Europe is on the edge. Most analysts are undecided: they're not sure if the situation there is bad or really bad.
Stocks are down, but the market seems undecided as to whether it will move back up or drop further down. Bonds are surging, setting records for low long term yields. Last week, financials were hammered, BOA most of all, but the damage was widespread. The FHFA, the conservator for Fannie and Freddie, broke with Treasury and filed 17 separate suits against individual banks and investment banks, claiming (for the first time) fraud, and seeking significant restitution. Some forecast that the drag from financials will be too much for the market to shrug off, so we are headed south
Some very few bright spots: auto sales are strong, and the Big Three are profitable and have added workers. Business profits continue strong, but this has been based on productivity, not revenue growth. Companies are getting the same output with many fewer workers, raising margins sharply and giving strong bottom lines. But this cannot continue forever. At some point, you need to build revenue.
The housing market is still soft. The pace of foreclosures has slowed dramatically from last year; and many analysts agree the "paperwork problem" is a major cause of the slowdown. Banks simply did not convey the mortgage papers to the securitization trusts, beginning in 2003, which would not have been a problem if they didn't need to foreclose. No one ever would have known. But foreclosures need paperwork, and surprisingly, judges, when they wake up, want to see proper paperwork. Since the papers weren't there, the banks began robosigning. When they were caught a year ago, they stopped for a short while. Now, in a major report from AP, they are at it again. When you don't have the papers, and you need to foreclose, you have to create them. Servicers are trying to claim that they are simply "implementing" the original transfer intent, even when they sign as officers of now defunct mortgage companies.
It's a mess, a HUGE mess, that is finally in the process of being uncovered. Treasury fought this uncovering tooth and nail. They correctly understood how this would derail the housing market. But with last week's events, it looks like they have failed. The truth is coming out. And this may well sink one or more banks. An early indication: US Bank, filed a $1.7 billion suit against BOA, putting ALL the mortgages in a trust they were trustee for back to BOA, saying they were all tainted in some way. This compares to the much cozier deal between BOA, Bank of New York Mellon, and some big bondholders (which is now under full scale attack for being way too easy on BOA), where BOA is only dinged for 2% of the nominal total of $440 billion in MBS bonds.
We cannot have a healthy economy with a sick housing market and our banks potentially about to be rendered insolvent, through exploding legal liabilities.
What's to be done? First, a few numbers. From Calculated Risk:
So 3.7 million homes have been foreclosed or sold by short sale by the end of 2010, with 4.3 million more loans in foreclosure or seriously delinquent. A separate estimate of home mortgages underwater in March of this year from Core Logic as reported in The Huffington Post has a total of 11.1 million home mortgage underwater, or 23.1% of US homeowners with a mortgage. Probably half of the 4.3 million loans in the table above are included in this 11.1 million figure, so will estimate that 13.3 million mortgages are underwater or in foreclosure, about 28% of total homeowners with a mortgage. Nouriel Roubini has estimated that an additional 8 million home mortgages are "close to underwater", i.e., within 5% of market. If this is a fair number, then 21.3 million home mortgages are underwater (or close to underwater), or almost 45% of homes with mortgages.
Now let's look at the rest of the household financial picture: have households cut down on other, non-mortgage obligations? are they saving more than before the crash? The answer to both questions is yes, according to the von Mises Institute:
The red line is a measure of consumer saving as a per cent of income, measured on the right scale. And the blue line measures non-mortgage obligations, as a per cent of income, measured on the left scale. This is clear and present evidence of why this recession is so tough to solve: this is not a business cycle recession; it is a balance sheet recession, with the balance sheet that got way out of whack belonging to the individual homeowner.
The consumer clearly wants to deleverage. As long as he/she is doing this - and the process will take years - GDP growth will be diminished. Remember:
GDP = C+ I + G + (X - M)
And the main driver (70%) is the individual consumer buying, i.e., C. As long as individuals feel the need to save and pay down debt at a higher than normal level, US GDP will struggle.
Is there anything to do to help Main Street, and in the process clear out the logjam in the housing market? And in looking for a policy solution, can we avoid the "moral hazard" problem of helping bad actors and doing nothing for folks who responsibly kept on making all mortgage payments?
I think so. In very broad outline, here is the idea: The Federal Government will buy up mortgages at fair market value and rent houses back at market rates, converting the homeowner's mortgage payment into rent. If the homeowner performs well in making rent payments over three years, he/she has an option to buy at fair market value with 5% personal cash, a 15% second mortgage, and an 80% first mortgage guaranteed by the government (FHA, Fannie, Freddie). This is modeled after the highly successful 100 year plus Danish mortgage program.
FDR's HOLC (Home Owners' Loan Corporation) bought and restructured one million loans for homes that had been foreclosed - with great success. Believe we should shoot for a 5 million home target, possibly more, which would be a huge movement of housing product off the active market and a gigantic deleveraging for consumers. The moral hazard problem would be addressed because homeowners who have stayed current could apply, as well as those facing foreclosure; and the homeowner is giving something up - ownership in the house.
Banks will not like this because they would have to write down their firsts and, most likely, write off their seconds. It might make sense to start with Fannie and Freddy, who already own a bunch of mortgages; but as FHFA Director Demarco's pushback against Treasury is now showing, this guy takes his conservator duties seriously, and will not just do anything Secretary Geithner wants. But there are ways, and, frankly, a banking crisis would make a plan like this easier to do.
How much would this cost? 5 million homes, assume a mortgage of $75,000: total investment - $375 billion.However, this is investment, not expense; and if the market pricing is right, the government should not lose money. The idea would be to package these homes and sell them off to Public/Private Partnerships (PPIP revisited) who would manage the pools of properties, instead of having this fall to the government.
This does not kill the American dream of homeownership - it defers it for a few years, and then it is resupported on a fiscally sound basis. "Dead beat borrowers" are not getting a free ride: they have to give up their ownership rights in the house; they have to pay market rent; and presumably they should be asked to keep up the home.
Is this doable politically? Right now, probably not. If there is a second banking crisis, probably yes. More soon.
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