KeNo's Housing and Economic Portal: Tuesday June 23 Housing and Economic stories

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Fed Hit by Subpoena: Fasten Your Seatbelt - (www.financialsense.com) The Federal Reserve was served a subpoena from a Congressional committee Tuesday, as lawmakers demanded documents related to Bank of America’s acquisition of Merrill Lynch. In our view, this is a precursor of more trouble to come for the Fed. We have argued for some time that Fed Chairman Bernanke completely underestimates the political dimensions of the policies he pursues. The various "credit easing" programs have little to do with monetary policy, the domain of the Fed. Monetary policy ought to be concerned with money supply or the level of interest rates, thereby allowing the markets to decide where the money flows. Instead, the Fed has been targeting specific sectors of the economy, such as helping the housing market or enabling car loans. The motivation is understandable, as the Fed is well aware that it may not be powerful enough to support the housing market otherwise, and sees it as crucial in its plan to prop up the economy. However, allocating money to specific sectors of the economy is fiscal policy and, as such, should be authorized and supervised by Congress. This facet is perilous for the Fed to ignore, as it invites political backlash. Last week, Bernanke was grilled by the House Budget Committee, giving him a taste of more to come; the subpoena is a further step. The ‘unconventional’ policies jeopardize the credibility and independence of the Fed. This takes its toll on the effectiveness of monetary policy, making any policy more expensive. Remember: the cheapest monetary policy is one where a Fed official simply utters a few words and the market reacts. Ever since the fall of 2007, monetary policy has become increasingly more expensive as the Fed’s effectiveness has been eroding. When Fed talk was no longer sufficient, the Fed had to enact an emergency rate cut in early 2008; since then, the Fed had to escalate its policies further, printing trillions of dollars. Unfortunately, this trend may accelerate rather than reverse. Fasten your seatbelts.

Bernanke e-mail claim in Merrill sale saga - (www.ft.com) Ken Lewis, chief executive of Bank of America, used the threat of invoking a “material adverse change” clause to break off his agreement to buy Merrill Lynch last December because he wanted to negotiate a lower price, Federal Reserve chairman Ben Bernanke claimed in an e-mail. Mr Lewis, who is scheduled to testify about the matter on Thursday at a congressional hearing, only dropped his threat after being told by former US Treasury secretary Hank Paulson that regulators, including Mr Bernanke, would remove him and his board if BofA tried to invoke the “MAC” clause. The House committee on oversight and government reform has been investigating whether federal regulators put undue pressure on Mr Lewis to complete an agreed deal last year to buy Merrill Lynch. After the Fed initially refused to comply with the committee’s request for documents and e-mails in the matter, the committee took the extraordinary step of issuing a subpoena on Tuesday to obtain material from the Fed that concerned the deal. One person familiar with the Fed’s history could remember only one previous occasion when it had been served with a subpoena. The Financial Times has learned that Mr Bernanke, in an e-mail, described Mr Lewis’s threat to invoke the “MAC” clause as a “bargaining chip”, and a “foolish move”, before concluding that “the regulators will not condone it”. A staffer at the Federal Reserve bank in Richmond, Virginia, said in an e-mail that top executives at BofA, including the bank’s chief financial officer, Joe Price, “want the transaction to go through but have to protect their shareholders”. Since January, when BofA revealed that it only completed the Merrill transaction following a promise of $20bn in taxpayer support from Mr Paulson, BofA shareholders have complained that Mr Lewis kept them in the dark about mounting losses at Merrill. Several have filed suit, and the Securities and Exchange Commission, as well as the government watchdog responsible for tracking funds paid out of the troubled asset relief programme (Tarp), are also investigating the matter. In January, following the disclosure that Merrill had payed $3.6bn in bonuses in late December, a month ahead of schedule and days before BofA completed is purchase of the firm, the New York state attorney-general, Andrew Cuomo, began an investigation. While conducting his probe into the bonuses paid out at Merrill Lynch, Mr Cuomo has investigated the interactions between Mr Lewis and his federal overseers. Mr Cuomo published his findings in a letter to Congress in April.

Bondholders Face Commercial Mortgage Losses as Principal Is Due - (www.bloomberg.com) Investors in bonds that packaged $62 billion of debt for U.S. offices, hotels and shopping malls are bracing for more loan defaults through 2010 as Bank of America Merrill Lynch says landlords’ monthly payments may jump 20 percent or more. Principal is coming due on the so-called partial interest- only loans as an 18-month-old recession saps demand for commercial real estate. About $179 billion of such loans were written between 2005 and 2007 and bundled into bonds, according to data from Bank of America Merrill Lynch. With soaring vacancies and falling rents, some cash- strapped borrowers will fail to cover the higher costs, said Andy Day, a commercial mortgage-backed securities analyst at Morgan Stanley in New York. About 87 percent of mortgages sold as securities in 2007 allowed owners to put off paying principal for several years or until maturity, compared with 48 percent in 2004, Morgan Stanley data show. “The worst is yet to come,” MetLife Inc. Chief Investment Officer Steven Kandarian said yesterday in a Bloomberg Television interview. “Typically there’s a lag between when the economy softens and when the defaults actually occur.” Investors have already seen prices on top-rated senior debt drop below 70 cents on the dollar from 95 cents a year ago, according to Aaron Bryson, a commercial mortgage-backed securities analyst at Barclays Capital in New York. Just a Stopgap: Interest-only mortgages were designed as a stopgap to allow owners to do renovations and absorb other costs. Owners delay paying principal for the first several years, lowering their initial monthly expenses. Partial interest-only loans allow for postponement of principal payments for a portion of the term. Full-term interest-only deals require the principal at maturity. Loans that postpone principal payments had become the norm by the time the commercial-mortgage bond market peaked two years ago, said Frank Innaurato, managing director of analytical services at Realpoint LLC, a Horsham, Pennsylvania-based credit- rating service. “The proliferation of interest-only loans was symptomatic of the loose underwriting standards of that time,” Innaurato said. “Borrowers were taking advantage of the best terms possible.” Property owners turned to Wall Street to finance office towers, apartment complexes and hotels as banks bundled the debt and sold it to investors. A record $230 billion in commercial mortgage-backed securities were sold in 2007, up from $93.3 billion in 2004, according to Morgan Stanley data. About $750 billion of such debt is outstanding, bank data show.

Geithner’s OTC plans alarm exchanges - (www.ft.com) The word “standardised” sounds innocuous enough. But its use in a US policy document on the future of over-the-counter derivatives has set alarm bells ringing at derivatives exchanges. Tim Geithner, US Treasury secretary, has said that to contain systemic risks he wants US laws to be changed to require clearing of “all standardised OTC derivatives through regulated central counterparties [CCPs]”. This marks a sweeping change to the way OTC derivatives are handled, implying a shift away from the dealers at banks who brokered such contracts to the formal exchanges that have long jealously eyed the huge OTC markets. But what does “standardised” mean? How much of the OTC markets can and should be shifted on-exchange, whether cleared or – as Mr Geithner also wants – traded? Nobody has a clear answer, since OTC derivatives come in many shapes and sizes, ranging from straightforward interest rate swaps to more tailored products such as “average price options” used by grain processors to hedge against movements in crop prices. Exchanges, many of which own their own clearing houses, might be expected wholeheartedly to welcome the Geithner proposals. But they are warning against a strict definition of “standardisation”. Craig Donohue, chief executive of CME Group, the largest US futures exchange, which owns a clearing house, says: “Standardised is not the right way to do it.” He and others are concerned that lawmakers in the US Congress may come up with a strict definition that would force a shift of OTC contracts into clearing houses that are ill-equipped for the task. They warn that such a move could expose clearing houses to unnecessary risks that could even damage the financial system at a time when regulators are looking at ways to protect it against future crises. Kim Taylor, president of CME clearing, says: “There is a danger in having regulatory mandates that are too broad, that would require clearing of products that clearing houses don’t feel comfortable risk managing.”

Muni bond market roiled as investors demand higher yields - (www.latimes.com) The municipal bond market is stumbling as investors turn more cautious while states and local governments ramp up borrowing. Tax-free yields on muni bonds rose Wednesday, continuing a reversal that began about two weeks ago. California state bonds were hit particularly hard. And Los Angeles Countypaid double what it expected as it raised more than $1 billion by selling short-term notes. The market’s demand for higher yields is pushing down prices of older fixed-rate bonds. That’s depressing share values of muni bond mutual funds. Case in point: The share price of the Franklin California Tax-Free Income fund slipped 3 cents, or 0.5%, to $6.54 Wednesday. The fund is down 2.7% since May 22 -- a relatively modest decline so far. In Wednesday’s trading, the annualized yield on the Bond Buyer index of 40 long-term muni bonds nationwide rose to 5.54% from 5.51% on Tuesday. The yield has risen from 5.22% on May 21. The muni market’s sudden troubles, after a strong rally for much of the spring, in part reflect the surge in U.S. Treasury bond rates: As Treasury yields rise they’re putting upward pressure on other interest rates. A heavy supply of new muni bonds also is weighing on the market, giving buyers the upper hand in setting interest rates. About $12 billion in new muni issues are expected to be sold this week, the most since the end of April, according to Bloomberg News data. For the California muni market there’s another issue, as most investors ought to know by now: As the state’s budget woes have deepened in recent weeks the market has begun to focus more intently on the potential fallout. Although Wall Street doesn’t believe the state could renege on its debts, investors have begun to demand much higher yields on California’s general obligation bonds to reflect the greater perceived risk of financial calamity. The yield on 10-year California general obligation bonds soared to 4.89% on Wednesday from 4.76% on Tuesday, according to Bloomberg data. The yield was 4.37% four weeks ago. "The whole muni market has gotten hurt, but California is leading the parade," said Stephen Kelleher, manager of the muni bond unit at brokerage Wedbush Morgan Securities in San Francisco. Of course, higher yields also mean opportunity for investors -- if they can stomach the risks. The state’s budget mess forced Los Angeles County to pay much more than it had planned on a sale of $1.3 billion in so-called tax and revenue anticipation notes, a normally routine borrowing counties undertake at this time of year.

U.S. Foreclosure Filings Top 300,000 as Bank Seizures Loom - (www.bloomberg.com) kmann, chief economist of the Washington- based Mortgage Bankers Association, said in an interview. “It will continue through next quarter at least.” Job losses and falling property prices are delaying the housing recovery as more homeowners are unable to pay the mortgage or have difficulty selling or refinancing. The unemployment rate climbed to 9.4 percent in May, the highest since 1983, the Labor Department said last week. Prices in 20 U.S. cities dropped 18.7 percent in March, according to the S&P/Case-Shiller home-price index. More home loans originated in 2005 or before are likely to default as unemployment climbs, said Rick Sharga, executive vice president for marketing at RealtyTrac. A record 1.37 percent of all loans entered the foreclosure process in the first quarter, with 29 percent tied to borrowers with prime, fixed-rate mortgages, the MBA reported May 28. Homes in foreclosure totaled 3.85 percent of all loans in the quarter, up from 2.47 percent a year earlier, MBA said. Balance Sheets Worsen: “The numbers are getting bigger and that’s what is bothering me,” said Patrick Newport, economist at IHS Global Insight in Lexington, Massachusetts. “You have banks holding these toxic loans, which means bank balance sheets are in even worse shape with the increase in delinquencies.” Additional U.S. home foreclosures will probably total 6.4 million by mid-2011, and inventories of foreclosed homes awaiting sale will probably peak in mid-2010 at about 2 million properties, JPMorgan Chase & Co. analysts led by John Sim wrote in a June 5 report. U.S. prices will likely drop 39 percent on average, they said. The May total was the third-highest in RealtyTrac records dating to January 2005.

Hartford To Take TARP Funds, To Sell Stock - (www.cnbc.com) Hartford Financial said Friday it will take $3.4 billion of federal bailout money and plans to sell as much as $750 million of common stock. The 199-year-old life and property insurer announced its plans eight days after saying Chairman and Chief Executive Ramani Ayer will retire by the end of the year, following big losses tied to investments and variable annuity sales. Citing a "continued uncertain economic environment," Ayer said taking part in the Troubled Asset Relief Program and selling stock represent important steps in building financial strength and remaining well-capitalized over the long term. The Hartford, Connecticut-based company received preliminary approval to participate in TARP on May 14. TARP was originally intended to help banks, but eligibility has expanded to a handful of insurers. Hartford said it plans to sell its common stock over time. It intends to use net proceeds for general corporate purposes, including possible debt buybacks.