Fannie and Freddie have a new program - when you default on your mortgage, you can trade in your mortgage through foreclosure and in return get a rental agreement.  Through rapid deterioration of the housing market and now prime loans, Fannie Mae and Freddie Mac have found themselves with around 100,000 homes that they own.  What to do with them?  Flooding the markets with excess inventory seems like a bad idea, so they chose instead to go into the landlord business.  The WSJ reports that the program will charge “market rents,” which are lower than the previous mortgage.  That seems obvious.  But it also brings up an obvious question - if rents are lower than the old mortgage payment, are the rents also lower than a mortgage based on current sales prices?

What the entities are doing is betting on an improvement in the housing market, waiting to sell inventory when things are better.  These are the same entities that told us in no uncertain terms in the summer of ‘08 that they needed no government funds, and are now $100 billion into our pockets as taxpayers, most likely needing more in the months ahead.  Having these entities become real estate speculators doesn’t make me feel better.

In the bizarro world of financial markets, our narrowly measured unemployment rate rose above 10% in the month of October and now the markets have inched higher. 

I did see a couple of people taking solace in the fact that the number of job losses is slowing, indicating that on the current slope we will be in positive territory by late spring of 2010.  I understand that.  I don’t agree with it, but I understand it.  The measure of the civilian labor force, or the number of people eligible for work, has continued to slide, which makes the measure of unemployment look better than it actually is.  We’ll see.

There is no good way to spin a move higher that goes over 10%. 

Apparently state governments are fightin’ mad at the fact that foreclosures are wrecking their economies.  They are eyeing mortgage lenders for creating the debacle, and on top of that, those pesky banks and other lenders are not helping to remedy the situation, often taking much too long to deal with loan modifications and other initiatives aimed at slowing the rate of foreclosure.  In an effort to take control,  states are weighing the possibility of suing mortgage lenders for fraud.  Take a moment to ponder this.  State governments, who have wildly over-promised what they can support through their own funding, are contemplating suing mortgage lenders for fraud because they potentially lent money to people who couldn’t pay it back.  This falls into the “I can’t understand that” category.

If a lender makes a loan that can’t be paid back, isn’t that sort of a bad business practice?  To say that the lender did it for profit is a bit confounding, since the business model - lending to people who were marginal borrowers - seems like it is doomed from the beginning.  In fact, many of those lenders are out of business.

But let’s entertain the idea for a moment.  Someone out there is responsible for creating a boom in economic activity through the promise of cheap home ownership - or at least that is the working theory here.  That boom created an unsustainable flow of capital and economic activity within states that they became accustomed to having.  Now the spigot is turned off, so let’s blame the group that created this mania.  To do this, you have to keep asking for the next step.

It can’t be the mortgage lender.  Barring out and out fraud (which of course happened, and was always illegal), we are talking about the sweet talk of easy home ownership at a low price, getting in on the fastest game in town, the real estate bubble, and directed at those who were at best marginal buyers and at worst non-qualified buyers.  This of course came through the lenders, but it started a little further up the chain.  You have to look at the Fed with their insanely low interest rate policy, which kept prices low.  But that’s not the end of the line. 

For the end of the line, you have to look at the bucket of money that eventually purchased a big chunk of those mortgages backed by low income borrowers who are now in trouble.  That would be me and you, through our agents Fannie Mae and Freddie Mac.  In the 1990s we gave direction to those two government sponsored entersprises (GSEs) to make sure that a large percentage of the loans they purchased were those backed by low or modest income borrowers.  So in this line of thinking - that someone, somewhere, created all this mess in housing by making homes TOO affordable and persuading people to buy homes they couldn’t afford - would have to lead you back to the big buckets of money that kept buying the loans.

When are the states going to sue the federal government for fraud?  I don’t know, but if it does, it will be interesting to watch!

Don’t get me wrong, I do not think Congress is responsible for this mess.  I think this was a group effort - CDS’s which were gussied up insurance contracts with no capital behind them, rating agencies who pandered to issuers, the Federal Reserve, and Congress had a bit part.  There are many others, including borrowers themselves.  In this post I’m just addressing a current issue with states, I’m not agreeing with their analysis.

Falling fertility

Oct 29th 2009
From The Economist print edition

Astonishing falls in the fertility rate are bringing with them big benefits

The above story appears in the latest edition of the Economist, a magazine we read faithfully as it gives an interesting “outside America” perspective on things.  This story has no political leaning, but instead quantifies the effects of falling birth rates.  In very un-typical fashion, the analysis couldn’t be more wrong in it’s conclusion.  The Economist points to the wonderful virtues of falling birth rates, clearly identifying a “goldilocks” generation where there are fewer children and fewer aged than there are workers.  So far, so good.  The article goes on at length about how wonderful this is, with its increase in output, more opportunities for women to join the workforce, increased productivity, etc.  Many countries are cited as examples of how this story goes - most of Europe and the US - and there are many countries cited as being in this storybook chapter of thier history right now.  But what comes next?  That question is not answered.  Only in passing is Japan mentioned as having issues because of  few workers per retiree and with almost no children coming along to revivie the economy.

It would have been much more enlightening for the article to delve into the truly long-term implications of a falling birth rate in the context of the current economic systems in place around the world.  A 20, 30, or even 40 year view is not enough.  We need to understand our obligations and abilities on a full 80 year cycle to clearly see how our policies of today will help or hinder the generations of tomorrow. 

As we contemplate phenomenal increases in government responsibility and liability, we need to do so with our eyes wide open.  To say such programs have worked elsewhere is only compelling if such programs worked during both goldilocks times and times of contraction.  So far such analysis has not made it to the scene. 

 In a seemingly unrelated article, Evan Ambrose Pritchard wrote a great piece in the Telegraph on why Japan should be the worry of the world instead of the US, as their financial situation is deteriorating by the day.  I say seemingly unrelated because it is an article about the failure of Keynesian economics as employed by the Japanese over the last 20 years, but the real driver of the failure is the totally wrong response of the Japanese government to their real problem - falling birth rates fifty years ago.  In the face of such a demographic shift, taking on more economic burdens at the government level was the complete wrong thing to do as the expectation going forward is for economic contraction.

I’d love to see the Economist take their analysis to the next step, asking what comes after the goldilocks period when you have an aging workforce and no replacement children.  It’s difficult to get much of anyone to look that far over the horizon.

Not every loser chosen by the government is a fat cat banker making millions of dollars, or a perceived corporate bad actor such as Lehman.  Many are just ordinary people, which is what makes some of the choices of the US government over the last year so much more difficult to fathom.  At issue is the results of the auto industry bankruptcies earlier in the year and how the pension mess has fallen out. We have written on this subject numerous times, and today the NYT has a feature on it (NYT, B1, 10/27/09).  The example “loser” is a woman who took early retirement at Delphi as the company encouraged, received a pension of $2,925 monthly since retirement, but after the end of the bankruptcy she will receive $390 monthly.  That’s correct - from $3k a month to $400.  I’d say that qualifies as losing. 

So what was makes her a loser?  Not being in a union is the short answer, but it’s not the full answer.  When GM spun off Delphi in the late 1990s, the Delphi United Auto Workers were given a promise that if their pensions were underfunded by Delphi that GM would “top-up” the payments.  So far, so good, as these are the dealings of private companies with their labor. 

Then Delphi does indeed go bankrupt in the mid 2000s.  The company quits making full contributions to their pension plans for all workers - UAW, United Steel Workers, white collar workers, etc.  In fact, they make tiny fractional payments.  Just as you would expect, four years and one heck of a bear market later, the pensions are all dramatically underfunded.  So Delphi does what is expected of a company in bankruptcy, they kick their pension obligations to the PBGC, which pays according to a very un-generous schedule, NOT according to what your pension benefits were at the company.  This is where the Delphi UAW workers hold up their trump card, the one that says GM has to “top-up” their pension payments in the event of underfunding.  Still, so far so good.  Except, GM is now bankrupt too.

This is where the winners and losers are sorted.

GM now agrees to make those payments. But there’s more.  The steel workers, electrical workers, and other unions cry foul because only the UAW is covered.  So GM graciously agrees to top up all union payments.  White collar payments? No.  Nada.  Zip.

Where did GM get the funds to make such payments, since they were bankrupt?  From taxpayers, who infused the company with $53 billion.

This is the same convoluted scheme that allowed unsecured creditors (union health trust) to jump ahead of secured creditors (bond holders).

 There are real consequences to these actions.  Those that control capital, both investors and corporate officers, will long remember these actions and include them in their decision-making in the years to come.  To pretend that such things have no consequence is disingenuous.  To treat these situations lightly, when they have such a devastating and unequal affect on people, is callous.

The above title was for an article written in the WSJ, October 20, 2009.

This is a topic we have been harping on for a long time.  Earnings are beating forecasts, but in general (excluding Apple) they are far below previous years.  Even then, those earnings were notched by reducing costs, which is a nice way of saying “firing people.”  This is nothing new, so I won’t spend a lot of time on it; I just want to make sure that we are keeping our eye on the ball here.

What is new, or rather what is subtle, is the change that is happening before our eyes.  For more than 20 years we have been talking about the change in consumption that would happen as our largest cohort (boomers) passed the age of peak spending.  We tried many times to paint a picture of what that world might look like.  In my mind, we always fell short.  Readers and listeners were always left with the impression that everything goes down, and must decline in a straight line.  It doesn’t happen, and isn’t happening, that way. 

What we’ve done is lower consumption, that much is true.  We have also changed what we consume.  Gone are the big ticket items that scream financial success (bigger, newer cars, for example), but also require a lot of financing.  It might not feel like it to the individual, but the minute we stop using debt to finance, we cut off one of the main sources of lifeblood to the economy.  We might still spend close to every nickel we have.  We might continue to eat out and buy new clothes. Without the turbo-charged effects of credit, the economy will still soften.  If we actually add savings on a continued basis, the effects are even greater.

The outcome remains the same - unemployment.  Which is the premise of separate but related article in the Journal today, “Firms Keep the Brakes on Hiring“  (the title is a little different online than in print).  Why wouldn’t they?  Demand has not returned, no matter what the MSM says.  Our current measure of hours worked in a week in the US is 33, the lowest on record (since the 60s).  When business picks up modestly there is no need to hire more people, just increase hours worked a little bit.

Less demand, less employment, the same or rising expenses (cost of living, debt payments, etc.).  This is not a recipe for a quick recovery. 

The Rockefeller Institute, at www.rockinst.org, is dedicated to the study of public finance, usually at the state and local level.  They have operated not in obscurity, but certainly out of what you would think of as the limelight.  For the last year, things have been different.  They get a ton of attention, and rightfully so.  They are counting in real-time the cost of this meltdown as measured in the flow of revenues to city and state governments.  The numbers are sobering.  In the 2nd quarter of ‘09, income tax collection down 27.5%, sales tax down 9.5%.  This at a time when we are demanding more services of those exact entities through medicaid payments and other social outreach programs.

There can be no escaping either the cause or the effect.  We are nationally making do with less.  The US government has stepped in not only to fund but also to spend, hoping that it can bridge the gap until our private sector picks up enough to take over.  That won’t happen anytime soon. 

Since the economy has not budged on the important items of demand growth, capital investment, capacity utilization, or employment, some of the major companies in America are taking action.  Real action.  They are advertising.  They are telling us that things are turning brighter, that we are witnessing the dawn of a new age of prosperity!  You just wait and see!  The NYT reported this morning on spots by both GE (like this one) and B of A that are basically feel-good television.  The hope is that they will capture and further energize what is seen to be a small but growing feeling of optimism. 

I understand it.  I want to be optimistic as well.  I’ve no interest in being the “downer” at parties when people ask what our view is of the future.  But I also prefer to be realistic.  Even in the article the NYT states, “On a more functional level, once banks like B of A start lending again, corporations like GE start hiring again and everyone begins advertising again, the economic recovery will have some fuel.”  That’s nice, but it avoids the much bigger question of why the cycle has slowed and what will revive it.

 Larry Summers was much clearer.  In a statement yesterday he said that “Lack of demand will be teh major constraint on output and employment in the American Economy for the foreseeable future.”  He also noted that, “The combination of low capacity utilization and substantial leveraging of household balance sheets raises questions about the sustainability of demand growth going forward.” (WSJ, 10/13/09, A3)

I’d say that about sums it up.  We can feel good about it, we can talk about all the potential, but unless there are clear reasons for and signs of demand growth, it all remains just that…talk.  It reminds me of those eery commercials starring Jeff Daniels that speak of all the wonderful things in Michigan and why companies should move there.  Knowing something of the economic climate in Michigan, I always wondered what the developers of that spot were thinking.  Did they think that everyday business people would see a 60-second ad on TV and think, “Hey!  Let’s move to Michigan!” without ever checking out the crime rate, the unemployment rate, the tax rate, the quality of life rating?  Are we that gullible?  Will we fall for advertising that wants us to believe things are better just because the idiot tube said so?  I don’t think so.

For over a year we have been dealing with the aftermath of slower and lower spending.  The repercussions of an overall spending decline continue to echo through the economy, with unemployment and slack capital stock being the most evident signs.  Our legislators are desperate to find a way out, and economists are debating the merits of more stimulus versus tax credits (a different form of stimulus) in order to pull job creation through the system.  The problem is that all of this misses the forest for the trees - we are choosing to spend less as consumers and that is a GOOD THING.  Cajoling, bribing, and in the end demanding that we spend more is not just irresponsible, but truly harmful. 

The exasperation with this situation is not limited to one economic or political view.  The differences are confined to the approach while the goal remains the same - get the economic engine going again through increased consumption. 

A better policy would be to explore what we can and should do when faced with excessive unemployment created through slack consumption.  Should we leave the unemployed on successively longer benefits (the state of NY is moving its unemployed benefits to 99 weeks)?  Should we dredge up the CCC and WPA of the ’30s and ’40s, not only handling work that needs to be accomplished by brazenly tackling make-work programs (state parks in the middle of nowhere)?  Or should we start down a path of cannibalizing market share, which would consist of identifying all of the industries that have moved overseas that we could quickly recapture through some targeted investment program, not through tariffs or a “guaranteed work” agreement? 

I don’t know the answer, but I strongly believe that this is the question.  The stimulus plan has not fulfilled its intended goal of containing unemployment below 8%.  Most of the funds spent so far have served only to plug ever-widening budget gaps at the state and local level.  If that is the goal, to use federal funds to keep states solvent so that they can maintain their employment rolls beyond their own fiscal abilities, then let’s be clear about it.  As we go down the path of ever-increasing federal budget deficits, we need to understand exactly what we are getting for our increased future burdens.

In all the talk about about expanding health coverage, there has been surprisingly little discussion of how states will pay for what is likely to be an explosion in participants in Medicaid.  Luckily we don’t have to wait any longer.  Instead, the deterioration in the economy has hastened the conversation along by causing Medicaid enrollment to jump in the past year, exactly when states are already strapped in their budgets. 

What is their plan?  In short, there isn’t one.  Unless you are the Senate Majority Leader.  His plan - which passed the committee level - is to shift the burden of increased Medicaid co-payments required by the state of Nevada to other states.  Senator Reid put forth a proposal that allows the 4 hardest hit states - RI, MI, OR, and NV - to shift their costs to other states, like MA and FL.  I guess the logic is that things are going so incredibly well in the Northeast and the Sunshine State that they can afford to carry a little more water.

The greater point is that the mounting burdens faced by states continue to grow, while their income continues to recede.  While some states are trying to meet these issues head on, like Indiana, others continue to act as if nothing is wrong - see anything put forth by the legislature in California for an example. 

Change doesn’t come easily or quickly in politics.  This battle will play out not over days or months, but over years.   Unfortunately the longer it takes, the deeper the holes become.  More benefits promised, less money to pay; as well as less income, less commerce, and lower asset levels to tax.