KeNo's Housing and Economic Portal: Thursday July 23 Housing and Economic stories

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TOP STORIES:

Let's Treat Borrowers Like Adults - (online.wsj.com) Imagine a man in California who speculated in real estate at the height of the housing bubble. He bought a house with no money down and an adjustable-rate mortgage. But before he could flip that house for a profit, the market collapsed. He then owed more than his house was worth, but he knew that under his state's laws it would be impossible for his bank to sue him for the balance of his loan if he abandoned the house to foreclosure. What is this man likely to do? Several hundred thousand people have found themselves in a similar situation in recent years, and they have walked away from their real estate investments. Nothing down, interest-only mortgages taken out by speculators in states with default-friendly laws have fueled the foreclosure crisis and have come to be seen as a major threat to the American financial system. They have also led the Obama administration to propose creating a consumer financial product safety commission to protect homeowners from dangerous loans. The premise of this proposal is that the financial crisis was created by predatory lenders taking advantage of hapless borrowers. But do consumers really need such protection? Or would such a commission make it harder and more expensive for consumers to find the loans they need? The idea of a financial product safety commission comes from Elizabeth Warren, a Harvard Law professor and the chairwoman of Congress's oversight panel for the Troubled Asset Relief Program. She says that such a commission is necessary because consumers cannot buy a toaster that has a one-in-five chance of exploding, but they can get a subprime mortgage that has a one-in-five chance of ending in foreclosure. But this simple-minded analogy misses the point. An unsafe toaster is a hazard to anyone who buys it. That's not true for loans. Virtually every credit product is valuable to some consumers. Low-documentation loans are a boon for homeowners with a lot of equity who want to refinance their mortgages (even as they are a dangerous thing to offer speculators). And unlike toasters, borrowers have substantial say over whether their loan "explodes." Foreclosures have risen throughout the country, but an epidemic exists only in a handful of areas -- Las Vegas, Phoenix, Miami and the Inland Empire region of California are all places where foreclosure rates are five to 10 times higher than the national average. These areas saw price bubbles that have now popped, giving many homeowners who owe more than their house is worth strong incentives to walk away from their loans. Treating all consumers as hapless victims rather than recognizing that many consumers rationally respond to incentives is a recipe for unintended consequences. It can lead to counterproductive regulation that makes loans more expensive and harder to get. Consider, for example, prepayment penalties in subprime mortgages. Banks charge such penalties because prepaying a mortgage makes it less profitable and subprime loans are already less profitable than prime loans. Empirical studies show that there is no link between penalizing borrowers for paying off their loans ahead of schedule and increased foreclosures. Yet, consumer advocates say these penalties are one reason why subprime borrowers find themselves underwater.

Detroit Public School System Ponders Bankruptcy - (Mish at globaleconomicanalysis.blogspot.com) Freep is reporting the Detroit Public School System May Wind Up In Bankruptcy. The Detroit Public Schools may have no choice but to file for Chapter 9 bankruptcy, which would make it the first big-city school district to use bankruptcy court to avoid paying millions to vendors, employees and bondholders, experts said Thursday. DPS Emergency Financial Manager Robert Bobb is continuing to consider the option and met Thursday with retired U.S. Bankruptcy Judge Ray Reynolds Graves. Jim McTevia of McTevia & Associates of Bingham Farms, which works with companies with serious financial troubles, said DPS has three choices to solve its projected $259-million budget deficit: raise more money, cut costs or declare bankruptcy. More revenues are extremely unlikely, given DPS's projected enrollment decline of 12,000 students and anticipated state funding cuts. McTevia estimated DPS would have to cut its costs as much as 50%, an almost impossible feat given that more than 80% of most school district costs are salaries and benefits mandated by contracts. Bobb, a state appointee who took charge of the DPS budget in March, was not able to balance the 2009-10 budget, which totals about $1.2 billion and calls for $21.8 million in debt service payments on bonds sold to eliminate past deficits. A bankruptcy filing could reduce the amount DPS will pay vendors and bondholders. It also could allow a judge to rule on DPS's requested changes to employment contracts, McTevia said. Bankruptcy A Done Deal: This looks like a done deal to me. The employment contracts and pension plans are untenable, wage and benefit reductions of 50% outside of bankruptcy are virtually impossible, and there is no money to be found anywhere unless Obama comes to the rescue. No large school district nationwide, has ever filed for bankruptcy according to the Washington-based Council of the Great City Schools, an association of 67 of the nation's largest school districts. With that, the pension time bomb has finally gone off. And if the judge dramatically slashes wage contracts and pensions, which is what every taxpayer everywhere should be hoping, it will set a nice precedent for other over-burdened school districts to follow suit.

Wind Projects at a Standstill - (www.washingtonpost.com) The Obama administration has made offshore wind energy a priority and an important part of its plans to create jobs and combat climate change, but even such favorable political breezes have not been strong enough to propel the nation's first projects. The economy has intervened, and an unfamiliar federal approval process could hold up leading projects. Just last month, Interior Secretary Ken Salazar distributed leases to explore five possible wind farm sites off Delaware and New Jersey on the outer continental shelf. The leases were the first ever, and Salazar proclaimed "a new day for energy production in the United States." But that day may be years in the dawning. Developer Bluewater Wind won two of the leases for sites 14 miles off Delaware and 15 to 18 miles off New Jersey. The company seemed to be barreling toward being first in the emerging industry, with plans to plant a wind farm into the seabed at Rehoboth Beach, Del. A year ago, it had even struck an agreement to sell power from the giant windmills to Delmarva Power. But now, its parent company, Australian investment firm Babcock & Brown, has buckled under the weight of the global economic downturn and is selling off its assets to reduce debt. Bluewater is looking for investors to keep its projects moving. "They're just reapproaching all of the other players out there, hat in hand," said Brian Yerger, chief executive of Aerca Advisors, a consulting company focusing on renewable energy. "There are a lot of balls in the air." Hundreds of large and small wind farms have been built on U.S. land, but that sector also is feeling financing frustrations. This week, oilman T. Boone Pickens backed off of his plans to build the world's largest wind farm in the Texas Panhandle, citing tight credit markets and lower natural gas prices. Pickens could not find financing to pay for the transmission lines that would hook up his wind farm to the Texas grid. Offshore developers face a similar problem. They need to find customers to buy their power and must do so before they can get financing to build. They must also navigate an untested federal permit process that was scheduled to take effect late last month, putting projects many years away from completion. Construction on even the most promising projects in Rhode Island, along with those in Delaware and New Jersey, won't begin for at least four years.

From Treasury to Banks, an Ultimatum on Mortgage Relief - (www.nytimes.com) Remember that infamous meeting last October at the Treasury Department, the one where then-Secretary Henry Paulson locked the chief executives of the nation’s nine largest financial institutions in a room, and wouldn’t let them out until they agreed to accept billions of dollars in government bailout money — whether they wanted it or not? O.K., that’s a bit of an exaggeration. But I was reminded of that meeting on Thursday night when I was shown a letter that the administration had just sent out calling for yet another big meeting at Treasury with yet another sector of the financial industry. Signed by Treasury Secretary Timothy Geithner and Shaun Donovan, the housing and urban development secretary, the letter demanded that representatives from the top 25 mortgage servicers assemble in Washington on July 28. It is likely to be every bit as painful for them as that Paulson meeting last October was for the bank C.E.O.’s. The subject of the meeting is going to be loan modifications. Specifically, the government is going to be asking — in none-too-friendly fashion — why the nation’s big servicers aren’t doing more to modify loans for homeowners who are in danger of defaulting on their mortgages. Back in the spring, after all, they all signed onto the administration’s new Making Home Affordable program, which uses a series of incentives — not the least of which is $1,000 to the servicers for every mortgage they modify — to help keep people in their homes and prevent foreclosures. And yet, five months later — and two years into the housing bust — the rising tide of foreclosures remains the single biggest threat to economic recovery. In 2005, at the height of the bubble, there were some 800,000 foreclosures. This year, sadly, we are on pace to see 3.5 million foreclosures, with no end in sight. “On Main Street, the recovery will begin when foreclosures stop,” said Senator Jack Reed of Rhode Island, who has been pushing the Treasury Department to get mortgage relief more quickly to homeowners at risk of foreclosure.

Mortgage Defaults: Many Are Intentional - (www.time.com) Up to 26% of U.S. homeowners who stop paying their mortgage may be doing so intentionally, not because they can't make the payments but because they don't want to put money into a house that's worth less than what they owe. That finding, from a paper by economists at the University of Chicago, Northwestern University and the European University Institute, raises some doubt about the approach the Obama Administration has taken toward stabilizing the housing market. The current approach focuses on whether or not homeowners can afford their monthly payments, and largely ignores the fact that some 20% of homeowners owe more than their house is worth — a situation known as negative equity, or being "underwater," which, according to the paper's findings, may itself trigger default. The paper's authors caution that their statistics are not exact and should be taken primarily as an indication that there is a looming problem, one that needs to be addressed. The 26% figure comes from a series of consumer surveys that feed into the Booth Chicago/Kellogg School Financial Trust Index. In December 2008 and again in March 2009, 1,000 people were surveyed and asked, among other things, if they knew anyone who had defaulted on a mortgage, and if they knew anyone who had defaulted on a mortgage even if he or she could afford to make the monthly payment. By taking the ratio of the two answers, the economists calculated that more than a quarter of defaults are, as they put it, "strategic." "They can still afford to pay but they decide not to," says Paola Sapienza, a finance professor at Northwestern University and one of the paper's authors. "It's very easy to do this in the U.S." Even though there are serious consequences to reneging on a home loan — including wrecked credit, not being able to buy another house for years to come, the cost of moving and the social stigma associated with being a person who does not honor one's commitments — lenders tend not to pursue former homeowners for the money they are owed because of the prohibitive cost of tracking down such people and suing them.

Goldman Sachs Loses Grip on Its Doomsday Machine - (www.bloomberg.com) Never let it be said that the Justice Department can’t move quickly when it gets a hot tip about an alleged crime at a Wall Street bank. It does help, though, if the party doing the complaining is the bank itself, and not merely an aggrieved customer. Another plus is if the bank tells the feds the security of the U.S. financial markets is at stake. This brings us to the strange tale of Goldman Sachs Group Inc. and Sergey Aleynikov. Aleynikov, 39, is the former Goldman computer programmer who was arrested on theft charges July 3 as he stepped off a flight at Liberty International Airport in Newark, New Jersey. That was two days after Goldman told the government he had stolen its secret, rapid-fire, stock- and commodities-trading software in early June during his last week as a Goldman employee. Prosecutors say Aleynikov uploaded the program code to an unidentified Web site server in Germany. It wasn’t just Goldman that faced imminent harm if Aleynikov were to be released, Assistant U.S. Attorney Joseph Facciponti told a federal magistrate judge at his July 4 bail hearing in New York. The 34-year-old prosecutor also dropped this bombshell: “The bank has raised the possibility that there is a danger that somebody who knew how to use this program could use it to manipulate markets in unfair ways.” How could somebody do this? The precise answer isn’t obvious -- we’re talking about a black-box trading system here. And Facciponti didn’t elaborate. You don’t need a Goldman Sachs doomsday machine to manipulate markets, of course. A false rumor expertly planted using an ordinary telephone often will do just fine. In any event, the judge rejected Facciponti’s argument that Aleynikov posed a danger to the community, and ruled he could go free on $750,000 bail. He was released July 6. Market Manipulation: All this leaves us to wonder: Did Goldman really tell the government its high-speed, high-volume, algorithmic-trading program can be used to manipulate markets in unfair ways, as Facciponti said? And shouldn’t Goldman’s bosses be worried this revelation may cause lots of people to start hypothesizing aloudabout whether Goldman itself might misuse this program? Here’s some of what we do know. Aleynikov, a citizen of the U.S. and Russia, left his $400,000-a-year salary at Goldman for a chance to triple his pay at a start-up firm in Chicago co- founded by Misha Malyshev, a former Citadel Investment Group LLC trader. Malyshev, who oversaw high-frequency trading at Citadel, said his firm, Teza Technologies LLC, first learned about the alleged theft July 5 and suspended Aleynikov without pay.