This report is the first of many blogs that will update my readers of "The Aftermath of Greed, Get Ready for the Coming Inflationary Boom" as well as those of you who may not have read my book.
Since the recovery of the residential real estate market is perhaps the primary exponent for a rebound of the broader economy, a critical update of the mortgage industry and the bailout of Fannie Mae and Freddie Mac (hereinafter referred to by their respective stock symbols FNM and FRE) is first and foremost.
Over five years ago I referred to FNM and FRE as the "evil twins", while teaching "Trends & Cycles in Real Estate" at the Southwestern School of Real Estate. Most attendees dismissed the inference, until now.
Citing reference from the excellent and courageous investigative journalism at the Wall Street Journal, I informed my classes that management at FNM was "cooking the books" and in time the story would unfold that could imperil FNM's existence as a publically traded company.
As I pointed out in GREED, the looting of FNM by Franklin Raines, its CEO, and others was particularly onerous. In 2000, Mr. Raines paid himself $20 million in compensation based, in part, upon $10 billion in profits that did not exist. Although Raines was ultimately fired, he was not required to repay bonuses received based upon fraudulent numbers and retired comfortably on $1.6 million per year — when he should have been serving time. Paul A. Gigot, who is the editor of the Wall Street Journal's editorial page and FNM's chief protagonist (and who was vilified from all quarters) sums it up appropriately when he said on July 23, 2008:
"The abiding lesson here is what happens when you combine private profit with government power. You create political monsters that are protected both by journalists on the left (like Paul Krugman of the New York Times), pseudo capitalists on Wall Street, by liberal democrats, and country club Republicans. Even now, after all their dishonesty and failure Fannie and Freddie could emerge from this taxpayer rescue more powerful than ever."
FNM and FRE, the "zombies" of finance (the dead feeding off the living), have been bailed out by US taxpayers as part of a broader housing bill that will become effective October 1, 2008, which allows the US Treasury to extend an unspecified (say unlimited) credit line to the twins. The bill also authorizes the government to buy stock in either company. FNM's and FRE's stock price had fallen more than 80% in the past year. It appears to this writer that this equity provision was inserted into the bill to reassure institutional investors who had been called upon to shore up the firms' capital, that there wasn't going to be a full nationalization of the companies (near term) rendering their investment worthless.
Capitalism has morphed into a new economic model. Profits are retained by private interests and losses are absorbed by taxpayers (more later).
The other major component of the housing bill (which is tabbed the "Housing & Economic Recovery Act of 2008") is the expansion of the Federal Housing Administration (FHA) which will insure up to $300 billion in new loans for desperate homeowners who could not qualify for FHA loans under existing rules and law. Forget the old Great Depression era FHA. This is a new turbo-charged, gas guzzling, super slick version of the old Model T and it runs on your greenbacks.
Based upon information available as of this date, here's an example of how the new FHA program might work.
A homeowner (who has spent at least 31% of their income on a mortgage) has an existing high interest sub-prime loan with (let's say) Countrywide Financial. The loan may already be in default as is 48% of Countrywide's $30 billion sub-prime portfolio. The borrower can refinance with the new FHA on a 30-year fixed rate loan at an interest rate significantly lower than any prime borrower on a conventional basis. Countrywide agrees to write down their mortgage to 85% of the current appraised value in exchange for a new loan guaranteed by FHA. The borrower presumably now has a loan that is affordable, Countrywide owns a loan that is fully valued on its balance sheet and the risk of default is assumed by taxpayers. A perfect win-win you-lose scenario.
The housing bill (HERA 2008) has a myriad of other features. Some are:
— A fund to provide more low income housing.
— A tax credit up to $7,500 for home buyers repayable interest free over 15 years
— A provision whereby the homeowner will share in any gains with FHA on a sale or refinance of the home.
— Grants for states and local government to buy foreclosed homes
— Counseling for homeowners being foreclosed.
— Raise loan limits for FNM and FRE to $625,000
— Raises the Federal Debt Limit to $10.6 trillion from $9.8
The paramount question is: What impact will this legislation have on the real estate market and when?
Once the massive bureaucracies at FNM, FRE, and FHA initiate their new guidelines, I believe that the results will be decidedly positive. Markets move on fundamentals and emotion. The housing bill changes the fundamentals. The present psychologically depressed market atmosphere will quickly turn positive as refinancings slow the foreclosures and new sales begin to absorb inventory. Hope Now Alliance has reported that it has renegotiated 181,000 loans in June and almost 2,000,000 homeowners have remained in their homes since the program started — another positive.
The new FHA loan limits are the greater of $271,050, or 115% of the local area median home price capped at $625,000, therefore the largest market segment in the US will come under the new law. The down payment has been increased from 3% to 3.5%. Starting October 1, 2008, the FHA will no longer accept down payment "gifts" that are funded by the seller (unless provided by an uninterested third-party) which will negatively impact sales but some experts believe that the $7,500 tax credit provision will be as effective longer term for home buyers. Given the history of the ten boom and bust cycles in the US over the past 34 years, this bail out plan was predictable and should serve as the cornerstone of the inflationary boom I forecasted in GREED.
For all the positives, there is a cost.
Every crises creates an opportunity for those who seek more power. Henry Paulson, the US Secretary of the Treasury, has proposed that ALL lending agencies, banks, investment banks, mortgage companies, mortgage brokers, et al, come under the jurisdiction of the Federal Reserve. That may comfort some, but to this writer it is a consolidation of power in the hands of a few — collectivism. Remember, it was the Fed's Greenspan Plan that initiated the real estate and lending bubble in 2002 and the Federal Reserve that took no action to curb the "Merchants of Debt" which led to the market's implosion and this aftermath.
Market consideration aside, I'm compelled to advise my readers that what has occurred in July 2008 represents a paradigm shift in America. Capitalism, as I've known it during most of my lifetime (the 1930's an exception) has acquired a terminal (but curable) illness. The Greenspan Era marked by the commoditization of credit (where character didn't count) and the securitization of debt (where the originators of the loan no longer retained an interest in the loan) has imploded in the aftermath of greed and in its place America begins its slippery slide to Socialism. As outlined in GREED, this fifth bust cycle since 1974, has prompted another short- term government fix that will manifest itself in a greater problem later. As a market analyst, I can give you this upbeat positive economic forecast for the near term. As an erudite pundit, I have to admonish you:
SOCIALISM HAS AN UNBLEMISHED RECORD
IT HAS NEVER BEEN SUCCESSFUL
Your comments and inquiries are welcomed.
H. L. Quist.