Economists Need Better Inflection Detection
Here’s a way of articulating the effect of force-feeding the economy residential investment from 1990 to 2005. This is in David Leonhardt’s “Economic Scene” column today in the New York Times.
It’s not fair to expect Mr. Obama’s economists to be clairvoyant. But they did make one avoidable mistake that led directly to their overoptimism. They relied on the same forecasting models that had completely failed to see the crisis coming.
These models, which are also used by Wall Street and various research firms, do a decent job most of the time. But they are notoriously bad at forecasting turning points because they are based on an assumption that the recent past will more or less repeat itself.
Clearly, recent economic history is not going to repeat itself. It included two huge asset bubbles, first in stocks and then in real estate. The models came to treat those bubbles — and the additional consumer spending they caused — as the new normal. When asset prices began falling, the models couldn’t keep up, with either the pace of declines or the economic damage they were causing.
Leonhardt argues that an effective Stimulus and an incipient economic recovery are two different things (i.e. just because the Stimulus is working doesn’t mean the economy’s getting better). His essay sort of suggests that the Administration’s money math meisters should redo their arithmetic and come back with a Stimulus 2 that actually gets the economy going again.
His big conclusion is to back the old car tire right over the rose-colored glasses: Look ahead with a sober eye.
Calculated Risk’s blog has been great at holding Treasury Department “stress test” scenarios for housing and unemployment up against the mirror of reality. Here he simply gives White House senior economic advisor Christina Romer enough rope to hang herself. She bids us to stay tuned as the real fun of the Stimulus starts kicking in, and says the programs will have palpable impact in the back half of 2009. Calculated Risk says, hey, that’s where we are now.
So we should see an impact in the 2nd half of 2009 … and that starts now!
The organizational structures, facilities, and implementation programs to get in place to actually spend $30 billion a month in Stimulus monies are enormous. One can believe that it would take this amount of time to get the infrastructure for spending in place.
But the material issue behind whether the Obama economists are way off in their math boils down to the continued tolerance limits of the financial system that the stress test may have failed to expose.
Also, it’s a natural in a highly politicized and polarized culture that people react in one of two ways to dramatic errors in significant economic forecasting: 1) they think you’re lying or spinning and have something to hide; or 2) they think you’re an idiot.
Either way, credibility takes a hit. So Christina Romer, Larry Summers, and Tim Geithner had better hope they’re right about second half traction for their programs. Not just in measuring whether the Stimulus money has been effectively deployed; but in seeing the multiplier effects of success begin to turn the tide of expectations from negative to positive.
Saddest Quote du Jour
Only those who are compelled by an old-fashioned sense of obligation might continue making payments.
This is the opinion of the Milken Institute’s director of regional economics Ross DeVol and president and chief executive Michael Klowden, which appeared this past Friday in the Financial Times.
They’ve mapped out a plan that the HUD Secretary Shaun Donovan, FDIC’s Sheila Bair, Treasury Secretary Tim Geithner, and the Fed’s Ben Bernanke should consider in light of the feeblest signs that home buying demand does exist if just a few of the foreclosure headwinds can be muted.
DeVol and Klowden note that the big flaw in Obama’s program to stem foreclosures is not in its mission nor even its structure, but in its math. A 105% LTV ceiling just doesn’t cover enough troubled homeowners, nor does the current program forcefully enough incentivize wavering borrowers to weather the storm and keep repaying.
To fix this conundrum, the Obama administration should add the homeowner principal forgiveness vesting plan to its program. Here’s how it works: After a valuation of the property and proper income and credit verification, two separate loans are made. The first loan, from Fannie Mae, would be for the current value. A second, interest-only loan, from the Treasury Department, would make up the difference between the current home value and the original mortgage.
We wonder how widely shared the two authors’ view is on the following assumptions:
- 6 out of 10 purchases since 2004 are underwater
- Every 100,000 foreclosures prevented translates into .5% on home price stabilization
The big time conclusion:
So, if 1.5m foreclosures were to be avoided, home prices would be 7.5 per cent higher than without the plan.
That’s a lot of wealth destruction avoided, a lot of consumption capacity preserved, a lot of jobs saved.
Still, it’s sad that the sense of obligation to pay back what one borrows is “old-fashioned.” Passe.
I Say, About that Toxic Asset Plan…
This ADD-sufferers’ version of the Geithner Put comes from the Financial Times, which uses explainer-graphics and a we-can’t-make-this-stuff-up voiceover to make the toxic asset plan clear enough for the dullest of us knives in the drawer.
Here’s a link to The Geithner Plan Explained from FT.com. You won’t regret the time it takes to register for the site.
Local Intel–Update 3/26 with Fixed SlideShow ;-)
People don’t buy nor do they sell homes pegged to national real estate trends. Nor even do potential investors or sellers of land make their decisions based on Case-Shiller or any broad stroke metric. Real estate is as local as the next door neighbor’s property line and the length of the drive or walk to necessary destinations like the school, or transportation, or shops, or healthcare.
Especially since job markets are in convulsion–real estate analyst John Burns calls for employment to retreat to 88% of adults who seek full-time work in the next couple of years–waves of local recesssions, lowpoints, and recoveries will occur in different locales at different moments.
The Concord Group, a land use and real estate consultancy, has plotted a recovery timeline for a number of geographies based on job and household formation dynamics that economic drivers have set in motion. No secret to the formula is that land prices, notoriously sticky, will exhibit give first and come closer to “bid” prices as soon as clarity emerges on the latest Geithner plan for banks’ toxic assets.
Once land truly resets and trades resume at some volume, the lot cost-base of new homes will firm up, and a corrected normalized level of volume and pricing will take shape.
Big Builder editor Sarah Yaussi has produced this brief drill-down of the Concord Group analysis, with commentary from Concord principal Andrew Borsanyi.
The Redemption: Geithner Plan a Wall Street Hit
Neither a borrower nor a lender be;
For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry.
This above all: to thine own self be true,
And it must follow, as the night the day,
Thou canst not then be false to any man.
– William Shakespeare, English dramatist & poet (1564 – 1616)
–”Hamlet”, Act 1 scene 3
Click image for access to Geithner's Wall Street Journal Op-Ed piece today.
The pipeline of trillion-dollar federal policy programs today offers the latest one that has made U.S. Treasury Secretary Timothy Geithner the sudden darling of Wall Street. Odd that several weeks ago–two weeks into his new job description–many of those same Wall Street denizens declared Geithner worse than useless, and as recently as last week, there were over-unders on when he would be headed out Treasury’s revolving door in ignominy.
Back those few weeks, the appetite for a groundwork of principles that would support a plan was not there, but now that the plan has been filled-out and articulated, critics are shutting up long enough for Geithner to appear to know what he’s talking about when he refers to the global financial complex and the trouble that it’s in.
Now that Wall Street investors appear to have bought-in to the details, the credibility capital Geithner seems to have lost when he opened his mouth in amid the crawl of stock tickers in mid-February now is back within his grasp.
The question remains though. What does the program fix? Borrower? Lender? Anyone?
Economics Nobelist, Princeton professor and New York Times columnist, Paul Krugman spells out the administration’s and Geithner’s theory underlying the current plan to wrest toxic assets from the banking system, a theory he disagrees with.
But banks can also fail even if they haven’t been bad investors: if, for some reason, many of those they’ve borrowed from (e.g., but not only, depositors) demand their money back at once, the bank can be forced to sell assets at fire sale prices, so that assets that would have been worth more than liabilities in normal conditions end up not being enough to cover the bank’s debts. And this opens up the possibility of a self-fulfilling panic: people may demand their money back, not because they think the bank has made bad investments, but simply because they think other people will demand their money back.
Bank runs can be contagious; partly that’s for psychological reasons, partly because banks tend to invest in similar assets, so one bank’s fire sale depresses another bank’s net worth.
So now we have a bank crisis. Is it the result of fundamentally bad investment, or is it because of a self-fulfilling panic?
Clearly, the assumptions underneath the administration’s plan embrace the latter of the two causes. So the program and the process, and the articulation, and the defiance that accompanies the roll-out of the Public-Private Investment Program rely extensively on a conviction that restoring calm and confidence–even a measure of greed–will get a flow of funds going.
But the base of the problem remains. Bad loans occurred. Lenders and investors took bad risks around those loans. People bought homes they should not have bought–20%-plus of them were investor purchases for flipping purposes during the final two or three years of the run-up–and now the reset on the value or lack thereof of those loans and the investments on top of the loans, will be deferred as a complex delay-the-pain mechanism kicks into action, aggregating what was bad into a toxic pool for a later day, and setting refurbished bank balance sheets back into business like an afternoon at the dog-groomers.
The wager here is twofold. One is that investors, lured by the virtual elimination of risk, will find that this is the place for all that pent-up liquidity that had been awaiting “the floor” for asset pricing before it moved in for the strike. Two is that borrowers will exhibit a more steadfast commitment to the obligations of their loans.
In our need for instant gratification and immediate solutions, we may have a blast of “good news,” that can bouy spirits and keep stocks on an upward trajectory for the month.
But we can see in our closer look beneath the headlines on existing home sales, starts, permits, etc., that there’s a lot of work to do, and much of that work is going to be a good, old-fashioned work-out between buyer and seller based on what a property is worth today, and tomorrow, and the day after, to someone who wants to live in that property.
Borrowing and lending are part of real estate in North America. So Shakespeare’s admonition could never be taken literally. But a great dramatist and poet of today would probably figure out a way to add to the phrase somehow. “Neither a borrower nor a lender be (unless there’s sufficient skin-in-the-game for the borrower and unleveraged capital on the part of the lender).”
Posting Plans
Tomorrow will continue to be a sparse day for posting here.
We’ll have an earlyish note, once again questioning conventional wisdom about what laws govern housing prices. And, probably by later in the day, we’ll begin to catch back up with observations from hither and yon.
Meanwhile, if you haven’t looked at it, check out the Charlie Rose interview with our U.S. Treasury Secretary.
Turbo Timmy’s Tenure Tenuous?
Credit The Big Picture for attention to this video.
It’s Chris Whelan, director of Institutional Risk Analytics, with a prediction about U.S. Treasury Secretary Timothy Geithner. In light of the reception Geithner’s gotten in his first six weeks in office, it’s no surprise powers-that-be might say his days as Treasury chief are numbered.
Cram Down Legislation: If Only Ty Pennington Could Get At It
To suggest that housing crisis problems we’re dealing with on March 4, 2009 are semantic in nature wouldn’t be fair.
Still, “cram down,” whether you hyphenate it, make it two words, or one, is just plain unsavory as a term. Which is probably why it stirs eruptions of vitriol about who’s getting stuck with what as conversation about whether it’s an appropriate tactic to bring to bear as smart people try to come up with smart strategy to battle the fact that people are losing their livelihoods by the 700ks every time we turnaround thanks to housing’s free-fall.
Whoever made up the term cram down is probably the same kind of person who’d invent that kind of plastic packaging that winds you up in the emergency room when you try to get at the electronic device you bought and want to open. Those people should go to a dark, fiery place for all eternity.
Two events gave us an idea about all this. The idea is basically this. Hire an ad agency, like R/GA in New York, and stop calling things names that sound vaguely like sticking a finger down your throat to get the desired effect. I.E. Brand the bugger!
Now that we’ve tipped you off to the idea, we’ll tell you about the two events that led to it. One was this. Did you notice something weird this week? U.S. Treasury Secretary Tim Geithner talked–a lot, and under a lot of pressure–and the stock market didn’t go into a WWI-style air casualty. Why? Branding. If Tim Geithner can be media trained into greater proficiency in selling in his genius to America’s elected representatives and to white-knuckled Wall Street investors, then, by all means, let’s fully explore the possibilities here.
For instance, look here. It’s New Deal 2.0, a promise of big government value on your taxpayer dollar.
Click image to original Wall Street Journal coverage on Obama's branding of the recovery in "Real Time Economics."
Who, after all, will be our protracted downturn’s Diego Rivera?
Now, back to cram downs. Here’s a prophetic Calculated Risk post from 2007 that’s about the best explanation and rationalization for the procedure that we’ve seen to date. In other words, it’s not about being overly generous to those homeowners who might be undeserving. It’s about making lenders pay the price for their greedy, unscrupulous practices and setting up a standard by which they’d never do it again.
I have some sympathy with the view that mortgage lenders “perform a valuable social service through their loans.” That’s why, when they stop doing that and become predators, equity strippers, and bubble-blowers instead of valuable social service providers, I like seeing BK judges slap them around. Everybody talks a lot about moral hazard, and the reality is that you’re a lot less likely to put a borrower with a weak credit history, whose income you did not verify and whose debt ratios are absurd, into a 100% financed home purchase loan on terms that are “affordable” only for a year or two, if you face having that loan restructured in Chapter 13. If you are aware that your mortgage loan can be crammed down, I’m here to tell you that you will certainly not “forget” to model negative HPA in your ratings models, and will probably pay more than a few seconds’ attention to your appraisals. You might even decide that, if a loan does get into trouble, you’re better off working it out yourself, via forbearance or modification or short sale, rather than hanging tough and letting the BK judge tell you what you’ll accept. That would be a major bummer, right?
Fast-forward to the present for a more updated take, posted on The Huffington Post, from David Abromowitz, senior fellow at the Center for American Progress, which probably has an ideological bent we’re not entirely supportive of. Still, we’re behind the philosophy of the assertion here.
Congress needs to finally enact a bankruptcy reform bill that includes one of the few real tools for breaking the grip of the devastating downward foreclosure spiral. There are many sound economic and policy reasons for Congress to provide a judicially approved “cram down” possibility for homeowners. Yet one basic reason gets less mention — it is simply a matter of fairness.
Few Americans realize that single family homeowners living in their own primary residence are the only real estate owners without cram down protections in bankruptcy. As U.S. Bankruptcy Court Judge Louise DeCarl Adler has aptly captured it, “we could always rewrite the loans on John McCain’s second through ninth homes but not on his first.” Donald Trump wouldn’t — and couldn’t — sign away his right to have a bankruptcy judge reduce the principal mortgage balance of a loan on one of his properties, but a homeowner starts out with Congress having previously taken that option away. Maybe with 1 in 5 families with a mortgage owing more than their house is worth — most of whom borrowed within their means when they first took out their loan — and 8 or 9 million households still potentially facing foreclosure, Congress will put homeowners back on equal footing with real estate moguls.
The measure is said to be due for vote in the House of Representatives Thursday. That’s probably enough time for a good advertising agency to turn around a campaign to rebrand the issue, and give it an entirely more asethetically compelling value proposition.
Move that bus!
HASP Details with the Devil in Them
Here’s the link to the U.S. Treasury Department “Home Affordable Modification Program Guidelines” that anchors President Barack Obama’s $75 billion Home Affordability and Stabilization Plan. Here’s a fact sheet that outlines the ambitions and broad workings of the Treasury plan.
The Wall Street Journal reports:
“Two weeks ago, the president laid out a clear path forward to helping up to 9 million families restructure or refinance their mortgages to a payment that is affordable now and into the future,” Treasury Secretary Timothy Geithner said Wednesday in a statement. “Today, we are providing servicers with the details they need to begin helping eligible borrowers.”
The administration’s new housing rescue effort includes a program aimed at reducing the amount homeowners owe per month. Under the program, the lender will have to first reduce monthly payments on mortgages so that the borrowers’ monthly mortgage payment is no greater than 38% of his or her income. The program will then match further reductions in monthly payments dollar-for dollar from 38% down to 31% debt-to-income ratio for the borrower.
The modified payments will be kept in place for five years and the loan rate will be capped for the life of the loan, Treasury said in technical documents provided Wednesday morning. After five years, “the interest rate can be gradually stepped-up by 1% per year to the conforming loan survey rate in place at the time of the modification.”
Treasury said that in order to reach that 31% debt-to-income ratio level, interest payments will first be reduced down to as low as 2%.
The equities markets, lenders, and capital sources have shown a high degree of intolerance for “plans to have a plan,” lack of details, lack of action. This release of information and operational steps can kick the program into gear effective now. The WSJ highlights the following in a post seeking audience comments on its Real Time Economics page.
Eligibility and Verification
Loans originated on or before January 1, 2009. First-lien loans on owner-occupied properties with unpaid principal balance up to $729,750. Higher limits allowed for owner-occupied properties with 2-4 units. All borrowers must fully document income, including signed IRS 4506-T, two most recent pay stubs, and most recent tax return, and must sign an affidavit of financial hardship. Property owner occupancy status will be verified through borrower credit report and other documentation; no investor-owned, vacant, or condemned properties. Incentives to lenders and servicers to modify at risk borrowers who have not yet missed payments when the servicer determines that the borrower is at imminent risk of default. Modifications can start from now until December 31, 2012; loans can be modified only once under the program.Loan Modification Terms and Procedures Participating servicers are required to service all eligible loans under the rules of the program unless explicitly prohibited by contract; servicers are required to use reasonable efforts to obtain waivers of limits on participation. Participating loan servicers will be required to use a net present value (NPV) test on each loan that is at risk of imminent default or at least 60 days delinquent. The NPV test will compare the net present value of cash flows with modification and without modification. If the test is positive – meaning that the net present value of expected cash flow is greater in the modification scenario – the servicer must modify absent fraud or a contract prohibition. Parameters of the NPV test are spelled out in the guidelines, including acceptable discount rates, property valuation methodologies, home price appreciation assumptions, foreclosure costs and timelines, and borrower cure and redefault rate assumptions. Servicers will follow a specified sequence of steps in order to reduce the monthly payment to no more than 31% of gross monthly income (DTI). The modification sequence requires first reducing the interest rate (subject to a rate floor of 2%), then if necessary extending the term or amortization of the loan up to a maximum of 40 years, and then if necessary forbearing principal. Principal forgiveness or a Hope for Homeowners refinancing are acceptable alternatives. The monthly payment includes principal, interest, taxes, insurance, flood insurance, homeowner’s association and/or condominium fees. Monthly income includes wages, salary, overtime, fees, commissions, tips, social security, pensions, and all other income. Servicers must enter into the program agreements with Treasury’s financial agent on or before December 31, 2009.Payments to Servicers, Lenders, and Responsible Borrowers The program will share with the lender/investor the cost of reductions in monthly payments from 38% DTI to 31% DTI. Servicers that modify loans according to the guidelines will receive an up-front fee of $1,000 for each modification, plus “pay for success” fees on still-performing loans of $1,000 per year. Homeowners who make their payments on time are eligible for up to $1,000 of principal reduction payments each year for up to five years. The program will provide one-time bonus incentive payments of $1,500 to lender/investors and $500 to servicers for modifications made while a borrower is still current on mortgage payments. The program will include incentives for extinguishing second liens on loans modified under this program. No payments will be made under the program to the lender/investor, servicer, or borrower unless and until the servicer has first entered into the program agreements with Treasury’s financial agent. Similar incentives will be paid for Hope for Homeowner refinances.Transparency and Accountability Measures to prevent and detect fraud, such as documentation and audit requirements, will be central to the program. Servicers will be required to collect, maintain and transmit records for verification and compliance review, including borrower eligibility, underwriting, incentive payments, property verification, and other documentation. Freddie Mac will audit compliance.
The worriers on Calculated Risk’s self-described “Commentariat” are fretting that the program is a multigenerational debt-shift. One comment re-coined the program “United States Program to Underwrite Real Estate Speculators… UPURS.”
Here’s a link to a statement from James Lockhart, director of the Federal Housing Finance Agency, about revelation of the plan’s details.
First Time’s A Charm — Home Buyer Tax Credit Due on 2008 or 2009 Income
Here’s the press release from the U.S Treasury.
Washington, DC – In an ongoing effort to deliver on swift implementation of the Obama Administration’s recovery, stability and affordability plans, the U.S. Department of the Treasury touted today the availability of an expanded tax break for first-time homebuyers – a provision under the American Recovery and Reinvestment Act of 2009 that will make up to $8,000 available now to qualifying taxpayers who buy homes this year.
First-time home buyers represent a significant portion of existing single-family home sales. In 2008, nearly one out of every two homebuyers were buying for the first time, and the expansion in the first-time homebuyer credit will make it easier for first-time home buyers to enter the housing market this year.
“The expansion of the first-time home buyer tax break as part of the President’s recovery agenda gives money to taxpayers when they need it most, while also targeting an important group of buyers,” said Treasury Secretary Tim Geithner. “We view our economic recovery plan, our financial stability plan and now this homeowner affordability plan as three legs of the same stool – an integrated whole that represents our immediate response to the current crisis. We remain committed to swift, efficient and effective implementation of all of these components.”
The announcement comes on the heels of the first Recovery Plan Implementation meeting led by Vice President Joe Biden at the White House this morning; Secretary Geithner was among several Cabinet secretaries to attend and offer updates on implementation efforts in progress at Treasury and its bureaus. Vice President Biden is overseeing the Administration’s implementation of the Recovery Act’s provisions.
The Internal Revenue Service (IRS) has posted on IRS.gov a revised version of Form 5405, First-Time Homebuyer Credit to incorporate provisions from the American Recovery and Reinvestment Act. Under the new law, qualifying taxpayers who buy a home this year before December 1 can claim up to $8,000, or $4,000 for married individuals filing separately, on either their 2008 or 2009 tax returns. Unlike the prior first-time homebuyer credit, this is money individuals do not need to pay back.