjuster determines your car was being used for business in a collision, your coverage could be denied.
  • Establishing or raising the value of an umbrella insurance policy to enhance your coverage limits. Think about it: if you have a catastrophic car crash that's your fault, if you have minimum coverage, your insurance carrier has every incentive to write a check for $25,000 (if that's your limit) and walk-away, leaving you with potentially hundreds of thousands in additional liability in the incident. Proper coverage including affordable umbrella coverage at $1 million, for example, could put your insurance company on the hot seat for up to $1.5 million in such an incident -- that's a sure calling card for their A-Team lawyers to come to your defense with that much of their own money on the line.
  • Whether your carrier is a mutual company, meaning its policy-holders own the company, or whether your carrier is a publicly traded corporation whose shareholders own the company. This basically gets to one important aspect: making sure your carrier, no matter how it's structured, has a good reputation for being fair about pay-outs on claims. In this Google era, you can do some private due diligence of your own as well.

Like I said, insurance is more than just a cheap quote. Sometimes you get what you pay for, and -- as is the case with my own professional role as a real estate broker -- sometimes the right adviser with the right ethics, experience, and expertise can get you far better results for the same "low price." At any rate, if you just go with the cheapest quote on anything in life without examining what's behind it, then whatever it is, you better hope you never need it.

Thursday, March 19, 2009

Local Option Appraisal Caps: An Assault On Property Tax

Texas is a property tax state. It has no income tax. The effect is that Texas counties have appraisal districts who appraise property values that are then used as the value basis for property tax rates. A property tax is calculated by multiplying the percentage rate (a sum of the rates of all taxing entities) by the value assessed by the appraisal district. Counties apply this to business property as well as to personal property, especially real estate.

The property tax is in many ways extraordinarily unfair and unreasonable. What could be the logic behind burdening property owners with almost the entire state financial needs? Yes, there are local sales taxes and some form of state franchise taxes on businesses, and god bless her Ann Richards got us a Lottery that was supposed to help fund education, but make no mistake the property tax is the staple of Texas state revenues.

I guess what bothers me most is this: someone could live in a modest home for 30 years and pay off their mortgage. They may never refinance or sell their property. But the county appraisal district has the power to raise the assessed value of the home over time to match or even exceed inflation in the district's sole judgment of property values. So the $150,000 home a person bought 30 years ago might be assessed today at $300,000 and at an average combined rate of 3%, this homeowner -- with her or his mortgage entirely paid off and even on a fixed income -- will have to pay $9,000 a year in state property taxes.

That's $750 every month to the state of Texas just for owning property that you might have entirely paid off and have held for 30 years.

Doesn't it make more sense to tax income? When someone makes income or converts investments into proceeds as taxable income, isn't it fair to ask for the good of society and its infrastructure that the recipient of the income pay a small share to the collective needs of the state? Wouldn't it make more sense only to tax income? Why tax savings or investments whose proceeds don't get tapped?

The idea that a person who has saved and paid off their house and is living on a fixed income (even if by choice) has to pay thousands a year on a house purchased 30 years ago but appraised at current value -- well it just strikes me as obscene.

But hey, we have no income tax. And that keeps Texas proud. Or something. I don't know.

Anyway, state representative Debbie Riddle of District 150 in Harris County includes an optimistic note in a recent email to some constituents about her "Option Appraisal Caps" plan, which would gut the state finance system as property owners concentrated in Harris County (the 4th largest in the nation and home to Houston), Bexar County (San Antonio), and Tarrant County (Dallas) would all surely go to the polls to limit annual appraisal raises to 3% of the prior year's assessed value.

It sounds democratic, and it is. It's a good plan. But the effect would be to force an income tax on the state. I don't think that would be such a bad thing.

From Representative Riddle's email:

As focused as I am on the budget right now, this week is exciting for me for other reasons. Tomorrow morning, I will lay out HB 46 before the Ways and Means committee. This is a bill I have been filing since 2005, yet I have never received a hearing because the previous chairman opposed Appraisal Caps in all forms. Finally, the time has come to let the legislature know about the need for appraisal reform in District 150.

House Bill 46 would allow counties to hold elections to determine their own appraisal cap, anywhere from three percent to 10 percent. In my mind, this is the ultimate solution to the ongoing appraisal cap debate. I understand that many of my colleagues would not be reelected if they mandated an appraisal cap any lower than 10 percent for the entire state. But areas such as mine are desperate for relief from appraisal creep and cannot receive it because of concerns from legislators who live hundreds of miles away. Under my proposal, the people of each county would be able to make their voices heard and set their own caps. It takes the decision out of the hands of legislators in Austin and into the hands of local taxpayers, where it belongs.

The bill has widespread bi-partisan support, and I believe it has an excellent chance of being passed out by the committee and put before the entire floor this session. It does require a constitutional amendment, which has to be approved by 100 of the 150 members of the House. I will continue to gather signatures on the bill, but I believe this could be the breakthrough so many of us have waited years to see!

Kudos, Representative. But I won't hold my breath.

Wednesday, March 18, 2009

Houston House Prices: Still Pretty Good

From the new Houston Association of Realtors press release on recent home sale data:
Single-Family Homes Update
At $182,316, the average sales price for single-family homes dropped 10.5 percent from February 2008, when it was $203,797. However, the figure is up $18,000 from January of this year. The median price of single-family homes in February was $138,970, off 8.0 percent from one year earlier, but up about $10,000 from January. The national single-family median price reported by NAR is $169,900, illustrating the continued higher value and lower cost of living that prevail in the Houston market.
Now I can tell you we are not seeing those kinds of declines in value on the far north side of Houston in quality neighborhoods and with quality homes. The decline there, if any, is hardly noticeable.

But really, this chart contained in the release is all you need to see to get a simple read of the situation in Houston:

Look at the trend lines. Both the average price (skewed higher by expensive homes) and the median price (half of all sales are priced higher, half lower) -- both average and median trend lines show something very important that you can clearly see just by eyeballing it:

Prices in the Houston area are at mid-2007 levels right now.

In case anyone missed it, 2007 was a pretty darn good year for housing in Houston.

Tuesday, March 17, 2009

Housing Starts: Only 1% Single Family

This just in. NBC analyst Diana Olick notes that inside this morning's numbers, well over 80% of the overall 22% increase in new housing starts are multi-family units; in other words, apartments.

So the number for single-family housing starts of the overall 22% increase is just 1% says Olick.

This is more in line with what we would expect in this economy. Ring around the rosy, we all fall down.

So people who moved out of apartments into new entry-level homes and are now moving out of those homes, they are looking for new apartments and they have already been relocated geographically within any metro area from where their old apartments were to the new production residential areas. This then, according to my analysis, leads to an increase in demand for new apartment complexes in areas that do not have them because those areas heretofore were developed only for single-family entry-level production homes.

Also, many other people who might otherwise be buying entry level homes just cannot afford to do so right now, but still want to be in good areas with good schools, and this too would create additional multi-family demand.

Also, many apartments are owned by very large investment groups that specialize in this class and often own hundreds and hundreds of units in communities across the nation. The successful ones are able to access development funds to meet the new demand.

Also, divorcees account for many multi-family unit occupants. Today a couple's net worth, particularly for younger couples, is not what it was two years ago (or a year ago). With less then to split and start over, many divorcees must turn to apartments but do not want to move far from their existing neighborhoods, jobs, and schools.

Also............ in recent years buyers did not have to put any money down on a new home. In fact, many buyers could finance up to 106% of a home's value and actually walk away from closing with cash in their pocket. This of course was part of the market insanity of that time. However now many people are having to delay a house purchase while they dial back their spending and their debt to save for a down payment - not necessarily a bad thing.

So this makes sense on multiple levels. It is still worth noting however that development of new multi-family units is still creating new construction and new jobs. And for many people, moving into an apartment for a while in order to recharge one's finances before buying a house with a conventional loan is a very good idea. It's what I did, and I'm glad I did it.

Uptick or Upstart? New Home Starts: UP

Just out, The Commerce Department reports this morning that:
The Commerce Department said the jump in housing starts to a seasonally adjusted annual rate of 583,000 units was the biggest percentage rise since January 1990.

That was also the first increase since April last year, when they advanced by 1.6 percent.
And the kicker? This is not what "the markets" had expected. Market analysts were expecting a smaller number.
Analysts polled by Reuters had expected an annual rate of 450,000 units for February.
The question now might be: with so many months of sinking new start numbers, is this just a natural uptick quirk within the larger trend, or is this a new inflection point that will reverse the trend?

Rest assured we are watching very very closely.

On a separate but related note, producer prices were announced at .1% rise, below market expectations. However the markets watch the "core" number, which excludes the traditionally more volatile energy and food costs. Those prices were slightly higher than expected. All said, this is very good news this morning. But with so much debt-financed stimulus, we have to keep an eye on inflationary dynamics. This isn't enough to be concerned this morning.
U.S. producer prices rose by less than expected in February as the pace of energy price increases slowed, government data on Tuesday showed, but prices excluding food and energy came in a bit above forecast.

Sunday, March 15, 2009

Houston #1 Corporate Growth In The United States

From the Houston Business Journal, a report about Houston at "the No. 1 spot for the first time on Site Selection magazine’s list of Top Metro rankings for corporate location and expansion activity."

Eat that, Chicago (#3)!!

And coming in at #2 behind Houston? Our little sister to the north, Dallas.
Site Selection said Houston clinched the top spot after scoring 179 corporate real estate deals in 2008, unseating three-year incumbent Chicago-Naperville-Joliet.
Dallas-Fort Worth-Arlington finished No. 2 with 156 projects, and Chicago came in third with 138.

Last year, Houston was No. 4 behind Cincinnati and St. Louis for cities with more than 1 million in population.

“Site Selection ’s award adds to the long and growing list of distinctions the Houston area is earning for our business recruitment, business retention, job creation and economic growth efforts,” Jeff Moseley, president and chief executive officer of the Greater Houston Partnership, said in a statement. “We will continue to show that the Houston region is the most attractive place to locate or expand your business in the United States.”
There is no place in The United States that I would rather own real estate right now than in and around the Houston metro area and definitely in the rightfully proud great State of Texas. (That's why I do, of course.)

Saturday, March 14, 2009

Before Stewart vs CNBC: Stewart vs Crossfire 2004

To follow up on yesterday morning's comment about the power of satire, and particularly of Jon Stewart's satire, here is the following from 2004:

Mmmmm me loves me some Jon Stewart. Political satire has a rich American history and a critical role to play in a functioning democracy, and in the case last week of Stewart vs CNBC, in a functioning capitalist democracy. Sometimes satire is the most effective way to bring such large and discordant forces into sharp relief. Operative word: sharp. See clip above and prior posts to wit. Jon Stewart is an American patriot and national treasure.

Friday, March 13, 2009

Jim Cramer vs Jon Stewart: All You Need To See

If you know nothing about the current financial crisis and you can only handle so much before you go off a "thought cliff," then this is all you need to see. All week, Jon Stewart has been criticizing the complicity of the financial network CNBC with lying Wall Street execs to mislead the world on the crisis that they all should have known and been honest about.

We need independent investigative journalism for a functioning capitalist democracy. Just watch.

And do not miss the shorter Part II:

There are several unedited outtakes at TheDailyShow.com. And for the record, this is not the first time that the comedian Jon Stewart has single-handedly changed the landscape of political media. But more on that another time. A small example: remember the long-running show "Crossfire" on CNN? Jon Stewart pretty much single-handedly destroyed the show with his searing on camera criticism, including on that very show confronting its hosts. Think about that.

This was an astounding interview with Jim Cramer of CNBC. That network cannot escape culpability (no matter how shared) in fueling the run-up to the current crisis, along with the other principals named earlier on this site.

Tuesday, March 10, 2009

You Know Nothing!

Apropos of nothing but humor as medicine...

I do not know who these ladies are, and I have never seen them before. But this is the most hilarious clip I have seen in months, sent by a friend. I laughed until I was crying... (FYI one lady uses a few choice words, in case you need to put your headphones on...)


Sunday, March 08, 2009

Our Town & The United States of America

It's no secret I'm a living cliche at times and do enjoy the Sunday Morning Times, mainly its in-depth front-page reporting, and the always thought-provoking writing of their theater-turned-Sunday-columnist-culture-critic Frank Rich.

This morning, Rich provides insight into our collective national moment by highlighting the resurgent play, Our Town, the famous 1938 play performed by many talented and/or under-resourced theatres because it requires no set and a large cast of extras (a prescription for high school and community production if there ever was one).

But this morning Rich reminds us why the play is also enduring - its timeless call to a collective sense of ourselves and our nation, captured in these times by Barack Obama's famous refrain, "We are the United States of America," that has resonated with many Americans. Sometimes, though, we could do well to "remember" history so that we are not condemned...

Writes Rich:

“WHEREVER you come near the human race, there’s layers and layers of nonsense,” says the Stage Manager in Thornton Wilder’s “Our Town.” Those words were first heard by New York audiences in February 1938, as America continued to reel from hard times. The Times’s front page told of 100,000 auto workers protesting layoffs in Detroit and of a Republican official attacking the New Deal as “fascist.” Though no one was buying cars, F.D.R. had the gall to endorse a mammoth transcontinental highway construction program to put men back to work.
He continues to frame our current moment with references to Warren Buffet, AIG, and Bernie Madoff:

We’re still working our way through the aftershocks of the orgy of irresponsibility and greed that brought America to this nadir. In his recent letter to shareholders, a chastened Warren Buffett likened our financial institutions’ recklessness to venereal disease. Even the innocent were infected because “it’s not just whom you sleep with” but also “whom they” — unnamed huge financial institutions — “are sleeping with,” he wrote. Indeed, our government is in the morally untenable position of rewarding the most promiscuous carrier of them all, A.I.G., with as much as $180 billion in taxpayers’ cash transfusions (so far) precisely because it can’t be disentangled from all the careless (and unidentified) trading partners sharing its infection.

Buffett’s sermon coincided with the public soul searching of another national sage, Elie Wiesel, who joined a Portfolio magazine panel discussion on Bernie Madoff. Some $37 million of Wiesel’s charitable foundation and personal wealth vanished in Madoff’s Ponzi scheme. “We gave him everything,” Wiesel told the audience. “We thought he was God.”

Rich argues next a fundamental point discussed on this site. The American economy has no hope of recovery until we see a massive return of jobs and job confidence to restore broad-based consumer-driven markets, the cornerstone of real estate spending and values as well. A primary driver of the severity of this current crisis is the concentration of so little of our collective national income in the vast middleclass and working Americans, which I personally define as those earning less than $250,000 taxable income per year. Rich:

The simplest explanation for why America’s reality got so distorted is the economic imbalance that Barack Obama now wants to remedy with policies that his critics deride as “socialist” (“fascist” can’t be far behind): the obscene widening of income inequality between the very rich and everyone else since the 1970s. “There is something wrong when we allow the playing field to be tilted so far in the favor of so few,” the president said in his budget message. He was calling for fundamental fairness, not class warfare. America hasn’t seen such gaping inequality since the Gilded Age and 1920s boom that preceded the Great Depression.

From the link behind "such gaping inequality" above is the following chart demonstrating the magnitude of the widening gap:
The chart shows the share of the richest 10 percent of the American population in total income – an indicator that closely tracks many other measures of economic inequality – over the past 90 years, as estimated by the economists Thomas Piketty and Emmanuel Saez. I’ve added labels indicating four key periods. These are:
The Long Gilded Age: Historians generally say that the Gilded Age gave way to the Progressive Era around 1900. In many important ways, though, the Gilded Age continued right through to the New Deal. As far as we can tell, income remained about as unequally distributed as it had been the late 19th century – or as it is today. Public policy did little to limit extremes of wealth and poverty, mainly because the political dominance of the elite remained intact; the politics of the era, in which working Americans were divided by racial, religious, and cultural issues, have recognizable parallels with modern politics.

The Great Compression: The middle-class society I grew up in didn’t evolve gradually or automatically. It was created, in a remarkably short period of time, by FDR and the New Deal. As the chart shows, income inequality declined drastically from the late 1930s to the mid 1940s, with the rich losing ground while working Americans saw unprecedented gains. Economic historians call what happened the Great Compression, and it’s a seminal episode in American history.

Middle class America: That’s the country I grew up in. It was a society without extremes of wealth or poverty, a society of broadly shared prosperity, partly because strong unions, a high minimum wage, and a progressive tax system helped limit inequality. It was also a society in which political bipartisanship meant something: in spite of all the turmoil of Vietnam and the civil rights movement, in spite of the sinister machinations of Nixon and his henchmen, it was an era in which Democrats and Republicans agreed on basic values and could cooperate across party lines.

The great divergence: Since the late 1970s the America I knew has unraveled. We’re no longer a middle-class society, in which the benefits of economic growth are widely shared: between 1979 and 2005 the real income of the median household rose only 13 percent, but the income of the richest 0.1% of Americans rose 296 percent.
Penultimately and for fun here, Rich doesn't miss the opportunity to pile on to the emperor clothes of CNBC and the righteous skewering by Jon Stewart shown earlier on this site. What's troubling is that the clips Stewart assembled were presented in full context and told a broader tale of CNBC and Wall Street insiderism that has become all-too-apparent now, and which CNBC is terrified to have revealed broadly.

Last week Jon Stewart whipped up a well-earned frenzy with an eight-minute “Daily Show” takedown of the stars of CNBC, the business network that venerated our financial gods, plugged their stocks and hyped the bubble’s reckless delusions. (Just as it had in the dot-com bubble.) Stewart’s horrifying clip reel featured Jim Cramer reassuring viewers that Bear Stearns was “not in trouble” just six days before its March 2008 collapse; Charlie Gasparino lip-syncing A.I.G.’s claim that its subprime losses were “very manageable” in December 2007; and Larry Kudlow declaring last April that “the worst of this subprime business is over.” The coup de grĂ¢ce was a CNBC interviewer fawning over the lordly Robert Allen Stanford. Stewart spoke for many when he concluded, “Between the two of them I can’t decide which one of those guys I’d rather see in jail.”

Led by Cramer and Kudlow, the CNBC carnival barkers are now, without any irony whatsoever, assailing the president as a radical saboteur of capitalism. It’s particularly rich to hear Cramer tar Obama (or anyone else) for “wealth destruction” when he followed up his bum steer to viewers on Bear Stearns with oleaginous on-camera salesmanship for Wachovia and its brilliant chief executive, a Cramer friend and former boss, just two weeks before it, too, collapsed. What should really terrify the White House is that Cramer last month gave a big thumbs-up to Timothy Geithner’s bank-rescue plan.

Finally, Rich brings it brilliantly together so as not to ruin our Sunday morning coffee:

In one way, though, the remaining vestiges of the past decade’s excesses, whether they live on in the shouted sophistry of CNBC or in the ashes of Stanford’s castle, are useful. Seen in the cold light of our long hangover, they remind us that it was the America of the bubble that was aberrant and perverse, creating a new normal that wasn’t normal at all.

The true American faith endures in “Our Town.” The key word in its title is the collective “our,” just as “united” is the resonant note hit by the new president when saying the full name of the country. The notion that Americans must all rise and fall together is the ideal we still yearn to reclaim, and that a majority voted for in November. But how we get there from this economic graveyard is a challenge rapidly rivaling the one that faced Wilder’s audience in that dark late winter of 1938.

Friday, March 06, 2009

Why AIG Keeps Getting Our Money

Yesterday I was disappointed at a seminar to hear a long-time mortgage broker blaming much of the current economic crisis on loosening credit requirements by Fannie Mae and Freddie Mac in "1998" he said. I guess the continuing policy for the next 10 years didn't factor in as much?

The truth is that Fannie Mae and Freddie Mac were started by the government but became private companies, and so their shenanigans were as deplorable in recent years as the now defunct Wall Street investment banks (the remaining ones are now "bank holding" companies). And they enjoyed an artificially low cost of financing because most investors assumed (correctly as it turned out) that they were "quasi" Government Sponsored Enterprises (GSEs). There was plenty of bad policy and deplorable management to go around.

But About That AIG Bailout.....
However the current economic crisis, as we have discussed here, is NOT primarily about housing. Rather, its roots can be found in the legally off-the-books wildly dangerous "derivatives" trading that really led to all the "toxic" (read: worthless) assets in large financial institutions left holding the bag so to speak. The insane mortgages were fueled by that appetite for derivatives products on Wall Street.

So added to all this, AIG (and others) step in to provide another insane product, namely "insurance" for investors. This means the investors pay a premium on their investment (reducing their profit a little bit) to pay AIG, which then promised investors around the world that if the investment failed, then AIG would pay back the investors the amount of their investments, essentially creating truly "risk free" investments in complicated financial instruments and various bonds.

The US government, through Congress and 2 successive Presidents, made all this virtually untraceable and unmanageable, not subject to any regulation. The result? A whole lot of these "insurance" policies were issued without any money to back up the promises made by the insurance company, often AIG. Who were AIG's investors they were insuring? The insured investors are called AIG's "counterparties."

And those investors were often large financial institutions then providing financing to other smaller financial institutions. Mixed in with all this are various retirement funds, charities, municipalities, sovereign funds, pensions and so forth.

So if AIG is dissolved, you can start to imagine how all these other financial institutions would be wiped out and how that could start a world-wide daisy chain reaction.

That's why AIG keeps getting our money. It's not AIG we're keeping afloat - it's all those other institutions that were relying on the insurance AIG provided to secure their investment risk. AIG is effectively dismantled.

With that in mind now, you can follow this post from Talking Points Memo by publisher and political journalist Josh Marshall that goes into some further and more frightening detail:

I'm sure the knowledgeable people already know this. But it turns out that one of the features of the 2005 Bankruptcy bill was to put derivative counter parties at the front of the line ahead of other creditors in bankruptcy proceedings. Actually, from what I can tell, they don't just go to the head of the line. They got to skip the line entirely. As the Financial Times noted last fall, "the 2005 changes made clear that certain derivatives and financial transactions were exempt from provisions in the bankruptcy code that freeze a failed company's assets until a court decides how to apportion them among creditors." As the article notes, ironically, this provision which Wall Street pushed for and got to protect investment banks actually ended up hastening the collapse of Lehman and Bear Stearns last year.

Down in the article there are also the mentions of the entertainingly named "International Swaps and Derivatives Association", one of the lobbies that helped get the change in place.

Along these lines, TPM Reader GG sent in this last night ...

Respectfully, you guys are totally misunderstanding something crucial in the AIG bailout: Derivatives claims are not stayed in bankruptcy. (Yet another brilliant innovation from the 2005 bankruptcy reform legislation.)

If AIG were to go down, derivatives counterparties would be able to seize cash/collateral while other creditors and claimants would have to stand by and wait.

Depending on how aggressive the insurance regulators in the hundreds of jurisdictions AIG operates have been, the subsidiaries might or might not have enough cash to stay afloat. If policyholders at AIG and other insurance companies started to cancel/cash in policies, there would definitely not be enough cash to pay them. Insurers would be forced to liquidate portfolios of equities and bonds into a collapsing market.

In other words, I don't think the fear was so much about the counterparties as about the smoking heap of rubble they would leave in their wake.

Additionally, naming AIG's counterparties without knowing/naming those counterparties' counterparties and clients would be at best useless, and very likely dangerous. Let's say Geithner acknowledges that Big French Bank is a significant AIG counterparty. (Likely, but I have no direct knowledge.) BFB then issues a statement confirming this, but stating it was structuring deals for its clients, who bear all the risk on the deals, and who it can't name due to confidentiality clauses.

Since everyone knows BFB specialized in setting up derivatives transactions for state-affiliated banks in Central and Eastern Europe, these already wobbly institutions start to face runs. In some cases this leads to actual riots in the streets, especially since the governments there don't have the reserves to help out. If you're Tim Geithner, do you risk it? Or do you grit your teeth and let a bunch of senators call you a scumbag for a few more hours?

I'd be curious to hear what other knowledgeable readers think about this. But separate from the immediate financial implications related to AIG, it does point us toward the larger political economy point: the self-reinforcing cycle in which financialization leads to vast sums of money concentrated in the hands of paper-jobbers, who then mobilize that money in Washington to rewrite the laws to privilege them for even greater profits.

A final question, I'd be curious to hear from people who work in this space what even the notional rationale would be for having derivative counter parties able to skip the line in a bankruptcy proceeding.

Thursday, March 05, 2009

Hell Hath No Fury Like Jon Stewart Scorned

Okay. Let's set aside "truthiness" for a moment and look at what a snubbed talk show host and staff can put together in service of the truth. For anyone who watches CNBC for financial news - following is a potentially life savings saving recap:

And there's more...

What Really Happened
And here's where you find out what really happened at AIG and what brought down Wall Street...

There is a reason Jon Stewart is a cultural phenom and has been doing this show for ten years. There's a reason he's probably the leading news provider for young voters. It's as though the financial media and its guest executives think the public has a memory span of 30 seconds. But then, that's what Jon Stewart is for.

Tuesday, March 03, 2009

The Professor and the Pool

I received the following email in a chain about the stimulus bill. Suffice it to say it's from people who are frustrated and confused (and that's okay) about the stimulus policy. I'm "that jerk" who responds to these chain emails with my own opinion, posted below under the original email here...

I love this explanation. Makes total sense to me!! n

Shortly after class, an economics student approaches his economics professor & says, "I don't understand this stimulus bill. Can you explain it to me?"

The professor replied, "I don't have any time to explain it at my office but if you come over to my house on Saturday & help me with my weekend project, I'll be glad to explain it to you." The student agreed.

At the agreed-upon time, the student showed up at the professor's house. The professor stated that the weekend project involved his backyard pool.

They both went out back to the pool & the professor handed the student a bucket. Demonstrating with his own bucket, the professor said, "First, go over to the deep end & fill your bucket with as much water as you can." The student did as he was instructed.

The professor then continued. "Follow me over to the shallow end & then dump all the water from your bucket into it." The student was naturally confused but did as he was told. The professor then explained that they were going to do this many more times & began walking back to the deep end of the pool.

The confused student asked, "Excuse me, but why are we doing this?" The professor matter-of-factly stated that he was trying to make the shallow end much deeper. The student didn't think the economics professor was serious but figured he would find out the real story soon enough.

However after the sixth trip between the shallow end & the deep end, the student began to worry that his economics professor had gone mad. The student finally said, "All we're doing is wasting valuable time & effort on unproductive pursuits. Even worse, when this process is all over, everything will be at the same level it was before so all you'll really have accomplished is the destruction of what could have been truly productive action!"

The professor put down his bucket & replied with a smile, "Congratulations. You now understand the stimulus bill."

My friend who sent this to me, and with whom I'd previously discussed our nation's situation as we've discussed on this site, is a very very smart man, a PhD in fact, and I adore him and his family. He didn't deserve my frustrated tone, but he did deserve another point of view. He replied, "I obviously touched a nerve." Friends are great to remind us (me) of our outer bounds. Anyway, my reply:

That's wholly inaccurate and makes no sense, FYI. It's more like the pool is full of shared drinking water, and there was a catastrophic leak and the pool is now only half full. Nobody wants to put water in the pool because nobody's sure if it's still leaking, and nobody's really sure what happened, so everyone is hoarding their own water, what little they have left, and they are damming up every little contributory stream near them, diverting it from the pool, which only exacerbates the problem as water continues not only to leak but to evaporate.

Now the government, in charge of the pool, can piddle around complaining about who caused the cracks and blaming enemies and getting the people with little water left to get angry at those who have more water and those with more water to blame and make fun of the people who depend on the pool for daily needs and nobody pays attention to what caused the catastrophic leak or even verifying if the damn thing is still leaking. Even if the leak has stopped, how do we get the level back up so everyone will stop being afraid and restore the flows? Should politicians ask everyone just to pour their water back in on a voluntary basis and in the meantime everyone just stick it out while people with little water run out, and even those with more start running out?

Should the government put a garden hose in the pool to try to overcome any remaining leaks and maybe start to fill it back up and just hope for the best? Is a trickle sufficient? Is a garden hose insufficient? Are there enough people and neighbors who are willing to divert their own water through their own private hoses to try to fill the thing back up while nobody's sure if it's still leaking?

What if the government is the only entity with a firehose capable of shifting water -- with the promise to repay -- from big neighbor's giant pools back into our pool until we can a) stop and fix the leak and b) restart the flow of contributing streams in the system from the citizens? Mind you, our pool is already the biggest of them all, and all our neighbors' pools have unexplained leaks too, and we're all facing the same problem.

Scared water doesn't flow.

Scared money doesn't spend.

Monday, March 02, 2009

Stimulus Money for Toll Roads: Good Policy

Let the political games begin. Now that the stimulus bill funds are being allocated by state and local authorities, well-meaning but terribly misinformed citizens and grand-standing politicians are cutting off our economic noses.

The purpose of the stim bill was to create immediate spending through public investment projects, the so-called "shovel ready" projects that retain and create infrastructure jobs immediately.

The following story from The Houston Chronicle is about the current kerfuffle among perennially disgruntled citizen activists and perennially grand-standing politician enablers of both parties.

As Stephen Colbert would say, the idea that allocating stim funds to toll roads is an unfair application of public funds sounds "truthy," meaning it has a ring of truth and so often is accepted as truth by people who miss the larger context that stands their "truthy" argument on its head. First:

$700 million eyed for toll projects
Grand Parkway's among 21 Texas roads in allocation

By ROSANNA RUIZ Copyright 2009 Houston Chronicle
Feb. 27, 2009, 9:37PM

The Texas Department of Transportation has set aside more than $700 million in economic stimulus funds for toll road projects across the state, sparking criticism and questions about whether the pay-to-drive roads are an appropriate use of the federal dollars. ...

“It’s a total rip-off,” said Terri Hall, director of Texans Uniting for Reform and Freedom, a nonprofit opposed to toll roads. “That’s not how the money is supposed to be used.” ...

“I think it’s unfortunate that the discussion about these funds has eclipsed the broader discussion about the state’s transportation needs,” TxDOT spokesman Chris Lippincott said. ... [emphasis added]
I have to side completely with TxDOT on this. Toll roads, whether you like them are not, are not the issue right now. But that's really the beef that Hall has, namely toll roads in general and not this specific application of funds which has a different purpose of employing people and getting funds flowing into the cash-starved economy. I can respect Hall's citizen activism.

The political grandstanding, however, not so much:
U.S. Rep. Pete Olson, R-Sugar Land, who sits on the House Transportation and Infrastructure Committee, also questioned the use of stimulus funds on toll roads.

“It concerns me that state officials would prioritize toll projects that will hit already hard-pressed Texas drivers with additional fees,” he said... [emphasis added]
And so where has Olson's opposition to Texas toll-roads been in the last decade as the state turned more and more to toll road construction financing to avoid "public spending" to improve highways and reduce congestion? Yeah, that's what I thought.

For the record, a Democrat in the state legislature, Rep. Jim Dunnam, D-Waco, is the one "whose criticism led the commission to postpone its vote." Grandstanding has no party affiliation.

A reminder of reality from the U.S. House Transportation Committee:
The economic stimulus bill does not address toll roads, only that proposed projects satisfy requirements to create jobs and promote economic growth, said Jim Berard, a spokesman for the U.S. House Transportation Committee.
That's right. "[C]reate jobs and promote economic growth." Whether funds are used for immediate construction of schools, charter schools, highways, toll roads, government buildings -- public infrastructure regardless of how it's publicly financed is good stimulus. Now cannot be the time to piddle over the relative merits of various infrastructure projects. Is the project ready? Will it employ people? Will it create a public benefit when it's complete? That's all we need to know.

In addition to $181 million for the Grand Parkway, TxDOT’s list includes an additional $50 million for four new ramps connecting the Eastex Freeway and Beltway 8. ...
The above ramps proposal will connect a key alternative to the free I-45 north corridor into downtown Houston to the 2nd outer loop around Houston in a free portion (it becomes toll as it circles toward the west). These toll roads are not sparsely used. From before 6AM in the mornings until after 9AM and again for a few hours in the evening, these "toll" roads are used by thousands and thousands of motorists seeking the most efficient route around the city. The flyovers onto the 2nd outer ring will create even more incentive for motorists to use the toll roads and will off-set public tax dollars required to maintain these highways. You might argue with the idea, but you can't argue about the merits of the project at this moment in time.

There is a 3rd outer ring under construction in "segments" that will relieve traffic on Houston's other clogged highways that are mostly free. Better traffic capacity will benefit everyone, whether they choose to pay the tolls or stay on free highways. It's the driver's choice at any given moment on any given day.
Harris County Commissioner Steve Radack, whose precinct includes Segment E of the Grand Parkway, said the segment satisfies the federal stimulus mandate as a “shovel-ready” project. ...

Radack [argued] that a planned overhaul of U.S. 290 is not at the appropriate stage for the stimulus funds. ...
Radack points out that activists' demands that funds be used for a free northwest corridor (a "spoke" from the hub, so to speak) are misinformed because the project they advocate does not meet the criteria of the stim funds: the money couldn't be spent immediately and would not create immediate jobs. Yes, sometimes this governing stuff is actually kind of complicated.

Finally, the scale of the spending on the toll and free portions of area highways is of sufficient magnitude to achieve the express purpose of the stim funding:
The proposed Grand Parkway would span 180 miles, circling around the Houston area, at a projected cost of $4.8 billion. Segment E calls for a 15-mile, four-lane toll road that would connect the Katy Freeway and U.S. 290 at an estimated cost of $330 million, according to the Harris County Toll Road Authority. ...

Krugman: The Deficit Reduction Plan Can Work

In Saturday's New York Times, Nobel Laureate Princeton Economics Professor Paul Krugman sounds an optimistic tone about Obama's proposed new budget while still sounding a cautionary note about long-term economic challenges. It's worth a read.

Can he actually reduce the red ink from $1.75 trillion this year to less than a third as much in 2013? Yes, he can.

Right now the deficit is huge thanks to temporary factors (at least we hope they’re temporary): a severe economic slump is depressing revenues and large sums have to be allocated both to fiscal stimulus and to financial rescues.

But if and when the crisis passes, the budget picture should improve dramatically. Bear in mind that from 2005 to 2007, that is, in the three years before the crisis, the federal deficit averaged only $243 billion a year. Now, during those years, revenues were inflated, to some degree, by the housing bubble. But it’s also true that we were spending more than $100 billion a year in Iraq.

So if Mr. Obama gets us out of Iraq (without bogging us down in an equally expensive Afghan quagmire) and manages to engineer a solid economic recovery — two big ifs, to be sure — getting the deficit down to around $500 billion by 2013 shouldn’t be at all difficult.

Note all the big "ifs" however. They include a) a successful stimulus policy, which is still a working policy, and b) an ability to extremely reduce defense spending by achieving successful plans in both Iraq and Afghanistan (the new monster on our backs). Krugman also points to successful reform of spiraling health care costs for individuals and over-billing of Medicare to achieve substantial budget savings. These are big "ifs" indeed.
But won’t the deficit be swollen by interest on the debt run-up over the next few years? Not as much as you might think. Interest rates on long-term government debt are less than 4 percent, so even a trillion dollars of additional debt adds less than $40 billion a year to future deficits. And those interest costs are fully reflected in the budget documents.

This is somewhat more optimistic than yesterday's post here about the risks of overextending the national debt as a) tax revenues decline with contracting production in the economy, and b) federal debt-spending is required to unfreeze credit markets and replace lost demand (to preserve jobs basically). This is a double whammy, but Professor Krugman says these dynamics could feasibly be limited to the short term, an assumption on which all policy planning seems to depend right now.

The overall outlook is best summed in Krugman's closing lines.
So we have good priorities and plausible projections. What’s not to like about this budget? Basically, the long run outlook remains worrying.

Sunday, March 01, 2009

Early Indicator: Interest Rates to Rise

I received the following from a lender at Network Funding LP, but I can't figure out who owns the copyright. At any rate, very interesting headline and information.
Supply Concerns Boost Mortgage Rates

... [M]ortgage rates rose slightly during the week. The reason is that concerns about the enormous supply of debt that the government will need to issue outweighed the other factors. [emphasis added]

...This week, the Obama administration proposed a $3.6 trillion budget plan, with an estimated deficit of $1.75 trillion, which is enormous by historical standards. The Treasury will need to issue debt to borrow money to fund all of this. As the government issues more debt, the interest rate offered generally must rise to attract additional investors. Interest rates on similar investments such as MBS then move higher as well to compete for funds from investors.

Reflecting their concerns about an increase in supply, investors required higher interest rates at the large Treasury auctions during the week. The auction results showed that demand from foreign investors remained strong, which was very good news. If foreign investors should ever reduce their purchases of US bonds, then interest rates in the US would be likely to rise. [all emphasis added]

These are dynamics long discussed on this blog. Like day follows from night, so will inflation follow from the massive stimulus required to unfreeze credit and consumer markets where "scared money doesn't spend." Not to mention the very very real massive losses the banking sector faces from their catastrophic past lending practices, which further reduces available private money into the demand side of the economy.

These factors necessitate the enormous spending from the last credit-worthy entity capable of replacing all the lost demand (through debt-financed spending), namely the federal government.
Unstated in the quote however is the notion that investors/lenders require higher returns when loaning money even to the United States government because at some point, the investors/lenders begin to worry a little bit more about the government's ability to raise enough tax revenue from the economy's future production in order to pay for the national debt load (remember we're starting already over $10 TRILLION in the hole, with an actual doubling of the national debt in the last 8 years with nothing to show for it).

An important caveat: The United States will never default on its loans, that's the market assumption. But it may, if necessary, only avoid doing so essentially by printing money to pay down the debt, which only ends up causing inflation as new cash enters the system without being backed by any real production or assets. This raises prices of everything, yes, but it also reduces the real value of debt as "printed money" pays down the loan balances. Everyone loses.

To illustrate, imagine if you could pay off your mortgage not by keeping a job and making payments with the fruits of your labor or even by inheriting enough existing money to pay it off -- but rather you could just print your own money to pay it off, or successfully pay it off with a "valid" hot check. See? The only "winner" is the one printing the money, but then the printer will never get an affordable loan again either.

That's kinda the dynamic that gets figured in here, the risk level of that scenario above actually happening, as foreign and domestic investors consider issuing loans to the federal government. As the lenders' or "investors'" concerns rise, then so does the pay they demand in return for their loan -- the interest rate.

And all interest rates are related in some fashion. So when the federal government has to pay a higher interest rate for its debt, so too do individuals borrowing with mortgages, as no person or entity is seen as "more" credit-worthy than the United States government.

(In finance, the 10-year Treasury bond rate is often referred to as the "risk-free" rate.)

No, this will not be on the exam.