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Wednesday, February 25, 2009

The Rescuers

I live in a nice house. It's not a mansion, but a nice house. I also live in a nice neighborhood. It's not millionaire row, but its nice. At the peak of the housing market, I was making good money, and I thought very seriously about moving to a larger, more expensive home in the subdivision adjacent to mine. As the market slowed I thought even more seriously about it, because I thought I could find a bargain. In the end, I decided that I was better off in my older, more modest home. What a great decision that was! Six months later I was laid off. Now I have started my own company. Those of you that are self employed understand what it is like to not get a regular paycheck even though you work. Any money I make goes back into my company, and it has been seven months since I have seen a paycheck. I should be the perfect candidate for a government bailout.

Alas, despite the lack of income I have paid all of my obligations on time. I had plenty of savings (and still have some) to get me through this. If I had only known that the federal government would be pushing loan modifications, I wouldn't have wasted my money on something as useless as savings. I would have bought that big beautiful house on millionaire row. I blame my parents for instilling me with financial sense and personal responsibility. Little did they know how useless those virtues would be in 2009.

Now that I have resigned myself to the fact that I won't benefit from any financial rescues, and will in fact be paying for the rescue of others for years to come, I can objectively review the President's announced Homeowner Affordability and Stability Plan. The plan covers three key areas: creating opportunities for homeowners to refinance; encouraging a larger number and more effective loan modifications; and strengthening of the governments commitment to Fannie Mae & Freddie Mac.

Refinancing
The first part of the plan is the affordability initiative. Loans that are currently owned by Fannie or Freddie or in mortgage back securities guaranteed by the government sponsored enterprises will be eligible for a refinance to current interest rates, which are very low by historical standards. A lack of equity is keeping many people from refinancing, so the President's proposal is to allow for loan amounts up to 105% of the current value. That will certainly open up the opportunity for some homeowners to refinance. It will leave out quite a few as well. For example, people who don't have a conforming loan (Fannie or Freddie) currently will not be eligible. Also, if they are so upside down (owe more than the house is worth) that 105% is not sufficient, they won't qualify either. There are a lot of homeowners here in Arizona that fall into that category. Jumbo loans are also not eligible (over $417,000). The Mortgage Bankers Association has argued that the 105% limit should be removed from the plan. Their argument is that Fannie Mae and Freddie Mac already have the liability for the existing loans no matter what the loan to value ratio is. Therefore it is in their best interest to refinance these loans to lower rates regardless of how much the value of the home has declined. That's a pretty valid argument, especially since there is already a precedent set in the form of FHA and their streamline refinance program.

Modifications
The second key to the plan is to increase the number of and the effectiveness of mortgage loan modifications. Many people have fallen behind on their mortgage payments and the only thing that will save them from foreclosure is a lender that is willing to change the terms of the loan and make the payment more affordable. Obama's plan calls for lenders to modify mortgage payments down to 38% of the borrower's gross income. In addition, the government will match dollar for dollar a reduction of the payment to 31% of the borrower's gross income. There are additional incentives that can be paid to the lender if the modification is successful (meaning the borrower makes the payments and stays in the house) as well as incentives for the borrower (beyond being able to keep their house) in the form of principal reductions for successfully paying their modified payment on time. It's a positive to get some guidelines on what has been a messy and confusing subindustry called "Loan Modifications." Lenders will continue to struggle with the problem of filtering true hardship cases versus those individuals that look to take unfair advantage of the lender and taxpayer. And the borrowers with the true hardship cases are not likely to comprehend how the plan works anyway. If they claim to have not understood their original mortgage that got them in trouble, how are they going to understand this?

Low Rates
The final part of the plan will likely be the most effective. That is because it is simple. The Treasury will continue to purchase Fannie & Freddie mortgage backed securities and increase their portfolios. The fact that the government is buying mortgage backed securities is keeping mortgage rates low. That is great for those that can refinance. It is really great for first time homebuyers that can now finally afford to by a home because of the devaluation that has occurred.

Meanwhile, I will continue to pay my mortgage on a timely basis. I even have one of those evil adjustable rate mortgages. My rate is lower than any fixed rate you can get now, and it is scheduled to go down again in a couple of months. An adjustable rate mortgage doesn't seem nearly as "evil" as the government taking my money to pay down someone else's mortgage.

Sunday, February 15, 2009

Light in a Dark Economy

On the weekends my wife, Jen, goes to WalMart to do the weekly grocery shopping. Meanwhile, I hang out with our two sons for a few hours. Today we played whiffleball. When Jen returned she commented that WalMart seems to be getting more and more congested with shoppers as of late. I wasn't surprised. The chain is just about the only retailer that actually performed well in the fourth quarter of '08. When times are tough, shoppers will be more price sensitive, and WalMart has the reputation for having the best prices. Of course, that's common sense. This got me wondering, what other "common sense" winners might there be in a tough economy? Let's put it this way, with unemployment rising, what are the growth areas for jobs?

1. WalMart Greeter - So I already established that WalMart has more customers, so they need a nice elderly person to greet them. If you are over 65, this job is for you.
2. Mortgage Loan Workout Specialist - Mortgage loan modifications are the service du jour. Since most homeowners no longer have equity, it's the new refinance.
3. TARP application reviewer - There is a backlog of 2,000 applications for bailout funds. Since the government is only getting through about 50 per week, that means that banks are waiting at least 9 months before they get a response on their TARP fund requests.
4. Keynesian Economist - The passage of the stimulus bill is based on the assumption that government spending will stimulate the economy. Well, that depends on what the money is spent on. Tax cuts help, as does some of the spending, at least temporarily. Regardless, if you know formulae for fiscal multipliers by heart, then you are sure to get a job as a White House economic advisor.
5. Liquor Store Owner - Cheap vices do well in recessions. Alcohol and cigarettes are sure to be good sellers with the light supply of discretionary income. Local governments won't mind since those items come with a hefty sales tax.
6. Security - More liquor stores are also likely to get robbed. So anything related to security should do well. Cameras, alarm systems, and rottweilers should all sell well.
7. Gun Sales - Also related to security, but the criminals will also be buyer them. But they will likely be buying on the black market.
8. Repo Man - duh!
9. Attorney - I'm not sure on the specifics here, but lawyers will always find a way to fleece the public.
10. Federal Bureaucrat - There are tons of examples, but here is just one. In the recent stimulus bill, there is an appropriation for $2 billion dollars described as "Extra money for the Office of the National Coordinator for Health Information Technology." Really? "Extra Money?" Well I'm sure some of that extra money will go to hiring some highly productive bureaucrats.

So there you go. When you thought there was only darkness in this economy, I have shown you the light.

Monday, February 2, 2009

Why Do People Think that the New Deal Worked?

It is with some sadness that I write this article. Irrelevant to this topic, I must acknowledge that I am an Arizona Cardinals fan and have been through many losing seasons. Our magical ride came to an end with 35 seconds left on the game clock on Super Bowl Sunday. It was the most exciting Super Bowl I have ever watched. It ended with me wanting to cry, and with my eight year old son Dominick actually crying as he sat on the couch in his Larry Fitzgerald jersey. It is cliche to say that we always have next year. But in Cardinal Nation, this is the first time we can hope for next year and actually believe it. After decades of being a loser, the Cardinals are now a force in the NFL.

As far as the economy goes, I am not convinced that there is hope for next year. I have heard so-called experts talk about a recovery in 2010, but they can never explain what will drive the economic growth. They just assume that what goes down will eventually go up. They fail to acknowledge that "what goes up" needs something to lift it.

Congress (at least the controlling party) and President Obama are selling a stimulus plan that uses a Keynesian philosophy of government spending to lift the economy. I have heard several politicians announce that this is their "best" opportunity to pass legislation since the Great Depression. What kind of legislation you ask? Legislation that spends money, and lots of it.

Certainly there are some worthy spending plans that the federal government can use to temporarily lift the economy and have long lasting benefits as well. Infrastructure spending that relates to energy independence and transportation are a good example as long we are smart about the choices of projects (e.g. don't just throw taxpayer money as something because it sounds green). When I read in the paper about the $900 billion stimulus package containing items that may be noble causes, but hardly qualify as "economic stimulus," I realize that very little has changed in our federal government. Does spending $335 million on programs to stop sexually transmitted diseases create jobs? Someone may argue that it does, and perhaps it does create a few, but tell me with a straight face that we'll get $335 million worth of jobs. How about an extra $50 million for that great economic engine, the National Endowment for the Arts? While there are some provisions that will actually create jobs, for example tax relief, much of it is simply a wish list by politicians for their pet projects or quid pro quo for their campaign supporters.

FDR is widely known as one of our greatest Presidents for leading the country through the Great Depression and World War II. The economic devastation of that era was much wider and deeper than what we are experiencing today (so far). He took drastic measures as soon as he took office in 1933 with colossal spending projects in the form of the New Deal to get Americans back to work. And it worked. Well, it worked temporarily. When he tried to pull back on some of the spending in 1937, the economy actually got worse than it was in 1932 before he started. New Deal spending relieved some of the symptoms of unemployment, but it did not solve the root of the problem. It took winning the largest war in world history to bring us out of the Depression.

It is worthwhile to note that the cost of this package well exceeds the entire cost of the Iraq war. Are we spending only to temporarily relieve symptoms as the New Deal did? What we need are businesses to invest in the economy. Business drives a market economy, so the government needs to give us a stimulus package that motivates people to invest in business, and business to invest in the market.

My recommendation to Congress and the President (it's kind of arrogant for me to think that they care about my recommendation) is to pare down this package dramatically to focus on projects that can have a true economic impact within the next 12 to 18 months. Energy independence and grid improvements, transportation infrastructure, and tax incentives are all subjects that will drive our rise from this economic funk. The consequences of wasting money on politician's pet projects are severe. Huge additions to an already out of control national debt limits what we can do in the future and will lead to inflation. Combined with a stagnate economy (stagflation), it will be an ugly situation for years to come. We need to care about what makes up $900 billion. Don't simply be satisfied that it is a big number and assume we need what they're giving us.