Spreading the Poverty Around?
Dear Congressional Wealth Destruction Followers,
President Obama announced last week his preliminary plan to stop foreclosures for seven to nine million American families. The key components are granting bankruptcy judges the power to reduce mortgage amounts, subsidizing mortgage servicers and owners to offer reduced principal and interest payments for homeowners in trouble, rewarding homeowners who stick to a reduced payment plan with bonus payments, giving Fannie Mae and Freddie Mac more flexibility to lend up to the current value of the house, and, as already provided in the $ 787 billion stimulus package, offering genuine first time home buyers up to $ 8,000 in tax credits if they purchase a home this year.
The Wall Street Journal estimates the plan will cost up to $ 275 billion. In its core assumptions, the overall plan has several main premises that are hostile to freedom and property. This Congressional Wealth Destruction Monitor points out several ways this new, larger government intrusion will actually make us all poorer. As Tom Paine might have put it, that government is worst that governs most.
One Congressional Wealth Destruction that will occur here is giving bankruptcy judges the power to override settled law and existing contracts: what banks thought was collateral is no longer collateral. This is tantamount to a seizure of the collateral by the government. The most likely unintended consequence of this is that new mortgages will be made at increasingly higher rates that reflect what risks unsecured creditors have--somewhat like credit card rates which are typically 10% to 15% higher than mortgages.
What will higher mortgage rates do for housing prices? Kill them. Under current Congressional proposals, some estimate the immediate write down of Alt-A and prime loans at up to 1/3 of certain loan pools--with immediate losses in the many billions. As the stock market digested this and other proposals since the election, bank stocks have fallen by 62% and since January 1, the S&P 500 Index is down 15.3%. In about a year and a half, the aggregate market capitalization of the financial stocks has dropped from $ 1.4 trillion to less than $ 300 billion, with much of the loss ultimately caused by Congressional intrusion. And what will falling housing prices do in terms of financial harm to first time home owners who misread risk and misallocated capital by buying a huge asset that has gone down sharply, and is more likely than not to continue going down due to increasing government intrusion?
Another premise implicit in the housing plan's structure is that all money belongs in principle first to the government and may be doled back out to the populace as a reward for servitude. The plan's tax credits are like that, and the bonuses for sticking to your payment plan are like that. But these carrots may be illusory, because they phase out for people with incomes over $150,000--that is to say, the people who are most likely to actually get fresh credit and therefore could actually act.
But the part of the plan that got Rick Santelli's fabulous outburst so much attention is that the plan requires the 92% of homeowners who are on time with their payments, and all the people who rent (many of whom wish they could own a home) to subsidize those who are in trouble at this moment. As Santelli said "the plan promotes bad behavior." It is not hard to sit across the kitchen table and come up with a master plan to get behind in your payments if the government will step in and cram the loss down the bank's throat and require your neighbor to cover your losses. Tax plans that assume that people will keep their behavior static and not respond to incentives are futile.
President Obama was adamant that those who gamed the system to speculate would not receive a penny under the plan. But this will require Herculean effort and lead to more unintended consequences. Is the government going to investigate every modifying borrower's historical financials to look back in time to see if they were utterly accurate about their income, assets and prospects at the time they got the loan. Sheila Bair, head of the FDIC, said last week "I think it's just simply impractical to try to do a forensic analysis of each and every one of these delinquent loans that may have been originated two or three years back to find out whether income had been appropriately stated at that time." The plan also does not apply to large mortgages, re-financed mortgages, or private mortgages.
While President Obama claims that between seven and nine million families will get to re-structure their loans under the plan, there are so many requirements, qualifications and gotchas in the housing plan that it is not likely to help as many people as intended, but harm many more than thought possible. Perhaps we could also do forensic investigations of the campaign promises of our politicians.
Another terrible aspect of the plan is that it mainly seeks to aid government agencies with this relief, and leave the half of the mortgage market that was privately loaned in the lurch. Private banks will not be eligible for refinance aid but have all the follow on liability from the destruction of their collateral and so on.
Perhaps this is what Secretary Treasury Geithner means when he refers to a "Public-Private" partnership. Investors for the last 50 years have been the victims of a "public-private" partnership with respect to their stock market gains and losses. Capital gains are fully and immediately taxable. Capital losses are limited to $3,000 per year. The government gets to expand at the expense of private business trying to compete with it. And now the government proposals appear to be self-fulfilling, because they have so destroyed the bank stocks that many no longer have enough access to equity capital to meet their regulatory requirements. For example, this Monday morning we were greeted with the de facto creeping nationalization of Citibank.
So we have arrived at a vastly complicated Rube Goldberg contraption designed to pick a moment in time and to prevent the collapsed housing prices from resulting in mortgage defaults, and in particular, foreclosures. But at the prices many of the defaulting borrowers paid for their homes, in financial terms, they never really owned their homes. They only had an option. Now their option has expired and they must go back to renting. It's not the end of the world. In fact, now that the myth of ever rising real estate prices has been shattered, for many people it may be a better financial deal. Postponing foreclosures and restructurings only adds to uncertainty and prolongs the pain. We may be transforming a recession into a depression. When this fix does not work, things will get worse, not better, because as a country we will have thrown good money after bad.
The President cited a study that foreclosure signs induce an average of a 9% drop in housing prices. But in an economy that self heals, that drop should be temporary. In effect, the government is using taxpayer wealth to attempt to permanently support housing prices and more sinisterly support the property tax scheme associated with them. Because if people abandon property, who will pay the property taxes? The beleaguered banks left holding the bag? Certainly not.
Think of it as wage and price controls for housing. It didn't work for Nixon. It didn't work when Roosevelt and Hoover tried to fix wages. It didn't work for Hammurabi. The beauty of the free market is its spreading of hope. Anyone can participate. The horror of a government controlled market is the extinguishment of hope. Anything the government can do for you, it can also undo if it so chooses. And as we continue to abandon the rule of law and the sanctity of contract, the corrosive effect on the confidence of the markets will get ever more sour.
What is required are free market oriented solutions that get capital flowing and enfranchise the 92% of homeowners that are on time to begin to think positively about the housing market. There is $ 9,000,000,000,000 on the sidelines in cash deposits, money market funds, and treasuries. That is a better place to look for help than our overstretched government.
Eric T. Singer
Congressional Effect Management
The Congressional Effect Fund seeks to avoid market destabilizing uncertainty and the effects of news of potentially wealth damaging legislation by investing in the market (via the S&P 500 Index) only when Congress is on recess, and primarily in interest bearing instruments when Congress is in session.
The Congressional Effect Fund is the culmination of my many years of frustration with government folly, and I am delighted to have launched and be managing a vehicle I hope will reward investors and, in so doing, also highlight the deleterious effects of poor Congressional action. It is my sincerest hope that strong investor support of this endeavor will promote and further freedom in America as our founding fathers intended.
If you need assistance completing the investment application, or have additional questions about the Fund, please do not hesitate to contact me directly. Or, you may contact the Fund's distributor, Matrix Capital Group at 1.888.553.4233.
Investments in mutual funds involve risks. Read the prospectus and consider the Fund's investment objectives, risks, charges and expenses carefully before investing or sending money. The Congressional Effect Fund is a newly-formed entity, and although the Advisor’s portfolio manager, Eric T. Singer, has been a portfolio manager for private investment vehicles in the past, he does not have previous experience running a registered investment adviser or managing a mutual fund. Accordingly, investors in the Fund bear the risk that the Fund may not be successful in implementing its investment strategy and investors in the Fund bear the risk that the Advisor’s inexperience managing a firm may limit its effectiveness. There is no assurance the Fund’s investment objectives will be achieved. Past performance does not guarantee future results. Investment return and value will fluctuate so that when redeemed, shares may be worth more or less than the original cost.
23 February 2009
This arrived in my in-box tonight. It would be funny if it weren't so weird and scary. OK - it's still funny.