It is kind of flattering that I have heard from several of you after taking a month off of writing. I have no idea how many people read this, and how it gets around, or if it does, but it is nice to know that some of you think enough of this column to ask where it went. It didn’t go anywhere, but I did take a month off.

Up until the last week in August, I had every intention of getting out an article for August. Chaney, Jackson and I took a family vacation to Wisconsin and Minnesota during the first week in August, and of course that was the perfect excuse….I was taking a month off.

In truth, the amount of things I commit to eventually have the functional effect of being too much. There are rewards in all of the things I commit to and I do get to most of them, but there is a tax on the mind and body, though I might deny it to others, the truth is known to me, and my wife. So the column was on hiatus for a month, allowing a bit more sleep, which I figure I might as well enjoy for the next two weeks before baby Zoe shows up.

Plus I have been sanding her room like a madman whenever I have a moment to do so. The previous inhabitants were children raised by wolves and the madness that they conducted in the home is always evident in the staggering damage they left behind. They attacked these walls, floors, doors, windows and ceiling with what appears to be a combination of a mace, a compass, a lot of stickers, glitter, an industrial orange peeler, paint, magic marker, a drill and so forth, so it takes quite a lot of time to clean up the otherwise beautiful pine paneling.

So there’s that…

The other item preventing my waxing poetic on the state of our nation and our economy is that the news changes so quickly as to make my points redundant. Even now as I type, I have a new email asking me about all of this and what it means for everyone. Imagine trying to keep pace with all of the misdeeds and misdirection of the Bush administration….well this is their financial team we are talking about. It is a mess beyond the messiest mess you have ever seen. Worse than a pre-school spaghetti dinner….bad people….really bad. I am only human. I have actually been percolating for some time, so this could get wordy…..

The basic fact is that the government bailed out Fannie Mae and Freddie Mac. Why? They were “too big to fail”, and yet, they were failing. As the biggest entities in the mortgage business, they inevitably have suffered great losses as the industry has faltered so badly. The fact that less loans of theirs fail than comparable pools is because they had what is considered the strictest lending process. The fact that even those loans are failing is because they too lost sight of their responsibilities to borrowers and bondholders because it was overshadowed by their allegiance to their stock price and shareholders. As banks asked for less and less documentation, making more and more decisions on credit score alone, and even volunteering to void needs for income and asset verification, Fannie and Freddie inevitably offered more and more stated findings, requiring less documentation, fewer appraisals, and more of the madness that is still filtering through the rocks.

This takeover happened directly following forceful statements that it would not happen by the regulators responsible for this action. They denied the need for intervention at every rumor and report that these companies were not well run or under-capitalized to the degree of the potential need. They denied that they would use the powers they asked Congress for and received last month. I didn’t catch CSPAN, so here is a somewhat rhetorical and imaginary interchange that may have gone on during those hearings…

”So basically Congress, what we’re saying to you is that we’d like the right to do so, but you know, we’re not going to like, do it”. Yes we are.

“OK, so if we give you the power, you won’t use it unless it is absolutely necessary. By the way, I am winking now. Can you see me winking? Is this thing on?” Gee…I hope he got that…

So, shocking as it was, they took over the companies on Sunday. They informed their top management they were on their way out, and Monday, the market opened to a huge rally at this monumental news. It is important to note that in tossing all of the executives under the bus for mismanaging things, the whole operation is now being governed by the regulators responsible for the oversight of these companies in the first place. It is hard to lay it all on the feet of anyone, but for millions of dollars, the CEOs and a few others will walk away and fall on their swords. Don’t feel bad for them either. These are new executives who were put in by both companies’ boards of directors on the throes of previous incidents causing the ouster of the previous executive team. In all cases, their departure was and will be very handsome indeed.

Clearly, the buck stops elsewhere, and not where responsibility would normally set it. The Federal Reserve, Treasury Department, the Federal Housing Finance Agency, Congress and the President all worked together to put together the latest economic stimulus package, part of which gave them the authority to take Fannie and Freddie over, which they needed, despite the fact that both companies were created by the government for the express purpose of creating a more far-reaching system for home lending.

Both companies are considered Government Sponsored Entities. They have charters to create opportunities for home lending, which is for many, the embodiment of the American Dream. They achieve this by giving banks the money to lend in reverse of their lending. Their bond making and selling ability is what provides the liquidity that allows lenders to make fresh loans.

In other words, the banks lend the money, and Fannie and Freddie buy the loans from the bank, even though they will likely employ the bank to continue to service the loan, collect the money, pay the taxes, etc. In total, the numbers are brain-hurting. They own or insure over 45% of all residential mortgages in the country to the tune of over $5.3 trillion.

Unbelievably, the takeover doesn’t really change anything. The existence of the secondary mortgage market is what enables there to be such broad based home lending. The benchmark 30 year fixed mortgage only exists because of these companies’ publicly issued bonds, so the priority was to maintain that market place. The market place is one in which banks front the money, sell the loan to the GSEs who pay the banks back the money they fronted plus their fees for services rendered and ongoing services. The mortgage is packaged with other mortgages, turned into bond issues, and put on the open market in the form of mortgage backed securities, and in the mortgage debt world, Fannie and Freddie debt is the cream.

In theory, they offer the best proof of ability to pay since they write the rule books on how lending is derived. The strength of the sale of their debt is the direct determining factor of where rates are, and in theory, we should have been at rates far lower than we have been for over a year. The reason that rates haven’t fallen to levels comparable to their current bond price range at other times in the recent past when the same issues hit those levels is because of the huge drop in volume. Mortgage backed securities were down over 80%in volume from their trading this period a year ago.

Then on Thursday September 4, 2008, PIMCO triggered this whole craziness by issuing a statement that they would no longer buy mortgage backed securities. This from perhaps the largest buyer of bonds in the world and the manager of the Total Return fund, the world’s largest bond fund, is the word of God. Therefore on Friday September 5, 2008, foreign governments and major hedge funds were dumping bonds and shares. Freddie was forced to pay exorbitant rates for short term borrowing which was the final sign that the companies had finally lost investor confidence. The decision was all but made when the executives of Fannie and Freddie were summoned before James Lockhart, head of the Federal Housing Finance Agency, Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson. A lovely get together in which the companies’ executives were informed they were being dismissed in the near term. By the time the government stepped in, PIMCO had changed its tune, and suddenly was buying mortgage backed securities all weekend despite its proclamation that initiated the sell-off that formulated the governments plan in the first place.

This is status quo I suppose in an era where Bill Gates and Warren Buffet are the apparent populist voices of our time, but it reeks. The latest advice on the future fate of Fannie and Freddie from the business sector “experts” is basically to let the free market correct their behavior. Yeah. Great job so far. Usually when you hear this sort of rhetoric, and in this case especially, the undying allegiance to free markets is from those that actually seek to further their ownership of these markets which are never really free at all.

Further evidencing their party’s thinking, Governor Palin has vowed to make the companies smaller and make sure they return to the private sector. It is so disheartening to live in a time in which once a problem emerges, the side that benefits from the current state of affairs uses it as an opportunity to take even more. That is exactly what this type of thinking results in.
Energy crisis? Let’s drill in protected lands. Let’s expand nuclear power. Let’s increase ethanol subsidies.

Giant bigger-than-a-hedge-fund bail-out? Let’s let the free market work!

What do you think the auto industry is thinking right now? The losses endured by Fannie and Freddie over the last four quarters are nothing compared to the losses at GM or Ford. Inevitably, the airline industry, and every beleaguered industry that has been mismanaged or poorly run or achieved a critical mass that is crushing them to death will have their hands out too. The real smart ones will get in line now before it becomes obvious how little the government can do to bail out everyone that needs it.

We have a mentality that we have to protect these entities at all costs, and the human costs are indeed dire, but the government couldn’t be expected to subsidize the telegraph industry just because they employed a lot of people. Times change and companies only cry about the effect of lost jobs when it is obvious that the pain will finally reach the executive suite. The auto industry fought tougher fuel standards for years until it became what people wanted, and now they are falling over themselves to get in front of the issue.

If you were to believe television and marketers and the spin artists, you would think that BP, Mobil, Dow Chemical, DuPont and Waste Management are the greenest, earth friendliest companies out there, just as the wind mills grace the background of a John McCain commercial. The sick thing is the number of people that buy this spoon fed slop.

Getting back to the issue of the mortgage giants’ fall, it is indeed quite flip to say that it was the wrong thing to do entirely. By the time they acted, it was the best available option. Fannie and Freddie were in fact, too big to fail without systemic collapse. Doing nothing would lead to an extraordinary constriction of available credit. Banks reliant on their own ability to securitize these loans would pay a considerable sum to market them, and then fight to attract turned-off investors. The result would be out –of-control lending problems beyond what we have already. Nobody but the most gilded of borrowers would ever get a loan, and rates would be significantly higher than what we know today. The flip side is the bail-out will have a cost far in excess of the low-ball $25 billion figure that is being floated right now and it will need to be borne by every tax payer in the United States.
It should also be borne by the banks in a similar write down of assets against this debt, but that’s crazy talk in this world. That’s like regulators regulating instead of deregulating or something.

The real problem is this myopic look at matters like this was the only solution, and that it was done at the right time, and that nothing could have been done sooner, or that anything will get any better as a result of it. If Paulson, Bernanke, Lockhart and their crew had parachuted into the situation and acted as they did, they indeed would be worthy of praise and good thinking, but they’ve been here during the run-up, the crash, the burn and everything. The existing rules governing banks, brokers, GSEs, and a host of other regulated companies and industries are quite adequate to prevent a system wide collapse, and even problems far less severe, but the failure is in the utter lack of enforcement. Not enforcing laws encourages lawlessness, and so it goes.

The total shake out of the housing crisis and the collapse of Fannie, Freddie, Bear Stearns, Indymac, and a host of other companies which at least theoretically have boards of directors, and oversight and regulators and rules and laws to guide their continued existence, will certainly dwarf the $300 billion price tag on taxpayers that the Savings and Loan debacle had. Clearly, it isn’t likely to harm any of the key figures in a long term fashion considering that the Republican nominee for President of the United States was one of the five Senators in the Keating Five and was rebuked by the Senate for his role in the affair.

The idea that you can return these entities to let the free market do their work at fixing it is akin to, I dunno….giving the Republicans another shot at fixing this enormous mess we have.

There is a solution, but it is the opposite of the proposed idea of letting the free markets control these entities and that is to do the exact opposite. Nationalize the companies. And yes, I am serious.

First of all, with the full faith and credit of the United States, the debt has backing. The direction that bond issues for conforming loans were headed is to the same place that jumbo loans are already at, namely, without a market place. The rates for jumbo loans are so high because they eat up so much capital of banks that have to portfolio them, and therefore ensure high returns at the front end with higher rates. The result would have been a further deepening of the housing problems we are already immersed in. The short term effect is lower mortgage borrowing costs, but all the while credit standards continue to tighten.

I admit that there is one real problem with nationalizing the biggest players in the secondary mortgage market, which is that at the moment, the leaders of this country are inept and only promote other inept members of their ilk to run the components of government. So you need to do two things really….nationalize the companies and change our country’s leaders. It is seriously our only possible hope.

Many say that the government can’t possibly act in this role, but the Federal Housing Administration is already in the home loan business. The failure of sub-prime and low-doc lending has renewed use of the FHA loans, and the government is already in the business of operating a secondary market, managing risk, writing loans, and more importantly, offering a payment option for the funding of the loans that ultimately fail in the form of borrower paid insurance. The notion that we don’t want to grow government or let the federal government get too big is the private sector code term for letting businesses do whatever they want, operate recklessly and against the public interest, and receive government assistance at their time of failure. In truth, the free markets only believe in free markets when they are on the receiving end. When things go awry, they are big fans of the welfare state as long as it is corporate welfare.

The government is already in control of the entities, and it is only a matter of a few weeks before there is an opportunity to replace a government that has made a monumental mess of everything, so that the positions that are responsible for oversight are watchful. So that regulators are not in the business of deregulating. So big business does not help create energy and environmental plans. So that there aren’t more and more unenforced laws. So that the incompetent are not steering the ship. Appointments are a critical factor in changing the modus operandi of our elected representatives.

It is really the right time to change the world. Why? Because it is much worse than you think out here. The louder that people say everything is fine, the same lies only serve to deafen those that might hear things and change them. When you consider the state of affairs, remember that all the takeover of Fannie and Freddie did was serve the present system of mortgage markets. The government is putting taxpayer money on the line with the notion that it will eventually heal itself. It does nothing to loosen lending standards, and that is where the failure is. Lenders are refusing to lend. Credit standards continue to tighten. They don’t want to do loans, and therefore they do not. The purchase of these mortgage backed securities is accompanied by tough talk about never getting into our present predicament again, so no one is able to get out of loans that they can’t make work.

Further, none of the loans have been written down to reflect the lowered value of the collateral. This is SOP for responsible accounting, but the lenders’ idea is that while the collateral has lost value, the intent is to press for payment. The problem is the number of people that can’t hack it anymore has gotten to the point where it is a true crisis, and the lack of a responsible reaction to it is worsening daily. The future is that as more people realize they owe more than they own, more and more of them will just say “fuck it” and walk away. You have an entire quasi-generation of homeowners that are frozen in their home because of their equity position. Many of them will be able to live through this and recover to a positive equity position, but many will feel the pain of this sales market if they are forced to move, or the desire to move is so great that they must.

This isn’t a normal business cycle. You need to let go of that notion. The problem with people saying things are fundamentally strong, or that it is a shallow recession, or that we aren’t even in a recession is that the curve is not a gentle bell shaped gradient….it is a vertical leap. By the time you figure out where you are, you are in worse trouble than you can handle.

The lower borrowing costs will likely help out a bit in the short term because in addition to lower payments, it is a strong market for buyers. I am already seeing prices that seem unbelievably low compared to what I saw so recently. Many people are able to afford more since the price has been under pressure for going on three years. The problem is that in addition to tighter lending, there is way too much inventory, and the desire to make diamonds out of this mess has everyone looking for the next big thing, namely foreclosures, which is just the next big disaster on the horizon. That’s a column for a different day though…

The other reason we need action now is that our economy is weaker than it is perceived to be because we use terrible data to measure it. On Friday September 5, 2008, we also saw markets react very badly to the latest jobs report. Despite very low expectations, job losses were worse than expected with 84,000 jobs lost in August which is the 8th straight month of declines. This occurred as the need continued to grow with another 250,000 people entering the workforce in the same period. The most damaging number however was the headline grabber….a new Jobless rate – 6.1% last seen in September 2003.

The bad news is that this number isn’t even close to the accurate number, and it has people thinking “it isn’t as bad as 1978, 1983, 1929….” If you calculate totals as they did in those days, things are very bad indeed. Our jobless number does not count a variety of classes that would have been counted in similar time frames and during previous recessions, or during the Great Depression.
Here are some folks not part of the unemployed:

“Discouraged workers” – those looking for work for longer than their benefits eligibility….once you lose your eligibility, you are also no longer considered unemployed. A lovely double whammy….well we can’t help you anymore, but congratulations, you are no longer unemployed.

Haven’t sought a job in the last 4 weeks? Not unemployed, even though there were 1.6 million people the government counts in this category known as “Marginally Attached”, which is over 20% higher than these numbers a year ago.
Then there is “part time for economic reasons” which are the folks that would like to have full time work, but they are only able to secure a part time job….again….not counter. That would be 5.6 million according to government statistics.

If you add the Marginally Attached, Part Time for Economic Reasons and Discouraged Workers, as they would have been in the era before the Bush presidency, it would be around 10.6%. Measuring against past eras, it has not been this high since the great depression in an era with similar calculations.
Another group not counted is independent contractors, which is literally the definition of a real estate agent, many contract mortgage underwriters, many construction trade laborers, and a host of others who may also be out of work, but aren’t considered to be. I have had at least 8 jobs where I was considered an independent contractor, and during each of these points in my life, including now, I would not even be considered in the workforce calculations. These numbers are not tracked by the government, so it is hard to estimate how it would affect the real unemployment data.

More than interest rates, jobs drive the housing market, and until we fix this, we won’t fix the mess.

We also haven’t by any means seen the end of the problems with banks. Washington Mutual is replacing their CEO after losing over 90% of their stock value in the last year. Lehman Brothers is thought to be a takeover target one day, receiving a boost in share value, only to find the suitor disinterested after looking into the possibility and having 35% of its value gone in one day. A good rule of thumb is to disbelieve any statement they make about their financial help since it is routinely proven false by the end of the weekend. Get real nervous when banks start talking about their manageable problems in the commercial lending side, as this is what they initially said about their residential holdings and their amount of sub-prime borrowing.

The stock losses for major financial institutions and the number of bank closings, failures, and problems has already made the financial pits look like the floor of a slaughterhouse, and the day is early. We also have yet to really see the fall-out from the Equity line and second loan market bottom, or the change in status beyond the poor underwriting, low doc products, etc. Further, revolving credit debt is at an all time high, and the time to pay on all that debt eventually comes. Many of those will default and the banks will be forced to deal with even more write-downs. This isn’t imaginary, it is reality. FDIC monitoring creates a list of problem banks, which has 117 banks listed in the report from Q2 2008, up from 90 in Q1 2008, a 30% increase in a single quarter. Can’t wait to see the new figures.
Loans that are late by at least 90 days, delinquent, or in default reached a figure of 20% (counting all debt) of all loans according to the latest FDIC figures. TWENTY FREAKING PERCENT! How much of that will be recoverable? The banks are the last to see the decline in value. As I have said many times before, the homes that are in foreclosure are often the worst priced listings I see in my day-to-day functioning as a Realtor and it is fundamentally because the lenders refuse to believe they have to write-down each individual debt.

At the same time, banks now have to deal with a flood of maturing debt that will cost them considerably. As an example, there is a record $871 billion of bonds backed by the likes of Wachovia and Lehman Brothers maturing by the end of next year. Many are being forced to pay a stiff premium when comparing the margins promised against treasury yields based on their current pricing. This is similar to the Adjustable Rate Mortgage problems that are occurring for consumers, but it is at the top level of lending, and could lead to a further tightening in an environment where lenders do NOT want to lend. That is the bottom line. The mortgage bond may be priced attractively, but volume is down over 80% in a year due to the lack of confidence people have in the process, the product, and the collateral and borrowers pooled together in these securities.

Throwing the littlest guy in the room under the bus is so-cliché, you would think they would try something else, but why stop doing what works? Just as the Federal government will toss a few CEOs under the boss, banks are throwing the “mortgage broker” as a whole under that bus at the moment in painting brokers as the lynch pin in the process of the mortgage mess. The mortgage broker is the littlest player in the game, and therefore the most obvious target. The latest in this effort would perhaps be the recent lawsuit of ResCap, a division of GMAC against a dozen mortgage brokers for brokering bad loans. This is akin to R. J. Reynolds suing the corner liquor shop owner because he sold their cigarettes.

In all mortgage broker relationships I am aware of, lenders do the underwriting, review the documents, see the tax returns and the like. In cases where they didn’t ask to see those documents, it is their product that allowed the borrower to seek the credit. Any isolated incident may show that a broker may be guilty of terrible mistakes and misdeeds in any number of cases, but just as the broker brokered the deal, the borrower took the money, as did the lender, as did the secondary market purchaser, as did the bond issuers, as did the bond insurers, and the investors that bought all this mess. It was all spurred of the same greed to profit on the housing industry when it was touted as the last silver lining of a gloomy economy. So quickly we forget.

By the way, one other bit of news you may have missed also happened this past Friday.

Federal Regulators also took over Silver State Bank, which was run by John McCain’s son, Andrew McCain. Ahhh….leadership……experience…family.

I say, no more years.