Freddie to stop buying Option ARMs

Freddie Mac announced that it would stop buying interest-only mortgages because of their poor performance overall[1]. That's one GSE down, one more to go. Given the fiscal insanity our government has been engaged in, even the slightest steps toward rationality—compelled by obvious and overwhelming evidence—I suppose we can welcome as progress.

In broader news, there has been widespread reporting lately on the generally poor performance of housing and its tepid recovery[2,3]. What hasn't been reported on is the upcoming wave of Option ARM resets scheduled from the end of 2009 through 2012. This will be the second of a one-two punch to the housing market that began with the subprime resets back in 2006-2008. Option ARM resets will be at least as big, in terms of dollar value, but are spread out over a broader period so they might not have quite the obvious impact of subprime. This will particularly hit the mid-range market in the bubble states. Bottom line, we've had minimal housing recovery since 2008 and house prices are likely to fall further now.

So, Freddie is getting out right before the real disaster hits. They should have gotten out a lot sooner and in fact never existed at all subsequent to their conservatorship by the federal government or enactment by Congress. Still, I find myself pleased by the news.

Sources:
1. Freddie ends buying of all interest-only mortgages.
2. Sales of previously-owned houses unexpectedly fall.
3. Midwest home sales figures reveal mixed picture.

UPDATE [2/28/10]: Fannie Mae's loses were nearly $75B in 2009, following $60B in 2008. That's about $1000 T*Bux shifted to every tax payer in America... for just one GSE. Similiarly, AIG is reporting loses of $11B in 2009, down from $100B in 2010. AIG was the conduit through which TARP bailout money was directly handed to banks, foreign and domestic, free and clear, no strings attached and no need to pay it back. The GSEs allow the shifting of toxic securities from banks balance sheets on to the tax base.

Wall Street Bonuses

It is being widely reported today that Wall Street bonuses increased by 17% in 2009. I mention this only to underscore that this is the fundamental problem of bailout activity of any sort: it supports the wealthy at a cost to everyday Americans. Sure, is it posed as benefitting the poor or the greater good or some nonsense like that, but it never works that way, never has, never will. Hopefully one day more people will look upon such claims with suspicion.

Personally, I think deep down they know the party is over and are cashing in on what is left.

Fed Rates

I'd just like to quickly comment on the distinction between the Discount Rate, which was increased Thursday, with the Federal Funds Rate, which is the more prominent interest rate policy and remains unchanged at zero percent.

The "Federal Funds Rate" or "Overnight Rate" is a necessary fudge factor in a system of fractional reserve lending, where banks have only a small percentage of cash on hand to cover their deposits. If there are substantial withdrawals or loans, and reserves dwindle, they have quick access to cash through the Federal Funds Rate. Getting money from the Fed in this way is ordinary, everyday business.

The "Discount Rate" is a longer term loan when banks find themselves generally undercapitalized and need emergency money to weather adverse circumstances—like say more loans going bad than tolerance limits allow. In these circumstances banks are mostly encouraged to seek loans from other banks to stay afloat. If they have to go to the Fed for this sort of loan, it casts a shadow of doubt. At least it used to. Bailout circumstances being the way they are, who knows, maybe no longer.

So, raising the Discount Rate will adversely affect the ability of struggling banks to survive. The likelihood of an FDIC seizure increases, and with that, opportunities for healthier banks to acquire the assets of seized banks at fire sale prices. Of course, at 0.75% the Discount Rate is still extremely low, but if the Fed wratchets it up in a step-wise fashion, this may be what we see.

UPDATE [2/23/10]: Today the FDIC reported a 27% increase in "problem" banks for the year 2009. If the discount rate keeps going up, as hopefully it will, it could be feeding time soon for the healthier banks.

Fed Increases Discount Rate

In a surprise move that is hopefully indicative of a broader change in policy, the Fed increased the discount rate to 0.75% yesterday (from 0.5%). This came rather out of the blue; usually the Fed gives a better "heads up" before this sort of thing. The Federal funds rate remains the same at effectively 0%, so for all practical intents and purposes zero-interest rate policy remains in effect.

Mortgage Modifications

Reuters is reporting Bank of America has made around 12,700 mortgage modifications with the assistance of the Obama stimulus passed last February [1]. This is better than two prior mortgage renegotiation programs under Bush, which to my knowledge affected exactly zero modifications, even though billions were alotted. Extending the figure across the board to other banks, one can guess the number of modifications overall is somewhere in the tens of thousands. Not a particularly high number given the scope of the problem, but not zero either.

Mortgage modification is a good solution, one that would automatically happen if free market principles were allowed to flourish and Congress and the Federal Reserve Bank weren't happily offering generous bailouts to the banks. In a free market, the banks would be motivated to modify mortgages because getting paid less is better than foreclosure.

As it stands, banks can avoid modifications and simply hang on to foreclosed properties if they expect ongoing government subsidies. Mortgage modification now happens only under government enticements and coercion.

Sources:
1. BofA modifies 12,700 under govt program.

National Debt Ceiling Increases to $14.3T

It was just in December that the national debt limit was raised from $12.1T to $12.4T. Today, it was increased more substantially to $14.3T [1], or $103,675 T*Bux. On average each tax paying American would owe more than $100,000 on the federal debt.

Obviously, everytime we reach the debt limit, Congress is just going to pass a higher limit, so this debt limit is effectively meaningless. The real debt limit is when people stop buying Treasury Bonds. The U.S. has some wiggle room there still, but countries like Greece and Argentina are discovering what that limit is. The way things are going, so too will the rest of the world eventually.

Source:
1. Obama signs bill raising debt limit to $14.3 trillion.

In Defense of the Euro

News sources have been reporting the euro is faring poorly because of problems in Greece [1-3], specifically the impending inability to pay off its debt. Problems with debt repayment and borrowing costs are growing worse. I don't know if it has reached terminal limits, but it sounds close.

Looking at the one year graph of the dollar vs. the euro, the trend line is headed in a southerly direction, but it remains squarely between the highs and lows for the year. This might not even be a diminution of the euro, but a strengthening of the dollar.

Say Greece does default on its debt, how would that affect the euro? National governments are an economic entity just like any individual or business—where income comes from taxes and is spent on government services. Governments contribute neither to the inventory (since all they provide are services) nor the money supply (central banks do that), so the stability of the Greek government has little to do with the amount of euro's in circulation, or what is for sale in euros.

Perhaps people are concerned the European Central Bank will monetize Greek debt to help them out, as a kind of charity. I anticipate that is highly unlikely, but I won't rule out the possiblity. Some commentators have even questioned the euro's viability if Greece defaults [2,4]. How this resolves will be informative since Greece will be one of the first of many dominoes to fall.

Sources:
1. U.S. dollar, yen gain on Europe debt woes.
2. Greek financial crisis proves test for euro zone.
3. Europe debt fears sink euro.
4. Greece's financial crisis puts future of the euro into question.

UPDATE [2/11/10]: The European Union has pledged "moral support" to Greece, whatever that is, but no money. I'm sure the euro responded negatively, but this is good news for it.

UPDATE [2/14/10]: No love from Germany to Greece today. A poll of Germans showed a majority would rather see Greece expelled from the euro zone than to bail them out. Of course, the two events are unrelated—there is no requirement for Greece to be bailed out for it to keep using the euro. Greece though, may want to leave to create its own currency that it can inflate from within to support its spending. That wouldn't, however, forgive its debt in euros.

UPDATE [2/24/10]: Thousands of Greeks take to the streets today in protest of responsible government spending. Things get personal as Greece demands more money from Germany for the Nazi occupation of WW2. There have been suggestions over the past few days in the news media that Greece covered up the true state of its economic situation with the help of Goldman Sachs.