Lambertville, NJ A Small Corner of Quiet

Lambertville, NJ is a small town on the New Jersey side of the Delaware River. The other side is New Hope, PA. It presents a quaint calm location with an old restored canal, part of the old Delaware River barge canal and many small shops. Given the economic problems a quiet walk along the River can be settling, so take a few moments of contemplation on the fact that all of this may very well remain no matter what Washington does.

A Little Logic, Perhaps?

The Administration is as per Larry Summers willing to put $50 billion into helping people pay for their mortgages. The Bloomberg reports says:

"Summers, who is director of the White House’s National Economic Council, said the economy will be in for a rough time for a while and that unemployment will continue to rise, even with the stimulus package.

“I fear the economy will probably be showing decline and jobs will probably be being lost for some time going forward,” Summers said. He added that the stimulus will probably prevent the unemployment rate from going above 10 percent, after it reached 7.6 percent in January"

However let us just apply a small bit of logic.

First, assume that a person bought a home at some price, but the issue was that they could pay the mortgage, no matter what the price. It was not the price but the ability to pay the mortgage which was important. If the market value of the home falls then the ability to pay may or may not have changed but that may very well be independent of the value of the house. The person could be ill or could have lost their job, a risk of say 8-10%, and thus could no longer pay. We assume that the lender would factor in such risk. If they factored in 4-5% risk then they suffer an excess loss of 4-5% which may be their profit but would not collapse their Balance Sheet.

Second, if the First assumption is not correct, that is the lender knew ab initio that the borrower could not pay, or the borrower lied and defrauded the lender, or there was collusion by both to defraud the loan buyer such as Freddie Mac, then this is a criminal act, with one or two parties involved. So where is the Department of Justice? Why has not one Lender and not one Borrower been indicted? This applied to Bush as well as Obama.

Third, the current theme is that if one has bought an asset, and one had entered into a legal transaction and one is still able to pay for the debt on the initial purchase, then if the asset is now no longer worth what it was purchased for then one should have the rest of the taxpayers eat the loss and assist that person! Fair, only of you are the current administration. It may buy votes, but frankly it may also cost votes amongst those paying. A dangerous plan.

Is this what Summers is doing? We shall see.

An alternative to this is that we create a Government Home Loan Bank which then takes the mortgage notes at face value, namely for the value of the property at time of purchase less payment on principal. Even better, if the Government Bank could negotiate a haircut on the purchase of a mortgage at risk, it could get a $300,000 mortgage for say $200,000. The Bank then reissues a new mortgage at that value, and for say 3% and 40 years. If the borrower was able to pay the original note then this new Government Home Loan Bank note would be very payable also. Unless of course there was fraud at the outset and then they should and must pay!

Then at the time of sale, if the value of the asset is less than what the note is worth, say the home was originally for $300,000, and the mortgage was at that level as well, but the sale of the house in a fair market price is $225,000, then the Government takes the loss. However if the owners hold the asset for a while, and if the economy improves, then those losses could be de minimis and spread out over time.






Then even better, the Bank would be ahead of the game and the Government could sell shares in the Bank and finally privatize it totally for a handsome profit. Novel idea, no! Imagine the Government managing it so we the taxpayers do not have to pay and in addition we make money! See what happens when you do not just have bureaucrats and academics.

Why not try that rather than paying people to pay the people who created this mess! If there were the slightest bit of honesty anywhere in these loans then this simple plan should work. If not then we are just paying off the Countrywides and their ilk. Pity, just more of our grandchildrens' future down the proverbial rat hole!

Stress Test vs Colonoscopy

Treasury Secretary Geithner said last week:

"First, we're going to require banking institutions to go through a carefully designed comprehensive stress test, to use the medical term. We want their balance sheets cleaner, and stronger. And we are going to help this process by providing a new program of capital support for those institutions which need it.

To do this, we are going to bring together the government agencies with authority over our nation's major banks and initiate a more consistent, realistic, and forward looking assessment about the risk on balance sheets, and we're going to introduce new measures to improve disclosure.

Those institutions that need additional capital will be able to access a new funding mechanism that uses funds from the Treasury as a bridge to private capital. The capital will come with conditions to help ensure that every dollar of assistance is used to generate a level of lending greater than what would have been possible in the absence of government support. And this assistance will come with terms that should encourage the institutions to replace public assistance with private capital as soon as that is possible."

The metaphor of a stress test may result perhaps from some recent event in his personal life but frankly in no ways reflects what he needs to do. A stress test puts the patient under a load, increasing heart rate and cardiovascular output and then seeks to observe electrical aberrations which are reflective of blockages in normal cardiac response. There is no way he could put the patient, in this case the economy under any more stress, otherwise he will be conducting an autopsy. Perhaps the metaphor is more correctly a colonoscopy, which frankly is what needs to be done, see what is in there, for better or worse, remove the polyps, perhaps other lesions and pray for the best.

I have been examining the Balance Sheets of Bank of America and other major institutions. It is more difficult than translating hieroglyphics without a Rosetta Stone. One cannot ascertain what is good or what is bad.

Perhaps a solution is to have the market make that determination, the good old market. The Government could create a floor under the securities with a swap like structure, an insurance policy if you will, that would guarantee a bottom above zero for the packages sold. The Government does not have to buy them but merely insure them at some level, a level well less than the values transacted.

With all of the now unemployed quants on Wall Street perhaps a Draft of quants into a military like service corps would help solve the problem and instill discipline in the quants.

Where is Robespierre When We Truly Need Him?

The Tennis Court Oath, the famous painting by David, depicts the victory, specious as it may have been, of the common people over their King. In many ways this was reflected this week as Congress passed the massive expenditure program and then began to strike out against the perpetrators of the acts, the Bankers. The Dodd amendment which caps salaries, albeit well timed, will have unintended consequences far beyond the good Senators intents, whatever they may have been.

The key question is when do we expect the shy and ruthless lawyer from the sticks, Robespierre, to enter the scene and begin the mass beheadings. Will it be the Fairness Doctrine, will it be choice in medicine, will it be the explosion of taxation and the drying up of all investment capital, perhaps we just eliminate any person with an entrepreneurial tendency.

Friday the 13th: The Shoes are Starting to Drop

Yesterday Charter declared bankruptcy, Chapter 11, and down went $3 billion of their debt. That means that $23 billion of their total liabilities are also most likely gone. Sirius is on the edge and on Tuesday next week they may likely fall flat on their fact as well. We detailed this several months ago as the next set of shoes to drop. We have counted 110 companies averaging $5 billion each in potential default, and reaching almost a total of $1 trillion in high yield default, not to mention the dumping of the equity holders.

We also have said we do not see the end of this mess until the end of 2010. with unemployment exceeding 10.5%. The passing today of the Stimulus Bill may moist likely have little if any effect. It wastes money and does not address the true problem. Christina Romer presented the Obama response to the Stimulus passage and the presentation was like a 5th Grade teacher telling her class about the joys of Tetanus shots, how wonderful they will be not that they may hurt like hell! Between the mercurial and High School debater in Geithner and the happy faced Romer, one is left with a very hollow feeling that we may be getting into real trouble. Where is Larry Summer when we really need him.

A Very Bumpy Road

We opened our portfolio on December 1, 2008 as a way to test the market transition to the Obama Administration. The portfolio was characterized in an earlier blog. We have been tracking it since then and our interest is in seeing how this cross economy package does. Metals, telephone, food, technology, chemicals, retail. A mix of dividend producing stocks in what would be a solid space. All have significant capital needs and all can be predictive of the economy in general.

What do we see a month later, well it is getting worse by the minute. After the Geithner talk today we see a continuing collapse.As we have argued before the economy needs a plan, any plan. The Obama Mantra egging on the HR 1 mass of giveaways, we need it now, like the old "I want my MTV!", seems to be lacking in his own backyard. The banks must be purged, the market must clear, and the lingering uncertainty will just cause further harm. In many ways Geithner appears as some High School Senior in the Debate Team, holding himself erect but lacking any experience and exuding abject terror and not confidence. We need Chuck Yaeger for Treasury and not some fresh pilot trainee.