A life guard, Brighton Beach, New York
Ilargi: Turns out, Timothy "Disaster" Geithner has a list of 4 friends that take up a very large segment of his time on the phone. They're the CEO’s of Goldman Sachs and JPMorgan Chase, as well as both the Chairman and the CEO at Citigroup. Apparently, these 4 men are his only close friends. Reading through the AP report on Geithner's appointment calendars, you get the distinct impression that the US Treasury Secretary stops just -but only just- short of putting the president on hold when he calls. Members of Congress are not that lucky.
What does Geithner talk about with his buddies-of-yore? Well, one thing we know they must have discussed a lot is how to make sure the Federal Reserve and Geithner's own Treasury could shove $1.2 trillion into the housing market, as reported by the Federal Housing Finance Agency, mainly through Fannie Mae and Freddie Mac, but increasingly also through the FHA and Ginnie Mae. FHFA acting director Edward DeMarco claims there's $750 billion more (!) "available if necessary" for the same purpose.
The [Federal reserve] has paid $885 billion for mortgage securities, most of them issued by Fannie or Freddie, and also has given the GSEs $131 billion to buy up their debt obligations. DeMarco called these infusions a "considerable backstop" and said they empowered the firms to play "a critical role in bringing some measure of liquidity to the mortgage market.
Of course, most of this money flows towards the biggest mortgage lenders, which apart from Geithner's speed-dial cronies include the likes of Bank of America, which is, if they know what's good for them, looking, as we speak, for a new CEO who's close to Geithner, to replace Ken Lewis who was not, and Wells Fargo, the remaining giant mortgage lender in the field. That should about cover it.
Still, at least part of the almost $2 trillion is also used by Fannie and Freddie to prop up independent mortgage banks , by committing in advance to buying up any loans that "meet certain standards". What is achieved by this is an ongoing semblance of a free market. And as long as the taxpayer pays for and guarantees that semblance, that's fine with the big boys.
The independent banks that are artificially kept alive through these programs have found ways to add to their stroke of luck.
- The Mortgage Bankers Association recently announced that independent mortgage lenders made an average profit of about $1,100 per loan originated in the first quarter of the year, an astonishing 635 percent increase from the previous quarter.
- Nine big mortgage lenders, representing about two-thirds of the market, made about $9.1 billion in the first six months of the year off loan originations [..]. In 2008, those lenders made about $3.3 billion for the whole year.
- "There's been a return of fees -- originating fees, underwriting fees, processing fees -- fees you haven't seen in years," says Guy Cecala, publisher of Inside Mortgage Finance. "There are roughly 12 to 20 fees you wouldn't have seen as recently as two to three years ago. But lenders can charge them, so they're charging them. "This is the greatest period in recent memory for generating income,"
- Then there's the issue of the massive government subsidies designed to spur lending, resulting in low interest rates for mortgages.[..] Ironically, the fact that government-supported mortgage giants Fannie Mae and Freddie Mac now back four out of every five new mortgage loans has made the process for lenders much easier. "We live in an automated mortgage processing environment,"[..] Fannie- and Freddie-backed loans require little more than a few clicks of the mouse on the part of the lender. "If you type in Fannie or Freddie, the system will tell you whether it's a go or not,"
Inevitably, in an environment where a government and central bank are so eager to hand out public funds to keep a long-dead skeleton of an industry "alive", what's left of that industry will try to drive an ever harder bargain. So when the government shows its fear of a coming wave of Option ARM foreclosures, you get this:
- Lenders and government officials are searching for ways to head off a wave of defaults on pay-option adjustable-rate mortgages, which are threatening to become the next storm to hit the U.S. housing market. ARMs aren't easy to modify because of the risky features of the loans and their concentration in states where property values have plummeted the most.
- Administration officials have been talking to mortgage investors and servicers about ways to help option ARM borrowers avoid foreclosure, but the parties don't appear close to a solution. A major sticking point: whether lenders need to forgive loan principal to help the borrowers stay in their homes.
- The major mortgage servicers -- J.P. Morgan Chase & Co., Wells Fargo & Co. and Bank of America Corp. -- also hold large portfolios of option ARMs acquired through purchases of other banks. Investors suspect that they are reluctant to forgive principal on option ARMs in their servicing portfolios because that could trigger write downs of the banks' option ARM holdings.
Now, first of all, loan modification programs initiated by the Obama administration have overall been miserable failures so far. And second, when a government offers truckloads of money to save companies, and the latter respond with entire lists of demands for the privilege of saving them, you have a real big political problem on your hands, so much so that you have to wonder about that government's intentions. The public's best interest would undoubtedly be served by saying something like "if you don’t want it, take a hike". But that's not happening. And with Tim Geithner's phone pals in line to be the main beneficiaries of what does happen, that should perhaps not be too much of a surprise.
To keep the mortgage money machine rolling, new tax credits for home buyers are about to be agreed on, this time for all buyers, and with more credit to be had. Calculated Risk points out that if you look at only those people who would not buy a home without the help, the overall cost of the newly negotiated credits would come to between $100,000 and $150,000 per home. That is the kind of thing you find in your thesaurus under perverse.
While still stuck in the unbelievable mess they've created in the domestic real estate market, the same parties, the Fed and Washington, that have the political power to hand out your funds, are now turning their eyes towards commercial real estate. There is no reason whatsoever to assume that their adventures in that field will be any more successful, or any less expensive (to you) than what they've so far lost by intervening in the housing market. And lost it is, don't you doubt it, all the trillions of dollars of it. A large chunk of it will go to the friends-of-Timmy banks, and the rest will simply evaporate as home prices keep plummeting. The trillions have achieved no more than a year, maybe 18 months, of respite. Not respite from falling, prices have kept on decreasing, but respite from falling much harder.
There is nothing the government can do to stop this. Why not? Because consumer credit is plunging, and will continue to do so for some time to come. Because there are 10.6 million properties available, or 25 months worth of inventory at present market sales speed. Because prices have a long way more to fall before they fall into any realistic "affordable" scale. Because unemployment rises by between roughly 500,000 and 1 million people each month. Many more will lose their homes to the equally rapidly rising numbers of foreclosures, adding still more inventory to what's already there.
Obama, Geithner and Bernanke need to get the hell out of the mortgage market, or they will squander more and more taxpayer money on lost propositions. And all this is so obvious that it's impossible not to wonder why they do what they do. The answer to that question can be found in Tim Geithner's rolodex.
The number of homeowners who are underwater is getting bigger all the time. Another 10-15% drop in prices will see well over half of them owing more than they "own". And while that process is in full flight, the government induces the next batch of hapless dreamers to become part of the American nightmare, apparently not hindered by any moral compass.
Feds Spent $1.2 Trillion to Keep Fannie, Freddie, Others Afloat in FY 2009
The U.S. Treasury and Federal Reserve pumped a total of $1.2 trillion in investments into the U.S. mortgage market in fiscal 2009, according to a report by the government last week. The Federal Housing Finance Agency gave a full accounting of the infusions so far – most of them to the troubled government-sponsored mortgage enterprises Fannie Mae and Freddie Mac.
But in a speech at the New England Mortgage Bankers Conference in Providence, Rhode Island, the agency’s acting director, Edward DeMarco, argued that another three quarters of a trillion dollars was available if necessary. The amount already spent remained impressive, however. By the fiscal year’s end on Sept. 30, the Treasury Department had given Fannie and Freddie $96 billion in cash for preferred stock shares, and another $181 billion to purchase underperforming mortgage-backed securities from the firms.
The lion’s share of the outlays, though, came from the Fed’s coffers. The national bank has paid $885 billion for mortgage securities, most of them issued by Fannie or Freddie, and also has given the GSEs $131 billion to buy up their debt obligations. DeMarco called these infusions a "considerable backstop" and said they empowered the firms to play "a critical role in bringing some measure of liquidity to the mortgage market.
In a separate development, Freddie Mac warned prospective buyers of its foreclosed properties that bids needed to be in by Oct. 30 to collect on an offer that would cover part of the sale’s closing costs. Freddie has 34,700 in real estate owned properties. Buyers also must close on their homes by Dec. 31 to qualify for the closing cost discount. "Every home shopper should know there are only 30 days left to save potentially thousands of dollars in transaction costs when they buy a HomeSteps home," Freddie vice president Chris Bowden said in a statement.
Fannie and Freddie to Aid Mortgage Banks
Fannie Mae and Freddie Mac are preparing to introduce a program aimed at helping independent mortgage banks acquire the short-term credit they need to make home loans, according to people familiar with the plans. The two government-backed mortgage companies, the main providers of funding for U.S. home loans, plan to provide advance commitments to purchase home mortgages that meet certain standards. The goal is to reduce risks faced by independent mortgage banks so they can obtain short-term credit.
Spokesmen for Fannie and Freddie declined to discuss details of the plan, and the companies' regulator, the Federal Housing Finance Agency, declined to comment. But other people briefed on the situation said Fannie and Freddie plan to build on a previously undisclosed pilot program that Freddie has with Provident Funding Associates LP, a large national mortgage lender based in Burlingame, Calif., and with NattyMac, a so-called warehouse lender based in St. Petersburg, Fla., that provides short-term funding to mortgage companies.
Under that pilot program, these people said, Freddie makes commitments to purchase loans made by Provident Funding that are financed by NattyMac. NattyMac is responsible for ensuring that the loans meet certain quality standards set by Freddie. The commitments from Freddie reduce the risk that NattyMac or Provident will be stuck with loans that are rejected by Freddie or Fannie and can be sold to other investors only at a huge discount. Provident Funding officials couldn't be reached for comment. A spokesman for NattyMac's parent company, Guggenheim Partners LLC, a New York-based financial-services concern, declined to comment.
Many independent mortgage banks have gone out of business or reduced their lending in the past two years because they have been unable to get enough funding from warehouse lenders. Wall Street firms and some big banks have withdrawn from the business, partly to conserve capital for other purposes. As a result, independent mortgage banks are losing market share to better-financed banking giants. In this year's first half, the three biggest mortgage lenders -- Wells Fargo & Co., Bank of America Corp. and J.P. Morgan Chase & Co. -- accounted for 52% of new home mortgages, according to Inside Mortgage Finance, a trade publication. In 2007, the top three had a 37% share.
U.S. Government, Lenders Seek Ways to Head Off New Mortgage-Default Wave
Lenders and government officials are searching for ways to head off a wave of defaults on pay-option adjustable-rate mortgages, which are threatening to become the next storm to hit the U.S. housing market. Option ARMs aren't easy to modify because of the risky features of the loans and their concentration in states where property values have plummeted the most. Once the rage in Florida and Nevada, the loans catered to creditworthy borrowers who had to stretch a great deal to buy a home in an overheated market.
Administration officials have been talking to mortgage investors and servicers about ways to help option ARM borrowers avoid foreclosure, but the parties don't appear close to a solution. A major sticking point: whether lenders need to forgive loan principal to help the borrowers stay in their homes. "All sides are talking," said Laurie Goodman, a senior managing director of broker/dealer Amherst Securities Group. "The servicers and investors have different solutions to the problem. Servicers are more reluctant than investors to forgive principal."
Mortgage investors contend that forgiving loan principal is crucial because so many option ARM borrowers are underwater, owing much more than their homes are worth. Meanwhile, servicers favor taking other measures before writing off any loan principal. The government risks a backlash from borrowers who are paying off their loans in full if it takes steps to encourage principal forgiveness.
The major mortgage servicers -- J.P. Morgan Chase & Co., Wells Fargo & Co. and Bank of America Corp. -- also hold large portfolios of option ARMs acquired through purchases of other banks. Investors suspect that they are reluctant to forgive principal on option ARMs in their servicing portfolios because that could trigger write downs of the banks' option ARM holdings.
Delinquencies and foreclosures of option ARMs are climbing and the problem is expected to get worse. In the second quarter, 15.2% of option ARMs were at least 60 days past due, compared with a 5.3% delinquency rate for all mortgages, the Office of the Comptroller of the Currency said in a report analyzing 34 million U.S. mortgages. Meanwhile, 10% of option ARMs were in the process of foreclosure, more than triple the 2.9% rate for all mortgages, the OCC said.
The poor performance partly reflects the loans' heavy concentration in the four states that have seen the sharpest price drops. Option ARMs represent nearly 40% of loans at least 60 days past due in Florida and in Nevada and 28% of such loans in California, according to First American CoreLogic. One in five delinquent mortgages in Arizona is an option ARM. Making matters worse, more than a million option ARMs are due to reset over the next four years, according to First American CoreLogic. When that happens, borrowers who were making partial interest payments will have to make fully amortizing payments reflecting a larger loan balance.
Option ARMs aren't good candidates for the government's loan-modification program. Borrowers with such loans are often already struggling to make already very low payments, leaving little room to cut the payments further. Some borrowers are so deeply underwater that lenders would have to write off or defer huge amounts of loan principal to achieve a sustainable modification. That could trigger a failure of the net present value test required to complete a modification under the government's program.
Mortgage servicers are seeking changes to the program to make it work better for option ARMS. They propose forgiving deferred interest, converting the loan to one with an interest-only period and increasing the loan term before any principal is written off. By contrast, investors favor refinancing borrowers who qualify into a Federal Housing Administration-backed mortgage after the loan principal has been cut.
Wells Fargo, which values the Pick-A-Pay loans it acquired when it bought Wachovia Corp. at $90.45 billion, says it has been successful in modifying them on its own or through the government's program. "We continue to work with the administration on industrywide solutions that address the unique nature of option ARM and negative-amortizing loans," Wells Fargo spokesman Kevin Waetke said.
Investors argue that slashing monthly payments or forbearing principal -- when portions of the loan balance is deferred -- won't help many option ARM borrowers because they are so upside down on their mortgages. The concern with principal forbearance is that people may still owe much more than their house is worth, said Michael Henriques of Magnetar Capital, a mortgage investor. "There's no material incentive to maintain or take care of it," he said. That deterioration drags down the property values of the neighboring houses as well, prolonging the housing recovery, Mr. Henriques said.
Bank of America valued the pay-option loans it acquired when it bought Countrywide Financial Corp. at $23.2 billion as of December 31, 2008. Meanwhile, J.P. Morgan holds nearly $40 billion of option ARMs from its acquisition of Washington Mutual last year.
Geithner Frequently Talks To Select Group Of Bankers
Even during his most frenzied days, when Congress is demanding answers or the president himself is calling, Treasury Secretary Timothy Geithner makes time to talk to a select group of powerful Wall Street bankers. They are a small cadre of businessmen who have known and worked with Geithner for years, whose multibillion-dollar companies all survived the economic crisis with help from U.S. taxpayers.
When they call, Geithner answers. He has spoken with them immediately after hanging up with President Barack Obama and before heading up to Capitol Hill, between phone calls with senators and after talking with the Federal Reserve chairman, according to a review by The Associated Press of seven months of his appointment calendars. The calendars, obtained by the AP under the Freedom of Information Act, offer a behind-the-scenes glimpse at the continued influence of three companies – Citigroup Inc., JPMorgan Chase & Co. and Goldman Sachs Group Inc. – whose executives can reach the nation's most powerful economic official on the phone, sometimes several times a day.
There is nothing inherently wrong with senior Treasury Department officials speaking regularly with industry executives, or even with the secretary keeping tabs on the market's biggest players, even though critics say Geithner risks succumbing too much to these bankers' self-interested worldview. "It's appropriate for Treasury officials to keep in touch with those who work in the markets every day, particularly when the economy and the markets are so fragile," Treasury spokesman Andrew Williams said.
What the calendars show, however, is that only a select few can call the treasury secretary. After one hectic week in May in which the U.S. faced the looming bankruptcy of General Motors and the prospect that the government would take over the automaker, Geithner wrapped up his night with a series of phone calls.
First he called Lloyd Blankfein, the chairman and CEO at Goldman. Then he called Jamie Dimon, the boss at JPMorgan. Obama called next, and as soon as they hung up, Geithner was back on the phone with Dimon. While all this was going on, Geithner got a call from Rep. Xavier Becerra, a California Democrat who serves on committees that help set tax and budget policies. Becerra left a message.
In the first seven months of Geithner's tenure, his calendars reflect at least 80 contacts with Blankfein, Dimon, Citigroup Chairman Richard Parsons or Citigroup CEO Vikram Pandit. Geithner had more contacts with Citigroup than he did with Rep. Barney Frank, D-Mass., the lawmaker leading the effort to approve Geithner's overhaul of the financial system. Geithner's contacts with Blankfein alone outnumber his contacts with Sen. Christopher Dodd, D-Conn., chairman of the Senate Banking Committee.
Partly this is explained by the extraordinary clout of these companies. Goldman, JPMorgan and Citigroup are among the dominant players on Wall Street. Their executives can move not just markets but entire economies. Treasury invested heavily in all of them to keep the industry afloat. But size does not tell the whole story. Treasury has a huge financial stake in North Carolina-based Bank of America Corp., but CEO Ken Lewis appears on Geithner's calendars only three times. Morgan Stanley CEO John Mack also appears three times.
Geithner's relationship with Goldman, JPMorgan, Citigroup and their executives dates to his tenure as president of the Federal Reserve Bank of New York. As one of Wall Street's top regulators, Geithner worked closely with executives and built relationships he brought with him to his corner office at the Treasury Department. The prominence of those relationships is clear by the company they keep on Geithner's calendars.
On March 24, just after Geithner announced plans to help banks sell off toxic debts left over from the housing market meltdown – which stood to be a boon for big banks – his calendars reflect a busy morning. He had a briefing on terrorism financing, a meeting on tightening financial regulations and a prep session for congressional testimony. Geithner emerged to take just three phone calls, from Vice President Joe Biden, New York Attorney General Andrew Cuomo and shortly before heading to Capitol Hill, from Dimon. Officials at JPMorgan, Citigroup and Goldman had no comment on Geithner's calendars.
Geithner's predecessor at Treasury, Henry Paulson, similarly kept in close touch with Wall Street power brokers. Though his calendars showed many contacts with bankers at the height of the banking crisis, they showed frequent calls with Blankfein at key times. Paulson came to Treasury from Goldman. At the New York Fed and then at Treasury, Geithner helped put together multibillion-dollar taxpayer bailouts for Wall Street investment firms, including Goldman, JPMorgan and Citi. Even banks that have repaid the money still enjoy massive subsidies. Their quick returns to record profits and million-dollar bonuses sparked outrage.
Critics said the government was too quick to help the banks and was unwilling to let them suffer the consequences of their bad bets. Geithner's calendars could contribute to the perception that the treasury secretary is too close to Wall Street, said Simon Johnson, a former chief economist with the International Monetary Fund and professor at the Massachusetts Institute of Technology's Sloan School of Management. "Your worldview in the middle of a crisis depends on whom you talk to and what their perspective is, and you need a broad cross-section of opinions to truly understand what's happening," Johnson said.
By seeking information from such a narrow group of contacts, Johnson said, Geithner risks limiting his exposure to the views of his trusted banker colleagues. Geithner must believe he can set aside their inherent biases, he said, adding, "I don't see how you do that."
Despite Housing Slump, Mortgage Lenders Making Record Profits From Fees
Never ones to let an opportunity go unexploited, mortgage lenders are taking advantage of a market fueled by low interest rates and massive government subsidies to turn record profits. Their secret: The return of "junk fees." The Mortgage Bankers Association recently announced that independent mortgage lenders made an average profit of about $1,100 per loan originated in the first quarter of the year, an astonishing 635 percent increase from the previous quarter.
Nine big mortgage lenders, representing about two-thirds of the market, made about $9.1 billion in the first six months of the year off loan originations, according to Inside Mortgage Finance, a leading trade publication that collects data from lenders. In 2008, those lenders made about $3.3 billion for the whole year. Meanwhile, real estate agents, consumer advocates and mortgage researchers say consumers are paying more than ever in fees, typically tacked on at the end of the transaction. Though rarely more than a few thousand dollars, the fees, multiplied by every homeowner trying to refinance an existing mortgage and every prospective home buyer taking on a new one, can add up to billions in undeserved profits, experts say.
"There's been a return of fees -- originating fees, underwriting fees, processing fees -- fees you haven't seen in years," says Guy Cecala, publisher of Inside Mortgage Finance. "There are roughly 12 to 20 fees you wouldn't have seen as recently as two to three years ago. But lenders can charge them, so they're charging them. "This is the greatest period in recent memory for generating income," he adds. The rate of profits per loan has nearly doubled from last year, according to Inside Mortgage Profitability, an Inside Mortgage Finance publication.
"You do wonder what's going on here," says House Financial Services Committee member Brad Miller (D-N.C.). "Is this a case of the mortgage industry making great profits, at a time when consumers are suffering, yelling the sky is falling when in fact they're doing quite well? I'm more concerned that the banks are misrepresenting the true picture." Realtor Rose L. Harris, owner of Re/Max Elite Properties in Coral Gables, Fla., says she sees fees on every loan. "I see a lot of junk fees," she says. "Even for people who have really good credit and qualified down payments... they are being charged a lot of extra fees."
Cecala points to several factors behind the resurgence of fees. Among them: fewer lenders, which means less competition. Many of the biggest lenders have gone out of business. "Mortgage lending used to be very competitive," Cecala says. "There were lots of different players, and the competition kept prices low.... But now, if you want a loan you pretty much have to accept the lender's terms... You can't play them off one another." Also, brokers no longer play such a big role in the mortgage industry. In 2005, brokers were responsible for 31 percent of all mortgages, Cecala says; in the second quarter of this year, they had 15 percent of the market. With fewer brokers demanding a piece of the pie, lenders are keeping more of the profit.
Then there's the issue of the massive government subsidies designed to spur lending, resulting in low interest rates for mortgages. With rates so low, lenders can tack on extra fees without it being as noticeable, Cecala says. Ironically, the fact that government-supported mortgage giants Fannie Mae and Freddie Mac now back four out of every five new mortgage loans has made the process for lenders much easier. "We live in an automated mortgage processing environment," Cecala says. He notes that Fannie- and Freddie-backed loans require little more than a few clicks of the mouse on the part of the lender. "If you type in Fannie or Freddie, the system will tell you whether it's a go or not," he says.
The Mortgage Bankers Association points out that much of its profit numbers were the result of refinancings of existing mortgages, thanks to low interest rates. "Refinancings tend to be good for consumers because they often reduce their mortgage rate," MBA spokesperson Carolyn Kemp wrote in an e-mail. "The first quarter [of 2009] was a period of high refinancing volume so many consumers were taking advantage of lower interest rates." Norma Garcia, a senior attorney with Consumers Union, calls attention to Bank of America's profits. The bank made about $3.3 billion off mortgage originations through June, and another $2.8 billion off servicing mortgages (essentially collecting payments), according to Inside Mortgage Profitability.
Garcia notes the bank's abysmal record at modifying troubled mortgages -- it has modified just seven percent of eligible loans under the government's $75 billion loan modification program -- and its bailout haul -- the federal government has committed $45 billion in taxpayer money to the bank. "They're keeping the money for themselves," Garcia says. "Given the need for credit, is it fair for them to be making these profits?"
Home Builders to Push for Tax-Credit Extension
The home-builder industry will make a strong pitch for extending the $8,000 first-time home-buyer tax credit and expanding it beyond first-timers at a U.S. House hearing Wednesday. The National Association of Home Builders will argue the credit has helped to stabilize the housing market and also boost the broader economy, according to prepared testimony.
"The economic stimulus created by established households moving into new homes and the added construction necessary to answer demand where there is no excess supply generates jobs, wages, salaries, business income and tax revenues," Joe Robson, an Oklahoma home builder, will say in prepared remarks on behalf of the NAHB to the House Small Business Committee.
The home-builder group is pushing to extend the credit through Dec. 1, 2010, and open it to all people buying a primary residence. It estimates that this would boost home sales by nearly 400,000 next year, creating nearly 350,000 jobs. The credit is set to expire Nov. 30 of this year. The panel also will hear from other groups, such as the National Association of Realtors, that support extending the credit.
Pamela Volm, the president of a Maryland construction company, will say in prepared remarks that the tax credit should be extended because it is helping to keep construction workers employed. "New buyers purchasing homes would mean millions upon millions of dollars injected into local businesses and the communities in which they are located," Ms. Volm will say.
The Mortgage Bankers Association supports expanding eligibility for the tax credit and also wants to increase its size to $15,000. The trade group, in a statement submitted to the panel, argues its proposal will help to combat a glut of homes in certain parts of the country. "In simple terms, demand is not keeping up with the current supply. MBA supports tax initiatives that would encourage home purchase activity," the group says in the statement.
The Housing Tax Credit: NAHB Projections and more
by Calculated Risk
From the NAHB:Extending the credit through Nov. 30, 2010 and making it available to all purchasers of a principal residence would result in an additional 383,000 home sales ...The NAHB has also been arguing to expand the tax credit from $8,000 to $15,000. But using $8,000 per home buyer - and estimating 5 million home sales over the next year - the total cost of the tax credit would be $40 billion.
According to the NAHB this would result in 383,000 additional home sales. Dividing $40 billion by 383 thousand gives $104,400 per additional home sold!
That is higher than my original estimate that an extension of the tax credit would cost about $100 thousand per additional home sold.
Note: If the NAHB meant $15,000 per home buyer, the cost would be $75 billion - or $157 thousand per additional home sold.
And this doesn't include the costs of the unintended consequences.
The tax credit is simply motivating some renters to become homeowners (not reducing the overall number of excess housing units). This is pushing up the vacancy rent, pushing down rents and leading to more commercial real estate (CRE) defaults and foreclosures - and will lead to more losses for lenders. The additional defaults associated with lower rents will probably be higher than the cost of the tax credit. From the WSJ: Fed Frets About Commercial Real Estate[Fed economist] Mr. Conway's presentation painted a bleak picture of the sliding real-estate values and enormous debt that will need to be refinanced in the next few years. Vacancy rates in the apartment, retail and warehouse sectors already have exceeded those seen during the real-estate collapse of the early 1990s, Mr. Conway noted. His report also predicted that commercial real-estate losses would reach roughly 45% next year. Valuing real estate has always been tricky for banks, and the problem is particularly acute now because sales activity is practically nonexistent.
More than half of the $3.4 trillion in outstanding commercial real-estate debt is held by banks.
Motivating some renters to become homeowners has increased demand at the low end and pushed up house prices (more demand). However when the tax credit eventually ends (it will someday), the price-to-rent ratio will equalize, applying downward pressure on home prices. Many of the additional sales in 2009 were to buyers who used the tax credit as their downpayment. These were marginal buyers who haven't proven the ability to manage their finances and save for a down payment. The default rates will probably be higher for these buyers than for other buyers. The housing tax credit raises the risk of deflation. Falling rents will probably already push core CPI close to zero in 2010. An extension of the housing tax credit will probably push rents down further (as those 383,000 additional home buyers move from renting to owning), and that will probably mean core CPI will be negative in 2010. Not only will this impact any program adjusted by CPI (like Social Security), but this could lead to a deflationary mentality for consumers - with consumers holding off purchases waiting for lower prices.
Anyone analyzing the tax credit should call the economists at the BLS and ask about how falling rents will impact owners' equivalent rent and CPI. Then call the economists at the Federal Reserve and ask how CPI deflation will impact consumer behavior and monetary policy. Welcome to the Fed's nightmare.
Mortgage Crisis Shuffles Toward Fancier Neighborhoods
Has all the good news dribbling in from the housing front masked a new crisis? New home sales have risen for five months now, the latest Case-Shiller figures say prices are rising and homebuilders like Toll Brothers and Pulte Homes are seemingly off the critical list. But as the market stabilizes nationally, affluent neighborhoods around the country could soon be in for a jolt. The reason: super-sized mortgages.
According to Credit Suisse First Boston, interest charges on $118 billion worth of "jumbo" mortgages--big ones, generally over $417,000, that Fannie Mae and Freddie Mac are allowed to buy--will shift from fixed-rate to floating-rate in the next three years. They're not all in trouble, of course. If benchmark interest rates stay low, as many analysts expect, some homeowners could see their mortgage payments drop a bit. So concern about standard jumbo ARMs has been muted.
But looming behind these ordinary jumbos, there's a worrisome, wealthy man's subprime crisis in the works. Many of the well-off took out "option-ARM" or "Alt-A" loans. The attraction: Little or no proof of income to qualify for the loans and, often, artificially low payments for five years after they were granted. Problem is, these loans demand higher catch-up payments in later years so even if rates fall, monthly bills will rise.
Now at least $354 billion of these loans will reset soon. Many who took out these alternative loans assumed they could avoid the higher payments by refinancing once their incomes or the values of their homes rose. But that hasn't happened. And the numbers are scary: 75% of option-ARM holders are paying less than the full interest charges on their mortgages, with the difference added to principal that they must start paying on reset. The pain could be especially acute next summer, when the dollar value of option-ARM and Alt-A loans resetting will be double the amount it was last August.
"The less-than-interest option attracted everyone but especially business owners who wanted more capital and people moving to wealthy areas who couldn't otherwise afford to," says Mark Hanson of real estate consultancy M. Hanson Advisors. Within 10 miles of Mill Valley in wealthy Marin County, Calif., 35% of 600 homes in foreclosure (average appraised value: $860,000; average net equity: -$98,000) were financed with option-ARM loans, Hanson says. This time next year, he adds, "time bombs will be going off everywhere."
Most vulnerable are rich towns in California and Florida, where more than half of these loans reside. In the areas around San Francisco and Naples, Fla., a quarter of fixed-to-floating jumbos are scheduled to reset in the next year, according to First AmericanCorelogic. In the Washington, D.C., area and towns around Stamford in wealthy Fairfield County, Conn., more than one-third are resetting over the next two.
Homeowners facing higher payments next year might try refinancing, but many now owe more than their homes are worth (73% of interest-only loans are underwater) and so banks are understandably reluctant to toss a lifeline. In Moraga, Calif., a tony San Francisco suburb where home prices average $926,000, mortgage broker Cory Reid says more than 100 homeowners have sought his help refinancing this year. But with home values down 20% from the peak, he says, banks aren't jumping. Prices could fall another 20%, he fears, as people who can't afford higher payments start selling homes.
In well-off Darien, Conn., where prices have fallen maybe 25%, broker Timothy Sickinger has gotten calls from anxious locals wanting to refinance too. While making big salaries and taking out seven-figure mortgages, many residents didn't save much, he says, which could trigger sales when those mortgages reset next year. It's always likely, of course, that many affluent homeowners will be able to scrape together enough money to pay higher mortgages. But if enough of them struggle to do so the economy's comeback could pause. The top 20% U.S. earners, after all, account for 60% of consumer spending.
Fed Frets About Commercial Real Estate
Banks in the U.S. "are slow" to take losses on their commercial real-estate loans being battered by slumping property values and rental payments, according to a Federal Reserve presentation to banking regulators last month. The remarks suggest that banking regulators are girding for a rerun of the housing-related losses now slamming thousands of banks that failed to set aside enough capital during the boom to cushion themselves when the bubble burst.
"Banks will be slow to recognize the severity of the loss -- just as they were in residential," according to the Fed presentation, which was reviewed by The Wall Street Journal. A Fed official confirmed the authenticity of the document, prepared by an Atlanta Fed real-estate expert who is part of the central bank's Rapid Response program to spread information about emerging problem areas to federal and state banking examiners throughout the U.S.
While the Sept. 29 presentation by K.C. Conway doesn't represent the central bank's formal opinion, worries about the banking industry's commercial real-estate exposure have been building inside the Fed for months. "More pain likely lies ahead for this sector and for those banks with heavy commercial real estate exposures," New York Fed President Bill Dudley said in a speech Monday.
In another sign that many U.S. financial institutions are inadequately protected against potential losses on commercial real-estate loans, banks with heavy exposure to such loans set aside just 38 cents in reserves during the second quarter for every $1 in bad loans, according to an analysis of regulatory filings by The Wall Street Journal. That is a sharp decline from $1.58 in reserves for every $1 in bad loans from the beginning of 2007.
The Journal's analysis includes more than 800 banks that reported having more half of their loans tied up in commercial real-estate, ranging from apartments to office buildings to warehouses. Loan-loss reserves typically rise and fall during any credit cycle, being drawn down as losses mount. Some analysts and investors say the recession combined with inadequate loan-loss provisions when times were good have left banks dangerously vulnerable to the deteriorating commercial real-estate market.
Mr. Conway's presentation painted a bleak picture of the sliding real-estate values and enormous debt that will need to be refinanced in the next few years. Vacancy rates in the apartment, retail and warehouse sectors already have exceeded those seen during the real-estate collapse of the early 1990s, Mr. Conway noted. His report also predicted that commercial real-estate losses would reach roughly 45% next year. Valuing real estate has always been tricky for banks, and the problem is particularly acute now because sales activity is practically nonexistent.
Some of the banks with especially low levels of loan-loss reserves are teetering. Capmark Bank, based in Midvale, Utah, and owned by commercial real-estate finance firm Capmark Financial Group Inc., had 11 cents in reserves for every $1 in bad loans it reported in the quarter ended June 30, the Journal analysis shows. A Capmark spokeswoman said in a statement that the amount of loans written off by the bank, totaling $357 million as of June 30, "should be taken into account when evaluating possible future losses."
Capmark's parent company, owned by investors led by private-equity firm Kohlberg Kravis Roberts & Co., warned last month that a bankruptcy filing could be imminent and said regulators intend to order Capmark Bank to raise capital and improve its liquidity. Capmark Bank got a $600 million capital infusion from its parent company in late September. These days, many U.S. banks have adopted a policy of extending loans when they come due even if they wouldn't make those loans now. In some cases, values of the underlying property have fallen below the amount of the loan.
"There's been an extend-and-pretend philosophy by banks to forestall hits to their balance sheets that might occur," says Patrick Phillips, new chief executive of the Urban Land Institute, a real-estate industry group.
Matthew Anderson, a partner at research firm Foresight Analytics, adds: "It's like taping paper over a hole in the wall." Last month's Fed presentation supports criticisms that banks have been slow to take losses on bad commercial real-estate loans. The value of commercial real-estate loans as recorded by banks has declined at a much slower rate than property values since 2005. But banks have been slow to absorb losses on their loans partly due to "capital preservation" concerns, the report states.
Bank examiners are stepping up their scrutiny of commercial real-estate portfolios at U.S. banks. Michael Stevens, senior vice president of regulatory affairs at the Conference of State Bank Supervisors, said regulators are reviewing greater volumes of commercial real-estate loans than they did before the financial crisis erupted. Commercial real-estate loans are the second-largest loan type after home mortgages. More than half of the $3.4 trillion in outstanding commercial real-estate debt is held by banks.
The Fed presentation states that the most "toxic" loans on bank books are so-called interest-only loans, which require borrowers to repay interest but no principal. Those loans "get no benefit from amortization," the report states. "Today, most of the borrowers are paying because interest rates are so low, but the question is whether the loans will get paid off when they come due," said Michael Straneva, global head of Ernst & Young's transaction real-estate practice.
Regulators are zeroing in on banks that use interest reserves to mask bad construction loans. When such loans are made, banks typically calculate interest that would be paid and set that money aside, basically paying themselves until the loan becomes due or the property generates cash flow. Regulators want to make sure banks don't have a false sense of security only because the interest reserve is paying the loan. Banks need to look at "the sources of repayment" to determine whether the loan will get repaid, says Darryle Rude, supervisor of industrial banks at the Utah Department of Financial Institutions.
According to Foresight Analytics, more than 40 U.S. banks have been hit so far this year with enforcement actions by regulators that include alleged misuse of interest reserves. Some banks with unusually low levels of loan-loss reserves based on the Journal analysis said those figures reflect their decision to aggressively write off hopeless loans. "We've tried to both build up our charge-offs and reserves," says David Shearrow, chief risk officer of United Community Banks Inc. About 80% of the Blairsville, Ga., bank's problem loans have been charged down to a level where the bank thinks it can sell them.
The Most Toxic Loans in Commercial Real Estate
Not all commercial real-estate loans are created equal. In Wednesday’s Journal we reported that U.S. banks have been "slow" to take losses on battered commercial real-estate loans, according to a Federal Reserve presentation to banking regulators last month. So which are the most toxic loans? The answer will sound familiar to anyone who’s followed the subprime mortgage meltdown. The Fed presentation points to Interest-only loans, held by banks or repackaged into securities, as the most poisoned piece of the commercial real-estate pie.
Interest-only loans allow borrowers to pay only the interest on the loan for a set period of time but no principal. A lot of these loans were made at the market peak, get no benefit from amortization and have seen a decline of more than 45% in the values of the properties backing the loans, the Fed presentation notes. As a result, borrowers with these loans likely will a hard time refinancing when they come due. From 2010 through 2013, about $175 billion of five-year interest-only loans bundled into CMBS will mature, but that figure would be much bigger when it comes to interest-only commercial loans held by banks. "CMBS dollar amount is low compared to bank ‘IO’ problem," says the Fed report, referring to interest only.
Another interesting point made by the Fed presentation is that while commercial real estate is continuing to decline, the reason for the drop is shifting. Up until now, values have dropped about 30% from the peak primarily because of the evaporation of capital and a massive recalculation of risk within the industry, it says. Buyers are demanding much lower prices and higher yields to compensate for the risk they’re taking on.
But now, lower rents and higher vacancies also are dragging down values, the presentation notes, predicting another 10% to 15% decline in 2010.
U.S. Consumer Credit Fell By $12 Billion in August
U.S. consumer credit fell in August for a seventh straight month as banks maintained restrictive terms and job losses made households reluctant to borrow. Consumer credit fell by $12 billion, or 5.8 percent at an annual rate, to $2.46 trillion, according to a Federal Reserve report released today in Washington. Credit dropped by $19 billion in July, less than previously estimated. The series of declines is the longest since 1991.
Labor Department figures last week showed there were more job cuts than forecast in September and the jobless rate kept rising. The data prompted President Barack Obama to say he’s working to "explore any and all additional measures" to spur growth, and underscored forecasts for the Federal Reserve to keep its benchmark interest rate near zero through next year. "Demand for credit has just gone through the floor," said Ellen Zentner, senior macro economist at Bank of Tokyo- Mitsubishi UFJ Ltd. in New York. "Households are in paying- down-debt mode, they’re not in the mode of taking on new debt."
Economists had forecast consumer credit would drop $10 billion in August, according to the median of 36 estimates in a Bloomberg News survey. Projections ranged from a decline of $15 billion to an increase of $6.2 billion. The Fed initially said consumer credit decreased a record $21.6 billion in July. Stocks, which were little changed most of the day, rallied late as bank shares climbed following an analyst’s upgrade. The Standard & Poor’s 500 Index increased 0.3 percent to close at 1,057.58. Treasury securities rose, sending the yield on the benchmark 10-year note down to 3.18 percent at 5:16 p.m. in New York from 3.26 percent late yesterday.
Revolving debt, such as credit cards, decreased by $9.91 billion in August, the Fed report showed. Non-revolving debt, including loans for automobiles and mobile homes, fell by $2.07 billion. The Fed’s report doesn’t cover borrowing secured by real estate. The category that covers car loans fell at a slower pace as the government’s "cash for clunkers" program helped push up personal spending in August by the most since October 2001. Purchases jumped at a 1.3 percent annual rate in August, the Commerce Department said Oct. 1. The gain included a 5.8 percent increase in inflation-adjusted spending on durable goods such as autos, furniture and other long-lasting items. Incomes climbed 0.2 percent for a second month in August and inflation decelerated, the report showed.
The clunkers program, which expired Aug. 24, helped boost auto sales to a 14.1 million annual rate in August, the highest in more than a year. Auto sales dropped 35 percent in September, to a 9.2 million pace, according to Bloomberg data. "Outside of the cash-for-clunkers spending frenzy, which inherently may have required a purchaser to take out a loan, the decline in consumer credit would have continued to accelerate in August," Bank of Tokyo-Mitsubishi UFJ’s Zentner said. "Come September, we’ll see consumer credit pick up its old trend and continue to drop" at an accelerating pace.
Economists surveyed last month by Bloomberg estimated consumer spending increased at a 1.7 percent rate in the third quarter, while saying it will ease to a 1 percent pace in the last three months of the year as government stimulus measures fade and unemployment continues to rise. The U.S. has lost 7.2 million jobs since the start of the recession in December 2007. That is the biggest decline since the Great Depression. Payrolls fell by 263,000 in September following a 201,000 drop the prior month, while the unemployment rate rose to 9.8 percent, the highest since 1983.
"Growth will likely not be strong enough" to reduce the jobless rate "quickly," and other labor indicators "paint a bleaker picture," New York Fed President William Dudley, said in a speech Oct. 5. U.S. credit-card defaults surged to a record in August as unemployment rose to the highest in a quarter century, Fitch Ratings said Oct. 1. Write-offs for loans deemed uncollectible climbed to 11.52 percent, compared with 10.55 percent in July, according to Fitch’s Prime Credit Card Charge-off Index. Loans at least 30 days delinquent, an indicator of future losses, "remained elevated" at around 5.5 percent, Fitch said.
Card issuers have struggled with rising defaults as the recession drove up unemployment. Credit-card write-offs typically track the U.S. jobless rate. The percentage of soured loans surged at the biggest U.S. card lenders, including JPMorgan Chase & Co., Bank of America Corp. and Citigroup Inc., the banks reported in federal filings on Sept. 15. Even so, recent data have shown manufacturing, housing and services are stabilizing, helping to boost stock prices and bolstering Americans’ finances. Household wealth rose by $2 trillion in the second quarter, the first increase in almost two years, according to the Fed’s Flow of Funds report on Sept. 17.
American Express Co., the biggest U.S. credit-card issuer by purchases, said Sept. 24 it plans to reverse compensation cuts made earlier this year because the economy is on the mend. A memo sent to the New York-based company’s employees from Chief Executive Officer Kenneth Chenault cited "a somewhat more positive outlook about economic conditions in the coming months." Chenault also said "the challenges we face are far from over," pointing to "stubbornly high" unemployment, lower consumer spending and decreases in home prices. "We are likely to see a prolonged period of slow economic growth."
Compassion Is No Reason to Delay Foreclosure, Appeals Court Tells Judge
A Florida appeals court has told a judge that "benevolence and compassion" are not grounds for delaying a foreclosure sale. "Although granting continuances and postponements are, generally speaking, within the discretion of the trial court, the ‘ground' of benevolence and compassion … does not constitute a lawful, cognizable basis for granting relief to one side to the detriment of the other," the court said in its opinion.
The appeals court ruled in the case of a Florida couple, Joseph and Blanca Doyle, who owned an 8,300-square-foot home, the Daily Business Review reports. The Republic Federal Bank obtained a $2.5 million foreclosure judgment against the Doyles in November 2008, nine months after initially filing suit. Miami-Dade Circuit Judge Valerie Manno Schurr delayed the foreclosure sale by a month to allow the couple time to sell the home. "Everybody knows that we are in a bad time right now, and I hate to see anybody lose their home," Schurr explained.
The extension would have given the couple enough time to file for bankruptcy outside a six-month moratorium on a new filing issued by a federal judge who tossed their initial bankruptcy petition as frivolous, the story says. The bank’s lawyer, Charles Rosenberg of Carlton Fields, told the Daily Business Review that "the immediate reason we filed was because of their abuse of the bankruptcy system." The appeals court noted the Florida statute governing foreclosure sales imposes a deadline that was contravened by Schurr’s ruling. "The continuance thus constitutes an abuse of discretion in the most basic sense of that term," the court said.
Cash for Trash: Better Never than Late
The following was written by Linus Wilson, a finance professor at the University of Louisiana at Lafayette, the media’s go-to guy on calculating the value of transactions between the government and the banks [..]
The U.S. government does few thing better than create debt. After a year of talking about it, the government is going to have the chance to throw their good debt, Treasury bills notes and bonds, after bad, non-performing toxic loans and securities. The Federal Deposit Insurance Corporation (FDIC) and the U.S. Treasury are going their separate ways on their cash for trash schemes at this point. Accountants and investors should be wary of the big prices they see coming from the FDIC’s auctions, but taxpayers should be afraid of the U.S. Treasury’s efforts to re-inflate the securitization bubble.
The FDIC is nearing the century mark of bank failures this year and it has a lot of bad assets to unload. On Tuesday, October 6, 2009, it announced that it sold a $4.5 billion, festering pool of condo loans from the failed lender Corus Bank. The last 10-Q for the failed Chicago lender said that it had $3.3 billion in non-performing loans with heavy concentrations in busted condo markets of Miami and Los Angeles. Yet, zero-coupon, FDIC-guaranteed debt and a billion dollar line of credit led to the price of $2.8 billion. That price of about 60 percent of par seems rich when almost 70 percent of the loans are non-performing. A few weeks earlier the FDIC did its first Legacy Loans Program auction.
My paper "Slicing the Toxic Pizza: An Analysis of FDIC’s Legacy Loan Program for Receivership Assets" found that the nearly 6-to-1 government subsidized leverage in the first Legacy Loans Program sale boosted prices by over 20 percent. Yet, the irony is that these subsidies don’t help the FDIC and ultimately taxpayers because the FDIC is offering cheap financing to sell assets it already owns. Any higher prices just offset the subsidized financing if the auctions are competitive. Yet, any marks obtained from these auctions are certainly inflated.
The Legacy Securities Program run by the U.S. Treasury with an initial taxpayer outlay of $30 billion is set to launch soon. More asset managers are closing their investment funds every week. The problem with the Legacy Securities Program is that the government will probably use cheap leverage to finance the sale of trash assets that it does not already own. That means that the taxpayer subsidies are enjoyed by the banks selling the assets. My research shows that the most troubled banks will be reluctant to part with their toxic securities. Yet, the healthy banks will be all too eager to unload those assets at inflated prices. Come Halloween the U.S. Treasury will be handing out the goodies. Unfortunately, taxpayers will be getting none of the treats but all of the cavities.
Obama under fire over falling dollar
The falling US dollar is giving ammunition to the critics of the Obama administration and fuelling broader concerns about the potential erosion of America’s reserve currency status. The depreciation of the US dollar is sparking growing jitters among critics of the Obama administration over the potential loss of America’s reserve currency status. Economists point out that a declining dollar could prove a boon to the US economy in the absence of credible anxiety over inflation.
Republican politicians have highlighted the dollar’s slide as evidence of waning US power. Sarah Palin, the former vice-presidential Republican candidate, on Wednesday sought to link the dollar decline to rising US indebtedness and dependence on foreign oil. "We can see the effect of this in the price of gold, which hit a record high today in response to fears about the weakened dollar," she wrote on her Facebook site.
With other nations also expressing concern about dollar weakness, the administration is at pains to emphasise that it understands the responsibilities that come with issuing the world’s reserve currency and will live up to them. "It is very important to the United States that we continue to have a strong dollar," Tim Geithner, Treasury secretary, said at the weekend. "We recognise that the dollar’s important role in the system conveys special burdens and responsibilities on us and we are going to do everything necessary to make sure we sustain confidence."
Angst about the dollar – which has fallen 11.5 per cent on a trade-weighted basis over the past six months – extends beyond ideological conservative political circles. Last week, Robert Zoellick, president of the World Bank, warned that "the United States would be mistaken to take for granted the dollar’s place as the world’s predominant reserve currency." Much of today’s debate echoes the traditional political response in the US whenever the currency depreciates. But it is now accompanied by warnings from America’s creditors, many of which are widely rumoured to be eyeing large purchases of US real assets such as property and companies.
"The dollar has always been a testosterone issue among America’s political classes," said Norm Ornstein, a veteran analyst at the conservative American Enterprise Institute. "This time there may be a legitimate debate to be had over the dollar’s reserve status, but Sarah Palin is not qualified to participate in it." While the latest swoon in the dollar is attracting attention, analysts say that it needs to be put in context. In trade-weighted terms, the dollar is essentially back to where it was at the start of the financial crisis on August 9, 2007, according to Federal Reserve data.
While the price of gold has gone up, financial market measures of inflation expectations have not. The yield on the 10-year note was trading at 3.18 per cent on Wednesday. Indeed, analysts say that the dollar’s slide stems more from investors’ growing appetite for risk and the prospects of interest rate rises elsewhere. "The first order reason for the decline in the dollar has been the normalisation of markets," said Ken Rogoff, a Harvard professor and former IMF chief economist. "The financial crisis probably has brought forward the day when the dollar is no longer dominant – but maybe from 75 years to 40 years."
Asian countries step in to support dollar
Asian central banks intervened heavily in the currency markets on Thursday to slow the slide of the US dollar amid growing concern about the potential impact on the region’s export driven economies. Traders said most of the Asian central banks had been buying US dollars, with the Bank of Korea among the most active following a round of intervention by Seoul earlier in the week. Other central banks identified by traders as significant buyers of US dollars included Thailand, Malaysia, Taiwan and Singapore, which is a frequent market participant because of its managed currency regime. In Hong Kong, the Chinese territory’s central bank said it had injected HK$8.525bn into the financial system to prevent the currency from rising beyond its fixed trading band against the US dollar.
The central bank intervention appeared to have been triggered by a fresh wave of dollar selling by investor concerns about weak consumer credit figures in the US. Upward pressure on Asian currencies increased as Australia released strong employment growth numbers only two days after becoming the first G20 central bank to raise interest rates since the beginning of the global financial crisis. The dollar came under fresh pressure across the board on Thursday. The euro rose 0.4 per cent to $1.4745 against the US currency, while the yen rose 0.2 per cent to Y88.47. Against a basket of traded currencies the dollar fell 0.6 per cent to 76.008, close to the lowest level of the year.
However, traders said the central bank intervention appeared to be aimed at controlling the pace at which the US dollar declines rather than an attempt to stop Asian currencies appreciating. "I don’t think this is just notional, but I don’t think they are massively intervening either," said Adam Gilmour, a Citigroup managing director who is co-head of the bank’s Asia Pacific foreign exchange and derivatives businesses. "I think they are just trying to slow down the movement. I don’t get the impression that anybody is trying to draw a line in the sand."
Ashiok Chawla, India’s finance secretary, said that New Delhi would not intervene to weaken the rupee "as long as the movement is not volatile and takes place based on fundamentals within a sort of range and moves two-ways." There was confusion about the intentions of the Bank of Japan, which appeared not to have entered the market, although the yen strengthened to Y88.22 to the dollar in Tokyo, from Y88.61 in New York on Wednesday. In Taiwan, analysts and traders said there were clear signs that the central bank had intervened to keep the island’s currency below the psychological barrier of 32 Taiwan dollars to the US dollar. The Taiwan currency closed in Taipei at T$32.137.
In Bangkok the Thai central bank confirmed that it had intervened to soften the rise of the baht, which has appreciated 4.5 per cent so far this year to hit a 14-month high of Bt33.29 to the dollar on Thursday. "Some days its strength is beyond economic fundamentals," Suchada Kirakul, an assistant governor at the Bank of Thailand, told reporters. "The baht is strong and we are still taking care of it." In was unclear whether the Indonesian central bank had intervened in response to pressure from prominent local business people for action to prevent the rupaih from rising too far too fast .
Debt-Market Paralysis Deepens Credit Drought
A year after Washington rescued the big names of American finance, it’s still hard to get a loan. But the problem isn’t just tight-fisted banks. The continued disarray in debt-securitization markets, which in recent years were the source of roughly 60 percent of all credit in the United States, is making loans scarce and threatening to slow the economic recovery. Many of these markets are operating only because the government is propping them up.
But now the Federal Reserve has put these markets on notice that it plans to withdraw its support for them. Policy makers hope private investors will return to the markets, which imploded during the financial crisis. The exit will require a delicate balancing act, government officials said. "You do it incrementally, where and when you think you can, and not sooner," said Lee Sachs, a counselor to the Treasury secretary, Timothy F. Geithner.
The debt-securitization markets finance corporate loans, home mortgages, student loans and more. In good times, they enabled banks to package their loans into securities and resell them to investors. That process, known as securitization, freed banks to lend even more money. Many investors have lost trust in securitization after losing huge sums on packages of subprime mortgages that had high default rates. The government has since spent more than $1 trillion trying to restore the markets, with mixed success.
Until more of the securitization market revives, or some new form of financing takes its place, a wide range of loans needed to secure a lasting economic recovery will remain elusive, experts said. "Given the imperative for securitization markets to fuel bank lending, we won’t have meaningful economic growth until securitization markets are re-established," said Joseph R. Mason, a professor of banking at Louisiana State University. Mr. Sachs agrees: "It’s very important these markets come back to get credit to businesses and families who need it, and also as a sign of confidence."
Enormous swaths of this so-called shadow banking system remain paralyzed. Depending on the type of loan, certain securitization markets have fallen 40 to 100 percent. A once-thriving private market in securities backed by home mortgages has collapsed, from $744 billion in 2005, at the peak of the housing boom, to $8 billion during the first half of this year. The market for securities backed by commercial real estate loans is in worse shape. No new securities of this type have been issued in two years.
"The securitization markets are dead," said Robert J. Shiller, the Yale University economist and housing expert who predicted the subprime collapse. The government is supporting them, he said, but it’s unclear what will happen when it extricates itself. "We’re stuck," he said. Despite the running problems, federal officials hope to start weaning the securitization markets off government support next spring. The Federal Reserve has spent about $905 billion buying government-guaranteed mortgages in an effort to keep mortgage rates low. It will continue buying until it reaches its target of $1.25 trillion.
Complicating the Fed’s plan, banks — the other source of credit next to the securitization markets — continue to rein in lending, according to data from the Federal Reserve. And next year, banks face accounting rule changes and capital requirements that could further restrict their ability to make loans. To be sure, certain corners of the securitization market are percolating again, thanks to the government’s Term Asset-Backed Securities Loan Facility, or TALF, which provides attractive financing for investors who buy the securities.
Bonds backed by consumer debt — credit card debt, auto loans and some student loans — are being issued at costs close to those before the financial crisis, an indication that the market is functioning again. But the program applies only to borrowers with stellar credit. It does not cover credit card debt or auto loans for people with blemished credit histories. "The market is coming back, but a lot of it is because of TALF," said Hyun Song Shin, a Princeton economist who studies securitization. "The big question is, Will the private issuance market stand on its own two feet without TALF, or has there been a fundamental change in the market that it is somehow hobbled permanently?"
That question is hard to answer as long as the government is dominating certain securitization markets. So far, the Fed has been most aggressive in supporting the market for mortgage-backed securities, which plays a crucial role in housing finance. The Fed is virtually the only buyer for these instruments, purchasing about $905 billion worth of government-guaranteed mortgage-backed securities through mid-September. Industry analysts estimate that is about 80 to 85 percent of the market.
"This is public support," said George Miller, executive director for the American Securitization Forum, which represents the industry. "At the end of the day, the mortgage risk is held by the taxpayer." Investors are particularly concerned about the commercial real estate market. A big worry is that $50 billion of securitized commercial property loans are due to be refinanced in the next year. If that can’t be done, a toxic mix of declining property prices and maturing loans could lead to fresh losses at many banks.
"If there’s no mechanism, those properties will default," said Arnold Phillips, who oversees mortgages and structured securities for the $50 billion in fixed-income investments managed by the California Public Employees’ Retirement System. As long as the market remains closed, banks will be reluctant to make loans for commercial real estate, since they would have to hold on to them, rather than package them into securities. Meanwhile, the programs the government has started have not changed securitization practices that many investors say were a cause of the financial crisis. Lawmakers remain concerned that when securitization comes back, it does so in a way that doesn’t put the financial system at risk.
"Our challenge is to have a robust securitization process that adds value to the economy and doesn’t undermine it," said Senator Jack Reed, Democrat of Rhode Island and chairman of the Banking Subcommittee on Securities, Insurance and Investment. He plans to hold a hearing on securitization next month to find out why consumers and businesses are still having so much trouble getting loan
US Jobless Claims Decrease in Latest Week
In a positive sign for the labor market, the number of U.S. workers filing new claims for jobless benefits decreased more than economists expected last week. Total claims lasting more than one week, meanwhile, also declined. Initial claims for jobless benefits fell by 33,000 to 521,000 in the week ended Oct. 3, the U.S. Labor Department said in its weekly report. The last time initial claims were this low was on January 3. The previous week's level was revised from 551,000 to 554,000. Economists surveyed by Dow Jones Newswires had expected a decrease of only 11,000.
The four-week moving average of new claims, which aims to smooth volatility in the data, also fell by 9,000 to 539,750 from the previous week's revised figure of 548,750. The last time the four-week moving average was this low was on January 17. Thursday's weekly claims figures come just one week after the Labor Department issued a grim report showing that U.S. employers eliminated more jobs than expected in the month of September and the unemployment level had surged to 9.8%. The report said that non-farm payrolls declined by 263,000 in September, with the largest job losses occurring in the construction, manufacturing, retail trade and government sectors. Economists surveyed by Dow Jones Newswires survey had expected a 175,000 decrease.
Despite the fact that initial claims fell last week by a larger amount than expected, they still remain at a fairly elevated level. The high level of claims coupled with the results in the September jobs report both appear to suggest that the labor market may take some time to heal. Economists at JP Morgan Chase & Co. wrote in an economic analysis last week that claims generally appear to be on a downward trend, but the pace at which they are falling is a bit sluggish.
"The drop has been somewhat slow relative to other large recessions," the economists wrote last week. "Initial jobless claims have fallen 18% in the 26 weeks since they peaked. In the same time span, jobless claims fell by 23% after the 1975 recession, 33% after the 1980 recession, and 29% after the 1982 recession. Claims are usually a good predictor of employment, and the slowness of their decline could indicate a sluggish recovery in the labor market."
In the Labor Department's Thursday report, the number of continuing claims -- those drawn by workers for more than one week in the week ended Sept. 26 -- fell by 72,000 to 6,040,000 from the preceding week's revised level of 6,112,000. That represents the lowest figure since March 28.
The unemployment rate for workers with unemployment insurance for the week ended Sept. 26 also fell down to 4.5% -- a decrease of one percentage point from the prior week's unrevised rate of 4.6%. The largest increases in initial claims for the week ending Sept. 26 were in California, Ohio, Illinois, Missouri and Tennessee. The largest decreases in initial claims were in New York, North Carolina, Arkansas and Florida.
U.S. bank M&A slump seen for many more months
The U.S. banking sector will see more consolidation, but any pickup in unassisted deals may not happen before the end of next year, with auctions of failed banks dominating activity in the coming months, bankers said on Tuesday. New regulations, need for capital, overcapacity in the industry and stronger banks going on the offensive will drive independent mergers eventually, but that would play out over years, not quarters, industry executives and advisors said at the SNL Bank M&A Symposium in New York.
"M&A activity has clearly slowed," KeyCorp Chief Executive Henry Meyer said. "But I think we will see things pick up again, maybe as early as the end of next year. Maybe it will be 2011 and beyond." For now, though, auctions of failed banks by the Federal Deposit Insurance Corp (FDIC) are likely to dominate M&A activity in the banking industry. Meyer and two of his fellow panelists, New York Community Bancorp Chief Executive Joseph Ficalora and People's United Bank Chief Executive Philip Sherringham, said they were all eyeing banks in FDIC-run auctions.
"There is still such uncertainty in the marketplace in terms of taking on somebody else's problems," Meyer said. "We are really in a wait-and-see mode." Many bankers and investors seem to be focused on FDIC deals and don't want to consider unassisted transactions even if the circumstances make sense, said Joseph Moeller, a managing director at Keefe, Bruyette & Woods. "There seems to be a borderline unhealthy focus on FDIC-assisted deals," said Moeller, who spoke at a separate panel of investment bankers earlier in the day.
The traditional mergers and acquisitions market has come to a halt, Moeller said, adding that his investment bank had been active in raising capital for companies. "We do expect, given the credit uncertainty, to see a lot more capital raising by banks over the next 12-18 months," said Brian Sterling, co-head of investment banking at Sandler O'Neill & Partners, who was on the panel with Moeller.
In his keynote address earlier, Sullivan & Cromwell Chairman Rodgin Cohen said some obstacles to deal-making could be removed with the right regulatory action and creative deal structures. External constraints such as accounting rules that can increase the losses an acquiring bank has to realize on a target's loans after the deal and regulatory restrictions on acquisitions by weaker banks and private equity firms were hindering deals, Cohen said. Cohen, who was involved in most of last year's financial institutions deals, also said some of the concerns about losses from a bank being purchased could be addressed with deal structures, where the ultimate payout to the target's shareholders depends on how the bank performs over a few years.
Fiddling with accounting rules won't fix the banks
The financial crisis has reinvigorated a debate on the effectiveness of our accounting and regulatory frameworks. This column shows that banks, hoping to preserve their book capital, use accounting discretion to systematically understate the impairment of their real-estate-related assets. But the accounting reforms announced thus far are exacerbating the gap between book and market values.
The current global financial crisis has reinvigorated a debate on the effectiveness of the existing accounting and regulatory frameworks for banks. Questions abound, ranging from adequate capitalisation levels of banks to the boundaries of financial regulation (see Financial Stability Forum, 2008). Part of the debate on financial reform centres around the information required from banks for effective market discipline and supervisory action. This includes not only thinking on the required level of detail on disclosure of bank assets and liabilities but also on their valuation techniques and the appropriateness of current accounting rules more generally (for a survey, see Laux and Leuz, 2009).
Downturns encourage banks to use accounting discretion to overstate the value of distressed assets. Accounting techniques do not generally generate large differences between the book and market value of bank assets. At times of financial crisis when asset markets become distressed, however, large differences between book and market value of assets may arise, especially when assets are carried based on historical cost. Such differences may give rise to incentives for banks to use accounting discretion to preserve their book value, for example, by using advantageous asset classifications or valuation techniques. As a consequence, discretion in accounting rules allows banks to legitimately disguise underlying balance sheet stresses. Overstated book values of bank assets may further give rise to undue regulatory forbearance.
Is the book value of banks’ capital inflated?
During the ongoing financial crisis, large differences have indeed arisen between market and book values of US banks, as their market values have sharply eroded on the expectation of major writedowns and losses on real estate related assets.
- By the end of 2008, more than 60% of US bank holding companies had a market-to-book value of assets ratio of less than one, compared to only 8% of banks at the end of 2001.
- Over the same period, the average ratio of Tier 1 capital to bank assets stayed constant at about 11%. The market value of bank equity thus dropped precipitously against a backdrop of virtually constant book capital.
This raises doubts about the relevance and reliability of banks’ accounting information – the two main criteria on the basis of which accounting systems are evaluated – at a time of financial crisis.
There is reason for concern. In a new paper, we show that banks use accounting discretion to systematically understate the impairment of their real-estate-related assets in an effort to preserve book capital, especially following the onset of the current financial crisis (Huizinga and Laeven, 2009). Three pieces of compelling evidence support the thesis that banks use accounting discretion to overstate the book value of capital.1. Banks’ balance sheets overvalue real-estate-related assets compared to the market value of these assets.
We estimate significant market discounts on banks’ real estate loans starting in 2005, averaging about 10% in 2008. As the typical US bank holds over 50% of its assets in the form of real estate loans, the implicit discount in loan values goes a long way toward explaining the current depressed state of bank share prices. Investors started discounting banks’ holdings of mortgage-backed securities (MBS) in 2008. For that year, the average discount on these assets was 24%. Even MBS that are carried at fair value appear to be significantly overvalued on the books of the banks.2. Banks with large exposure to MBS experience large excess returns when fair-value accounting rules are relaxed.
Beginning in mid-2008, there were increased pressures to grant banks more leniency to determine the fair value of illiquid assets such as thinly traded MBS to prevent these fair values from reflecting fire sale prices.
- Correspondingly, on 10 October2008 the Financial Accounting Standards Board (FASB) clarified the allowable use of non-market information for determining the fair value of financial assets when the market for that asset is not active.
- Subsequently, on 9 April 2009, the FASB announced a related decision to provide banks greater discretion in the use of non-market information in determining the fair value of hard-to-value assets.
As expected, the stock market on both occasions cheered the banks’ enhanced ability to maintain accounting solvency in an environment of low transaction prices for MBS. Using an event study methodology, we find that banks with large exposure to MBS experienced relatively large excess returns around both announcement dates, indicating that these banks in particular are expected to benefit from the expanded accounting discretion.3. Banks use accounting discretion regarding the realisation of loan losses and the classification of assets to preserve book capital.
Banks have considerable discretion in the timing of their loan loss provisioning for bad loans and in the realisation of loan losses in the form of charge-offs. Thus, banks with large exposure to MBS and related losses can attempt to compensate by reducing the provisioning for bad debt. We indeed find that banks with large portfolios of MBS report relatively low rates of loan loss provisioning and loan charge-offs. We also examine banks’ choices regarding the classification of MBS as either held-to-maturity or available-for-sale, distinguishing between MBS that are guaranteed or issued by a government agency and those that are not.
In 2008, the fair value of non-guaranteed MBS tended to be less than their amortised cost. This implies that banks could augment the book value of assets by classifying MBS as held-to-maturity. Indeed, we show that the share of non-guaranteed MBS that were denoted held-to-maturity increased substantially in 2008. Classification of this kind is also advantageous for banks whose share price is depressed on account of large real-estate-related exposures. Consistent with this, we find that the share of MBS kept as held-to-maturity is significantly related to both real estate loan and MBS exposures. Moreover, these relationships are stronger for low-valuation banks.
Banks’ balance sheets offer a distorted view of the financial health of the banks
Taken together, these results indicate that banks are currently using considerable accounting discretion regarding the categorisation of assets, valuation techniques, and the treatment of loan losses. Accounting discretion appears to be used by banks to soften the impact of the financial crisis on the book valuation of their assets. While some accounting discretion is unavoidable as accounting systems in part are mechanisms for firms to reveal asymmetric information to investors and other outside parties, accounting discretion entails the risk of generating highly inaccurate accounting information during downturns such as the present financial crisis. Inaccurate accounting information in the case of banks can be especially harmful, as it may lead to regulatory forbearance with concomitant risks for tax payers. In the present financial crisis, the financial statements of banks appear to overstate the book value of assets to the point of becoming misleading guides to investors and regulators alike.
Vested interests are pushing for changes that erode the value of fair value accounting. The outcomes of stress tests of major US banks conducted by the US Treasury in 2009, which calculated capital shortfalls at several major banks, are testimony to the fact that publicly available accounting information at the time provided an inadequate picture of the health of the concerned banks. Thus, the present crisis can be seen as a “stress test” of the accounting framework that reveals that book valuation need not always reflect the best estimate of asset value, especially at a time of sharp declines in market values. Accounting reforms announced so far, however, seem to go in the opposite direction of increasing the gap between book and market values. This is testimony that bank interests weigh heavily in this debate.
Saudi Prince Tells U.S.: Dump Citigroup Stock, Now
One of Citigroup’s largest individual investors, Prince Alwaleed bin Talal, exhorted U.S. regulators to sell their shares in the mega bank quickly, according to the magazine Emerging Markets. As DS News reported last month, Citigroup has already approached the federal government to work out a strategy for reducing its 34 percent stake in the bank. That move followed action by other banks, like Wells Fargo, that have sought to reverse instances of government intervention that came along with taxpayers’ stimulus funds.
Citi accepted a total of $45 billion in bailout funding from the government under the Troubled Asset Relief Program. In return, the company signed over 7.7 billion shares of preferred stock to the feds – shares whose dividend payments must be honored by the bank before it can pay returns to any other shareholders.
Prince Alwaleed said that situation was bad for private investors and the economy at large. "The earlier the U.S. government exits its investments in those companies, the better," the influential Saudi billionaire said in his magazine interview, published on Sunday. "We need to give confidence back to the shareholders and investors that these companies are moving along without government support."
Alwaleed’s investment firm, Kingdom Holding Company, initially owned a 3.6 stake in Citigroup before agreeing to pump more capital into the storied financial institution in late 2007. In his interview, he said he expected the bank to operate at a profit as early as next year and to regain its standing as a market leader. "Citigroup has learned a huge lesson," he said. "The worst is behind them right now."
GM Falls Short on Some Goals, CEO Says
General Motors Co. hasn't met several significant goals it planned to achieve by year's end, including work- force reductions and the sale of failing brands, Chief Executive Frederick "Fritz" Henderson told reporters and analysts Wednesday. Mr. Henderson outlined progress made by GM in the 90 days since it emerged from bankruptcy protection. He also announced that Mark LaNeve, GM's sales chief and longtime executive, is leaving for a job at an unidentified company. Mr. LaNeve headed sales and marketing until Mr. Henderson restructured the management team and put former product head Bob Lutz in charge of marketing.
Mr. Henderson said GM is on track to meet cash flow and cost-reduction targets, though he didn't elaborate. GM will release financial results for the third quarter in mid-November, he said. Also on schedule are plans to shrink GM's U.S. dealership network. The company has reduced North American production to what Mr. Henderson said is an acceptable level. GM's global market share rose slightly in the third quarter compared to the first half of this year, he said, though the figure is still below last year's.
However, GM has about 10,000 more U.S. workers than it planned to have by the end of 2009 after buyout programs for hourly and salaried programs fell short. GM aimed to have 64,000 workers. GM also missed a Sept. 30 goal of finalizing a deal to sell the Hummer truck brand to a Chinese manufacturer. And a plan to sell Saturn to Penske Automotive Group fell through after Penske failed to find a company to build the vehicles once GM stops making them, though Mr. Henderson said the development won't hurt GM's restructuring.
GM also is racing to complete the sale of a majority stake in its Opel European unit to a consortium let by Canadian parts maker Magna International Inc. Mr. Henderson said Magna and GM remain in concessionary talks with European labor groups. Meantime, the company's sales have suffered amid a global sales slump, and GM lost two percentage points of market share in the critical U.S. market. Mr. Henderson said the company's market share remains slightly ahead of the conservative estimates the company made early this year when laying out its restructuring plan.
"We are knocking some of these things off and staying focused on getting the rest of these matters behind us before the end of the year," Mr. Henderson said. "We are quite confident we will come out of this with a competitive cost structure." Mr. Henderson faces intense pressure from GM's new chairman and the U.S. government--the company's new majority owner--to stem the sales slide and improve GM's financial performance. The move to publicize its restructuring moves contrast with the more buttoned-up strategy of Chrysler Group LLC.
Chrysler, which also reorganized in bankruptcy court and like GM is partly owned by the U.S. government, has said little about its recovery efforts. However, Chrysler CEO Sergio Marchionne on Wednesday said he will publicly release details of his five-year revival plan for the company on Nov. 4. The briefing, to be held at Chrysler's headquarters in Auburn Hills, Mich., will outline product plans and the new image focus for the Chrysler, Jeep and Dodge brands.
The End of Fish
Our oceans have been the victims of a giant Ponzi scheme, waged with Bernie Madoff–like callousness by the world’s fisheries. Beginning in the 1950s, as their operations became increasingly industrialized--with onboard refrigeration, acoustic fish-finders, and, later, GPS--they first depleted stocks of cod, hake, flounder, sole, and halibut in the Northern Hemisphere. As those stocks disappeared, the fleets moved southward, to the coasts of developing nations and, ultimately, all the way to the shores of Antarctica, searching for icefishes and rockcods, and, more recently, for small, shrimplike krill. As the bounty of coastal waters dropped, fisheries moved further offshore, to deeper waters. And, finally, as the larger fish began to disappear, boats began to catch fish that were smaller and uglier--fish never before considered fit for human consumption. Many were renamed so that they could be marketed: The suspicious slimehead became the delicious orange roughy, while the worrisome Patagonian toothfish became the wholesome Chilean seabass. Others, like the homely hoki, were cut up so they could be sold sight-unseen as fish sticks and filets in fast-food restaurants and the frozen-food aisle.
The scheme was carried out by nothing less than a fishing-industrial complex--an alliance of corporate fishing fleets, lobbyists, parliamentary representatives, and fisheries economists. By hiding behind the romantic image of the small-scale, independent fisherman, they secured political influence and government subsidies far in excess of what would be expected, given their minuscule contribution to the GDP of advanced economies--in the United States, even less than that of the hair salon industry. In Japan, for example, huge, vertically integrated conglomerates, such as Taiyo or the better-known Mitsubishi, lobby their friends in the Japanese Fisheries Agency and the Ministry of Foreign Affairs to help them gain access to the few remaining plentiful stocks of tuna, like those in the waters surrounding South Pacific countries. Beginning in the early 1980s, the United States, which had not traditionally been much of a fishing country, began heavily subsidizing U.S. fleets, producing its own fishing-industrial complex, dominated by large processors and retail chains. Today, governments provide nearly $30 billion in subsidies each year--about one-third of the value of the global catch--that keep fisheries going, even when they have overexploited their resource base. As a result, there are between two and four times as many boats as the annual catch requires, and yet, the funds to "build capacity" keep coming.
The jig, however, is nearly up. In 1950, the newly constituted Food and Agriculture Organization (FAO) of the United Nations estimated that, globally, we were catching about 20 million metric tons of fish (cod, mackerel, tuna, etc.) and invertebrates (lobster, squid, clams, etc.). That catch peaked at 90 million tons per year in the late 1980s, and it has been declining ever since. Much like Madoff’s infamous operation, which required a constant influx of new investments to generate "revenue" for past investors, the global fishing-industrial complex has required a constant influx of new stocks to continue operation. Instead of restricting its catches so that fish can reproduce and maintain their populations, the industry has simply fished until a stock is depleted and then moved on to new or deeper waters, and to smaller and stranger fish. And, just as a Ponzi scheme will collapse once the pool of potential investors has been drained, so too will the fishing industry collapse as the oceans are drained of life.
Unfortunately, it is not just the future of the fishing industry that is at stake, but also the continued health of the world’s largest ecosystem. While the climate crisis gathers front-page attention on a regular basis, people--even those who profess great environmental consciousness--continue to eat fish as if it were a sustainable practice. But eating a tuna roll at a sushi restaurant should be considered no more environmentally benign than driving a Hummer or harpooning a manatee. In the past 50 years, we have reduced the populations of large commercial fish, such as bluefin tuna, cod, and other favorites, by a staggering 90 percent. One study, published in the prestigious journal Science, forecast that, by 2048, all commercial fish stocks will have "collapsed," meaning that they will be generating 10 percent or less of their peak catches. Whether or not that particular year, or even decade, is correct, one thing is clear: Fish are in dire peril, and, if they are, then so are we.
The extent of the fisheries’ Ponzi scheme eluded government scientists for many years. They had long studied the health of fish populations, of course, but typically, laboratories would focus only on the species in their nation’s waters. And those studying a particular species in one country would communicate only with those studying that same species in another. Thus, they failed to notice an important pattern: Popular species were sequentially replacing each other in the catches that fisheries were reporting, and, when a species faded, scientific attention shifted to the replacement species. At any given moment, scientists might acknowledge that one-half or two-thirds of fisheries were being overfished, but, when the stock of a particular fish was used up, it was simply removed from the denominator of the fraction. For example, the Hudson River sturgeon wasn’t counted as an overfished stock once it disappeared from New York waters; it simply became an anecdote in the historical record. The baselines just kept shifting, allowing us to continue blithely damaging marine ecosystems.
It was not until the 1990s that a series of high-profile scientific papers demonstrated that we needed to study, and mitigate, fish depletions at the global level. They showed that phenomena previously observed at local levels--for example, the disappearance of large species from fisheries’ catches and their replacement by smaller species--were also occurring globally. It was a realization akin to understanding that the financial meltdown was due not to the failure of a single bank, but, rather, to the failure of the entire banking system--and it drew a lot of controversy.
The notion that fish are globally imperiled has been challenged in many ways--perhaps most notably by fisheries biologists, who have questioned the facts, the tone, and even the integrity of those making such allegations. Fisheries biologists are different than marine ecologists like myself. Marine ecologists are concerned mainly with threats to the diversity of the ecosystems that they study, and so, they frequently work in concert with environmental NGOs and are often funded by philanthropic foundations. By contrast, fisheries biologists traditionally work for government agencies, like the National Marine Fisheries Service at the Commerce Department, or as consultants to the fishing industry, and their chief goal is to protect fisheries and the fishermen they employ. I myself was trained as a fisheries biologist in Germany, and, while they would dispute this, the agencies for which many of my former classmates work clearly have been captured by the industry they are supposed to regulate. Thus, there are fisheries scientists who, for example, write that cod have "recovered" or even "doubled" their numbers when, in fact, they have increased merely from 1 percent to 2 percent of their original abundance in the 1950s.
Yet, despite their different interests and priorities--and despite their disagreements on the "end of fish"--marine ecologists and fisheries scientists both want there to be more fish in the oceans. Partly, this is because both are scientists, who are expected to concede when confronted with strong evidence. And, in the case of fisheries, as with global warming, the evidence is overwhelming: Stocks are declining in most parts of the world. And, ultimately, the important rift is not between these two groups of scientists, but between the public, which owns the sea’s resources, and the fishing-industrial complex, which needs fresh capital for its Ponzi scheme. The difficulty lies in forcing the fishing-industrial complex to catch fewer fish so that populations can rebuild.
It is essential that we do so as quickly as possible because the consequences of an end to fish are frightful. To some Western nations, an end to fish might simply seem like a culinary catastrophe, but for 400 million people in developing nations, particularly in poor African and South Asian countries, fish are the main source of animal protein. What’s more, fisheries are a major source of livelihood for hundreds of million of people. A recent World Bank report found that the income of the world’s 30 million small-scale fisheries is shrinking. The decrease in catch has also dealt a blow to a prime source of foreign-exchange earnings, on which impoverished countries, ranging from Senegal in West Africa to the Solomon Islands in the South Pacific, rely to support their imports of staples such as rice.
And, of course, the end of fish would disrupt marine ecosystems to an extent that we are only now beginning to appreciate. Thus, the removal of small fish in the Mediterranean to fatten bluefin tuna in pens is causing the "common" dolphin to become exceedingly rare in some areas, with local extinction probable. Other marine mammals and seabirds are similarly affected in various parts of the world. Moreover, the removal of top predators from marine ecosystems has effects that cascade down, leading to the increase of jellyfish and other gelatinous zooplankton and to the gradual erosion of the food web within which fish populations are embedded. This is what happened off the coast of southwestern Africa, where an upwelling ecosystem similar to that off California, previously dominated by fish such as hake and sardines, has become overrun by millions of tons of jellyfish.
Jellyfish population outbursts are also becoming more frequent in the northern Gulf of Mexico, where the fertilizer-laden runoff from the Mississippi River fuels uncontrolled algae blooms. The dead algae then fall to a sea bottom from which shrimp trawling has raked all animals capable of feeding on them, and so they rot, causing Massachusetts-sized "dead zones." Similar phenomena--which only jellyfish seem to enjoy--are occurring throughout the world, from the Baltic Sea to the Chesapeake Bay, and from the Black Sea in southeastern Europe to the Bohai Sea in northeastern China. Our oceans, having nourished us since the beginning of the human species some 150,000 years ago, are now turning against us, becoming angry opponents.
That dynamic will only grow more antagonistic as the oceans become warmer and more acidic because of climate change. Fish are expected to suffer mightily from global warming, making it essential that we preserve as great a number of fish and of fish species as possible, so that those which are able to adapt are around to evolve and propagate the next incarnations of marine life. In fact, new evidence tentatively suggests that large quantities of fish biomass could actually help attenuate ocean acidification. In other words, fish could help save us from the worst consequences of our own folly--yet we are killing them off. The jellyfish-ridden waters we’re seeing now may be only the first scene in a watery horror show.
To halt this slide toward a marine dystopia, government intervention is required. Regulatory agencies must impose quotas on the amount of fish caught in any given year, and the way they structure such quotas is very important. For example, simply permitting all fisheries to catch a given aggregate number of fish annually results in a wasteful build-up of fleets and vessels as fisheries race to grab as large a share of the quota as possible before their competitors do. Such a system may protect the fish, but it is economically disastrous: The entire annual quota is usually landed in a short period, leading to temporary oversupply, which, in turn, leads to low prices. The alternative is to limit the number of fishermen, with those retaining "access privileges" being able to catch their assigned fraction of the overall quota whenever they want, without competing against other fishermen. Such individual quotas lead to less overall fishing effort and, hence, bigger profit in the fishery.
Unfortunately, most fisheries economists, fixated solely on corporate short-term profits, argue that, for such a system to work, access privileges must (a) be handed out for free, (b) be held in perpetuity, and (c) be transferrable (i.e., sellable and buyable like any other commodity). They call this construct "fishing rights" or "individual transferable quotas." However, there is no reason why a government should not auction off quotas with access privileges. The highest bidder would secure the right to a certain percentage of the quota, with society as a whole benefiting from providing private access to a public resource. This would be similar to ranchers paying--as they do--for the privilege to graze their cattle on federal lands. Grazing "rights" on the other hand, would simply give ownership of public land to ranchers, which is something few would consider.
Some Pollyannas believe that aquaculture, or fish farming, can ensure the health of stocks without government action--a notion supposedly buttressed by FAO statistics showing such rapid growth in aquaculture that more than 40 percent of all "seafood" consumed now comes from farms. The problem with this argument is that China reports about 68 percent of the world’s aquaculture production, and the FAO, which has been burned by inflated Chinese statistics before, expresses doubt about its stated production and growth rates. Outside of China--where most farmed fish are freshwater vegetarians, such as carp--aquaculture produces predominately carnivorous marine fish, like salmon, which are fed not only vegetal ingredients, but also fishmeal and fish oil, which are obtained by grinding up herring, mackerel, and sardines caught by "reduction fisheries." Carnivore farming, which requires three to four pounds of smaller fish to produce one pound of a larger one, thus robs Peter to pay Paul. Aquaculture in the West produces a luxury product in global terms. To expect aquaculture to ensure that fish remain available--or, at least, to expect carnivore farming to solve the problem posed by diminishing catches from fisheries--would be akin to expecting that Enzo Ferrari’s cars can solve gridlock in Los Angeles.
Others believe that fish populations can be rebuilt through consumer awareness campaigns that encourage buyers to make prudent choices. One such approach is to label seafood from fisheries deemed sustainable. In Europe, for example, consumers can look for the logo of the Marine Stewardship Council (MSC), a nonprofit started by the World Wildlife Fund and Unilever, which has a large fish-trading division. At first, the MSC certified only small-scale fisheries, but lately, it has given its seal of approval to large, controversial companies. Indeed, it has begun to measure its success by the percentage of the world catch that it certifies. Encouraged by a Walton Foundation grant and Wal-Mart’s goal of selling only certified fish, the MSC is actually considering certifying reduction fisheries, with the consequence that Wal-Mart, for example, will be able to sell farmed salmon shining with the ersatz glow of sustainability. (Given the devastating pollution, diseases, and parasite infestations that have plagued salmon farms in Chile, Canada, and other countries, this "Wal-Mart strategy" will, in the long term, make the MSC complicit to a giant scam.)
The other market-based initiative, prevalent in the United States, distributes wallet-size cards designed to steer consumers toward fish that the group issuing the cards deems to have been caught sustainably. Their success is considerable if measured by the millions of cards given away, for example, by the Monterey Bay Aquarium, but assessing the impact on the fisheries is difficult. For one thing, the multitude of such cards leads to contradictions and confusion, as the same fish are assessed differently by different organizations. For example, ahi tuna is rated as "safe," "questionable," and "avoid" on the wallet cards issued by three U.S. nonprofits. A bigger issue, however, is that these cards generate only "horizontal" pressure--that is, a group of restaurant-goers might chide each other for ordering the cod filet or might ask the overworked student who served them where the fish came from, but this pressure does not reach wholesalers, fleet operators, or supermarket chains. "Vertical" pressure exerted by environmental NGOs on such decision-makers is far more effective. But, if that’s true, why not directly pressure the government and legislators, since they are the ones who regulate the fisheries?
The truth is that governments are the only entities that can prevent the end of fish. For one thing, once freed from their allegiance to the fishing-industrial complex, they are the ones with the research infrastructure capable of prudently managing fisheries. For another, it is they who provide the billions of dollars in annual subsidies that allow the fisheries to persist despite the lousy economics of the industry. Reducing these subsidies would allow fish populations to rebuild, and nearly all fisheries scientists agree that the billions of dollars in harmful, capacityenhancing subsidies must be phased out. Finally, only governments can zone the marine environment, identifying certain areas where fishing will be tolerated and others where it will not. In fact, all maritime countries will have to regulate their exclusive economic zones (the 200-mile boundary areas established by the U.N. Law of the Sea Treaty within which a nation has the sole right to fish). The United States has the largest exclusive economic zone in the world, and it has taken important first steps in protecting its resources, notably in the northwest Hawaiian islands. Creating, or re-creating, un-fished areas within which fish populations can regenerate is the only opportunity we have to repair the damage done to them.
There is no need for an end to fish, or to fishing for that matter. But there is an urgent need for governments to free themselves from the fishing-industrial complex and its Ponzi scheme, to stop subsidizing the fishing-industrial complex and awarding it fishing rights, when it should in fact pay for the privilege to fish. If we can do this, then we will have fish forever.