Thursday, October 16, 2008

FDIC ChairWoman and Me....How To Put An End To This Mess.

I think I've found my hero, Sheila Bair, the FDIC Chairwoman. In an interview with the Wall Street Journal she said:

"Why there's been such a political focus on making sure we're not unduly helping borrowers but then we're providing all this massive assistance at the institutional level, I don't understand it," she said. "It's been a frustration for me."

The fatal flaw in the plan's being pushed by the Treasury and the Federal Reserve is that none of the plans address the underlying issue - housing prices and foreclosures.

This is not to say the government isn't doing a lot, they are - which is different (despite what is being misreported) than during the Great Depression. The government became hands off and protectionist during the Depression and held onto the Gold Standard for too long. Things didn't start improving until the government stepped into help - its not that things wouldn't have naturally improved, they would have, but it could have taken even longer.

This time the government (and world governments) have taken measures to help prevent what happened in during the Great Depression, so far they have been unsuccessful, but I suspect that many of the measures are simply a matter of time.

Of course the one thing nobody has addressed directly is housing and foreclosures. Congress did pass a $300 billion "Hope for Homeowners" package earlier this year, but that was a smokescreen to make you THINK they were doing something about the little guy when in reality they were passing legislation to bail themselves out of the Fannie and Freddie mess (the bill was modified to allow for the conservatorship of the two mortgage giants). The Hope for Homeowners program is in a word...non-existent. The program was meant to encourage lenders to lower the loan amount to 90% of the current home value and then refinance the loan off the books into the FHA - because it required such a massive write down, there has been very few if any takers for this program. In fact, it is nearly impossible to get a lender to even talk about the program, IF they even know about it. Heck, I called Freddie Mac the other day and an employee of 20 years didn't know he was now a government employee!

John McCain has actually taken a very good stab at this underlying problem, yet has gotten zero credit for it....most likely because his proposal is a complete giveaway. He proposes to refinance underwater homeowners out of their loans - basically buying the loans at full price from the institution who owns the loan. The problem with this proposal is it is TOO MUCH government money being spent. You may think me crazy to say that considering the $700 billion "rescue" package that congress passed (at a treasonous cost of $150 billion in extras), however there is a high probability that the entire $700 billion will come back plus more, so in reality it isn't really a giveaway, its an investment that should (that's a big should) bring more into the treasury than is expended.

Its easier to propose a $700 billion dollar program that will make the Treasury (and thus the American people) money than it is to propose a $300 billion program that is a direct giveaway to banks and taxpayers. Readjusting the mortgages by reducing principal is a good idea and will help to stem the current crisis and get housing back to stability, but it shouldn't be done as a complete giveaway.

For those of you who are wondering just why the heck I would propose rewarding those who got themselves in over their head you must remember that you are being affected by this crisis precisely because of these people's situation and THEY now hold the power over all of us. What do I mean? Let me give you a personal example, myself:

Four years ago my wife and I decided that it was just too expensive to buy the home we wanted in Orange County. We wanted to have more children and I wanted her to stop working (for at least a few years), the problem was that I felt the housing market was overpriced, in fact, I was featured in a June 14, 2004 Bloomberg article by John Wasik titled "Is U.S. Housing Boom Coming To An End?". The opening to the article is as follows:

"Is the long, ascending march in U.S. home prices reaching a summit?

Scott Dauenhauer, a fee-only financial planner in Laguna Hills, California, for one, isn't sanguine about home prices in Southern California, where double-digit increases are common.

Having sold his 1,000-square-foot, two-bedroom home six months ago for $350,000 -- he paid $170,000 in 2000 -- Dauenhauer says he's not really timing the market, yet found home prices in his area ``ridiculous.'' He's looking for a three-bedroom home with a yard for his wife and three-year-old son in Orange County. For now, he's renting while prices continue to soar.

As rising mortgage rates chasten the housing boom, it's time to consider whether you should buy new property or borrow against your home based on the presumption that home prices will ascend endlessly.

``A friend who lives about mile away who has a four-bedroom, 2,500-square-foot home said a home similar to his just sold for over $900,000,'' Dauenhauer said. ``I think there's a bubble. It's similar to the Nasdaq (stock market) several years ago. I tell any clients who come to me who want to buy a house that there's more downside than upside now to the home market.''

To buy the home we wanted in Orange County would end up costing up at least $1.2 million (this was 2004), this is an interest-only payment of $6,250 per month, add in taxes and HOA dues and the monthly cost rises to about $7,800. I pride myself on living within my means and being able to offer a great financial planning service at a reasonable cost, it was clear what I had to do - either double my fees to my clients (which I wouldn't do) or move out of Orange County and buy where I could afford.

We decided to move to Murrieta, CA - a town an hour east of Orange County. We were able to buy a brand new home just like the one we wanted in Orange County for $470,000, that is a 60% savings. We saw the bubble coming and did what we thought was best, buy what we could afford. The problem is that Riverside county (where Murrieta is located) got hit hard by the bubble, much harder than I would have ever expected. Murrieta's rapid growth came from people who worked in Orange, Los Angeles, and San Diego Counties - they commuted (sometimes the husband and wife). When gas prices nearly tripled to close to $5 per gallon, it was too much to take - they were spending upwards of $1,000 or more per month on gas and living in a home that had fallen dramatically in value.......many left. This caused an even further decline in housing prices. I had my home appraised in February 2007 at $555,000. I knew this was a sham appraisal, there was no way it was worth that - I saw this happening everywhere (I called them pick-a-price appraisals). My house is now worth probably $270,000 (though I doubt I could sell it for more than $250,000). There were a lot of people buying houses that never should have been in the market in the first place and this artificially inflated prices, when those people left the market......the merry-go-round stopped and prices fell dramatically - in my case 55% from its high.

Unlike many of the homeowners, I've got a great deal on my mortgage. I've always believed in being conservative when it came to a mortgage - thus I got myself a 30 year loan with a 5.875% interest rate. The payments are affordable and there are no adjustments to come. The problem though is my house is worth a heck of a lot less than what I owe. The power has shifted dramatically to me - if I walk, the owner of my loan is going to have major problems. The second trust deed would be completely wiped out and the first trust deed would have a foreclosed home that will sit on the market for 6 - 12 months or longer with no income and will probably sell for $250,000 if they're lucky. This is a minimum 40% loss for the first trust deed holder. I've got every incentive to walk away and if I suffer. By the way, I'm not walking away - but there are a lot who would.

You suffer because the downward spiral will continue in housing, we'll see more houses on the markets due to foreclosures, less buyers because the banks will continue to NOT loan money as their balance sheets deteriorate even further (and need even more government infusions) and the mortgage backed securities will be worth even less....which creates even further problems. Just as in the great depression, the banks have stopped lending (71% of home lending during the great depression was government). They won't start lending again until they see safety. Washington Mutual has a huge amount of Option Arm loans coming due in the next 24 months and this will put further pressure on homeowners to walk away. The more that walk away the further the decline goes and the more everyone suffers - Trillions have been lost because Billions were walked away from. One other you think I'm going to put a dime into my house while its worth about half what I paid? Not a chance, my wife wants hardwood floors and crown moulding.......there is no way I'm putting money into this thing.......and I can tell you that my neighbors feel the same way, this further hurts the economy.

My main point is the FDIC Chairwoman is right, we need to give an incentive to homeowners who can afford to stay in their homes to actually stay in the homes and not walk away. As much as I hate government intervention, desperate times call for desperate measures and a program that combines government incentives, direct infusions, government guaranteed loans and a loss sharing provision with the banks and owners of the loans is what is needed. Banks shouldn't be made whole by the government, however if they have to take too much of a loss they simply won't take it.

I'm not saying all of this as an effort to get a government bailout, if it helped I'd forgo principal reductions if it meant others could get them. My clients stock portfolio's are hurting right now and the underlying causes are not being addressed - that is my main concern.

It is time we moved past this housing/credit/financial crisis and the way to do it is to address the underlying problem - housing.

Scott Dauenhauer, CFP, MSFP, AIF