While there were many threads of thought that could turn into policy when Congress is presented a proposal in January 2011, I rub my Conjecture Ball and foresee:

The Government sponsored artists currently known as Fannie and Freddie shift from hybrid private/Government controlled entities to straight up Government controlled.  OK, it’s not really speculation when Timmay Geithner states: “We’re not going with a system where private gains are subsidized by taxpayer losses.”  Anyway, they abandon the practice of implicitly guaranteeing (~90% of all) mortgages today in favor of an explicit guarantee that reads like an insurance policy.  So, the Government will provide mortgage insurance for a fee instead of the Freemium model currently enjoyed by financial institutions.  That model didn’t work out real well for anyone except big ass banks.  Our Government hasn’t been real savvy when it comes to financial engineering…free really shouldn’t be the new business model, with all due respect to Chris Anderson.

Government Sponsored Mortgage Insurance (GSMI).  This is interesting, really.  The premiums for something like GSMI would be paid by the individual mortgage holder and the policy would insure the actual asset, not the business entities that hold them…suitably addressing Mr. Geithner’s statement above.  Fannie and/or/nor Freddie can thus go back to performing the duties they were essentially created to carry out: To create affordable housing for the masses and mitigate risk on their behalf.  They could still maintain, even increase their influence on the market whilst scaling back on the actual buying of mortgages…insuring parts thereof instead.  Theoretically this shift would provide enough incentive and security for the private sector to gradually re-enter the mortgage space and fill any vacuum created by the Governments very, very gradual decrease in purchasing mortgages.  A new fee like GSMI means other fees and current tax deductible benefits currently innate to a mortgage take a hair cut…like the mortgage interest deduction.

The powers that be are focused on providing suitable, affordable housing…just not necessarily through home ownership.  As such, rental market dynamics are being primed for adjustments. Multi-family housing loans made accessible and desirable due to favorable GSMI terms seems highly plausible.  There are likely to be other subsidies into the rental market from initiatives like PETRA to help shore up this sector of affordable housing.

If you continue to listen closely and look closer, the landscape is being primed for The Ultimate Fix…

“The only way to fix it is to flush it all away.”

One of my favorite bands goes by the name of Tool.  They create deep, dark, complicated music, but they are an acquired taste…not for everyone.  The following is a verse from one of their songs appropriately named ‘Aenima‘  **Bad Language Warning**  Skip down if you are offended by profanity.

Some say the end is near
Some say we’ll see armageddon soon
I certainly hope we will
I sure could use a vacation from this
Bullshit three ring circus sideshow of  Freaks
Here in this hopeless
fucking hole we call L.A.
The only way to fix it is
to flush it all away
Any fucking time, any fucking day
Learn to swim, I’ll see you
down in Arizona Bay.

So, nix the reference to Los Angeles and ‘Arizona Bay’, fill in metaphors of choice and it sounds like they’re waxing philosophical about the economy, the housing market specifically.   Rather prophetic too since this is whats about to happen…actually its already started.

Over the next six or so months the housing market will continue to tank as financial institutions release huge amounts of distressed (shadow) inventory into the market creating supply that far exceeds the ability to consume.  This will exert extreme downward pressure on property values.  The number of banks will continue to contract.  Homeowners will continue walk away from their houses.  The National Association of Realtors will continue to tell anyone who is listening that its a great time to buy.

These sour conditions will be amplified with the seasonal slowdown to such a point where everyone is clamoring for additional Government ‘intervention’ or stimulus or Print More Money!!  Except I don’t think there will be much, if any, of that.  There really isn’t much left to be done except to allow the existing system to flush itself and prepare for what comes out the other side.

Whats on the other side of this economic enema?  Explicit Government guarantees via the artists formerly known as Fannie and Freddie to keep the cost of credit within reach of the qualified rather than the entitled, increasing private money participation, and a retooled rental market system to support all the displaced homeowners.  Dead inventory will be channeled off through a series of initiatives like HomePath.  The housing market and property values drop below this ‘double dipped’, false floor we’ve been dancing on for almost 2 years…and there is no where to go except up.  Which equates to a real recovery and sustainable growth which will lead to inflation and all those other problems that we can worry about that sometime post 2012, assuming that whole Mayan prophecy thing doesn’t absolve us of any future responsibilities.

This painful process constitutes a necessary de-leveraging of an economic system thats based on a debtor society which has been taught to borrow/spend beyond it’s means.  While it may hurt and otherwise cramp our very American style, its really not the end of the world as we know it.

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The Ultimate Fix

John Paulson was an interesting figure in the whole SEC vs Goldman Sachs stink-eye contest, which ultimately ended up with Goldman getting slapped on the wrist with a fine and restitution to damaged investors for ‘making a mistake‘.  Looks like J-Paul managed to stay out of range of any collateral damage and made billions by helping build the elegant piece of financial engineering that enabled Goldman to make their ‘mistake’…directly contributing to the housing bubble and subsequent *pop*.

Former Treasury secretary and Goldman Sachs exec Henry ‘Hank’ Paulson (of no relation to John) donned his 20/20 hindsight glasses for the Financial Crisis Inquiry Commission.  Too bad he didn’t practice what he preached while he was in the middle of it all…

Ben Bernanke the Federal Reserve Chairman warned about warning of pending warnings as to what the Feds future economic policy changes may look like.  This ‘no surprises’ strategy is intended not to spook investors and/or cause knee jerk reactions.  Unfortunately well prepped domestic policy changes wont do much to reduce the anxiety of investors as global headline news continues to cause such spooky, knee-jerk reactions…but thanks for the warning ahead of the warnings about your read and react strategy Ben.

More in line with the real estate (and mortgage) markets proper, I started a series about how some real innovation was required in the aspects of business and cost modeling for the industry’s to change in meaningful ways.  New sexy search UI’s and social media are fun and all but they do little to address the core problems at hand.  Beauty is only skin deep and the insides of these industries are nothing short of fugly.

Politics tend to get in the way of meaningful change when it comes to the real estate industry, evidenced by the strong aversion from real estate professionals to offering consumers a peek into their professional track records or ‘report card‘.  The Houston Association of Realtors (HAR) launched an Agent match product that was by most accounts very benign in regards to the information being displayed for public consumption.  Nonetheless they had to take the product down within 48 hours of its official launch because inmates run the asylum in real estate-land.  Thats sad.  I applaud Bob Hale of HAR for having the guts to push for this type of initiative and believe he is 100% correct when stating: ‘It will happen outside of the industry, and everybody will be mad’.

Another Captain Obvious moment- Alan Greenspan.  The former Fed Chairman really stepped out on a limb recently by prognosticating that another dip in home prices could cause a double-dip in the overall economy.  Never mind that no one can agree on what really constitues a double dip recession, outside of the notion that the economy shrinks, then grows, then shrinks again, then…doesn’t the economy do this all the time?  Double dip, W-shaped, recession, depression, correction…all economic semantics for:  Our economy is going nowhere fast with long term issues like high unemployment, shadow inventory and mortgage underwriting standards so tight you couldn’t pull a pin out of a lenders ass with a John Deere tractor…

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All real estate, economics and the unimportant aspects of life aside-

A dear friend, peer and overall great human being passed away last evening.  Joe Ferrara may have lost his battle with cancer but he won the hearts and minds of countless people through his unselfish nature and consistent nurture.  While I mourn your death, I celebrate your life.  Rest in peace Joe…

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Honest Mistakes, 20/20 Hindsight, No Surprises, Real Innovation and Double Dip ‘Psycho-Semantics’

Well you can throw all that logical shit out the window.

There are days when stocks rise and rates fall.  There are days when rates rise and stocks fall.

I pride myself on staying pretty up to date with what goes on in the financial markets, particularly their actions subsequent effects on prevailing mortgage rates…and I have no f*cking clue where mortgage rates are going on a daily or weekly basis, no one does.  Anyone who says they do is guesstimating at best, and my guess is that even the best market prognosticators are maybe 50% correct 50% of the time.

Its pretty safe to say rates are going to trend upward at some point because they can’t get any lower.  Like any other instapundit I can tell you why they moved the way they did after the fact.  When money en masse moves into Mortgage Backed Securities, rates go down.  When money moves out of MBS positions en masse, rates go up.  Outside of that, there are so many variables effectuating the market, I hereby deem predicting the short-mid term direction of mortgage rates with any sort of consistent accuracy logically impossible.

For example, the Euro has taken a beating because its connected to the troubled economies of PIIG countries (specifically Greece), subsequently strengthening the dollar causing investors to move to the relative safety of US backed Treasuries.  Couple that with the ban on naked short selling in Germany because financial institutions were creating mortgage investments that are (secretly) designed to fail and you have market conditions to keep mortgage rates low.  Yeah, that shit was easy to foresee.

FTW!

Markets are emotionally supercharged akin to an estrogen laced PMS’ing bitch, effected by wide ranging global events and as such there is simply no logical way to predict if rates are going to rise or fall on the short and mid term.  Rational economics left with the industrial age and technical investing is quickly following.  Floors, ceilings and other traditional technical investment indicators are being shattered and/or crushed.  These are the days of behavioral economics where cognitive biases rule over rational decisions.  When emotions run high, there’s no telling what happens 4 minutes from now let alone 4 weeks.

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Estrogen Infused Markets Equals Unpredictable Mortgage Rate Forecasting

You can’t make this stuff up:

Magnetar Capital, a Chicago based hedge fund, went into business in 2005 at about the time that Sub-Prime mortgages were recognized as being ‘toxic’ in the sense that they don’t perform, as in- Homeowners don’t make their payments and investors don’t get paid.  Nonetheless, they started buying up these toxic loans (through various conduits) and bundling them up in Collateralized Debt Obligations (CDO’s), creating huge demand and liquidity for dogshit mortgages to put people in.

All Magnetar CDO’s contained the worst kind of mortgages…the No Income No Asset, No Job, Low FICO, short term ARM variety located in states with the highest appreciation mortgages…the mortgages that default like the consumers they gave them to had no income or jobs with a poor track record of paying debts back.

Magnetar subsequently bought Credit Default Swaps (CDS’s) or insurance policies against the dogshit CDO’s (they created) just in case they defaulted.  CDS’s cost money in the form of premiums, just like you pay on your car insurance.  Magnetar used the higher yields from the CDO’s they created to pay the CDS insurance premiums…until the CDO’s defaulted that is…then they collected the insurance policies payout.  These insurance policies paid out far more to the hedge fund than any  loss they would incur if, err, when the CDO defaulted.

This became known as ‘The Magnetar Trade’ as is being pegged as the primary reason the US Housing market crashed so hard and pulled the world economy down with it.

For review:  The Magnetar Trade strategy was to fuel the marketplace by purchasing dogshit mortgage securities (creating liquidity and loans) bundle them up into CDO’s, sell them to investors as AAA rated then bet Big Money on the fact the CDO would default, and collect said Big Money when they did.  It was simple, elegant even, and legal.

Almost every major institution on Wall Street played this game, executing ‘Magnetar Trades’…Merrill Lynch, JP Morgan, Lehman Brothers even the Streets most prestigious firm: Goldman Sachs.  John Paulson of Paulson and Co. (near future scapegoat/pariah) created the Abacus Fund for Goldman.  Abacus was architected after the Magnetar blueprint.

Recently the SEC decided to bring a lawsuit against Goldman Sachs alleging fraud around the Paulson created Abacus hoo-ha.  The core of the suit alleges Goldman deceived and sold investors on a security that Paulson helped design to fail, and made a bunch of money because of it.

Regardless of lawsuits and agendas, there is no getting around the fact that these sort of ‘investment strategies’ by ‘Wall Street’ negatively effected millions of homeowners…fuck the investors and investment banks.  It’s not hard to draw a pretty straight line between Wall Street greed and the implosion of the US Housing market.

I don’t think the lawsuit sticks but it raises an incredible amount of awareness in the public arena around a sophisticated and sinister Wall Street play that negatively effected millions of homeowners.  That’s great for pushing an agenda, especially a political one as the timing of all this is obviously politically motivated…but this isn’t a political post- I pro-actively filibuster myself from political arguments so this doesn’t turn into a 3000 word circular argument.

Consumers were unwitting pawns subsidizing this game of sophisticated capitalism…that’s whats going to be played out in the press on on TV. So, will a public growing more weary by the day of Big Government side favorably with Big Government having its way with Wall Street?

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How to Short The US Housing Market and Throw an Economy Into a Recession

However, there are some interesting facts to consider besides traditional logic…

Contrived Attrition?

The ironic part is that the forces that helped bring this market to its knees may be the same that build it back up.  Let me explain…

Back in July 2008 I questioned whether some of ‘this’ wasn’t a bit contrived…I still do.

These two posts written in July 2008 speculated on possible alternative reasons Fannie and Freddie stock was plummeting…special note to the link citing the  Financial Accounting Standards Board decision to favor a simpler accounting method for Qualified Special Purpose Entities that serviced mortgages into securities for the benefit of adjusting distressed borrowers ARM’s.  What?  In a nut shell, at the end of the day, lenders wouldn’t be able to bury losses from the public’s eyes like they used to and their financial reports would suffer.

Coincidentally or not, on July 6, 2007 the SEC eliminated the ‘Uptick Rule‘ which was implemented in 1938 to curb the type of concentrated short selling of stocks where speculators make money when the stock price drops.

New accounting methods for financial institutions will show increased losses on paper, naturally priming the pump for plummeting stock prices.  Sans uptick rule, speculators smell bearish conditions and short stocks with fervor, driving companies and portfolios values into the ground.

By October 2008 blood was in the streets and investors start shorting financial institutions stocks in historical volume, acting as if they were…going out of business…? Fannie and Freddie are sequestered from the chaos.

Conventional money (401(k), Mutual Funds, regular people etc) got the hell out of the way and out of the market.  Institutional investors ate each other for lunch. Everything went ‘Pear Shaped’.  Many stocks are today worth less thah 50% of their value from 18 months ago.

The Government announces plans that they are going to Bailout ‘the worthy’ using a hodge-podge of methods, some useful others akin to little more than a circle-jerk, including buying preferred and common shares of these floundering financial (and related industry) behemoths that are ‘too important to fail’.

The Return of ‘Favorable’ Accounting and Keeping The Bears on a Leash…

March 10th 2009…The Dow surged 6%+ on the following news (Courtesy Wall Street Journal)

Federal Reserve Chairman Ben Bernanke said in a speech it was important to address the valuation of illiquid assets. Banks want leeway in accounting for illiquid holdings, and investors were encouraged by Mr. Bernanke’s statement, though he said that he wouldn’t support the suspension of mark-to-market rules.

“Bernanke said the magic words — that the Fed was considering looking at accounting standards,” said Fred Dickson, market strategist at D.A. Davidson.

It would appear after looking at yesterdays market swing that the accounting standards that Mr Bernanke is alluding to will favor banks, shoring up value in investors eyes, hence the mini-rally. Were his words transcribed as ‘We’ll let you get back to some creative accounting soon’

Barney Frank also stated the SEC may reinstate the ‘uptick rule’ as early as April, which has to re-establish overall market confidence by keeping the Bears on a bit of a leash, mitigating the extreme volatility.

Is it That Crudely Simple?

Was this all contrived to flush out all of the ‘toxic’ securities faster rather the wade in the muck for years?  Where the floodgates purposely opened only to close them back up when the time was right?

I’m often asked when I think the real estate and mortgage market will bottom out.  My answer usually coincided with the end of the 2-5 year period after NINJA (No Income/Asset/Job) loans were banished from the marketplace…around September 2007…so September 2009 is when support could naturally start to manifest.

There are now a myriad of artificial factors suggesting this ‘time to bottom’ could be ‘moved up’.  Coupled with the news yesterday, it very well could be sooner (end of ‘09) rather than later (end of ‘12).

A real sign that the markets are back on track would be when lenders will get back to sensible underwriting standards.  From 2002 to 2007 mortgage underwriting was as fast and loose as a brothel in Amsterdam.  2008-current, you can’t pull a pin out of a lenders ass with a John Deere tractor they’re so tight.  There is a middle ground, which is a topic for another post…

I’m not here to call the beginning of the end to these crazy economic times, there is still a looong way to go with many details to be worked out and ups/downs in front of us…I just can’t help but wonder aloud if aspects of this ‘economic meltdown’ weren’t contrived to push the crap out of the system quicker, knowing full well there would be (justified? acceptable??) collateral damage…It sounds ridiculous to say, yet resonates as plausible to the (my) mind…

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Contrived Attrition? Washingtons Play in The Fall and Rise of Wall Street