Have We Learned Nothing?

Michael Pomerleano writes that nothing has changed in terms of regulating our global financial system, he is afraid of another crash, I encourage you to read this article, what follows are a few excerpts:

Considering the number of luminaries attending — Christina Romer, head of the Council of Economic Advisers, and Kevin Warsh, a member of the board of governors of the Federal Reserve System, among others — I expected to find a strong shared sense of direction and a determination to take the correct steps following the financial carnage. I did not.

Foreign participants free of official shackles or self-imposed loyalties to past institutional affiliations were forthright. Andrew Sheng of the China Banking Regulatory Commission reproached us for thinking that throwing debt at a global problem of insolvency will succeed. He presented striking data. The subprime losses of $150 billion in 2007 required US government aid of $13.2 trillion as of 19 June 2009. In 2008, salaries of the top 10 banks reached $75 billion (up from $31 billion in 1999), while cash dividends to shareholders were only $17.5 billion. Management took 4.3 times more than shareholders at a time when shareholders were injecting capital and government was guaranteeing deposits. He pointed to the critical principal-agent fiduciary problem. Essentially, financial sector losses will be paid for by future taxation (large fiscal debt) or inflation. To this I add that the US Treasury “stress tests” led to an injection of roughly $67 billion in 2009. This year alone, the committed bonuses are more than $75 billion.

Francesco Papadia of the European Central Bank observed at the conference that in Europe there is no debate about the ECB. I can only conclude that both the EU and the US are tolerant, naïve societies prepared to accept the loss of our future to regulators and financiers. Sadly, the indifferent attitude in Europe and the debate in the US are leading to a path of no reform, and the financial system will game the taxpayer again.

Unbelievable.


Scott Dauenhauer CFP, MSFP, AIF

Idiocranomics: Re-REMIC's...More of the Same, Did We Learn Nothing

When I read this Wall Street Journal article I about fell out of my chair. I honestly thought it was a parody, something you'd see on The Onion, its not.

In essence a Re-REMIC is a repackaged pool of loans....or a re-repackaged pool of loans! Banks and Insurance companies are upset that they can't sell the junk on their balance sheet and they are ticked that they have to actually hold capital against lousy assets, so they came up with a scheme to package junk assets with seemingly "good" assets, pay a ratings company to turn the entire package into a AAA rated security so that they can hold the same assets on their balance sheets......but with less capital. Does any of this sound familiar to you? Anyone?

"There is $350 billion to $400 billion in market value of securities with no natural buyer due to their rating," Barclays said in a June report. "The re-remic market provides a way out of this gridlock by creating new AAA securities, which are likely to be viewed as attractively priced."

It is quotes like the above that make me want to both laugh and cry because they are so incredibly stupid. So the bank holds assets that there is "no natural buyer" because they are poorly rated....this is total and complete baloney - every asset has a buyer at the right price. Secondly, if you put lipstick on a pig, you still have a pig - but the Wall Street magic combined with a small payoff to one of those trusted rating agencies turns the pig into something, a Stallion if you will. This is the same financial alchemy that was at the heart of the financial crisis.

A year later and we've learned nothing.

Scott Dauenhauer CFP, MSFP, AIF

No-Money Down...Back in 2005!

Hussman: Tradeable PAR's = Solution to Mortgage Mess

If you don't read John Hussman's Weekly Commentary, you are missing out (find it at www.hussmanfunds.com). This week's commentary is especially brilliant, not just because of the market commentary (he is not optimistic), but because he continues to provide details of a system that would help to solve our nations mortgage mess (no it has not been solved and its about to get much worse) without much help from the taxpayer. I've provided an excerpt below, but you should really read the entire commentary.

The mechanics of PARs

On the mortgage side, I noted in March (On the Urgency of Restructuring Bank and Mortgage Debt, and of Abandoning Toxic Asset Purchases) “If there is any good news at present, it is that the capital infusions of late-2008 have temporarily stabilized the banking system, and that the U.S. economy is presently enjoying a brief and modest reprieve from the financial crisis. This is largely the result of an ebbing in the rate of sub-prime mortgage resets, which reached their peak in mid-2008, with corresponding mortgage losses and foreclosures a few months later. Since this crisis began, the profile of mortgage resets has been well-correlated with subsequent foreclosures. This reset profile is of great concern, because the majority of resets are still ahead. Moreover, the mortgages to which these resets will apply are primarily those originated late in the housing bubble, at the highest prices, and therefore having the largest probable loss. Undoubtedly, some Alt-A and option-ARM foreclosures have already occurred, but the likelihood is that major additional foreclosures and mortgage losses lie ahead. If we fail to address foreclosure abatement during the current window of opportunity (early to mid-2009), there may not be time for legislative efforts to contain the resulting fallout.”

We have done nothing material on this front. I continue to believe that foreclosure abatement requires debt restructuring. Short of major voluntary write-downs by lenders, which are unlikely, the best approach would be to use the Treasury as a coordination mechanism to administer what I've called “Property Appreciation Rights” or PARs (skip to the next section if you believe the credit crisis is over).

Here is some additional detail on how these might work. A homeowner with a mortgage of say $350,000 would renegotiate the debt with the lender, replacing it with, say, a $200,000 mortgage obligation plus a $100,000 PAR (and an outright reduction of $50,000). The PAR would not be payable directly from the homeowner to the mortgage lender. Instead, two things would happen. First, the homeowner would owe the PAR amount to the Treasury out of any future appreciation of the home, or if sold, appreciation on subsequent property, and ultimately out of the homeowner's estate (possibly less some exclusion based on the size of the estate). Second, the Treasury would aggregate all PAR payments received from the pool of homeowners owing them, and would distribute them proportionately to the mortgage lenders holding the PARs. In this way, the PARs would be fully tradeable and investable instruments, similar to closed-end mutual fund shares, with the Treasury acting essentially as a payment collector (through the IRS) and transfer agent. The PARs would most likely trade at a discount to their face value. More on that below.

In order to prevent advantages or disadvantages based on the date one enters the PAR pool, new revenues would be distributed to PAR holders in proportion to their remaining unpaid claims. The “Face Value” of each share would be calculated by the Treasury as the ratio of unpaid PAR claims to the number of PAR shares in existence. In practice, it would be reasonable to have several “tranches” of PAR shares, reflecting differing loan-to-value (or better yet, PAR-to-value) classes, which clearly have differing probabilities of being paid off in full.

For example, suppose the pool begins with $100,000 in PAR obligations from a homeowner, and the Treasury issues 100,000 PAR shares to the mortgage lender, for a Face Value of $1 a share. If $20,000 of payments are made, the new Face Value for a share would be reduced to the ratio of Unpaid Claims to Outstanding Shares, or $0.80.

Suppose now a new $100,000 of obligations enters the pool. In this case, the mortgage lender receives 125,000 PAR shares ($100,000 / $0.80). There are now $180,000 in unpaid obligations, and 225,000 outstanding shares, not surprisingly, representing $0.80 of unpaid claims per share. If a payment of $45,000 was now received, $20,000 would go to the mortgage lender who has 100,000 PAR shares), and $25,000 would go to the second lender (who has 125,000 PAR shares). In each case, the amount received is proportional to the outstanding amount of unpaid claims due to each holder.

Would the PAR securities trade at face value? Probably not, and that is a great advantage, because it provides a natural way for the underlying mortgage debt to be restructured while at the same time pooling the losses across all participants.

Specifically, in addition to satisfying payment of a PAR obligation by paying money to the Treasury, the homeowner could tender PAR shares (purchased on the open market) directly to the Treasury, and have the obligation canceled at the then prevailing Face Value of those PARs. I know that sounds complicated, but consider an example.

Suppose that a homeowner has a $100,000 obligation to the Treasury. Suppose also that the current Face Value of a PAR is $0.80, and PAR shares can be purchased on the open market (from mortgage lenders liquidating their questionable loans) for say, $0.60 a share. In lieu of paying $100,000 to the Treasury, the homeowner could tender 125,000 shares ($100,000 / $0.80 face value), to the Treasury, which would in turn retire the outstanding PAR shares as well as that homeowner's obligation. As a result, the Face Value of other outstanding PARs would be unchanged, so no existing holder would be helped or harmed by the transaction. Those 125,000 shares would cost the homeowner only $75,000 on the open market, even though it would cancel a $100,000 obligation.

This is important: notice that what has happened here is that some existing PAR holder has, in effect, negotiated a reduced mortgage settlement with some homeowner (in this case, a $25,000 reduction in the mortgage obligation), canceling that portion of the mortgage debt, even though the PAR holder may not have been that specific homeowner's lender in the first place.

In short, by creating a tradeable instrument, administered by the Treasury (but not requiring any public funds other than those administration costs), a market mechanism would be created to settle troubled mortgage obligations, even between unrelated participants.

Scott Dauenhauer CFP, MSFP, AIF

Idiocranomics: Ken Fisher Says We Need More Debt...What?

If this video doesn't blow you away I don't know what will. Here is a guy (warning, he's among the most narcissistic money managers around) who argues with a straight face that the United States is "underindebted" or we don't have enough debt. He then perpetuates the myth that we had more debt at the end of WWII than we do now (which is true if you exclude entitlement debt which is off-balance sheet).

This is truly unbelievable, the US is not "underindebted" it has way too much debt and its getting worse. Why anybody gives this guy any credibility is beyond me.



Scott Dauenhauer CFP, MSFP, AIF

Strong or Weak Dollar? Inflation or Deflation?

The Dollar has been weak lately and if you listen closely enough you can hear the printing presses at the Fed working overtime. This would of course mean that the dollar is about to collapse and no longer be the reserve currency of the world, it also means hyperinflation unlike anything the US has witnesses since the Civil War.....or does it?

Let me first state that I am concerned about the dollar weakening. I am concerned about inflation and the national debt makes me sick to my stomach. Having said that, I'm also concerned about deflation. I can make plausible arguments for both a strong dollar and a weak dollar, as well as for both inflation and deflation.....and that is the problem.

The future is impossible to predict, but there are always signs that lead you into the right direction, avoiding the forks in the road is the tough part.

I can paint a plausible scenario of a dollar collapse, except that I can't figure out just what currency would take the place of the dollar. What currency in the world is deep enough (in terms of availability) and stable enough (in terms of the economy and debt) to overtake the dollar? Certainly not China's. The world is not about to trust their reserve currency to a communist nation, even one that has become dominant utilizing some capitalist themes. The U.K. is weaker than the U.S. and the Euro is just not strong enough....yet. We could see a dollar devaluation, but not a collapse against other currencies, the dollar could continue to be the reserve currency, but we could witness a collapse of the dollar against certain commodities....instituting a "commodities" standard.

We could see deflation for several years, then followed by inflation. What is clear is that nothing is clear right now.

What I do know is that the Fed is attempting to re-create the bubble in asset prices. What I do know is that the financial system we have currently is in shambles and by not letting it fail, we've essentially made the price much higher when it does.

The Federal Reserve Chairman has been paraded as a hero, the captain of a marvelous vessel. This vessel may very well be the Titanic.

The stock market may very well continue to rise, that is not something I can predict. Interest rates may stay low as people hoard cash and create such demand that interest rates stay low. It may take many years before the problems that were solved with band-aids rip open again and reveal that major surgery was needed.

In the meantime, the bulls are running, the recession is over......here's to the new bull market!!

As for the 23% of un or under-employed people in California and in other states, its time to celebrate.

If you get the feeling that I'm a bit pessimistic, you are probably correct. I am a life long optimist, however I try to temper my optimism with a bit of realism, there are paths out of these problems. The paths are not easy, they will hurt - this current path is not sustainable.

Scott Dauenhauer CFP, MSFP, AIF

Wells Fargo Time Bomb? Give Me A Break

Can somebody tell me why the following is even happening? I'll let you read the story, but the quick and dirty is that Wells Fargo bought Wachovia and with it came exposure to some derivatives that have a good chance of blowing up (in other words major losses that might not be showing up on the balance sheet now). My beef here is not with Wells Fargo or Wachovia (okay, a little with Wachovia) its with the Federal Reserve and the FDIC - how in the world were these "Banks" allowed to write insurance policies on risky mortgage securities? Why is this stuff even on a bank's books?

I keep hearing calls for greater regulation, of which some of it I support (like requiring a company to reserve their CDS exposure), however I have to wonder why we aren't talking about how badly our current regulators failed. Under Ben Bernanke and Timothy Geithner (during the Bush years) banks were essentially regulated as if risk didn't exist. Our banking regulators were so asleep at the switch one wonders if they weren't on an Ambien drip; yet they are the same ones who are now in charge and calling for greater regulation. Just who is going to enforce these new regulations? The same guys who failed to enforce the old regulations?

In my opinion banks need to go bank to being banks, they shouldn't be writing unreserved, off-balance sheet insurance policies on esoteric, difficult to value securities. They should make appropriate loans and accept deposits - nothing else.

I never supported Glass-Steagall's repeal, but I also wasn't against it....I figured we would put appropriate and reasonable measures in place to protect the banks and taxpayers, I was not just wrong, I was naive (I was only 23 at the time). I saw the combination of entities that were highly regulated and relatively low-risk to be a no-brainer. In reality there is no reason why banks and insurance companies can't be combined, if regulated properly - however, investment banks should not be traditional banks.





Scott Dauenhauer CFP, MSFP, AIF

China alarmed by US money printing

When China begins lecturing us and it makes sense.......that is not good.

"If they keep printing money to buy bonds it will lead to inflation, and after a year or two the dollar will fall hard. Most of our foreign reserves are in US bonds and this is very difficult to change, so we will diversify incremental reserves into euros, yen, and other currencies," he said.

No pun intended, but....the money quote:

"The US spends tomorrow's money today," he said. "We Chinese spend today's money tomorrow. That's why we have this financial crisis." Yet the consequences are not symmetric.

"He who goes borrowing, goes sorrowing," said Mr Cheng.

It was a quote from US founding father Benjamin Franklin.

The Communist Chinese government quoting Benjamin Franklin.......does anyone else feel like they are living in the Twilight Zone?

Scott Dauenhauer CFP, MSFP, AIF

WSJ: Warning, The Deficits Are Coming

You Must Watch IOUSA

I just finished watching I.O.U.S.A, a short version is embedded below for your viewing pleasure (or displeasure). You can watch the full version online if you have Netflix. I've linked above to an article by John Fund in the Wall Street Journal in which he interviews David Walker, former head of the Government Accountability Office (I know, sounds like a contradiction in terms, but stay with me).

I encourage you to watch this video and to read the article. It is non-partisan, but extremely important. We are racking up debt at an unprecedented pace and we've been doing it for years now. Did you know that adding Medicare Part D added an additional $8 trillion unfunded liability to our nation's balance sheet (which shows up off-the balance sheet!)?

We are on a path toward destruction and its not just one party. In our two party system of Democrats and Republicans we have essentially a one-track mind - Spend, Spend, Spend. Democrats prefer Tax and Spend, Republicans prefer Cut Taxes and Spend - both parties are very united behind one value - Spending. Sure, they like to spend on different things, but they both spend and are both out of control. America and its politicians are addicted and each new session of congress is the fix our congressional leaders need to satisfy their obsession. Spending has become so profligate that many people mistake the Swine Flu for a condition that politicians have when pushing through their pork barrel spending.

David Walker is on a national tour and a life journey to save America from itself. Our spending has now even become a matter of national security. The Chinese and other foreign countries own nearly a third of our outstanding treasury bonds (this doesn't include the GSE debt), if you don't believe this buys them a seat at the table then you can ignore when Timothy Geithner rushes over to China to calm them down about our spending (its pretty bad when the Chinese are lecturing us). In addition, an overleveraged nation that runs into borrowing trouble will be less able to protect themselves.

The consequences of current policy (which is the same as the old policy) of spending and more spending without any real reform could be devastating to our nation. We must address this problem and we must start now.

I urge you to watch the full version of I.O.U.S.A., but if you don't have enough time at least read the linked to article and watch the embed below. This is no longer about our future, but about our kids and grandkids.







Scott Dauenhauer CFP, MSFP, AIF

WSJ: Loan Losses Spark Concern Over FHA

As if this isn't familiar. Last year it was sub-prime, wall street banks and Fannie/Freddie - after they all collapsed the FHA stepped in to continue making loans that don't make a lot of sense. Make no mistake, the FHA lending has help prevent an even greater collapse in housing, but at what price? The FHA now even makes loans up to 125% of the house's value and to people who have less than perfect credit...sound familiar?

"They're probably going to need a bailout at some point because they're making loans in a riskier environment," says Edward Pinto, a mortgage-industry consultant and former chief credit officer at Fannie Mae. "...I've never seen an entity successfully outrun a situation like this."

What happens if we end up having to bail out the FHA? We're already about to bailout the FDIC. Perhaps we should stop naming financial entities that have some government connection with names that start with "F".

"Resulting FHA losses are offset by premiums paid by borrowers. Federal law says the FHA must maintain, after expected losses, reserves equal to at least 2% of the loans insured by the agency. The ratio last year was around 3%, down from 6.4% in 2007."

Let me get this straight, the FHA can still operate successfully with reserves as low as 2% and is expected to hit that level soon and that is just fine? Wouldn't that indicate a leverage ratio of 50 times? Doesn't that sound like Bear Stearns or Lehman? The difference is government is not subject to the same accounting rules as private industry (though these days it seems like private industry isn't subject to their own accounting rules) and thus there would be no "run on the FHA" that could lead to a panic. However at some point somebody responsible has to step in and cut off the credit valve and stop making loans to borrowers who represent poor risks.

Would you make a loan of 125% of the value of a home to somebody who was behind on their monthly payments? Of course not, but guess what - you are. The FHA is a government (New-Deal Era) entity that is supposed to be self-insured via fees that borrowers pay, however loose credit guidelines will ensure that those fees are not nearly enough to cover the coming losses. No worries, the taxpayers will just bail the FHA out.

The housing recovery that has received so much press has been built on FHA loans, what happens if the FHA fails? Can it fail? These are questions that need to be asked and these lending practices must be stopped. If there was a sudden pullback in FHA financing, housing would drop substantially (it may still fall given the huge number of foreclosures on the way).

Scott Dauenhauer CFP, MSFP, AIF

Rise and Fall of the Dollar

Less you believe all that talk about the United States wanting a strong dollar, history would suggest otherwise.



I suggest clicking on the link above to get the full view.

Scott Dauenhauer CFP, MSFP, AIF