Random Musings

Just a few tidbits from recent developments. First, the Paulson plan to revamp financial regulation. This thing will never see the light of day. Like most of Paulson's plans (HOPE NOW, etc., ad nauseum), it's meant to be a politically expedient show of action that will result in inertia. But it's the show that counts, especially in an election year.

None other than Chairman of the House Financial Services Committee Barney Frank has pledged that credit unions won't be abolished, as was suggested in the Paulson plan, which would combine all consumer financial institutions under a single charter and regulator. Other protected interests will also be preserved, so the plan will never come to fruition. Bush Administration officials have already acknowledged that it won't become law this year, and with a new administration in place next year - possibly a Democratic one - you can bet we'll never see anything that looks remotely like this plan become a reality.

Speaking of Paulson's plans, guess what the tab at the post office was for the notification letters of the coming tax rebate checks? Not the checks themselves, mind you, just the letters letting taxpayers know they might - or might not - be receiving a rebate? How about $42 million? Hey guys, I already knew I wasn't getting a rebate, so you could have saved a stamp on me. After all, it's my money.

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What a week for stocks. This market just doesn't get the fundamentals. UBS takes the biggest write-downs in its history, cans its Chairman, says it's going to raise additional capital (which will just cover the write-downs), and the Dow goes up 400 points. Everybody (but me) says the write-downs show the worst is over - a total disconnect - and that the capital plan demonstrates that there is liquidity in the system. I'd prefer we wait until they actually get the capital to conclude that, especially given that the LIBOR-Fed funds spread is at its widest point of the year. Somebody out there doesn't think liquidity is ample, and there's a giant sucking sound coming out of wholesale financial institutions to prove it.

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Bernanke (who is a pansy) got called on the carpet by the Joint Economic Committee last week for bailing out Bear Stearns. Thank God. Ben said Bear announced it was going to file bankruptcy the next day, so he had to act. Maybe I should announce I'm going to file bankruptcy tomorrow - can I get a bailout too? Just like Bear's - take all my debt and place it in a Delaware corporation owned by the Fed so the taxpayer can take the hit when I don't pay it, and write me a ten-year loan that I don't have to start paying back for two years, at the discount rate.

Iowa Senator Charles Grassley earned some respect points from me when he told Bernanke, "We want to know about precedent." (There is none, Chuck, this is bold new territory for the Fed.) Grassley said if the Fed is going to bail out other Street firms, it's "a very dangerous signal." (Yep.) And, correctly noting the moral hazard in Bernanke's reckless action, he said:

"People are willing to take chances if they think that the federal government is going to step in and bail them out all the time." (Emphasis added, and you're darn skippy.)

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Hillary needs to fire whoever came up with the "3 a.m." ad series. The latest one is plain stupid: this time, the White House phone once again rings at 3 a.m., "only this time, it's a financial crisis." Let's see, the markets are closed, the banking system is closed, the Fed isn't meeting ... exactly what kind of financial crisis are we having at 3 a.m.?

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The publication "Advisor Perspectives" recently contrasted two subprime analyses, one which said the worst is over and one which said we've only seen the tip of the iceberg (guess which camp I'm in?). The highlights:

The rose-colored glasses guy, Richard Bove, who recently said "the financial crisis is over," cites these reasons. First, he says the Fed's "brilliant" and "innovative" actions to date (more accurately described as "ill-conceived," "reckless," and "desperate") "go to the heart of the credit problem and, 'unlike printing money,' are not inflationary." Really? Since when is slashing the funds target not the same thing as printing money? And if it's not inflationary, why's inflation going up?

Second, he calls the notion that housing prices will continue to fall "dead wrong." He says that's "inconsistent with historical evidence, which shows that real estate prices do not drop during a period of commodity inflation." Fine, Dick, show me a period of commodity inflation which has featured an 11-month supply of empty houses, with a million more foreclosures forecast, in which housing prices were stable, and I'm in your camp. Until then, recognize that this is not your father's period of commodity inflation. The particular stew that has led to this combination is unprecedented.

Third, Bove expects a bailout of the housing industry. Fine. But if that happens, things will get much, much worse, even if they get a little better for a little while. Besides, how is the government going to bail out the housing industry? Buy all those empty houses? As support of this notion, Bove thinks the Paulson plan will become law, which is about as likely as me winning Olympic gold in speed skating. He actually cites the fact that it's an election year as making this more likely. If anything, it makes it far less likely, especially with a lame-duck Republican President and a Democratic Congress that's salivating at the prospect of winning the White House back.

Bove then compares the current crisis to the 1990 credit crisis, which was fueled by the S&L crisis. He notes differences between then and now that he argues tell us that things aren't nearly as bad now as they were then. For one, he says there are no problems with third-world debt, as there were back then. (Yet. But as this thing migrates throughout the world, it's coming.)

Two, he notes there have been no private equity failures this time. (Again, yet. But that industry is among the next dominoes to fall.) He notes that commodity prices are rising, not falling as they were in 1990. (And this is a good thing? Does he not recall the 1970s? Can he say "stagflation?") And he says the commercial real estate market doesn't appear to be facing "real problems and the default rates are low." (Again, yet. This is another domino that's already on its way down.)

Finally, he notes that unlike the prior crisis, no banks have failed. (Again, yet. Arguably, one already has, but the Fed bailed it out. And more are on the way. And not just banks and investment banks.)

In short, Bove can't come up with one supportable argument to make his case.

By contrast, Whitney Tilson says we're "in the early stages of the 'bursting of the Great Mortgage Bubble,'" with which yours truly wholeheartedly agrees. He notes that home prices have to fall 34% to return to their long-term trend (and I've noted that we overbuilt so much during the bubble that builders could just sit absolutely idle for a year and a half before we caught up with supply). He cites foreclosures up 57% and repossessions up 90% year-over-year as of January, and notes that 8.8 million homeowners are upside-down in their house, with 30% of subprime loans underwater.

That last statistic is frightening, as we've entered a new world of homeownership. It used to be that the home loan was the last thing Americans would default on. Now, it's the car payment and the credit card, with the rationale being "I need my car to go to work, and I need my credit card to float from month to month, but I can live anywhere." These days, everyone's a speculator when it comes to their mortgage: if the house is worth less than the mortgage today, people are just dropping the keys in the mailbox and walking. Apparently they don't understand that, long-term, the house price will appreciate, while mortgages amortize (well, except for negative-am subprime option ARMs). Of course, who thinks long-term anymore?

Tilson further notes that about $440 billion of ARMs will reset this year, and in spite of the Fed's rate cuts, mortgage rates aren't going down. (In fact, I predict they'll go up throughout the year, even as the Fed continues to ease, due to inflation pressures at the long end of the curve and continued widening of credit spreads as other loan types show increasing default rates, something that's already showing up in credit cards and auto loans.)

Tilson cites the worst of these loans, those with two-year teasers, the bulk of which were underwritten in 2005 and 2006. Noting that there's about a 15-month lag between the first missed payment and foreclosure, he projects at least two years of trouble from this cohort of loans. His data illustrates that "the best quality two-year teaser loans made in 2005 are defaulting at annualized rates of 35%-46%. The worst quality of these two-year teaser loans are defaulting at 48% annually before the reset kicks in, and at 7%-8% per month immediately thereafter." Yikes.

For what it's worth, "Advisor Perspectives" agrees with Tilson, and thinks Bove's all wet. And so do I.