The Bitter Bill

We did not need yesterday’s dismal report on existing home sales (they fell more than expected) or today’s new home sales report to inform us that the US real estate market is the center of the recessionary/slowdown vortex. In truth, most of the economic and credit issues that are creating havoc for Americans emanate from the rotten housing market, which is why the House passage of the housing bill this week has been in the works for seven months. Who knows whether or not it will help, but ultimately, it is a bitter bill for responsible taxpayers to swallow.

The bill itself is a pot luck effort, filled with so many ingredients that it is impossible to cover them all in one article. The major highlights include something for every irresponsible party affected by the housing and credit crises, as well as some provisions that are aimed at helping the housing industry itself. (Note: the costs cited are estimated over ten years): $5.3 billion in low-income housing; $4.6 billion in tax-credits for first-time homebuyers; $3.9 billion in grants to allow states to buy foreclosed homes; and FHA insurance for up to $300 billion of home loans at a cost of $729 million. The bill will also give Fannie Mae and Freddie Mac a new regulator, financed by the lenders themselves. As a result of the bill, lawmakers had to raise the national debt ceiling to $10.6 trillion from $9.8 trillion.

The bill now goes to the Senate, where it could face tougher opposition, but is expected to pass. Considering that President Bush has withdrawn his veto threat, it looks like the taxpayers will be on the hook for the housing mess in a big way for many years to come. I am choking on the bill not just because it is so obvious that Congress and Federal regulators were perfectly content to sow the seeds of the problem and help their wealthy friends along the way, but because as they pat themselves on the back on the passage of the bill, they continue to frame issues in simplistic and often false ways.

I get frustrated when I talk about this mess, which is why I was told to “keep it down” when getting into a lively debate over dinner. A friend said that the people who “did” this should be punished. “Did what? You don’t mean to suggest that evil lenders were forcing borrowers to assume mortgages? Or that Wall Street salespeople begged clients to buy higher yielding securities? For every transaction, there were two willing participants, both of whom were succumbing to the greed of the day.” (This is when I was unceremoniously “shushed”.)

There is so much blame to go around in this turmoil that it is hard to know where to start. At every step along the way, there were decisions that required people--lenders, borrowers, lawmakers, Wall Street executives, Wall Street clients--to weigh the perceived risks involved in the transaction at hand. When things were going well, all of the parties erred on the side of being overly optimistic and took what can now be seen as reckless actions. (There were some illegal excesses, which should be remedied by existing fraud provisions.) Overall, greed trumped judgment, for everyone involved and now we are ALL paying the price.

Mortgage Moaning

“Woes Afflicting Mortgage Giants Raise Loan Rates,” screamed the front-page headline in the New York Times. Some people reacted with horror, believing that higher mortgage rates would further impede the housing market. True enough, but instead of seeing the negative, I thought, “sometimes the market itself takes better care of bad behavior than any Congressional policies.” We should see the shifts in the mortgage market as signs of healing and necessary prudence in the aftermath of one heck of a party.

One of the biggest shifts over the past eighteen months is that it has become more difficult to borrow money. While this may stymie a potential homebuyer’s efforts to find his “dream home,” another way of seeing it is to consider that NOT getting that loan may be the greatest stroke of luck that he may encounter. In fact, if lenders had applied similar, or at least somewhat tougher standards while the housing boom was at its height, there would not be so many people who are upside down on their homes or incapable of making their monthly mortgage payments.

The next, natural progression of the credit healing process nature is the change in the actual rate on mortgages, According to HSH Associates, a publisher of consumer interest rates, the average fixed rate for a 30-year conforming loan (one that Fannie or Freddie can purchase from the lender, or $417,000-$729,500, depending on where you live) was 6.71% on Tuesday. The average rate for a 30-year “jumbo” loan, which can not be sold to Fannie and Freddie, was 7.8%, the highest rate since December, 2000.

As predicted when the Fannie/Freddie mess erupted, mortgage rates are rising due to fears that without the government sponsored enterprises supporting the market, there will be fewer lenders available to make loans and those that survive are likely to charge higher interest rates. In essence, lenders are demanding more money (or “vig” as we used to call it on the trading floor) for providing borrowers access to their now-sacred capital. Who could blame them? They are struggling to collect on old loans that were extended, so they now must be extra-careful to only extend credit to borrowers who have sterling credit and are likely to pay each month for the life of the loan.

Now to the moaning part of the story: according to the Times, “for a $400,000 loan, the increase in 30-year rates in the last few days would add $71 to a monthly bill, or $852 a year.” Let’s think about this for a moment—the borrower in question is buying a $500,000 home, putting down 20%, or $100,000, and financing $400,000 with a conventional 30-year mortgage. Are we to believe that $71 per month might be the difference between being able to afford the $500 grand home and remaining a renter? If that’s the case, I have advice for our would-be buyer: you are too close to really be able to afford this house. And if he can only afford to purchase the house with an interest-only mortgage, then all bets are off—he is about to do something that could have significant long-term financial implications.

Ultimately, instead of moaning about the “negative” developments in the mortgage market, we should be applauding the self-regulating markets. These are the types of significant changes that will lead us out of the mess.

A Funny Thing Happened on the Way to Rate Cuts

The Federal Reserve under Alan Greenspan changed the way that people thought about the central bank. Previously, the Fed was almost parental in its role—making sure that the kids did not get too happy when the economy was growing and conversely, tried to make the bad times a bit more palatable. Then Greenspan came along and acted as if any pain in the system was intolerable. He would prevent our suffering and as a result, he became touted as every investor’s savior.

He didn’t start out that way—in the period from 1990-1991 the Fed policy under Greenspan was able to help the economy emerge from recession, without damaging its inflation-fighting credibility. But Greenspan changed over the course of his tenure. He morphed into the easy-going parent—the one who allowed the kids to party at his house without any ramifications and even cleaned up after the party.

The New Greenspan came into his own in 1998, when a large hedge fund, Long-Term Capital Management, was on the verge of collapse. As the firm imploded, the Fed lowered interest rates, which allowed investors to borrow money more cheaply to invest in the securities market, thereby averting a potential downswing in the markets. This action became known as the “Greenspan Put,” as investors assumed the Fed would act to save the system through monetary policy that would elevate market stability above all else.

Unfortunately, actions like these are what sowed the seeds of our current problems. In the aftermath of the tech-bubble bursting, the economy faced significant hurdles. Adding to the already-tense situation, the 9-11 attacks forced action by the Fed to help avoid a complete melt-down. In retrospect, 2001-2002 is not where the problems occurred. It was in 2003, when the Fed maintained the federal funds rate below the rate of inflation even after the pickup in aggregate demand occurred after the 2003 tax cut and the economy was recovering.

Greenspan was fortunate in that his policy decision happened to coincide with a time when globalization’s deflationary effects were peaking. The current Fed under Ben Bernanke has not been so fortunate. But a funny thing happened on the way to this round of rate cuts---there are significant ramifications that are not allowing them to work as well as they had worked under Greenspan. Sure the Fed has slashed rates, but as we sit at 2%, this Fed is dealing with the nagging problem of inflation. Gone are the fruits of globalization!

It is important to note that 2% federal funds rates is actually a stimulative level, but it is creating inflation and increasing the likelihood of elevated inflationary expectations. Bernanke and Co. can not afford to be the cool parents that allow the party to continue. These times demand some adult intervention. Without it, there will be a significant price to pay for all of us.

Fannie, Freddie, Tony and Brian

Remember last week when all the talk was swirling around the fact that mega-mortgage giants Fannie Mae and Freddie Mac were “too big to fail?” I was one of those pundits who reiterated this over and over again. While I still believe that is absolutely true, I also know that there are countless stories of businesses and business owners who are small enough to fail. Today is devoted to these hardworking folks.

Yesterday I went to my tailor, Tony. I truly believe that this man is an artist and send as many people as possible to him. His story is at once ordinary and spectacular in America. Tony came from Italy as a penniless teenager and landed outside of New York City in a small city called New Rochelle. Early on, he worked for others but when an older businessman named Klein approached him to buy his business, Tony jumped in with his wife as an able partner. They never changed the name from “Klein’s” but over the past forty years, it has been their business, their baby and they have been the proud owners through those years.

I walked into the store yesterday only to learn that Tony will be forced to close his business because the building had been sold and the new landlord had tripled his rent. “Jill, I can’t afford it – I am going to have to leave this business that I love so much. How could this happen?” How indeed! I know that I should be seeing this as just another part of the business cycle—the churn, as my friend Burt likes to call it. But like everyone else, once the story affects me and those about whom I care, I lose my capitalist instincts and instead focus on the human element behind the numbers. In many ways, Tony is actually one of the lucky ones. He is 64 and has saved plenty of money, but it is terrible to think that this vibrant professional may not be able to do what he loves.

Tony is in better shape than Brian, who owns a private trash hauling company. Last week, 48-year-old Brian told me that due to the rising cost of diesel fuel and the price pressure from his larger competitors, he was forced to close down the business, sell his trucks and figure out what to do next. He is not in the position where he can go without income for too long, so he will use the proceeds of the truck sales to keep his family afloat and look for a job. If the situation persists, he will have to make some tough choices, like selling his home or maybe raiding his retirement account.

These are just two stories among thousands that occur during a downturn. But it can seem vexing to consider that large, irresponsible companies like Fannie Mae and Freddie Mac are candidates for a bail out, while Tony and Brian are not. In some respects, the small businesspeople, who form the backbone of much of this economy, have taken it on the chin, while the big guys are able to survive. This is one of those nasty realities which is unlikely to change now or ever, but in the end, it still stinks.

Trading Down

My mother told me that she had purchased this fabulous jacket a few weeks ago—it was marked down by 60% and she loved it. But last week, she said, “I’m returning that leather jacket…it’s too much money to spend, especially with everything going on in the economy, don’t you think?” I was shocked. My mother might cut back on lots of things, but clothing was never in that category. Things must really be bad.

The story of my mother’s leather jacket is playing out all over the country. With the economy in rough shape and oil pinching our pocketbooks, a new and interesting trend is developing. At every segment of the wealth ladder, people are making decisions to tighten their belts – in some cases it is drastic. Economists are calling this trend “trading down” and it can be seen in retail, restaurants, vacation choices and in the auto industry.

That means that if you used to shop at Neiman-Marcus, you might head over Bloomingdales or if Target was your previous destination of choice, you might choose Wal-Mart or the Dollar Store. That’s why discount stores overall saw sales jump nearly 6% last month, while those of full-price department stores declined. According to Nielsen North America, which tracks store traffic and spending, visits to department stores are down 6% this year, down 7% at office-supply stores and down 10% at home-improvement retailers. Similarly, in the auto sector, what few cars are moving off the lots tend to be more affordable. In June, the entry-level Toyota Corolla became the best-selling vehicle in America, a spot held for more than two decades by the gas guzzling (and pricier) Ford F-150 pickup.

I think that this is great news. After a nearly two decade-long orgy of consuming, people are starting to change some of the habits that got them into trouble. All of the sudden you can see people clutching coupons as they move through the grocery store—retailers note that the use of discount coupons is starting to rebound after a 15-year slide. Dunnhumby Ltd., a consulting firm that tracks shopping habits for many retailers and says their retail clients are “radically” reducing spending, according to its analysis of their purchasing data. Have you heard about folks in the workplace brown-bagging it? In my own office, the number of people ordering in lunch has plummeted.

On the vacation front, people are staying closer to home, spending less money or taking advantage of the amazing deals that are offered. Out are the European bonanzas and in are the one week trips to a relative’s beach house. One friend told me that she used to go away for two weeks every summer, but has decided to go for one week this year and just hang out at home for the other week.
As consumers continue to adjust to the slowing economy and the reality of $4 per gallon gasoline, the “trading-down” trend will persist. Now if it holds when the economy turns around and we can learn how to save that money instead of going back to our old bad habits, then this painful period will have been well worth it in the long run.