Temporary footpath, Manhattan Bridge, NYC
Ilargi: When I read Andrew Jeffery's Keepin' It Real Estate: Subprime Lending Is Back With a Vengeance on Minyanville this weekend, I started wondering about the financial state US states are in. Not that I haven't read anything lately, but ooooh boy...... Jeffery's article looks to me to paint a portrait of a weird kind of desperation, of bankrupt governments and homebuilders conspiring to get $8000 federal tax credits forked over to potential buyers as quickly as possible, without looking at credit worthiness too much, or at all. The objective? Sucking short-term money out of federal funds doled out to those who can't afford what they get the credit for. Every home sold brings in property taxes, right? Jeffery rightly remarks that nobody has still learned anything from the Fannie and Freddie mayhem. Well, maybe that's because 99% of that still lies ahead of us. Here's some snippets:
Just when you thought it was safe to go back in the water... Subprime lending has come roaring back. But this time, reckless financial innovation isn’t being hatched on Wall Street. Instead, state governments are angling to “monetize” first-time homebuyer tax credits so borrowers can purchase homes with little or no money down. If this sounds eerily similar to the type of lending practices that got us into this mess, well, it should. The federal government, as part of the recently passed economic stimulus package, will refund first-time homebuyers up to $8,000 if they meet certain eligibility requirements. The program is frequently cited as one of the myriad reasons a bottom in the housing market is imminent.
In a big red warning sign on state finances, USA Today last week ran Federal aid is top revenue for states
In a historic first, Uncle Sam has supplanted sales, property and income taxes as the biggest source of revenue for state and local governments. The shift shows how deeply the recession is cutting. Federal stimulus money aimed at reviving the economy and a sharp drop in tax collections have altered, at least temporarily, the traditional balance of how states, cities, counties and schools pay for their operations. The sales tax had been the No. 1 source of state and local revenue since the mid-1970s, according to the Bureau of Economic Analysis. Before that, property taxes were the primary source.
That changed in the first three months of 2009. Federal grants — early stimulus money plus conventional federal aid — soared 15% in the first quarter to a seasonally adjusted annual rate of $437 billion, eclipsing sales taxes, which fell 2%. The federal government plans to provide about $300 billion in extra aid to state and local governments over the next two years, mostly for health care, education and transportation projects. State and local governments spend about $2 trillion a year, and the federal government is now paying about 23% of those costs.
States are counting on tax collections rebounding by 2012, when stimulus money starts to run out. The early flow of stimulus money helped lift total state and local revenue by 1.6% in the first quarter compared with a year earlier despite a 2.9% drop in total tax collections. Spending rose 1.5%. Things are getting worse for states that rely on the income tax. Reason: Unexpectedly large refund checks in March and April are going to workers who lost jobs or had wage cuts last year. Michigan's income tax collections are down $200 million and refunds are up about $200 million — a $400 million swing. Connecticut has paid nearly $1 billion in tax refunds this year, about 20% more than expected.Money Sources
Top revenue sources for state and local governments in the first quarter, compared with the same period last year:
Federal grants: 15%
Income taxes: -11%
Property taxes: 2%
Sales taxes: -2%
Other taxes: 2%
Sources: U.S. Department of Commerce, Bureau of Economic Analysis
In its State Budget Update issued on April 23, 2009, the National Conference of State Legislatures provides the following data:
The state fiscal situation is growing increasingly dire. As revenue shortfalls mount, budget gaps are swelling—in some cases to staggering levels. The only bright spot is the onset of federal stimulus funds provided through the American Recovery and Reinvestment Act of 2009 (ARRA). Without that money, state finances would be even more dismal. The bulk of state fiscal problems can be traced to the national recession and the resulting effects on state revenue collections. Revenues continue to falter and even repeated downward revisions have not captured the full extent of the decline. For many states, the current revenue situation is nearly unprecedented, at least in recent years. As one official noted, "This is the most dire fiscal situation in the state's recent history."
These persistent revenue shortfalls have generated yawning budget gaps. When enacting their budgets for fiscal year (FY) 2009, lawmakers collectively resolved a $40.3 billion budget gap. But their actions were not enough to keep their budgets balanced. Just a few months into the fiscal year, a new $32 billion gap opened, which eventually climbed to $62.4 billion. Officials hope the FY 2009 gap has peaked, but a few note that upcoming revenue forecasts could still add to their current fiscal year imbalance.
As bad as the FY 2009 situation has been, it is already eclipsed by a jaw-dropping gap of at least $121.2 billion for FY 2010. That is the shortfall states are aiming to resolve as they enact their new budgets. If FY 2010 budgets follow a pattern similar to the one in FY 2009 (and in FY 2008, for that matter), new gaps are likely to emerge after the fiscal year begins. But the nightmare does not end there. At least 31 states and Puerto Rico have already forecasted budget gaps in FY 2011, with the initial estimate at $44.5 billion.
I looked up some random articles on state budgets, which will need to be voted on soon, as you can see below. All of them, bar none, are based on expectations of new booms, recoveries and returning growth, while services will often be cut for the most needy. That's politics, after all: the sick, the elderly and the very young are not a force to be reckoned with if you're up for (re-)electon. And neither are those not hungry for good tidings and images of wealth and glory just beyond the horizon.
And who can blame the lower level elected officials, really, when Washington this morning simultaneously reports on the one hand that its 2009 budget deficit will yet again need to be revised upwards, leading to a situation in which almost half of what is spent needs to be borrowed, and on the other that it expects a 3.5% economic growth rate 7 months from now? Would perhaps a little caution not be a better approach? We'll see a lot more on state budgets and their horrors in the next few weeks, and on how the federal government will fund the collective shortfalls, which, I guarantee you, will turn out to far exceed $200 billion. The states' defense? "Washington told us we'd have 3.5% growth by Christmas. And they should know!"
Obama Economic Team Predicts 3.5% Growth by Year-End, Exceeding Most Forecasts
The Obama administration projected that the U.S. economy will expand at a 3.5 percent annual rate by year-end, a rebound that would be almost twice as strong as private forecasters expect. In the economic assumptions of its 2010 budget request, President Barack Obama’s economic team didn’t change its 2009 predictions for a 1.2 percent drop in gross domestic product this year, slower inflation, higher unemployment and lower market interest rates than a year ago.
As early as the end of this year, GDP may rise at a 3.5 percent annual rate, the same pace projected for all of next year, helped by a $787 billion stimulus package, the administration said in the report today. That’s more optimistic than the 1.8 percent fourth-quarter growth estimate in the monthly Blue Chip Economic Indicators survey released May 10. “Although the economic downturn so far in 2009 has been more severe than the administration expected when the forecast was finalized, if the financial system begins to function more normally, there is every reason to expect a somewhat stronger recovery given the depth of the current recession,” the White House said today. The administration expects “housing starts to reach bottom this year and to begin a robust recovery as relative housing prices stabilize,” today’s report said.
The Federal Reserve’s “novel” policies of extending funds to banks to boost liquidity and purchasing short- and long-term Treasuries also will help underpin the recovery, the White House said. Still, a doubling of the Fed’s balance sheet to about $2 trillion “holds the potential for an explosive increase in the nation’s money supply,” it said. “So far that has not occurred, because much of the increase in Federal Reserve liabilities has gone into idle reserves of the banks,” the administration said. The central bank “is prepared to reduce the assets on its balance sheet promptly as the economy recovers from the current recession and the crisis in the financial sector eases.” The report also said “inflation is expected to remain subdued over the next few years.”
White House: Budget deficit to top $1.8 trillion
With the economy performing worse than hoped, revised White House figures point to deepening budget deficits, with the government borrowing almost 50 cents for every dollar it spends this year. The deficit for the current budget year will rise by $89 billion to above $1.8 trillion - about four times the record set just last year. The unprecedented red ink flows from the deep recession, the Wall Street bailout, the cost of President Barack Obama's economic stimulus bill, as well as a structural imbalance between what the government spends and what it takes in. As the economy performs worse than expected, the deficit for the 2010 budget year beginning in October will worsen by $87 billion to $1.3 trillion, the White House says. The deterioration reflects lower tax revenues and higher costs for bank failures, unemployment benefits and food stamps.
For the current year, the government would borrow 46 cents for every dollar it takes to run the government under the administration's plan. In one of the few positive signs, the actual 2009 deficit is likely to be $250 billion less than predicted because Congress is unlikely to provide another $250 billion in financial bailout money. The developments come as the White House completes the official release of its $3.6 trillion budget for 2010, adding detail to some of its tax proposals and ideas for producing health care savings. The White House budget is a recommendation to Congress that represents Obama's fiscal and policy vision for the next decade. Annual deficits would never dip below $500 billion and would total $7.1 trillion over 2010-2019. Even those dismal figures rely on economic projections that are significantly more optimistic - just a 1.2 percent decline in gross domestic product this year and a 3.2 percent growth rate for 2010 - than those forecast by private sector economists and the Congressional Budget Office.
For the most part, Obama's updated budget tracks the 134-page outline he submitted to lawmakers in February. His budget remains a bold but contentious document that proposes higher taxes for the wealthy, a hotly contested effort to combat global warming and the first steps toward guaranteed health care for all. Obama's Democratic allies controlling Congress have already made it clear that they will reject key elements of his plan. Already apparently dead is a plan to raise $267 billion over the next decade to pay for his health care initiative by curbing the ability of wealthier people to reduce their tax bills through deductions for mortgage interest, charitable contributions and state and local taxes. And the congressional budget plan approved last month would not extend Obama's signature $400 tax credit for most workers - $800 for couples - after it expires at the end of next year.
Obama's remarkably controversial "cap-and-trade" proposal to curb heat-trapping greenhouse gas emissions is also reeling from opposition from Capitol Hill Democrats from coal-producing regions and states with concentrations of heavy industry. Under cap-and-trade, the government would auction permits to emit heat-trapping gases, with the costs being passed on to consumers via higher gasoline and electric bills. Among the new proposals is a plan - already on its way through Congress - that would increase the Federal Deposit Insurance Corporation's borrowing authority from $30 billion to $100 billion in order to grant a two-year reprieve from higher deposit insurance premiums while the industry is struggling.
Also new are several tax "loophole" closures and increased IRS tax compliance efforts to raise $58 billion over the next decade to help finance Obama's health care measure. The money makes up for revenue losses stemming from lower-than-hoped estimates of his proposal to limit wealthier people's ability to maximize their itemized deductions. The updated budget also would repeal an unintended tax windfall taken by paper companies that use a byproduct in the paper-making process as fuel to power their mills. The tax credits were never intended for paper companies, but now they could be worth more than $3 billion a year, according to a congressional estimate. The budget would make permanent the expanded $2,500 tax credit for college expenses that was provided for two years in the just-passed economic stimulus bill. It also would renew most of the Bush tax cuts enacted in 2001 and 2003, and would permanently update the alternative minimum tax so that it would hit fewer middle- to upper-income taxpayers.
Obama Rally Won’t Last While Jobs, Spending Wane
We have just had a stock rally that is linked to U.S. President Barack Obama’s first 100 days. It was a decent sprint, but I don’t think it has legs. The Standard & Poor’s 500 Index managed to rebound from its dismal showing in 2008. If you measure the index from Obama’s inauguration on Jan. 20 through April 30, the benchmark gained 10 percent with dividends reinvested. If you stayed in the market all of last year, though, you still have some ground to make up after losing 40 percent during one of the worst years for stocks since the Great Depression. So the Obama rally is still a pyrrhic victory so far.
The same can be said in emerging stock markets, which lost more than half of their value last year. They have risen 34 percent in Obama’s first 100 days -- as measured by the iShares MSCI Emerging Markets Index exchange-traded fund. At the start of Franklin Delano Roosevelt’s first term as president, U.S. stocks surged more than 50 percent, while the economy improved only slightly. Obama may also be benefiting from a “honeymoon effect” or what economist John Maynard Keynes called “animal spirits.” Bonds haven’t fared quite as well under Obama. The Vanguard Total Bond Market ETF, which was up about 7 percent last year, was off almost 1 percent during the Obama period.
Another lackluster asset class is commodity funds, which also lost about half their value last year. They are down about 1 percent during the period, if you track the returns of the Goldman Sachs Commodity Strategy Fund. The Obama rally was fueled by optimism that most of the largest U.S. banks won’t collapse. The market may believe that the “unknowns” of their balance sheets are now known. A handful of patients may pull through while the rest of the U.S. economy at large, reeling from diminished consumer spending and high unemployment, still has a fever. Even though payrolls fell less than expected -- by 539,000 -- in March, the U.S. labor market is projected to remain weak for months.
Those losing -- or afraid of losing -- their jobs reel in their spending. A Bloomberg survey of economists forecast that spending will drop 0.1 percent this year. For the American economy, that’s not encouraging news. Let’s say stocks are due for another tumble. Will bonds provide the safe haven they did last year? Deflation -- a general decline in price levels -- is ruling the day during a massive deleveraging going on from Main Street to Wall Street. You can’t forget that three burst bubbles have blistered stock returns to such an extent that investors in 20-year U.S. Treasuries beat the S&P 500 from 1979 through 2008, says Robert Arnott of Research Affiliates in Pasadena, California.
While stock routs generally favor fixed-income investors, risks still loom. Bond prices may plummet after Western governments have to fully finance all the debt they need to sell for their economic stimulus packages. The Obama administration’s recently announced $3.4 trillion budget alone will balloon the federal deficit to a projected $1.7 trillion. Inflation may come back to ravage debtor countries then. So make sure you protect your bond holdings through inflation- protected securities and commodity funds. In judging current events, separate politics and recent returns from what you need to do. Find out how much you will need to comfortably live on and see if you are saving enough. Understand and measure the kinds of risk you are facing with each kind of asset. How much can you lose? A lot of people didn’t ask that question in 2008.
Don’t be nationalistic when it comes to your stock allocations, either. Growth will probably come from places you have never been and don’t understand. You may even want to cut down on your U.S. stock holdings by investing in a global portfolio such as the Vanguard FTSE All-World EX-US Index ETF that samples non-U.S. equity returns. Most of all, forget recent returns and spread your money between bonds, stocks, commodities, real estate, Treasury- Inflation Protected Securities and cash. And never forget to eschew investing decisions according to political polls and current stock-market returns. Those red herrings have the shelf life of all other fish.
Irrational Exuberance 3.0 Is Oozing Into Markets
If the bubble that just burst didn’t work out for you, build a better one. That looks like the rationale of Asia investors. Their optimism has driven the MSCI Asia Pacific Index up 38 percent from a five-year low on March 9. In recession-plagued Hong Kong alone, shares have gained 52 percent. Even Japanese stocks are rallying as deflation seeps backs into Asia’s biggest economy. Few doubt that in a world of recession and toxic debt, Asia is the least ghastly region. But 38 percent? Or 52 percent? Bullish on Japan? All that’s driving the rally are signs that the U.S. may not be heading into a new Great Depression. It’s not underpinned by indications that solid growth is afoot, just a sense that fewer of us will soon be homeless. Bubble, anyone?
Welcome to Irrational Exuberance 3.0. Alan Greenspan’s 1996 utterance about buoyant asset values has become a cliché. In 2009, though, the sentiments behind the former Federal Reserve chairman’s signature phrase are fusing together with chatter about Web 3.0. And that’s where the trouble begins. Web 2.0 is a catchall for the second generation of Internet development and design and the explosion of online social- networking sites, blogs and other media. Web 3.0, at least as one can ascertain, would be like having a massive and personalized database that can answer complex questions. Web 2.0 was about making connections with people. Web 3.0 would be connecting information with information.
What Web 3.0 has in common with the financial crisis is that its future is in the eye of the beholder. Just as some look at U.S. bank stress tests and rejoice, others are losing sleep over balance sheets. Just as some see Web 3.0 as a vast wilderness of untapped business opportunities, others are concerned that cyberspace’s next generation will erase all privacy and copyrights. It’s understandable to grasp at the slightest hint of good news. Concerns that swine flu will infect as many as 2 billion people, as the World Health Organization has said, hardly help. News of anything from financial contagion to a terrorist attack to a pandemic could drop at any second and spook investors. So, yes, a little sunshine sounds great.
There are signs that Fed Chairman Ben Bernanke’s “green shoots” are sprouting in the Asia-Pacific region. In Australia, employers and consumers are defying the predictions of central bank Governor Glenn Stevens and Prime Minister Kevin Rudd. Last month, both said the country was in its first recession since 1991. Retail sales jumped by the most in four months in March, while exports to China have soared 80 percent this year. There’s much riding on China’s 4 trillion-yuan ($586 billion) spending package. Many are betting that loose monetary and fiscal policies will safeguard growth. Yet none of this seems reason enough for Asian shares to surge.
The U.S. is a key reason why. Even if the biggest economy has bottomed, and it’s far from clear it has, that doesn’t mean business as usual for Asian exporters. U.S. consumers still need to increase their savings and reduce debt, lots of it in high- interest-rate credit cards. That means less spending. The Fed’s desire to return some normalcy to borrowing costs also may cap economic-growth rates. The last thing Bernanke wants is for a Japan-like dependency on ultra-loose credit to become ingrained in a $14 trillion economy. That could devastate the dollar and damage hard-won gains in controlling inflation. Bernanke’s challenge is to find the exit strategy that continues to elude the Bank of Japan. The process certainly won’t help the U.S. win any global growth contests.
The risk that we are seeing bear-market rallies around the globe is real. Just ask long-time businessman Ronald Arculli, 70, who says he “wouldn’t be a buyer” of Hong Kong stocks, which are at their most expensive valuations since January 2008. Arculli, by the way, is the chairman of Hong Kong Exchanges & Clearing Ltd. “The basis for growth hasn’t established itself yet,” Arculli says. “We’re hanging on to every piece of good news. In Hong Kong’s domestic economy, you still have a lot of tales of woe.” It’s a disorienting world and markets might not know where we are. Ten years ago, central-bank rate cuts and government spending restored growth, plain and simple.
That was before the emergence of a shadow banking system. The financial regime of old was replaced by massive non-bank lending, structured investment vehicles and products allowing leverage to be built upon leverage. In a sense, markets went from a 1.0 environment to 2.0 briefly before believing they had already hit 3.0. The delusion that risks had been repealed was fed by a system that merely hid them. Now, the exercise is about getting back to a 2.0 market mindset and making it work. Once policy makers get serious about that task, greater transparency and accountability need to be the focus. At the moment, fresh irrational exuberance is obscuring that reality.
U.S. Recovery May Start, Then Sputter as Zarnowitz Rule Is Bent
The Zarnowitz rule may live, but not for long. The current contraction may so far be following the economic law named for Victor Zarnowitz, the late expert on business cycles: Deep recessions are almost always followed by rapid rebounds. Consumer confidence rose by the most in more than two years in April as surging stock prices and falling mortgage rates boosted optimism. A gauge of U.S. manufacturing activity had its biggest bounce since 2005 as companies eased up on efforts to slash inventories. Even the crippled housing market has shown signs of stabilizing.
The risk is that any snapback may end up stunted by structural impediments -- from heavily indebted consumers to a hobbled banking system -- that continue to weigh on the economy and may prevent a sustained run of rapid expansion. “We could see one or two quarters of 6, 5, 4 percent growth,” says Joel Naroff, president of Naroff Economic Advisors Inc. in Holland, Pennsylvania, who was the top forecaster of the U.S. economy in Bloomberg News surveys last year. “But that doesn’t mean that the economy will be in good shape. We’ll just be going from truly gruesome to bad.”
Bridgewater Associates agrees. The Westport, Connecticut- based financial firm, which says it manages $72 billion in assets, sees a good chance of a big spurt in the economy late in the year, with growth then settling back to a trend line of a shade over 2 percent. That would be well below the postwar rate of 3.3 percent. The economy shrank at an annual pace of 6.1 percent in the first quarter after contracting by 6.3 percent in the previous three months, the weakest six-month performance since 1957-58. Inventory cutbacks alone accounted for 2.79 percentage points of last quarter’s decline, as businesses slashed stockpiles at the fastest pace since government records began in 1947.
That has some economists expecting a fillip when companies ramp output back up after reducing unsold supplies to desired levels. If the increase is concentrated in a short period of time, the impact on growth in any given quarter might be significant. “An important influence on the near-term economic outlook is the extent to which businesses have been able to shed the unwanted inventories,” Federal Reserve Chairman Ben S. Bernanke told lawmakers on May 5. “As stocks move in better alignment with sales, a reduction in the pace of inventory liquidation should provide some support to production.”
That may already be happening at some companies. Toyota Motor Corp. is boosting the speed of a Camry assembly line in Georgetown, Kentucky, and is scheduling overtime at a factory building RAV4 sport utility vehicles in Woodstock, Ontario, as stockpiles ran low following previous output cuts. Housing is another area that may prove to be a surprise source of strength. Homebuilding began to buckle in 2006, chopping 1 percentage point from annual economic growth ever since. As the market stabilizes, that drag will dissipate, giving the economy a short-term boost. “Housing looks like it has bottomed,” says Allen Sinai, chief economist at Decision Economics in New York.
Confidence among homebuilders rose in April to its highest level since October as record-low mortgage rates below 5 percent started to stir demand. Prices for home resales in March posted their biggest monthly gain since June 2005, with some regions seeing multiple bids on properties. In southern California, one of the hardest hit areas, prices have begun to stabilize, according to KB Home Chief Executive Officer Jeffrey Mezger. “We’re seeing a floor,” he said in a May 4 call with analysts. That’s giving the Los Angeles-based company an opening to sell newly built homes.
The economy will also get a lift from President Barack Obama’s $787 billion stimulus package of spending increases and tax cuts, which was signed into law in February and is only now starting to kick in. While Federal agencies have allocated $88.1 billion of investment, so far just $28.6 billion has been spent. Louis Crandall, chief economist at Wrightson ICAP LLC, a Jersey City, New Jersey-based research firm, says consumers will also benefit this month from some $13 billion in extra Social Security payments. That leads Michael Mussa, a former chief economist of the International Monetary Fund, to argue that the U.S. will enjoy a so-called V-shaped recovery. Mussa, who’s now at the Peterson Institute for International Economics in Washington, invokes Zarnowitz in saying “there is no good reason to presume” that this recovery won’t be a strong one.
Zarnowitz, a native of Poland, fled the Nazis in 1939 only to end up in the Soviet gulag. After making it to the U.S. in 1952, he became a professor of economics at the University of Chicago and a leading expert on business cycles and economic indicators. He joined the National Bureau of Economic Research in 1952, where he was one of the seven economists who date recessions and expansions. He died in February at age 89. Many economists, including Naroff, disagree with Mussa. David Rosenberg, former chief North American economist at Bank of America and now chief economist at Gluskin Sheff & Associates Inc. in Toronto, says the current contraction isn’t a typical, inventory-driven recession: “This is a deleveraging cycle.”
Consumers are still saddled with hundreds of billions of dollars in debt built up during the boom years when home prices skyrocketed. As a percentage of net worth, household debt -- which includes mortgages -- stands at 27 percent, the highest on record, according to John Lonski, chief economist at Moody’s Capital Markets Group. Americans have also seen their wealth walloped. U.S. house prices rose 63 percent from 2002 to June 2006 and then fell 27 percent since that peak, according to national Case-Shiller data. The Standard & Poor’s 500 index hit a 12-year low in March and now stands 42 percent below its October 2007 peak. As a result, households are being forced to save more and spend less. Lyle Gramley, a former Fed governor who is a senior economic adviser for New York-based Soleil Securities Corp., sees the savings rate rising to 7 to 8 percent over the next few years from an average of 1.7 percent during the past decade. An added reason for restraint: the continued rise in unemployment, which climbed to a 25-year high of 8.9 percent in April from 8.5 percent in March.
Banks have also turned more cautious after piling up close to $1 trillion in lending and investment losses during the last two and a half years. A Fed survey released May 4 found that banks toughened terms on home and credit-card loans in the past three months. According to stress tests carried out by regulators, the nation’s biggest banks need $74.6 billion in additional capital to be able to weather a further worsening of the economy and keep on lending. “The biggest financial crisis in 70 years is likely to leave a legacy with consumers, business people and investors,” says Richard Berner, co-head of global economics for Morgan Stanley in New York. That “will have an impact on the kind of economic activity and the kind of rebound we’re likely to get.”
Upfront costs complicate Obama's health care plan
Costs are emerging as the biggest obstacle to President Barack Obama's ambitious plan to provide health insurance for everybody. The upfront tab could reach $1.2 trillion to $1.5 trillion over 10 years, while expected savings from wringing waste and inefficiency from the health care system may take longer to show. Details of the health legislation have not been written, but the broad outlines of the overhaul are known. Economists and other experts say the $634 billion that Obama's budget sets aside for health care will pay perhaps half the cost. Obama is hoping the Senate comes up with a bipartisan compromise that would give him political cover for disagreeable decisions to raise more money, such as taxing some health insurance benefits. In the 2008 campaign, Obama went after his Republican presidential rival, Arizona Sen. John McCain, for proposing a large-scale version of that idea.
Concerns about costs could spill over in the coming week when the Senate Finance Committee holds a hearing on how to pay for coverage. Committee leaders hoping to have a bill before the full Senate this summer must first convince their own members that it won't break the bank. "You go to a town meeting and people are talking about bailout fatigue," said Sen. Ron Wyden, D-Ore. "They like the president. They think he's a straight shooter. But they are concerned about the amount of money that is heading out the door, and the debts their kids are going to have to absorb." Sen. Mike Enzi, R-Wyo., said cost control has to come ahead of getting more people covered. "Unless we halt skyrocketing health care costs, any attempt to expand coverage will be financially unsustainable," he said.
Obama wants to build on the current system in which employers, government and individuals share responsibility for health care. He says his plan would make health insurance more affordable, particularly for small businesses and individuals. The government would subsidize coverage for low-income people and some in the middle class. The U.S. spends about $2.5 trillion a year on health care, more than any other advanced country. Experts estimate that at least one-third of that spending goes for services that provide little or no benefit to patients. So theoretically, there's enough money in the system to cover everybody, including an estimated 50 million uninsured. But one person's wasteful spending is someone else's bread and butter.
The office visits, tests, procedures and medications that the experts question represent a lot of money for doctors, hospitals, drug companies and other service providers. Dialing them back won't be easy. Providers will resist. Patients might complain their care is getting rationed. The chairman of the Senate Finance Committee, Sen. Max Baucus, said "it's clear that the financing of this is not going to be easy." Baucus, D-Mont., says the basic approach to health care must become more economically efficient. Instead of paying doctors and hospitals for the number of services they provide, as happens now, Baucus wants to tie reimbursement to the quality of care. Quality would measured by standards that doctors and hospitals have a hand in shaping. Yet those kinds of changes take time, several years or even the better part of a decade.
The money to cover the uninsured will be needed right away, about $125 billion to $150 billion a year. That leaves hard choices for lawmakers and Obama. Baucus favors requiring individuals to get health insurance, which will help. But he also supports subsidies for people who can't afford coverage -- a cost to the government. To help close the money gap, Baucus is open to some limits on the current tax-free treatment of employer-provided health insurance. Health benefits are considered part of an employee's compensation, but are not taxed. If all health insurance were taxed like regular income, the government could raise an additional $250 billion a year. In the campaign, Obama opposed tampering with tax-free employer-based health care, saying it would undermine the system that delivers coverage to most people. Other prominent Democrats agree. Asked if he would support taxing benefits, Rep. Charles Rangel, D-N.Y., the top tax-writer in the House, simply said: "No way!"
Baucus says doing away with the tax break altogether would cause harm, but some limitations might curb waste in the system. Obama's aides say he's still opposed, but willing to consider any serious proposals from Congress. Obama's opposition to taxing employer-provided health insurance isn't the only campaign position he might have to jettison to pay for health care. He once criticized his chief Democratic presidential rival, Hillary Rodham Clinton, for proposing that everyone in the U.S. be required to have medical insurance. Yet such a mandate probably will be in what Congress puts together because requiring individuals to pay would lower federal costs. For Obama, there are no easy ways to pay for health care. Options include raising other taxes, cutting deeply into Medicare payments to providers, or phasing in the expansion of coverage for the uninsured -- beyond his four-year term.
Ilargi: This is what I’ve always maintained on Fannie and Freddie: the government needs to get out of the mortgage business. It unnecessarily drives up prices and fattens bankers. Good to see I'm not alone in that.
Obsessive Housing Disorder
Nearly a century of Washington’s efforts to promote homeownership has produced one calamity after another. Time to stop.
In December, the New York Times published a 5,100-word article charging that the Bush administration’s housing policies had "stoked" the foreclosure crisis—and thus the financial meltdown. By pushing for lax lending standards, encouraging government enterprises to make mortgages more available, and leaning on private lenders to come up with innovative ways to lend to ever more Americans—using "the mighty muscle of the federal government," as the president himself put it—Bush had lured millions of people into bad mortgages that they ultimately couldn’t afford, the Times said.
Yet almost everything that the Times accused the Bush administration of doing has been pursued many times by earlier administrations, both Democratic and Republican—and often with calamitous results. The Times’s analysis exemplified our collective amnesia about Washington’s repeated attempts to expand homeownership and the disasters they’ve caused. The ideal of homeownership has become so sacrosanct, it seems, that we never learn from these disasters. Instead, we clean them up and then—as if under some strange compulsion—set in motion the mechanisms of the next housing catastrophe.
And that’s exactly what we’re doing once again. As Washington grapples with the current mortgage crisis, advocates from both parties are already warning the feds not to relax their commitment to expanding homeownership—even if that means reviving the very kinds of programs and institutions that got us into trouble. Not even the worst financial crisis since the Great Depression can cure us of our obsessive housing disorder.
We’ve largely forgotten that Herbert Hoover, as secretary of commerce, initiated the first major Washington campaign to boost homeownership. His motivation was the 1920 census, which had revealed a small dip in ownership rates since 1910—from 45.9 percent to 45.6 percent of all households. The downturn was likely the result of a temporary diversion of resources away from housing during World War I. For Hoover, though, the apocalypse seemed nigh. "Nothing is worse than increased tenancy and landlordism," he warned—though surely many things were worse. With little justification, he predicted that in just a few decades, three-quarters of all Americans would be renters. The press echoed the urgency. "The nation’s stability [is] being undermined," the New York Times editorialized. "The masses [are] losing their struggle for a better life."
Without waiting to see if postwar prosperity might solve the problem, in 1922 Hoover launched the Own Your Own Home campaign, hailed at the time as unique in the nation’s history. "The home owner has a constructive aim in life," Hoover said, exhorting Americans to buy property. "He works harder outside his home, he spends his leisure hours more profitably, and he and his family live a finer life and enjoy more of the comforts and cultivating influences of our modern civilization." Hoover urged "the great lending institutions, the construction industry, the great real estate men . . . to counteract the growing menace" of tenancy. He pressed builders to turn to residential construction and employers to support the cause. Some, like United States Steel and General Motors, agreed to provide parks and other amenities for the new housing developments that proliferated in response to Hoover’s call.
Hoover also called for new rules that would let nationally chartered banks devote a greater share of lending to residential properties. Congress responded in 1927, and the freed-up banks dived into the market, despite signs that it was overheating. The great national effort seemed to pay off. From mid-1927 to mid-1929, national banks’ mortgage lending increased 45 percent. The New York Times applauded the "wave of homebuilding" that "swept over" America; the country was becoming "a nation of home owners." The 1930 census would later reveal a significant elevation in ownership rates, to 47.8 percent of all households.
But beneath the surface were disquieting signs. For as homeownership grew, so did the rate of foreclosures. From just 2 percent of commercial bank mortgages in 1922, they rose to 9 percent in 1926 and to 11 percent in 1927. This happened, of course, just as the stock-market bubble of the late twenties was inflating dangerously, making the federal housing initiative all the more hazardous. Soon after the October 1929 Wall Street crash, the housing market began to collapse, just as in today’s crisis, though the reasons were slightly different: panicked depositors withdrew money from their accounts, prompting bank runs; the banks ran out of capital and stopped making loans; and the mortgage market seized up. Homeowners, who in that era typically had short-term mortgages that required several refinancings before being paid off, suddenly couldn’t find new loans. Defaults exploded—by 1933, some 1,000 homes were foreclosing every day. The Own Your Own Home campaign had trapped many Americans in mortgages far beyond their reach.
New homeowners who had heard throughout the initiative that "the measurement of a man’s patriotism and worth as a citizen" was owning a home, wrote housing policy expert Dorothy Rosenman in 1945, had been "swept up by the same wave of optimism that swept the rest of the nation." Financial institutions were exposed as well. Their mortgage loans outstanding had more than doubled between the early twenties and 1930—from $9.2 billion to $22.6 billion—one reason that about 750 financial institutions failed in 1930 alone. Construction firms, too, were ensnared, since they had heeded the government’s call and shifted to residential building. Housing starts jumped from about 250,000 new homes a year in the early 1920s to nearly 600,000 after the housing campaign—before slumping more than 80 percent after the crash. Construction jobs fell 70 percent from 1929 to 1933.
You might think that the Own Your Own Home campaign would have taught Washington the danger of trying to force homeownership up. Instead, the feds responded to the crisis with the Home Owners’ Loan Corporation (HOLC), a New Deal bailout program that made government an even bigger player in the housing market. Congress designed the HOLC to buy up troubled mortgages from lenders and then let homeowners refinance the loans with the government on more affordable terms. In theory, this would both aid strapped homeowners and clear bad loans from banks’ books, allowing them to resume mortgage lending. The HOLC was a massive new federal agency, employing at its height some 20,000 people—appraisers, loan officers, auditors. By 1936, the agency’s total payroll was $26.2 million, the equivalent of $388 million today.
The HOLC eventually received 1.9 million applications for mortgages and approved 1 million. Despite the more favorable terms that the HOLC offered, however, about one-fifth of the new mortgages defaulted, a failure rate that would sink a private-sector bank. Many who failed to pay might have been able to, but chose not to work out any arrangement with the government and essentially challenged the feds to kick them out—which officials were reluctant to do in the face of public opposition. HOLC loan officers classified about 65 percent of the defaults as resulting either from borrowers’ "noncooperation" or "obstinate refusal," according to an analysis by Columbia University economist C. Lowell Harriss. "This type of noncooperation could sometimes be attributed to a desire to obtain free housing . . . an object that, in view of HOLC’s nature, was not difficult to realize," Harriss wrote. Ultimately, the HOLC did file more than 200,000 foreclosure actions. And its purchase of bad loans never revived mortgage lending, which stayed flat for the rest of the decade. The nation’s economic fundamentals were so lousy that little demand existed for new home loans.
The Depression-era federal government created many other institutions to fix flaws in the mortgage market: the Federal Home Loan Bank system to provide a stable source of funds for banks; the Federal Housing Administration (FHA) to insure mortgages; the Federal National Mortgage Association (later known as Fannie Mae) to purchase those insured mortgages; and the Federal Savings and Loan Insurance Corporation to prevent future bank runs. These were valuable initiatives, but they meant that by the end of the Great Depression, the U.S. government had become the dominant force in the mortgage market.
Politicians could now use that regulated market to advance their own policy agendas—or their careers. Many housing experts of the time warned against this politicization, anticipating what was to come. Liberal housing advocate Charles Abrams, for example, publicly worried that as the Depression lifted, yet more new government plans to encourage homeownership would lure unsuspecting and unqualified lower-income families into the housing market. In a May 1946 McCall’s article, "Your Dream Home Foreclosed," Abrams told American housewives that their "dream house will be loaded with booby traps." The foundation of a stable economic system, Abrams argued, wasn’t a large percentage of homeowning families, as Hoover contended; it was "how sound the ownership is."
Initially, Abrams’s fear might have seemed without basis. Intent on a postwar project of boosting homeownership, the federal government had passed the GI Bill in 1944, extending a range of benefits to returning veterans—including government-subsidized mortgages. With the feds footing a big part of the bill, the nation’s long-moribund mortgage market came alive, more than doubling in volume between 1945 and 1950. By 1949, more than half of American households owned homes, and 40 percent of the new mortgages were government-subsidized. And with the Housing Act of 1949, Washington made permanent the powerful role in the mortgage market that it had assumed during the Depression.
But as homeownership grew, political pressure to allow riskier loans increased, too—exactly what Abrams had cautioned against. Rising home prices, a result of a booming national economy, soon began to drive some homes out of reach for ordinary Americans, among them veterans returning from peacekeeping duties in Europe and later from fighting in Korea. Under pressure to keep meeting housing demand, the government began loosening its mortgage-lending standards—cutting the size of required down payments, approving loans with higher ratios of payments to income, and extending the terms of mortgages.
By attracting riskier home buyers, these moves provoked a surge in foreclosures on government-backed mortgages. The failure rate on FHA-insured loans spiked fivefold from 1950 to 1960, according to a 1970 National Bureau of Economic Research study, while the failure rate on mortgages made through the Veterans Administration nearly doubled over the same period. By contrast, the foreclosure rate of conventional mortgages barely increased, since many traditional lenders had maintained stricter underwriting standards, which had proved a good predictor of loan quality over the years.
Ignoring these problems, the government embarked on yet another failed attempt to increase homeownership: the FHA’s urban-loan debacle of the 1960s and early seventies, its most ruinous lending mistake yet. This time, the object was to solve America’s urban discontent. Riots had ripped apart Cleveland, Detroit, Los Angeles, Newark, and other cities during the mid-sixties. Politicians in both parties argued that extending the American dream of homeownership to poor blacks (especially those who’d migrated from the rural South to northeastern cities) and to immigrants (especially Puerto Ricans) would stabilize urban communities and prevent further violence. "Past experience has shown that families offered decent homes at prices they can afford have demonstrated a new dignity, a new attitude toward their jobs," said Democratic congressman Wright Patman. Or as Republican senator Charles Percy bluntly put it: "People won’t burn down houses they own."
So in 1968, the federal government passed a law giving poor families FHA-insured loans that required down payments of as little as $250. Not urban uplift but urban nightmare followed. Seedy speculators began snapping up homes in transitional urban areas where crime and unemployment were rising. They would make lowball, all-cash offers to fearful residents, eager to sell and get out of the neighborhood. Once they had the properties, the speculators then turned around and used the new FHA-insured mortgages to sell the homes to low-income minority families for double or triple the price. Many of these mortgages—approved by bribed FHA inspectors—were way beyond the buyers’ means. And many buyers simply weren’t prepared for becoming homeowners. Some didn’t realize that they were buying properties for two to three times the going rate in their neighborhoods, or even that they’d be responsible for paying for utilities, property taxes, and maintenance.
In some markets, like Philadelphia and Detroit, more than 20 percent of the mortgages went to single mothers on welfare. And why not, the government reasoned—they enjoyed a steady stream of government income, didn’t they? This naive view ignored the growing evidence that such households suffered from family breakdown and social disorder, which made them less than ideal borrowers. Journalists also found numerous buyers who couldn’t read English and had no idea what their sales contracts said. Foreclosures spread like a horrible virus, infecting at least 20 cities. About 4,000 FHA-insured home mortgages in Philadelphia defaulted in just the three years from 1969 to 1971—more than the total number that the city had seen over the previous 33 years of FHA loans. Foreclosures made the FHA Detroit’s biggest homeowner, at a cost of roughly $200 million in losses. In New York, a 500-count federal indictment estimated that some 7,500 FHA-backed homes in East New York, Brownsville, Bushwick, and other troubled neighborhoods had gone bust, costing upward of $300 million. In the end, the government absorbed an estimated $1.4 billion in losses nationwide.
The failed program had more than a financial cost. Neighborhoods like Bushwick—a once-stable blue-collar community in Brooklyn—fell into ruin as scores of low-income buyers simply walked away from their properties, and arsonists, an urban plague at the time, torched the vacant homes. Residents who lived near abandoned houses began sleeping on their porches with guns in their laps to ward off the arsonists. Whole blocks remained burned-out for years. Sure, speculators and corrupt inspectors had duped the FHA. But the meltdown couldn’t have happened without Washington’s unexamined assumption that homeownership would transform the lives of low-income buyers in positive ways. "The program could not work because it tried to solve a problem of wealth creation through debt creation," Harvard historian Louis Hyman recently observed, aptly comparing the FHA scandals with today’s subprime crisis.
The national FHA scandal should have awoken Washington to the dangers of its homeownership-promotion efforts. Instead, the government simply changed its sights. Just as it had pushed the FHA to insure loans in poor neighborhoods, it now began pushing private banks to lend more in those neighborhoods. The new campaign lasted 30 years, but the outcome was—yet again—foreclosures on a massive scale. The main difference, as we know all too well, was that the foreclosures helped usher in a global financial crisis. This time, the government’s spur to action was claims by housing and civil rights activists that banks were "redlining"—intentionally not lending in minority neighborhoods. In April 1975, a new group of activists, the National People’s Action on Housing, brought the concept to a national audience at a Chicago conference.
Over the next few years, a series of studies by advocacy groups and local newspapers purported to prove that redlining was real. Black neighborhoods, the studies showed, received far fewer mortgages than mostly white areas did, and black applicants had their loans shot down more often than whites with similar incomes. Banks and academic experts responded that the studies didn’t include information about the creditworthiness of borrowers in black neighborhoods, a more important factor than income. Nevertheless, the media worked themselves into a frenzy, pillorying government officials who dared object to the studies’ conclusions.
Congress passed a bill in 1975 requiring banks to provide the government with information on their lending activities in poor urban areas. Two years later, it passed the Community Reinvestment Act (CRA), which gave regulators the power to deny banks the right to expand if they didn’t lend sufficiently in those neighborhoods. In 1979, the Federal Deposit Insurance Corporation (FDIC) rocked the banking industry when it used the CRA to turn down an application by the Greater New York Savings Bank to open a branch on the Upper East Side of Manhattan. The government contended that the bank didn’t lend enough in Brooklyn, its home market. Bankers recognized that a fundamental shift in regulation was taking place. Previously, the government had simply made sure that banks’ practices were safe and that depositors’ funds were protected. Now, it would use its power over banks to shape their lending strategies.
Soon after the Greater New York ruling, for instance, the Federal Home Loan Bank Board told a Toledo, Ohio, bank that it had to eliminate its practice of lending only to its current customers during times when funds were tight; the maneuver might be discriminatory. The FHLBB also cast a dubious eye on other bank actions to tighten credit in a downturn, such as raising the minimum down payment on mortgages. Other actions by federal regulators sent similar messages. In 1980, the FDIC told a Maryland bank that it couldn’t expand unless it started lending in the District of Columbia, even though the bank had no branches there. Soon, the government was instructing wholesale banks—institutions that have no branches and typically don’t lend to consumers at all—that they, too, had to pursue inner-city lending programs. The next stop on the road to 2008 was a fateful campaign to lower lending criteria, which, the housing advocates argued, were racist and had to change.
The campaign began in 1986, when the Association of Community Organizations for Reform Now (Acorn) threatened to oppose an acquisition by a southern bank, Louisiana Bancshares, until it agreed to new "flexible credit and underwriting standards" for minority borrowers—for example, counting public assistance and food stamps as income. The next year, Acorn led a coalition of advocacy groups calling for industry-wide changes in lending standards. Among the demanded reforms were the easing of minimum down-payment requirements and of the requirement that borrowers have enough cash at a closing to cover two to three months of mortgage payments (research had shown that lack of money in hand was a big reason some mortgages failed quickly). The advocates also attacked Fannie Mae, the giant quasi-government agency that bought loans from banks in order to allow them to make new loans. Its underwriters were "strictly by-the-book interpreters" of lending standards and turned down purchases of unconventional loans, charged Acorn. The pressure eventually paid off. In 1992, Congress passed legislation requiring Fannie Mae and the similar Freddie Mac to devote 30 percent of their loan purchases to mortgages for low- and moderate-income borrowers.
The campaign gained further traction with the election of Bill Clinton, whose housing secretary, Henry Cisneros, declared that he would expand homeownership among lower- and lower-middle-income renters. His strategy: pushing for no-down-payment loans; expanding the size of mortgages that the government would insure against losses; and using the CRA and other lending laws to direct more private money into low-income programs. Shortly after Cisneros announced his plan, Fannie Mae and Freddie Mac agreed to begin buying loans under new, looser guidelines. Freddie Mac, for instance, started approving low-income buyers with bad credit histories or none at all, so long as they were current on rent and utilities payments. Freddie Mac also said that it would begin counting income from seasonal jobs and public assistance toward its income minimum, despite the FHA disaster of the sixties.
To meet their goals, the two mortgage giants enlisted large lenders—including nonbanks, which weren’t covered by the CRA—into the effort. Freddie Mac began an "alternative qualifying" program with the Sears Mortgage Corporation that let a borrower qualify for a loan with a monthly payment as high as 50 percent of his income, at a time when most private mortgage companies wouldn’t exceed 33 percent. The program also allowed borrowers with bad credit to get mortgages if they took credit-counseling classes administered by Acorn and other nonprofits. Subsequent research would show that such classes have little impact on default rates. Pressuring nonbank lenders to make more loans to poor minorities didn’t stop with Sears. If it didn’t happen, Clinton officials warned, they’d seek to extend CRA regulations to all mortgage makers. In Congress, Representative Maxine Waters called financial firms not covered by the CRA "among the most egregious redliners." To rebuff the criticism, the Mortgage Bankers Association (MBA) shocked the financial world by signing a 1994 agreement with the Department of Housing and Urban Development (HUD), pledging to increase lending to minorities and join in new efforts to rewrite lending standards. The first MBA member to sign up: Countrywide Financial, the mortgage firm that would be at the core of the subprime meltdown.
As the volume of lending to low-income borrowers increased, the loans became big business. And slowly, the industry began pitching the loans with the same language that the government and activists had long used, and promoting the same debased lending standards. A 1998 sales pitch by a Bear Stearns managing director advised banks to begin packaging their loans to low-income borrowers into securities that the firm could sell, according to Stan Liebowitz, a professor of economics at the University of Texas who unearthed the pitch. Forget traditional underwriting standards when considering these loans, the director advised. For a low-income borrower, he continued in all-too-familiar terms, owning a home was "a near-sacred obligation. A family will do almost anything to meet that monthly mortgage payment." Bunk, says Liebowitz: "The claim that lower-income homeowners are somehow different in their devotion to their home is a purely emotional claim with no evidence to support it."
By the late 1990s, lenders, keen to find new markets to tap, had jumped completely on board the low-income-mortgage bandwagon. In 1997, homeownership had reached a then-high of 66 percent of households. By definition, that meant that many, even most, creditworthy households had already made the plunge. The biggest opportunities for new business thus seemed to be lower-income borrowers. "We believe that low-income borrowers are going to be our leading customers going into the 21st century," an executive for Norwest Mortgage, a Maryland lender, told the trade press in 1998. With Fannie Mae and Freddie Mac footing some of the bill, "banks are buying these loans from us as fast as we can originate them." Any concern that regulators should tighten standards as the loan volume expanded was quickly dismissed. When in early 2000 the FDIC proposed increasing capital requirements for lenders making "subprime" loans—loans to people with questionable credit, that is—Democratic representative Carolyn Maloney of New York told a congressional hearing that she feared that the step would dry up CRA loans. Her fellow New York Democrat John J. LaFalce urged regulators "not to be premature" in imposing new regulations.
And even with lenders now chasing this market enthusiastically, the Clinton administration kept pushing for higher government-mandated goals. In July 1999, HUD proposed new levels for Fannie Mae’s and Freddie Mac’s low-income lending; in September, Fannie Mae agreed to begin purchasing loans made to "borrowers with slightly impaired credit"—that is, with credit standards even lower than the government had been pushing for a generation. Congress later took up where Clinton left off. Not content that nearly seven in ten American households owned their own homes, legislators in 2004 pressed new affordable-housing goals on the two mortgage giants, which through 2007 purchased some $1 trillion in loans to lower- and moderate-income buyers. The buying spree helped spark a massive increase in securitization of mortgages to people with dubious credit. To carry out this mission, Fannie Mae turned to old friends, like Angelo Mozilo of Countrywide, which became the biggest supplier of mortgages to low-income buyers for Fannie Mae to purchase.
Executives at these firms won hosannas. Harvard University’s Joint Center for Housing Studies invited Mozilo to give its prestigious 2003 Dunlop Lecture. Subject: "The American Dream of Homeownership: From Cliché to Mission." La Opinión, a Spanish-language newspaper, dubbed Countrywide its Corporation of the Year. Meantime, in Congress, Waters praised the "outstanding leadership" of Fannie Mae chairman Franklin Raines. There was never any shortage of evidence that the new loans were much riskier than conventional mortgages. In October 1994, Fannie Mae head James Johnson had reminded a banking convention that mortgages with small down payments had a much higher risk of defaulting. (A Duff & Phelps study found that they were nearly three times more likely to default than conventional mortgages.) Yet the very next month, Fannie Mae said that it expected to back loans to low-income home buyers with a 97 percent loan-to-value ratio—that is, loans in which the buyer puts down just 3 percent—as part of a commitment, made earlier that year to Congress, to purchase $1 trillion in affordable-housing mortgages by the end of the nineties. According to Edward Pinto, who served as the company’s chief credit officer, the program was the result of political pressure on Fannie Mae trumping lending standards.
An Atlanta-area minority loan program, crafted hastily after a newspaper redlining exposé, provided further evidence. The program lent more than half of its mortgages to single women with children, including women on public assistance, some of whom took on payments of up to 50 percent of their monthly income. Within a year, 10 percent of the loans had gone delinquent and the homeowners were sinking deeper into other kinds of debt. Yet the program’s woes received little publicity. Community groups argued that the difficulties were all the fault of the banks, which should have offered the loans with lower interest rates. What made it easier to dismiss such ominous failures was that some of the nation’s most prestigious financial regulators and researchers, including the Federal Reserve Bank of Boston, got behind the movement to loosen lending standards. In 1992, the Boston Fed produced an extraordinary 29-page document that codified the new lending wisdom.
Conventional mortgage criteria, the report argued, might be "unintentionally biased" because they didn’t take into account "the economic culture of urban, lower-income and nontraditional customers." Lenders should thus consider junking the industry’s traditional income-to-payments ratio and stop viewing an applicant’s "lack of credit history" as a "negative factor." Further, if applicants had bad credit, banks should "consider extenuating circumstances"—even though a study by mortgage insurance companies would soon show, not surprisingly, that borrowers with no credit rating or a bad one were far more likely to default. If applicants didn’t have enough savings for a down payment, the Boston Fed urged, banks should allow loans from nonprofits or government assistance agencies to count toward one. A later study of Freddie Mac mortgages would find that a borrower who made a down payment with third-party funds was four times more likely to default, a reminder that traditional underwriting standards weren’t arbitrary but based on historical lending patterns.
Another reason government kept up the pressure was that no matter how high ownership rates climbed, there was always a group below the norm that needed help. The country’s substantial immigration rates in the 1990s and early 2000s, for instance, produced a whole new cadre of potential Latino borrowers. To serve them, the Congressional Hispanic Caucus launched Hogar, an initiative that pushed for easing lending standards for immigrants, including touting so-called seller-financed mortgages in which a builder provided down-payment aid to buyers via contributions to nonprofit groups. As a result, mortgage lending to Hispanics soared. And today, in districts where Hispanics make up at least 25 percent of the population, foreclosure rates are now nearly 50 percent higher than the national average, according to a Wall Street Journal analysis.
Washington’s, indeed America’s, housing obsession—decades of government and advocacy-group efforts to water down underwriting standards, private mortgage makers’ desire to find new pools of customers as homeownership rates rose, and the rapid growth of securitization of risky loans—carried a steep cost. When the Federal Reserve added low interest rates and plenty of financial liquidity to the mix, the housing boom became a bubble. And then, as everyone knows, the bubble burst in 2008, leading to economic disaster. Last year, lenders began foreclosure proceedings on some 2.3 million homes, and some experts have predicted that when the current financial crisis has ended, some 8 million homes will have wound up in foreclosure. Though lenders made risky loans to borrowers across the income spectrum, many of the failing mortgages today are in lower- and lower-middle-income neighborhoods. A Federal Reserve Bank of New York study of foreclosures in New Jersey, the state in its region hit hardest by the mortgage collapse, reveals that zip codes with the worst rates are mostly in areas where household income was "concentrated at the lower end of the household income range."
Yet before we’ve even worked our way through this crisis, elected officials and policymakers are busy readying the next. Barney Frank, the Massachusetts congressman who serves as chair of the House Financial Services Committee, has balked at proposals to privatize Fannie Mae and Freddie Mac, which would eliminate their risk to taxpayers and their susceptibility to political machinations. Why? Simple: the government uses them to subsidize the affordable-housing programs that Frank supports. California congressman Joe Baca, head of the Congressional Hispanic Caucus, also opposes reining in affordable housing lending. "We need to keep credit easily accessible to our minority communities," he asserts. Republicans and Democrats, meanwhile, have scrambled to reignite the housing market through ill-conceived tax credits and renewed federal subsidies for mortgages, including the Obama administration’s mortgage bailout plan, which recalls the New Deal’s HOLC.
As Harvard economist and City Journal contributing editor Edward Glaeser has observed, mortgage lenders have finally "recovered their sanity"—only to have government dangling subsidized low interest rates and tax credits in front of them and their potential customers all over again. Behind these efforts is a fundamental misconception among politicians that housing drives the American economy and therefore demands subsidy at virtually any cost. Changing notions of fairness and equity also cloud policymakers’ minds. Our praiseworthy initial efforts—to eliminate housing discrimination and provide all Americans an equal opportunity to buy a home—were eventually turned on their heads by advocates and politicians, who instead tried to ensure equality of outcomes. And so, for instance, when elected officials learned that under 50 percent of Hispanic households in America owned homes, Latino politicians sponsored a campaign to raise ownership. Yet the lower rate was perfectly understandable, given the lower educational levels, lower household incomes, and shorter tenure in the country of Latinos, compared with the average American household.
What principles, then, should govern federal policy toward homeownership and the housing construction market? First, our experience since the Great Depression teaches us that a rising economy is the best and safest way to boost homeownership. By some estimates, the "natural" rate of homeownership in America, without dicey government-enabled mortgages, would still be nearly 65 percent—among the highest rates in the world. Government’s most important role in the market should be to ensure a sturdy economy and a reliable judicial system that protects the interests of buyers and sellers in what is the largest transaction that most will ever undertake.
At the same time, government should do no harm, especially when it comes to the cost of housing. One reason politicians and policymakers continue to feel that they must subsidize mortgage rates and launch ownership campaigns is that since the 1970s, local housing and zoning regulations have raised the price of home construction—sometimes by hundreds of thousands of dollars, as economist Randall O’Toole has shown—and thereby reduced the supply of affordable housing. Half a century ago, America’s cities boasted a rich stock of affordable housing, even as their populations grew. Today, even shrinking cities often complain of a lack of it. One solution is for the federal government to tie aid to states to local regulatory reforms that reduce the cost of construction and encourage additional building. The federal government should also consider eliminating or capping the home-mortgage tax deduction, which drives up the price of housing in ways particularly damaging to lower- and moderate-income buyers.
Enshrined in our tax code since 1913, the deduction provides more disposable income to homeowners who itemize their taxes—mostly upper- and upper-middle-income buyers—who can use that money on bigger mortgages, increasing the price of housing. But many moderate-income households don’t itemize and thus don’t benefit from the tax break, and they’re left with fewer housing options as the cost of homes rises around them. In their study Rethinking Federal Housing Policy, Harvard’s Glaeser and Joseph Gyourko of the Wharton School of Business suggest capping the deduction at $300,000 of mortgage debt. That way, it would still benefit those moderate-income families that do itemize, while ending the exemption for others. Ultimately, the goal should be to end subsidies that amount to a government project to direct homeownership to places where Washington believes it should be taking place. That kind of political meddling in this vast marketplace has wreaked havoc time and again, and will continue to do so—if we keep letting it.
Keepin' It Real Estate: Subprime Lending Is Back With a Vengeance
Just when you thought it was safe to go back in the water... Subprime lending has come roaring back. But this time, reckless financial innovation isn’t being hatched on Wall Street. Instead, state governments are angling to “monetize” first-time homebuyer tax credits so borrowers can purchase homes with little or no money down. If this sounds eerily similar to the type of lending practices that got us into this mess, well, it should. The federal government, as part of the recently passed economic stimulus package, will refund first-time homebuyers up to $8,000 if they meet certain eligibility requirements. The program is frequently cited as one of the myriad reasons a bottom in the housing market is imminent.
Critics, however, argue that rebates don't end up in a buyer’s pockets until his or her 2009 tax returns are filed - even though rebates are credits, not just deductions. Homebuilders like Pulte Home, Lennar and KB Home, along with their lobbying arm, the National Association of Homebuilders, have thrown their full weight behind the rebate program, but say it still doesn't go far enough. In an effort to boost home buying -- even for marginally qualified borrowers -- a number of states are finding creative ways to advance the tax credit to buyers on the day they get their new keys, rather than having to wait for next year's refund check. This allows buyers to pay for things like closing costs, mortgage points - or even the down payment.
States are employing schemes whereby they offer prospective buyers low or no-interest loans for the amount of the tax credit, due upon of receipt of their money from Uncle Sam. If the borrower doesn’t make good, the loan becomes a junior lien on the property, with an interest rate that is far from usurious - usually just a bit over the prime lending rate. Missouri was the first state to launch such a program, and has since been joined by Delaware, New Mexico, Pennsylvania, Tennessee and others. States are even lobbying the IRS to deposit the refunds directly to the states, rather than to the home buyers, in order to circumvent non-payment. The IRS, for its part, “is reviewing” this idea.
In Washington, the state Housing Finance Commission runs a tax credit bridge-loan program, which it hopes will grow in the coming months. Not surprisingly, local real-estate professionals are behind the initiative. Washington Association of Realtors president Bill Riley told the San Francisco Chronicle he believes around half of would-be first-time buyers in his state “cannot save enough money for the down payment and closing costs.” Exactly. That’s the point. This is precisely what differentiates a “would-be” home buyer and a home buyer. And that’s the way it should be. If the federal government wants to subsidize home ownership, fine. It's already proven unwilling to learn the lessons of Fannie Mae and Freddie Mac about the costs of jamming borrowers into homes they can't afford.
But these rebates should at least be limited to borrowers that meet even the most modest requirements to buy a home in a responsible manner. The Federal Housing Administration -- another vehicle for government-backed mortgages where taxpayers bear all the risk -- gives out loans that require borrowers to post a meager 3% down payment. If a “would-be” homeowner cannot scrape together this amount of cash, that person should rent and save their pennies. They should not receive a no-interest loan from the state government. This is not discrimination, this is not redlining, its common sense. In a rush to prop up home prices and delay the ultimate day of reckoning for the vast majority of US real-estate markets, the federal government -- and now state governments as well -- insist on coercing taxpayers to over-leverage themselves and take on a debt burden they cannot truly afford.
Florida state budget hangs on hopes for new boom
Florida's elected leaders faced one big choice this year in reaction to a historic drop in tax revenue: They could hope that the boom times would come again. Or, they could try to change a Florida economy that critics say is no longer sustainable. They chose the former, leaving Tallahassee last week with a budget that, at best, will tide the state over until -- or if -- the tourism and construction industries regain their former luster. Instead of long-term fixes for loopholes in the state's sales and corporate taxes, lawmakers agreed to raise money by nearly quadrupling the state's cigarette tax and expanding gambling.
Even the business-backed Florida Tax Watch had recommended adding sales taxes to basic services such as haircuts and dry cleaning. Combined with bigger revenue streams such as adding sales taxes to professional services like attorneys' fees, Florida could have made up billions in lost revenue. Instead, legislators borrowed from savings accounts, even those that promised immediate economic benefits. They rejected programs that might have put Florida on a new economic path, such as Gov. Charlie Crist's plan to require 20 percent renewable energy sources like wind and solar that proponents say would have created thousands of jobs.
They allowed universities to raise tuition 15 percent at a time when the demand for an educated work force is rising and the unemployed are returning to school. They drained hundreds of millions from highway construction funds, sapping the job-creating work that many economists say is essential to restarting the economy. And despite their public opposition to President Barack Obama's economic legislation, Florida lawmakers quietly took $5 billion in federal stimulus that allowed them to barely maintain education spending, which has dropped in the past three years. Not that the choices were easy.
State legislators, in many ways, faced a far tougher challenge than did Obama and Congress. Unlike the federal government, Florida is legally bound to have a balanced budget, meaning state lawmakers could not borrow billions to stimulate the economy. House budget chairman David Rivera, R-Miami, spoke on last Friday's last day of a "parade of horribles" that have reduced the state's total budget from $74 billion just three years ago to $65 billion this year -- and even that does not do the revenue decline justice, because it includes the federal stimulus billions. "I believe we have survived," Rivera said. "We have survived with dignity. We can be proud of the results."
But Democrats, and some Republicans, questioned whether the borrowing and cutting would only make Florida's future less secure. "We had a real opportunity to begin reform because the only time people are willing to do that is in the midst of a crisis," said Sen. Dan Gelber, D-Miami Beach. "The only way we're going to get out of this cycle is by deciding that education has to be the No. 1 priority of this state." Programs helping those most in need, from in-home health care for the elderly to scholarships to helping young offenders stay out of jail, all took hits that could ripple into higher costs in the future.
"We choose to cut funding for those programs, yet we choose to provide more funding for prison beds, which is enormously more expensive," said Rep. Rick Kriseman, D-St. Petersburg. "Short-term choices with long-term ramifications, that's what we've done." AARP Florida State Director Lori Parham said the cuts in programs for in-home health care made "zero sense for taxpayers." "Many of the 50,000 residents on waiting lists for those services will wind up in nursing homes, where the costs of care borne by the state far exceeds the costs for home- and community-based care," Parham said.
The state's own economists offer little hope of better times in the immediate future. The Office of Economic and Demographic Research predicted in April that the state's population would remain stagnant through 2010 and then increase at an average annual rate of nearly 300,000 -- a far cry from the boom times of the past decade when more than 400,000 new Floridians were added in five of the past nine years. The office also projects that it will be three years or more before the state's revenues return to the 2005 peak. Wayne Blanton, executive director for the Florida School Boards Association, said the time has long come for Florida to expand the number of things that are taxed to prevent the over-reliance on tourism and growth.
"Florida has lived on growth. Every four or five years there were a million more people here," Blanton said. "They're not coming anymore. That means we've got to rethink how we fund government. We have funded it off of pure growth and we haven't had to worry. There needs to be some statesmen come up to bat." Blanton said that schools have already cut or eliminated non-classroom programs like athletics and intramural programs and things like art and music classes may be next. For example, junior varsity sports other than football will play 40 percent fewer games next season. Varsity teams will play 20 percent fewer. "What quality of life do you want?" Blanton said. "If you want less, that's okay," he said, but if not, "we've got to figure out a way to fund it."
Lawmakers maintained school funding with a bit of trickery, cutting and shifting state payments while allowing districts to raise property taxes while waiting on a local referendum to approve the increase until 2010. Similarly, lawmakers are touting a slight increase in overall higher education funding. But to hold steady, tuition may go up by 15 percent at state schools and millions in federal stimulus money will go away in the near future. Ten of the state's 11 public university presidents came to Tallahassee late last month, warning of "Armageddon" if threatened funding cuts occurred. But a few weeks later, University of North Florida president John Delaney said the ability to raise tuition marked a "breakthrough" for lawmakers that will allow the state's public universities to collect more funding directly from students.
"Our economy in Florida has been tied to tourism, agriculture and growth," Delaney said. "Those are either gone, flat or unreliable. Where we have an emerging Florida economy is the knowledge economy. That path is through universities. You get what you pay for." Despite the promise of increased funding that is not reliant on the foibles of the state economy, treading water is not a recipe for greatness, said Delaney, who said stable funding now means delays in competing with other states. "The problem in higher ed is it takes so long to build a program," he said. "You just don't go ahead and hire 10 faculty and be the number one program in the land. It takes decades to build, and building implies adding, growing, enhancing, improving. That pretty much takes money."
Ironically, as state lawmakers embraced the use of federal stimulus money to boost spending on "shovel ready" infrastructure projects, they also took $120 million from a fund set aside for road construction. Instead, the money will be used for other state needs. "These funds are state gas tax dollars collected from the people of Florida specifically for maintaining and improving our state's transportation system," said Doug Callaway, president of Floridians for Better Transportation, a business-backed group. "Floridians did not pay this so politicians in Tallahassee have an easier way out of the budget jam. "Now these millions will be spent on government programs where it is highly unlikely any new real jobs will be generated."
New Jersey's sinking state budget: A shortfall of sincerity
Someone should tell the state Republican establishment that the rats are supposed to jump off the sinking ship, not hop on deck. Last week the state Office of Legislative Services announced that New Jersey's ship of state is sinking faster than even the most pessimistic prognosticators had predicted. Tax collections in April, the month when income taxes are due, were off by so much that the Corzine administration must come up with a quick $1.2 billion by the end of fiscal 2009. That's a problem. Fiscal 2009 ends on June 30. It's hard to imagine coming up with that much in cost cuts or new revenue between now and then. The news led the Trenton Republicans to fire off a set of salvos against the administration. "Governor Corzine repeatedly rejected calls by Republicans over the last two years to build up a surplus that would cushion the state from an economic downturn," said one missive from the minority in the Senate.
It would indeed have been nice for the administration to set aside some money for a rainy day. But a lot of that rain is falling from clouds seeded by the Republicans back when they were in power. In the Whitman years the GOP borrowed more than $11 billion without voter approval for pension bonds and for a school-construction program that was poorly set up by the Republicans only to be poorly managed by subsequent Democratic administrations. And don't forget that 9 percent hike in public-employee pensions passed in the waning days of Republican rule. Those bills are now coming due. Of course, the Democrats were complicit in these and later spending excesses that benefited inside-Trenton interests much more than they benefited the taxpayers. The rat population in this ship's hold is thoroughly bipartisan. Meanwhile up in the captain's cabin, Corzine looks out over a sea of red ink that stretches as far as the eye can see -- yet still talks of expanding government services.
On the Republican side, gubernatorial nominee Chris Christie held a press conference in the Statehouse Thursday during which he lambasted Corzine for permitting this deficit to develop. "We should not be in a $1.2 billion hole with 56 days to go," said Christie. Just after lamenting the administration's failure to anticipate that drop in income-tax revenues, Christie proposed to cut those revenues even further. If elected, he said, he will provide an income tax of big but unspecified size. Meanwhile he will also provide big but unspecified property-tax rebates, he said. This is impossible. About half of the current budget is already dedicated to property-tax relief, including the entire income tax. Further reducing that flow of money will mean increases in New Jersey's property taxes, already the highest in the nation.
Granted, this is an election year and we can't expect straight talk from the leaders of either party. But the harsh reality is this: The only way to balance this year's budget, as required by the constitution, will be to delay a certain amount of expenditures until July 1, when they will go into next year's budget. And that in turn means the pressure to cut the budget for fiscal 2010 is even more intense than it was. Instead of squabbling over the latest bad news, the leaders should be giving us even more bad news. Each party should present a list of very specific budget cuts and stand by them - before the election. And before the ship sinks.
California state budget deficit grows to $20.5 billion
California’s budget shortfall grew last month, according to figures released Friday by Controller John Chiang. The state’s cash deficit grew to $20.5 billion on April 30. California started the fiscal year on July 1, 2008, with a deficit of $1.45 billion. General fund revenue was down $1.89 billion, or 16 percent, in April from budget estimates. Personal income taxes were down $1.06 billion, or 12.6 percent, and corporate taxes were down $831 million, or 35.6 percent, from estimates. Year-to-date revenue is $2.1 billion below expectations. Chiang warned that the state could be in deep trouble with the current fiscal year drawing to a close this summer.
“The state’s last shortage and the resulting payment delays in February hurt California taxpayers, businesses, local governments and public works projects — and yet the crisis looming could be at least three times as bad,” Chiang said in a news release. “Beginning this summer, we face a cash problem unseen in nearly eight decades, and the magnitude of that problem grows with every projected revenue dollar that fails to appear,” he added. California’s sales-tax rate increased April 1, however revenue from the rate increase will not start to arrive until the end of May. The state’s sales-tax receipts were down $108 million, or 19.9 percent, in April compared to budget estimates.
Tough budgeting decisions left up to Ohio senate
Budgeting should involve planning future spending by allocating expected income according to obligations and priorities. For members of the Ohio House, this apparently also involves wishful thinking. Now, it will apparently be up to state senators to bring the plan into line with reality. First, a review. About two years ago, state legislators approved a $52 billion biennial budget. The ensuing economic recession, however, resulted in changes to that spending plan, plus attempts to boost state revenue (such as the Ohio Lottery's addition of Keno). Despite the ongoing recession, Gov. Ted Strickland proposed a $54 billion two-year budget, which relies on $5 billion in one-time federal stimulus funding.
State budget director Pari Sabety's staff warned the governor income tax revenues had fallen by $322 million April 28. Yet the next day, state representatives voted - 53 to 45 - to pass an amended version of the budget proposal to which they had added $622 million. Next, state senators will get to work on the proposed budget. And Republicans who control the Senate believe they must trim up to $900 million in spending from the plan. The senators most likely will develop a revised proposal that reflects lower - and more realistic - revenue estimates. If they don't, Strickland should veto the legislation. But it won't come to that. The GOP-controlled Senate will have to make the tough decisions required to craft a responsible budget. How this legislative scenario is playing out could be just a coincidence, but we doubt it.
There's pain for all in Michigan state budget cuts
It's been a tough week in Lansing, which means there are going to be a lot of tough weeks coming up in a lot of communities in Michigan. Everyone knows there isn't enough state revenue -- primarily tax and fee collections -- to fund all the state programs that started the fiscal year as lines in the budget. The shortfall for the final five months of fiscal year 2008-2009 is estimated at about $1.3 billion. So Gov. Jennifer Granholm has ordered and lawmakers have approved more than $300 million in cuts to state programs and staff; federal stimulus dollars will make up the rest of the shortfall this year and stimulus money will be available again for 2009-2010, but that's it for those funds as far as we know.
State budget forecasters project a gap of about $1 billion between revenue and traditional programs in fiscal year 2010-2011. But those who favor smaller -- rather than larger -- government, as we do, should be concerned about the cutting necessitated by the slump in all kinds of revenues by the state. State troopers will be laid off, tens of thousands of workers furloughed and almost every department is asked to cut spending 4 percent. In addition, there will be significant cuts to health programs, long-term care services, work force training programs and even programs for disabled veterans. It isn't hard to see why the cuts are being made. Where taxes are concerned, the state really has four options: It can tax consumption, personal income, business activity and property. But consumption of everything from gas to automobiles is down. Hundreds of thousands are unemployed. Businesses are hurting. And property owners are facing the loss in value of their homes, or worse, foreclosure. So state revenues fall.
Michigan will begin to pull out of the recession when the auto industry stabilizes and the national economy begins to recover. But it's going to be awhile. After discussions recently with state budget experts, elected officials, business owners and economists, among others, we believe there are a couple of things lawmakers could do that could help in both the short and the long term. One is to finally make it easier for small businesses to expand, grow and create more employment opportunities. U.S. Rep. Pete Hoekstra recently told us about a trout farmer in the northern lower peninsula who is prevented by various state regulations and requirements from expanding his operation and adding 15 or so new employees, as he wants to do. Every public official running for office says Michigan needs to make it easier for businesses to locate, operate and grow here, and it's inexcusable that after all this time that still hasn't been done.
The second move would be to take a careful look at all the state tax exemptions, credits and deductions that are allowed. House Fiscal Agency Director Mitch Bean showed us this week that those tax rules, which in fiscal year 1998 increased state revenues by $6.8 billion, actually reduced revenues by $6.3 billion in fiscal 2008. He noted, for example, that a retired couple can receive a certain combination up to $110,000 in pension, Social Security and 401k disbursements without paying a single dollar in state income tax. Changing that would be a tough political sell, but at this point it's one of the things we should consider. And there are others. To be sure, balancing the state's budget, as required, over the next several years will be fraught with political peril. The work ahead is hard and painful. If there ever was a time for political courage, this is it.
Vermont budget stalemate: What now?
State budget talks broke down between legislative leaders and Gov. Douglas on Tuesday, tossing the Democratic leadership and the governor into a game of political chicken. The Democrats declared they would likely send out a budget of their own making and leave it to the governor to veto. If the Democrats leave in their request for $26.1 million in new taxes, while also transferring $19.8 million to the property tax, the governor’s veto will likely follow. Both sides have to ask how their intransigent positions serve the state. Since the start of the economic downturn, Gov. Douglas has been suggesting cuts needed to be made to state services, while refusing to consider tax increases. Twenty million in cuts were made to the proposed fiscal year 2010 budget back in August. Since then, political stalemate has prevented further action. Estimates vary, but current projections suggest the state could be looking at deficits as big as $116 million in fiscal year 2011, and $194 million in 2012 — and that’s assuming the economy bottoms out and we see 3 percent growth in both fiscal years. It is not a promising forecast.
Just where should the political process take us from here? One scenario is that after the showdown this week, the Legislature will adjourn and anticipate the governor’s veto. More dialogue will take place and finally they’ll propose another budget, call a special session and see if it passes and is approved by the governor. What’s certain is this: The longer the negotiating process goes into the summer, the deeper the cuts will have to be. The Democrats, it must be noted, recently made a big concession to the governor by agreeing that $19.8 million allotted to the Teachers’ Retirement Fund should be shifted from the state’s general fund to the education fund — meaning it would financed through the local property tax. The Democratic leadership had resisted such a shift for months, but recently conceded because it was the one way the governor has been willing to, essentially, increase taxes — though he has refused to call it an increase on the property tax because voters will have the opportunity to slash their school budgets.
Has the governor conceded? So far, not much. He has held to an ideological — almost pathological — aversion to raising any taxes, and that lack of compromise has jeopardized progress on the budget and led to poor decision-making — like cutting the budgets for the state’s regional development corporations by 8 percent, with another 12 percent cut in the offing. (That’s just plain dumb to cut funding for programs that focus on job development and economic growth.) For their part, the Democrats have been playing semantics with their talk of budgets “cut to the bone.” By all accounts, their proposed spending plan for fiscal year 2010 is up about 6.7 percent compared to fiscal year 2009. That may be a significant decrease from the initial budget proposal (therefore they can say they’ve cut their proposed spending), but in real terms it’s an increase — and much of that is being financed with the federal stimulus money. That is, as Gov. Douglas has been harping, a recipe for disaster two years down the road when the stimulus checks are gone.
The bottom line is not that difficult to perceive: Democrats must make some tough concessions to reduce government spending, and Douglas must concede to more revenue growth. Our guess is that most Vermonters have been hoping to see that logical compromise since the session began and are disappointed in the current stalemate. To that end, legislative leaders and the governor should review the budget line-item by line-item and make specific suggestions as to which programs should be cut, which reduced and which increased. The caveat is to understand that leaving programs decimated serves no one well, and that boosting programs that seek to raise government revenue — economic development, for example — makes sense in this economy.
On the revenue side, the governor can make the easy concessions on increasing the sin taxes (cigarettes and alcohol); adding a tax to digital downloads (essentially the same as paying a tax when you buy a record at a store); and closing the loophole on capital gains. Similarly, the governor should agree to a hike in the gas tax. For their part, Democrats must suggest cuts in programs. At this date, the human services budget, for example, is looking at a $180 million (by one report) increase over the prior year. Some of that increase is explained by higher unemployment payments, for example, and the added services required to help those most affected by the recession — as opposed to an expansion of services. Nonetheless, Vermont has always offered generous relief programs, and those may need to be trimmed in order to provide the basics to the thousands of additional people in need.
One mistake to avoid is weakening all governmental programs through cuts across the board, as Douglas has advocated, rather than to make the harder choices of selecting programs that add most value in hard times, while mothballing others. The governor should also be required to seek significant cuts in staffing throughout his administration — at a level back to when he first took office would be appropriate. Keeping public relations posts when vital services for people in need go lacking is an insult to all Vermonters. The overarching goal is to live within the state’s means, but recognizing also that ineffective government does as much economic harm to the state as does excessive taxation.
Treasurys advance before Fed buyback
Treasury prices rose Monday, pushing yields lower, before the Federal Reserve steps in once again to purchase long-term debt in the hopes of making borrowing costs affordable. Ten-year-note yields fell 6 basis points to 3.23%. A basis point is 0.01%. Yields move inversely to prices. Two-year-note yields fell 5 basis points to 0.94%. The Fed will purchase debt maturing between 2026 and 2039, with results after 11 a.m. Eastern time. Last time the central bank made purchases in this range of maturities, on March 30, it bought $2.5 billion.
So far, the Fed has purchased $88.37 billion in Treasurys, well on its way to its goal of $300 billion by the autumn. Still, 10-year-note yields, a popular benchmark for corporate and mortgage bonds, are higher than when the Fed started the program two months ago. That's raising concerns that borrowing rates will rise -- hampering any nascent economic recovery -- and spur the Fed to buy more Treasurys. "Mortgage rates are back near 5.00% after having fallen to 4.85% in April, and so investors are becoming wary of the possibility that the Fed will have to move more decisively to cap borrowing rates," said T.J. Marta, strategist and founder of research firm Marta on the Markets.
A two-week break from the pressure of Treasury auctions is also helping bond prices. Last week, the government sold $71 billion in notes and bonds, a record for its quarterly refunding. The government has been increasing its debt issuance to finance all of the economic stimulus programs and Fed operations to stabilize financial markets. Increased issuance tends to make investors demand higher yields to buy new debt or hold onto existing assets. "With supply behind the market for the next two weeks and the likelihood of very aggressive Fed buybacks this week, we look for 10-year yields to trade towards 3.15% and possibly 3.10%," said Thomas di Galoma, head of fixed-income-rates trading at brokerage Guggenheim Capital Markets.
Traders said declines in stocks, and growing speculation that the rally was overdone, increased the appeal of the relative safety of U.S. debt. The government's monthly employment report on Friday showed the economy lost a massive number of jobs for the 16th month in April, and the unemployment rate shot to a 26-year high. Financial companies are under heightened pressure as a report in The Wall Street Journal said that U.S. banks received concessions from the Fed regarding the government demands for fresh capital infusions.
Chinese deflation picks up pace but draws little concern
China's wholesale price index declined at a quicker pace in April, falling for the fifth-straight month, while consumer prices also accelerated to the downside, according to data released Monday by the National Bureau of Statistics. But several analysts dismissed the drops as a temporary phenomenon, with the prices to shift higher again in coming months as economic activity picks up. "As the economy continues to stage a recovery and credit growth continues to expand, consumer prices should show an uptrend in the second half of the year. Importantly, expectations of rising prices in the future will encourage consumer spending," wrote J.P. Morgan analysts in a note Monday.
Wholesale prices, as measured by the producer price index, dropped 6.6% from a year earlier, slightly further than expectations for 6.5% in a Dow Jones Newswire survey of analysts. The decline followed a 6.0% dip in March, with the index in negative territory since December. The consumer price index fell 1.5% in April, its third month of contraction and a faster drop than the 1.2% decline posted in March. However, analysts said the results largely reflected the effects of softening food prices and were in line with expectations from the Dow Jones survey. Consumer price have been on a weakening trend since February.
Analysts also said the slump in wholesales prices partially reflected the comparison with April 2008, when there was a big surge in oil prices, although the dumping of inventory into the supply chain and price cutting due to overcapacity also affected the results. "Producer prices will begin to kick up as soon as signs of a global recovery become more prominent and import prices for raw materials rise. Overall, mild deflation at this stage of China's growth cycle is not only tolerable, but a definite positive for households," Cantor Fitzgerald analysts said in a note Monday.
Capital One, U.S. Bancorp, BB&T to Repay U.S. Aid
Capital One Financial Corp., U.S. Bancorp and BB&T Corp. will sell shares to repay government bailout funds after stress tests showed the companies can weather a worsening recession without additional aid. Capital One, the credit-card lender based in McLean, Virginia, said today it would sell 56 million shares of common stock, while Minneapolis’s U.S. Bancorp said its sale would total about $2.5 billion. BB&T Corp., North Carolina’s second- biggest bank, reduced its dividend and began a public offering of $1.5 billion of common stock. Bank regulators examining the 19 largest U.S. lenders last week said the three companies wouldn’t need additional capital to survive a deeper, more prolonged recession. U.S. Bancorp Chief Executive Officer Richard Davis and BB&T CEO Kelly King had both said they wanted to repay their $6.6 billion and $3.1 billion in Troubled Asset Relief Program funds as quickly as possible.
“We firmly believe this action is in the long-term best interests of our shareholders and our company because of the risk and uncertainty associated with being a TARP participant,” King said in a statement. King said the decision to cut the dividend was “the worst day in my 37-year career.” KeyCorp, which the government deemed needed an additional $1.8 billion in capital after the stress-test, today registered to sell as much as $750 million in common shares. The Cleveland- based bank said it expects “to receive net proceeds from the offering of up to approximately $739,387,500, after estimated expenses and commissions,” and intends to use the proceeds for general corporate purposes.
Key, which last month slashed its dividend to 1 cent, said that because of “the challenges presented by the current economic and regulatory environment, we do not expect to increase our quarterly dividend above $0.01 for the foreseeable future and could further reduce or eliminate our common shares dividend.” Banks that accepted bailout money from the TARP are subject to government oversight and restrictions on compensation that that they say put them at a disadvantage to competitors. Banks that want to pay back the TARP money must get approval from the government and show they can sell debt in the public market without federal backing. The government’s stress test found that 10 lenders needed to raise a total of $74.6 billion in capital and that a deeper recession could lead to potential losses of $599.2 billion in 2009 and 2010 for the 19 lenders examined.
U.S. Bancorp also plans to sell $1 billion of five-year notes without a government guarantee as soon as today, according to a person familiar with the offering who declined to be identified because terms aren’t set. Wells Fargo & Co., which the government said needed $13.7 billion in additional capital, raised $8.6 billion selling shares last week, more than planned. Goldman Sachs Group Inc. in April, before stress test results were released, said it would raise $5 billion to repay federal rescue funds. Morgan Stanley last week raised $8 billion by selling stock and debt. The stress tests found that New York-based Morgan Stanley needed $1.8 billion in additional common equity as a buffer against potential losses.
Latvian economy in rapid decline
Latvia's economy contracted 18% in the first three months of the year, compared with a year earlier, as the country's recession accelerated. The slide in the manufacturing and services sectors continued in the first quarter, the statistics office said. The Latvian economy, driven by consumer demand, was hit hard last year amid the global economic downturn. In December the International Monetary Fund approved a 7.5bn-euro (£6.7bn) rescue package for Latvia. Output fell across all sectors of the Latvia economy during the first quarter of the year. The biggest drop was seen in hotels and restaurants, with activity down 34% on the same quarter in 2008.
"[The decline in GDP] was a bit worse in the early 90s, but we saw during the last few days that it was going to be a deep fall and it was deeper than expected," said Andris Vilks, chief economist for SEB Latvia. Latvia continues to have one of the most troubled economies in the European Union (EU). Its Finance Ministry has said it expects GDP to fall 13% this year. Latvia joined the EU in 2004 and its economy grew at an average of 10% per year, for four consecutive years. However, most economists believe the speed of that growth is the reason why it is contracting so sharply now. Separately on Monday, Latvia gained EU approval to shore up the country's second-largest bank JSC Parex with another state capital injection.
HSBC profit boosted by gain on own debt
Banking giant HSBC Holdings said Monday that its first-quarter underlying profit was substantially ahead of a year earlier due to $6.6 billion of one-off gains, as its investment banking arm also benefited from improved market share and margins. The group said that excluding the gains, which were due to a fall in the market value of its own debt, underlying pretax profit was down compared to a year ago, but still higher than the final quarter of 2008. It added the price of its debt rebounded in April, meaning much of the benefit will be reversed in the second quarter. HSBC, which doesn't give detailed quarterly figures for the group, also said loan impairment charges rose compared to a year ago, but declined from the high levels seen in the last three months of 2008.
The bank said in early March that it would shutter much of the consumer lending business in the U.S. that it acquired when it bought Household International in 2003. It said Monday that loan impairment charges on its exit portfolio from the business were $2.4 billion in the latest quarter -- a rise of $300 million from a year earlier, but down $600 million from the final quarter of 2008. Net income at the HSBC Finance business in the U.S. rose to $872 million from $255 million a year earlier, as gains on its own debt and related derivatives rose to $4.11 billion from $1.18 billion. Shares in the group were down 3.9% shortly after the announcement as other European banks traded mostly lower.
"Our operating performance in the first quarter was encouraging, boosted by record results from our global banking and markets business," said CEO Michael Geoghegan. "As a leading global deposit-taker, we are very much open for business, particularly for our core customer relationships, but demand for credit is subdued," he added. The group completed a $17.8 billion share sale in April, after taking significant goodwill impairments on its U.S. operations. Including this additional capital, the bank's Tier 1 capital ratio would have been 9.9% at the end of March, HSBC said.
Nortel posts wider loss as revenues plunge 37 percent
Nortel Networks Corp, the telecom equipment maker that filed for bankruptcy protection earlier this year, said on Monday its quarterly loss widened as the global economic downturn contributed to a sharp drop in revenue. Nortel, North America's biggest maker of telephone equipment, said it is completing its plans to decentralize some functions at each of its four main businesses to give it the more flexibility as it decides which divisions to sell. The company lost $507 million, or $1.02 per share, in the three months ended March 31. That compares with a loss of $138 million, or 28 cents, a year earlier. Revenue fell 37 percent to $1.73 billion with declines in all segments and regions, the company said. Analysts on average had expected Nortel to post revenue of $2.32 billion, according to Reuters Estimates.
The steep drop in sales was due to "the severe economic downturn and our filings for creditor protection," Chief Executive Mike Zafirovski said in a statement. Nortel filed for bankruptcy protection in January, blaming the economic crisis for derailing a turnaround effort that began in 2005. Since then, there has been widespread speculation among analysts and in media reports that the company may be sold off in pieces rather than revived as a viable stand-alone entity. Sources have said that Nortel rivals, including Nokia Siemens Networks, have approached the Canadian company with offers for key parts of its business. However, no deal has materialized so far.
Darker Times for Solar-Power Industry
The global recession and tight credit conditions have cast a chill on the solar-power industry after years of breakneck growth, and could usher in long-term changes in the industry. Banks have curtailed financing for major solar projects, and Spain -- the world's second-largest solar-power market after Germany -- has slashed subsidies for the industry, leading to sharply lower demand for solar cells. Sales of the tiny chips that convert the sun's rays into electricity are expected to drop by at least 20% this year. As a result, solar-cell manufacturers are delaying construction of new factories and sharply cutting prices. Several big solar companies, including Renewable Energy Corp. of Norway and Q-Cells SE of Germany, have scaled back ambitious profit and revenue goals, and are predicting a tough year ahead. Analysts expects solar cells to fetch an average of just $2 per watt this year, down sharply from $3.95 per watt in 2008.
"Last year we couldn't make enough solar cells to keep up with our customers' demands," said Anton Milner, chief executive of Q-Cells, the world's biggest solar-cell manufacturer by volume. "Now it's a buyer's market -- customers are coming back to ask if they can buy lower volumes and have lower prices than planned." In environmental terms, there may be a silver lining in the industry's woes. The drop in prices for solar-power gear could make solar energy more competitive with burning fossil fuels to generate electricity, even if oil prices stay at around $50 a barrel. Today, less than 1% of the world's electricity comes from solar power. "The dramatic cost reductions now happening in solar will be good for the industry and the environment in the long term," said Sven M. Hansen, chief investment officer of Good Energies LLC, which invests in renewable energy. "But in the short term, the outlook for solar companies has never looked more difficult."
World-wide shipments of solar cells to companies that install rooftop solar-power systems and build fields of solar panels for commercial energy production grew 85% to almost 6,000 megawatts in 2008, according to research firm Collins Stewart LLC. This year shipments are expected to fall to 5,575 megawatts. First-quarter sales at SunPower Corp. fell 22%, and the California solar-cell producer cut its revenue forecast for 2009 by 17%. Last month, Taiwan's Motech Industries reported its worst quarter since 2003 with revenues down 15% and net income down 80% to $1.4 million. Some industry watchers think the current downturn is more than a bump in the road. Dan Reis, analyst at investment-research firm Collins Stewart, says falling solar-cell prices could herald an era of lower profits and thinner margins. Sales of solar panels will boom in volume terms, Mr. Reis said, but since prices will be much lower, companies with low costs, such as Chinese manufacturers Trini Solar Ltd. and Yingli Green Energy, will have an advantage.
Even so, solar-cell makers may get some relief as countries including the U.S., Japan and China provide more support for renewable energy either as part of their economic-stimulus plans or to combat global warming. But those subsidies are unlikely to translate into an uptick in solar-cell orders until next year at the earliest. In the meantime, government subsidies and private-sector financing are likely to be scarcer than in recent years. The Spanish government will subsidize just 500 megawatts worth of solar projects this year, down sharply from 2,400 megawatts last year. Utilities and other developers are also finding it harder to get loans or raise investment capital for big solar projects. In the first quarter, global financing for renewable-energy projects fell to €11.5 billion from €20.5 billion in the fourth quarter, says London consulting firm New Energy Finance.
To adapt, Q-Cells' Mr. Milner has slashed capital-spending more than 40% from last year, and has postponed the construction of a new factory by six months. This year, the company, which hired 800 workers in 2008 as its revenue rose 30%, has let the contracts of its temporary workers expire and has laid off about 80 people. "I've gone from managing for rapid growth to managing for cost reductions," said Mr. Milner. To protect margins, the Q-Cells CEO pushed into the business of building big solar-energy projects. Last year, he formed a division that finds the project site, obtains the permits, builds the solar installation, and then sells the project off to investors, banks or utilities. "We've seen amazing growth, and this will soon become a significant part of our business," he said.
Shortages stir coffee and sugar prices
Caffeine addicts face higher prices for their daily fix as the wholesale cost of both coffee and sugar rise sharply because of poor crops and robust demand. "We are in a dangerous situation," Andrea Illy, chief executive of Italy’s leading coffee ?company, told the Financial Times, warning that prices could "explode" due to supply shortages. His comments echo those of other industry players – and point to a sharp shift in sentiment among analysts. Until recently, it was widely assumed that the global economic crisis would damp consumption and prices for coffee. However, that forecast proved wrong, since demand for coffee has remained high, even while consumers have moved from cafés to home drinking. International coffee prices last week hit a seven-month high, rising to $1.28 per pound, up 22 per cent from their December low, in New York trading.
Meanwhile, the spot price of Colombian coffee – which commands a premium because it is sought by gourmets – jumped to almost $2.20 a pound, a 12-year high, due to supply constraints. The crop in Colombia was damaged by heavy rains and the scarcity of supplies from the country is now "absolute", says Néstor Osorio, head of the International Coffee Organisation. Kraft, owner of the Maxwell House coffee brands, raised retail prices on its Colombian blend by almost 19 per cent last month due to the rising prices of Colombian coffee beans. Nestlé declined to comment on whether it has been raising prices on Nescafé. Separately, sugar prices in New York and London rose last week to their highest in almost three years. White sugar prices rose above $450 a tonne, a 52 per cent gain from mid-December, as traders bet that India, the world’s largest consumer, will require hefty imports to compensate for the failure of the local crop.
Swings in Indian sugar output, which move the country back and forth from exporter to importer, are a critical factor in global prices. Traders forecast that the country’s output will drop 40 per cent to about 15m tonnes in the 2008-09 season, well below the country’s consumption of about 23m tonnes a year. Peter de Klerk at London-based sugar merchants Czarnikow said that importing countries will "need to see retail prices rise to match the surge in the cost of sugar in the wholesale market". Traders said that the mood at last week’s sugar dinner in New York, the industry’s annual gathering, showed the market is bullish overall. At present, the International Sugar Organisation predicts a second consecutive market deficit in 2009-10.