Paulson on the Hindenburg: “The worst is just beginning”

February 14, 2008

***************MIKE WHITNEY REPORTING**********************************

It's a good thing Hank Paulson wasn't around in 1929 or we'd all be hawking apples on a street-corner. Paulson is currently on a personal losing-streak that would have been the envy of “Marvelous Marv” Thorneberry and the '67 Mets. In the last three months he's put together three new wacko programs to deal with the subprime crisis which have fizzled out in a matter of weeks. First, he tried to entice struggling investment banks to put their mortgage-backed bonds in a Super SIV (structured investment vehicle) to see if it would help off-load billions of dollars of down-graded junk onto unsuspecting investors. That flopped.

Then he brokered “Hope Now” (1-888-995-HOPE) which was designed to help the banks and homeowners work out the details for a “rate freeze” on mortgage resets. Paulson assured the public that 500,000 homeowners would take advantage of the program, which would dramatically reduce rate of foreclosures. So far, the Hope Now hotline has “provided counseling to just 36,000 borrowers. Representatives have suggested loan workouts for fewer than 10,000 of them, a small fraction of borrowers in need.” (“Earlier Subprime Rescue Falters”; Wall Street Journal) "Only 10,000 homeowners; and Paulson promised 500,000?!? That's a difference of 490,000. Another slight miscalculation.

This week, Paulson announced another new program, "Project Lifeline”, which focuses on homeowners who are delinquent 90 days or more on their mortgages. Here's a run-down of how it works: (thanks to Calculated risk)

“Project Lifeline involves servicers sending letters to borrowers--prime, Alt-A, or subprime, we're past pretense on that part--who are very seriously delinquent (90 days or three payments down or more). The letter says that if the borrower contacts the servicer within ten days, agrees to homeowner counseling, and provides sufficient financial documentation that the servicer can consider a case-by-case, deep-analysis style modification of the mortgage terms, the servicer will agree to put the foreclosure process on hold for 30 days while the workout is considered. If the borrower fails to respond to the letter, foreclosure proceeds.”

At the very best, the program buys a little more time for the homeowner to pick out a nice rental where he and is family can live after the bank repos his home.

So far, all of Paulson's “solutions” have been nothing more than “business-friendly” band-aides which fail to address the core issues of rising foreclosures, falling home prices, skyrocketing inventory, and tumbling sales. Yesterday, at a press conference in Washington, Paulson made this shocking admission in response to a reporter's question:

Reporter: "Sir, is the worst over, yet? Will 2008 have fewer foreclosures?"

Paulson: “In terms of sub-prime and the resets, the worst isn't over. The worst is just beginning.... There's close to 2 million adjustable rate mortgages where the rate is going to be reset over the next couple of years. These loans are of a vintage where there was the most lax underwriting. So, this is the biggest challenge and this is why this is so important.” (see the video at Calculated Risk)

Paulson is right; it is important. So, why is he wasting time with these bogus public relations gambits when he should be making serious recommendations?

Paulson's mortgage “modifications” just don't cut it. They're garbage. They just put off foreclosure to a later date. The only real solution to the problem is renegotiating the mortgages with the lenders so that people with “negative equity” have an incentive to continue making their monthly payments. Otherwise, the epidemic of “walkaways” will continue to spread threatening both the industry and the overall economy.

This week's housing stats from California illustrate how desperate the situation really is. DataQuick Information Systems said Wednesday a total of 9,983 homes were sold in Los Angeles, Orange, San Diego, Riverside, San Bernardino and Ventura counties last month, a drop of nearly 50% from January last year.

50%! That is unprecedented. California is in a housing depression and the best Paulson can come up with is a 30 day grace period for maxed-out homeowners?

That's nuts. California is a vital part of the US economy. In fact, California and Florida combined represent two-fifths of the nations' GDP. Is Paulson planning to let California go the way of New Orleans?

For the last four months, housing sales in California have plummeted 40% (year over year) At the same time, prices in Southern California have dipped a whopping 16.7%. The market is free-falling. So far, the only analyst who has come up with a reasonable solution is Professor Nouriel Roubini who suggests “a three year rate freeze and a reduction of the face value of the mortgages by the banks”.

Eureka! That's it. That is the only way to stem the tide of foreclosures and prevent a crisis that will suck the rest of the economy down a black hole.

And, for anyone who still doubts that a collapse in housing will batter the broader economy; here's a video of Yale economist Robert Schiller to clarify that point. It was Schiller who first predicted the dotcom bust in 2000 and is (perhaps) the most respected authority on the real estate bubble. http://econvideo.blogspot.com/

"A HISTORIC HOUSING BUST"

Economist Robert Schiller: “

We are in a historic housing bust comparable to that of the Great Depression. Prior to the Depression housing prices only rose 19% (between 1921 to 1925) and then fell 30% The cycle we are going through now, is a unique cycle; it will go down as the subprime cycle. The excitement in housing was unprecedented and the unraveling of that (bubble) will have unpredictable consequences....Real estate owned by households is roughly $20 trillion and we've already seen an 8% decline which means a loss of $2 trillion. That has a powerful impact on the economy...The losses are throwing peoples' balance sheets off. So now household balance sheets are in bad shape. People who used to be able to borrow against their house are facing new constraints. This is an ongoing thing that will last for more than a year. So we have unfolding problems to forward to.”

“We should be thankful that we have Ben Bernanke, who is an expert about the Great Depression at the helm. I don't think he will make the same mistakes that the Fed made that last time around... On the other hand, it (the bubble) is a major misalignment and cutting rates---when homes prices have doubled in the last decade---won't change that. The correction (in home prices) is not going to be stopped by the Fed.”

“If this isn't handled right, this could be a serious recession.” (ie Depression)

Notice how Schiller dismisses inflation as a major concern and emphasizes the potential dangers of a deflationary downturn. He would rather see more “stimulus” than the current $500 per person rebate. In other words, he anticipates a collapse in consumer spending.

Schiller continues:

“I am a big believer that 'confidence matters'. What is happening now, is that people are getting a succession of scare stories and personal savings are down... If you look at what happened before the Great Depression.....there was evidence of a sudden and sharp drop in consumer confidence and people pulled back and stopped spending. And we are seeing consumer confidence falling and I expect that it could take a much bigger tumble if we don't do something.”

Are you listening, Hank Paulson?

Consumer spending is down (excluding food and fuel) Also, “Consumer optimism is falling at the fastest pace since the 1990-91 recession,” according to a weekly survey released Tuesday by ABC News and the Washington Post. $2 trillion has been wiped out from falling home prices and another $600 billion will vanish this year in home equity loans. Traffic to the shopping malls has slowed to a crawl. Retail shops had their worst January on record. Homeowners are hoarding their earnings to cover basic expenses and to make up for their lack of personal savings. Attitudes towards spending is changing noticeably. The spending-spigot has been turned off. America's consumer culture is in full-retreat.

Everything Schiller said is taking place right now. So, where's the political leadership? With its head still in the sand?

"In the fourth quarter of 2007, new foreclosures averaged 2,939 a day, double the pace of a year earlier." (RealtyTrac Inc.) The banks are limited in their ability to issue new loans because of their own damaged balance sheets. Business inventories are on the rise. This week's release of the Institute for Supply Management's Non-Manufacturing Index (ISM) was a shocker. It showed steep declines in all areas of the nation's service sector---including banks, travel companies, contractors, retail stores etc—The Business Activity Index, the New Orders Index, the Employment Index, and the Supplier Delivery Index have all contracted at a “historic” pace.

These are the classic signs of overproduction. The next shoe to drop will be increases in unemployment. Layoff notices have already gone out in new construction, retail, car manufacturing and financial services. And, there's more to come. This is all the predictable outcome of “low interest” bubble making. It invariably ends in a painful deflationary spiral.

“Confidence matters”, Schiller warns.

Yes, it does. But the American people lost confidence in their leaders long ago. And that means there's probably trouble just ahead.

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Comments

[EM]

If Roubini is actually saying what I think you say, his "proposal" is idiotic and in any event, an example of pure populist demagoguery.

The idea that banks can freeze these rates and forgive enough of the mortgage balance to keep the borrower in their homes is absurd and insane. The largest banks in this country are in actuality INSOLVENT RIGHT NOW. Now maybe you agree with this and think that is more of a reason to implement this proposal, but the market apparently is not aware that these banks are broke because their stock prices do not reflect it and neither do their publivctly traded debt. This proposal would require a subsequent bailout of the banks which we may end up getting, eEven though both the banks and the borrowers shold suffer the consequences of their utter incompetent stupidity.

[Booba]

"Real estate owned by households is roughly $20 trillion and we've already seen an 8% decline which means a loss of $2 trillion." (prof. Shiller)
Oh-uh.... If professors do math like that then we are in trouble! :)
8% from 20 would be 1.6!!! :)
And another point.
The author quoted Shiller that the Goverment cannot stop falling home prices becuase they were doubled in thes decade (in many areas - in the last 4-5 years!).
The the author urge criticize Paulson that he didn't do anything!
Doesn't the author understand that the major problem is too many people in the country bought houses they cannot afford and took too much other debts?
The only way to improve the situation is to change those people's behaviour. In order to do that they must learn their lesson in the hard way.
Any other steps will prolonge the pain, no more.
Yes, it will be painful, but this is inevitable.
And the faster it happen the better for all of us.

[OC]

E,

Wouldn't this collapse the USD and the bond market?

Straight into Horns of Dilemma!!

[OC]

E,

I spoke too soon:

No Underwriter Support For Failed Muni Auctions

http://globaleconomicanalysis.blogspot.com/

[CK]

And then there is the credit rating on all the US govt debt. AAA right now but not for long. Any surprise that China and Europe are crabwalking as fast as they can to decouple their economies from the US economy.

[Elaine Supkis]

Remember, I didn't write this piece. I hope this is clear to everyone.

I, personally, believe that NO central bank has EVER stopped a depression freight train! The Fed was created to do this thing and it crashed spectacularly in 1930. Draconian laws

I already know what 'fixes' depressions: WARS. The bigger the depression, the bigger the wars. When the 1848 depression hit the world, England lashed out at CHINA. The US took half of MEXICO and burned Mexico City. Etc.

The 1893 panic, Russia and Japan had a war which Russia lost. The 1873 panic/depression saw similar wars break out.

This is why I do not want a bubble/panic/depression event. This is because we now have nuclear bombs and a country, the US, which has this itch to use them.

[flotsam]

The house buyers, bought these properties without having anyone hold a gun to their heads. These simpletons should not have bought anything they could not afford. The banks were complicit in offering fancy mortgages with no money down etc. This is not the fault of the rest of the country, if California is loaded with very stupid people, not my fault or any other citizen of the U.S. Let the chips fall where they will. Why should anybody else be liable for idiotic decisions made by baboons in Calif. or any other place? flotsamoverbd

[Ron Holland]

From Wolf Laurel in NC - I believe Merrill Lynch is correct about the arrival of recession in the United States. The housing downturn is negatively impacting property sales in second home communities in Florida. This is also slowing sales in NC mountain resorts that depend on Florida buyers.

Still the downturn in prices and building of inventories is starting to attract second home buyers from Florida looking for cool temperatures in our mountains. Also the dramatic decline in the dollar combined with weakness in American real estate markets are beginning to interest some bargain hunting European investors.

Ron Holland, Broker/Realtor with Wolf's Crossing Realty. See www.ronaldholland.com Ron markets resale mountain and ski resort properties in NC in Wolf Laurel and The Preserve at Wolf Laurel.

[Liberal AND Proud]

I remember a day when Republican capitalists were the smartest people on the planet.

Strike another victory for the '60s anti-establishment generation. They've now completely morphed into the most despicable, corrupt, elitists corporatists collection of crooks in the history of the planet.

And they're role model is the ultimate representation of the Peter Principle...George W. Bush.

The robber barons were pikers compared to this group.

[Ed-M]

Economist Robert Schiller:

"We should be thankful we have Ben Bernake, who is an expert about the Great Depression, at the helm."

Speaking of Bernake, did anyone else catch the obvious PANIC in his voice during his interview yesterday (which was broadcast over the mainstream media's evening newscasts)? Looks to me as if he's CONVINCED that there is nothing the Fed can do to prevent or forestall another great depression. Ugh.

[Dogbert]

Ex Goldman Sachs president (who sold worthless paper CDOs) Was Named by Bush as Treasury Secretary... SOLE PURPOSE "LET DUBYA Escape out Whitehouse Back Door Before DEPRESSION CRASHES!

[Liberal AND Proud]

And we're FREEEEEEE...Freee Fallin''...I'm free fallin', baby..your free fallin, baby...free fallin' baby...dollar's fallin baby...housin's fallin' baby...country's fallin' baby...Ben is bawlin' baby...while we're fallin' baby...

[Phil the Thrill]

I am currently short 10 yr treasuries... I think that's the best short-term game to play with respect to inflation.

I think we should work on an "inflation fund" on this board: interested people suggest ideas and critique those of others. It'd be quite insightful, I think.

If the Man won't protect us, at least we can protect each other!

[Elaine Meinel Supkis]

The problem is, the time has finally arrived for HIGHER INTEREST RATES. The bonds markets makes this perfectly clear.

The REVENGE OF THE SAVERS has arrived. And as always, savers tend to be bears, not bulls. So the bears will force everyone to reward savers, not spenders. This is why all madcap spending cycles are followed by bear cycles of savings.

So in the next two years, bond prices will jump. As well as plain vanilla CD prices. They have to get us to give them money. And alas, the attempt to steal money will rise. Say hello to taxes again.

[aprilzi]

There is the question who will pay for the old credits and who will take new credits?
For both there is nobody out there.

[Elaine Meinel Supkis]

It is called 'bankruptcy' and when empires do this, there is this big 'boom' sound.

[Phil the Thrill]

Wow, my mom's own muni bond just failed in auction... of course, I learn this after the fact after calling UBS "wealth mgmt" (oxymoron if ever there were one).

Muni's are "cheap" because deflated homes => reduced property tax income => broke munis => defaulted muni bonds.

[Elaine Meinel Supkis]

Yes, but the INTEREST RATES they now are being forced to pay are not cheap at all, not at all.

You can't resell older bonds from even last week. A rise of 15% in one week is.. UNHEARD OF. Amazing. Wow.

[Philistine]

I regretfully say that we live in interesting times...

Please go half-way down this article: you will then see my investment thesis:

http://www.bloomberg.com/apps/news?pid=20601009&sid=a97OeQgnkS5E&refer=bond

[Rex]

DOES ANYBODY KNOW WERE I CAN EXCHANGE ALL MY DOLLARS TO EUROS IN THE L.A. AREA, IF NOT EUROS I'LL TAKE PESOS. I JUST DON'T WANT WORTHLESS GREENBACKS!

[Investment Guru]

The real estate industry have been saying that real estate is an awesome investment. Well... Like all investments, you have to know when to cut your loses. If your investment makes money then keep it! If your investment loses money then dump it! If your home aka investment is "upside down" then dump it! Emotionally disconnect with your house, let the bank take it back, rent for a few years, and then buy it cheaper from the bank. Many people say that the bank/lenders screwed the homeowners. Well... IT's PAYBACK TIME! The homeowners should hand the key back to the banks, rent for a few years and then buy a better house at a 50% discount. If many homeowners refuse to buy properties from the banks for not less than a 50% discount, then the homeowners will have screwed the banks instead of the banks screwing them. This NEW, guaranteed, money-making system for homeowners will also save them money when it comes time to pay property taxes. Since the homeowners will have bought their home at a 50% discount, their "YEARLY" property taxes will also go down by 50%. It's a win-win situation for homeowners. Have your cake and eat it too! Buy a house at a 50% discount from the banks, and save 50% on property taxes. This system only works if current homeowners are willing to put in some effort in order to make a LOT of MONEY!

[Investment Guru]

When you hand your house keys over to the banks, say, "It's only business, nothing personal." :)

[Investment Guru]

THIS IS A ONCE IN A LIFE TIME OPPORTUNITY FOR HOMEOWNERS, DON'T MISS OUT! THIS GUARANTEED-MONEY-MAKE SYSTEM WILL NOT COME ALONG AGAIN!

[Elaine Meinel Supkis]

Banks will process US dollars to foreign currencies but they charge a hefty fee. So either you become a FX trader or you get other people to pay you in euros. In Manhattan, there are many Europeans on buying sprees and more and more businesses are collecting euros and then holding them.

[mike]

small hatters concern..... 25 percent house tax assessment increase......again and again, again......

[BM]

Let in a million new immigrants, so long as they purchase a $500k home with a min 5 year mortgage. Then a new housing boom...bank woes lessen...all is good.