Thursday, July 19, 2007

Winners and losers in housing market collapse, by gimleteye

In a quarterly conference call yesterday reported by The New York Times, JP Morgan CEO Jamie Dimon referred to the current business climate as “a relatively benign point in the credit cycle.”

The market judged the company differently, sending share prices 3 percent lower by the end of the trading day.

Market jitters and JP Morgan’s comments are relative to the subprime mortgage meltdown.

In recent weeks, Wall Street's biggest players have all stuck to the same pitch: that the subprime mortgage mess is “contained”.

It is about as contained as inflation. You remember inflation? That's the index that omits food and energy prices because American consumers don't drive cars or eat.

Who would omit the price of food or energy from a core index? Clearly, someone or ones who want Americans to believe the cost of living is nothing compared to the benefits of democracy.

That's how the meaningful is turned to meaning-less.

Along the same lines, today Federal Reserve Chair Ben Bernanke told Congress in his mid-year economic report that he thought "the demand for housing would stabilize "soon".

Understand, though, that the charade that passes for current thinking on the economy in Senate or House subcommittee hearings is stage-managed by well-educated and well-compensated types who know perfectly well how poorly the broad stock market indexes have performed in relation to inflation.

And they read the papers and the blogs: consumer confidence is down, homebuilders confidence is plummeting, and public corporations, like Pulte Homes in yesterday's announcement, are hemorraging value.

Behind closed doors, including the doors of the Federal Reserve, one must infer that the dialogue is of a substantially different character. These knife-blade conversations do not show up in print.

Still, it is no secret: billions of dollars in Wall Street bonuses, over the past decade, and expectations for future wealth are tied to the creation of debt tied to mortgages, both commercial and residential. For every $1200/square foot apartment sold in Manhattan, there is at least one optimistic Wall Street banker in waiting.

That debt goes by as many different names as there are flowers in a garden. It is known, ubiquitously, as financial derivatives.

Leaving Manhattan aside, until housing markets in the nation's fast growing regions started to collapse, under the weight of the same liar loans, mortgage fraud, and adjustable rate, interest only mortgages (better known as toxic financial waste), holders of financial derivatives really didn’t have to worry much about informing their own investors about the value of the debt.

As long as real estate prices were rising, no one asked.

No one asked in Congress, which allowed government sponsored entities like Fannie Mae and Freddie Mac to engage in massive fiscal irregularities. No one asked in pension fund management, which assumed that the blue chip folks at places like JP Morgan would hold their interests at the highest level of fiduciary responsibility.

But now that dozens of subprime mortgage lenders have shut their doors and left paperwork in shambles in hastily closed offices, now that Bear Stearns’ funds have gone belly-up like crappie in a red tide, suddenly the rating agencies responsible for providing accurate values for financial derivatives as well as other credit have started to do what they should have done in the first place.

“Moody’s Investors Service says it is paying a high price for its tough stance on lax lending standards for commercial mortgage-backed securities”, reported the Wall Street Journal yesterday.

“On a recent CMBS (commercial mortgage back security) offering issued by Morgan Stanley, which included 225 fixed-rate loands on 268 multifamily, commercial, and manufactured housing community properties” Moody’s rivals got the ratings business.

“We used to rate 75% of the deals, but since our announcement (tightening credit quality standards for CMBS pools), we were not asked to rate 75% of them,” says Tad Philipp, a managing director for Moody’s. ‘Our market share has done a complete flip.’”

From one point of view, Moody’s is costing the big banks money, in rating the issuance of debt (and bonuses, of course) and so big banks are penalizing Moody’s.

The sharper point of view is that the big banks are suppressing facts about the vast excesses they have created in financial derivatives and the additions they make to the net worth of the nation's top financial executives.

And so, when one reads in the NY Times, JP Morgan CFO Michael J. Cavanaugh saying that “the bank’s decision to increase its credit loss provisions did not reflect a spillover of subprime lending problems into prime lending”, it is natural that the world financial markets begin to wonder, what the hell is going on?

In another Wall Street Journal article yesterday, concerning uncertainty in credit markets—not just subprime—Charles Gradante, co-founder of hedge-fund consultant Hennessee Group, said, “Right now things are starting to become unglued.”

What exactly does that mean?

For one, the ABX index which tracks the price of insuring losses in subprime bonds has fallen precipitously. According to the Journal, “the portion of the triple-A subprime debt issued last year has fallen about 5% in the past week. The portion of the index which tracks low-rated triple-B bonds is down more than 50% this year.”

Beyond falling indexes, beyond the matter of hedge funds, like the two disappeared from Bear Stearns’, is the question: how many dollars and how many hedge funds have to re-price their assets to reality?

That’s the essence of what Joshua Rosen, a managing director of Graham & Fisher, an investment firm, told the New York Times in a related story, “Bear Stearns says battered hedge funds are worth little.” Asks Rosen, “...’do the prime brokers and others who have extended lines of credit to the hedge funds really have a good handle’ on how those borrowings have been invested?”

The answer is, no.

The response of banking regulators is “to increase scrutiny”. (AP, July 17) Now Federal Reserve Chairman Ben Bernanke is offering lawmakers "fresh assurances that regulators are taking steps to better protect would-be homeowners from abusive mortgage practices.”

And this crew is going to protect America from inflation?

Putting the right price to inflation is as much anathema to the Federal Reserve, to Congress and the White House, as re-pricing synthetic financial derivatives to banks and hedge funds they loan and invest, sometimes on opposite sides of the same financial instrument: both are as substantial as smoke from a crack pipe.

And yet, reality has a way of forcing the air from whatever pipe dreams materialized from “the ownership society”: one of the biggest speculative financial booms in US economic history, next to the bust it was meant to absorb, and did for a while.

It may be Jamie Dimon’s point of view that this is a “relatively benign point in the credit cycle.” Try telling that to an American who has lost his or her home, or, to one of the 176,000 Americans who got foreclosure notices in May.

According to California based RealtyTrac, it is “the highest figure they have ever recorded in their monthly report and is 90 percent higher than the numbers from a year ago.”


Anonymous said...

Soon, obviously a metaphor meaning 3-5 years like everyone connected to real estate is saying.

Great read of the impact, all previous posts on the subject are excellent.

Anonymous said...

Check out this report from Bloomberg, which says that Miami may be entering a deep depression as early as this October.

Anonymous said...

Maybe to save money we just need to get rid of our universities, considering that our politics is so dumbed down why shouldn't' this apply to our universities as well? Or perhaps we could raise the tuition so only the rich cold afford to go? Investing in education is such a waste anyways, what does it have to do with our tourist economy anyways? These are some of the choices presented below in this recent Chronicle article.

Florida Universities Brace for Budget Cuts


In muggy Gainesville, Fla., where college sports reign supreme, some leaders at the University of Florida are mulling the use of football tickets as a way to entice students to help cut costs.

To motivate students to graduate faster, the university may offer them a better chance of receiving tickets if they take on heavier course loads. The proposed policy is one of several money-saving measures under consideration at the institution, which faces a projected deficit of at least $20-million for the fiscal year that began July 1.

The University of Florida is not the only public college in the state trying to trim costs. After Gov. Charlie Crist blocked a 5-percent increase in statewide tuition in May, Florida's 11 public universities began bracing for a fallout. But the state's slumping housing market helped slow the economy, causing a shortfall in tax revenue that will force the colleges and other agencies to cut their budgets by at least 4 percent.

Now higher-education officials are drawing up plans to further shave costs with hiring suspensions, enrollment freezes, and other money-saving measures.

All told, the state's universities stand to lose at least $100-million with a 4-percent budget reduction, but the universities have been warned to prepare for a cut of up to 10 percent.

While midyear budget cuts are not as common as they were earlier this decade, public colleges in at least one other state, Maryland, have also been urged to tighten their belts.

The Board of Governors, which oversees Florida's public universities, will enforce a statewide enrollment freeze to cope with the deficit. Still, as colleges prepare for a tight year, administrators say their main priority is ensuring that students do not feel the brunt of budget-cutting efforts.

"Hopefully, we can shield them from most of the cuts," said J. Bernard Machen, president of the University of Florida.

That institution's 50,000 or so students are bound to notice some changes, though. After Mr. Crist reported the revenue shortfall, the University of Florida announced a campuswide hiring freeze.

Although there are no estimates on how many positions could be affected, Mr. Machen emphasized that the freeze is "not just a game."

Richard A. Yost, a chemistry professor at the University of Florida and chairman of the university's Faculty Senate, said faculty members would inevitably have to take on heavier teaching loads. "Given the size of the shortfall, I don't think the university has a lot of choices," he said.

The University of Central Florida, in Orlando, has instituted a similar hiring freeze, although certain positions can still be filled. For example, Central Florida is moving forward with plans to beef up its campus police force, and the university's planned medical school will also probably be an exception to the freeze.

But Central Florida, which is the state's fastest-growing institution, may still struggle to serve a booming population.

"That's going to be the biggest impact — the inability to hire faculty to meet our current enrollment," said Daniel C. Holsenbeck, a university spokesman.

Sudden Downturn

Even as administrators pledge to protect the quality of their institutions, students are growing wary of coming changes.

At Florida State University, which has instituted an enrollment freeze for the next admissions cycle, students seem "frustrated and disappointed at the same time," said Joseph O'Shea, the university's student-body president.

"It all happened so quick," he said.

The freeze will prevent Florida State from expanding its student body for the 2008-9 academic year, and the university is looking for other ways to trim about $15-million from its budget.

"You've got to go a long dang way to find that," said T.K. Wetherell, Florida State's president.

To save money, the university will cut back on some services. For example, the hours at campus libraries and computer labs may be reduced, Mr. Wetherell said. There will probably be fewer courses offered, and students will pay extra for transcript copies.

"We'll jack thermostats up in the summer and down in the winter," Mr. Wetherell added.

While Florida State is committed to shielding its student body as much as possible, Mr. Wetherell said, students are bound to feel some of the impact.

In Tampa, at the University of South Florida, administrators will feel it, too. This fall, the university's provost, Renu Khator, is scheduled to teach a beginner's-level Hindi class in addition to her administrative chores.

Other high-ranking officials at the University of South Florida, such as deans, may also be taking on teaching work, and the institution has announced its own hiring freeze.

Florida's 28 community colleges will also take a hit. Although the steps ordered by the Board of Governors do not affect those institutions, they are still set to lose money during the next year. The boards of trustees for each college have just begun to make plans for dealing with the budget cuts.

By the 2008-9 academic year, however, a few Florida universities will receive a boost. Mr. Crist recently signed a bill allowing the state's top three research institutions — the University of Florida, Florida State University, and the University of South Florida — to increase tuition by as much as 40 percent over several years.

Still, that measure will not take effect for another year, and it does not affect Florida's other eight public universities. The state's Board of Governors recently joined a lawsuit filed by a former U.S. senator, Bob Graham, to wrest control of tuition from the Legislature.

Mr. Graham, a Democrat who is also a former governor, hopes to secure that power for the Board of Governors so that it can raise tuition on its own. Although the Legislature approved a tuition increase this year, lawmakers have typically tried to keep rates low.

For now, though, all 11 of the state's public universities have to work with what they have.

"We've been doing a lot of planning to take these cuts, and we're trying to do it in a way so the students won't feel the pain," said Ms. Khator, of South Florida. "But it's very difficult."
Section: Government & Politics
Volume 53, Issue 47, Page A18