by Anonymous on 9/23/2007 10:50:00 AM

The Washington Post has some excellent advice for you, if you do. My favorite part was making sure you found a job thirty years ago that paid a lifetime pension with health coverage, and you stuck to it like glue. Otherwise, you'll want to look into the strategy of borrowing as much as possible (up to the conforming limit) at 6.50% because after taxes (retiree taxes, no less) you can surely end up ahead by investing your savings elsewhere. And if you're trying to maximize your mortgage interest deduction, why wait for RE prices to come down a bit more?

So a couple of folks with $600,000 in savings and a $20,000 balance on their HELOC (on the "paid off" home) allowed their names to appear in the newspaper. I'd guess by noon they'll have 47 mortgage brokers lined up in the driveway . . .

by Calculated Risk on 9/22/2007 06:01:00 PM

From Bloomberg: U.K. May Insure 100,000 Pounds of Depositor Funds (hat tip FFDIC)

The U.K. government may guarantee as much as 100,000 pounds ($202,000) of people's bank deposits as it seeks to avoid a repeat of the run on Northern Rock Plc, Chancellor of the Exchequer Alistair Darling said.

Currently the official deposit insurance program covers 100% of the first £2,000, and 90% up to £35,000. This is a flawed insurance program, and didn't prevent the bank run at Northern Rock. To stop the bank run, the British government ended up guaranteeing all deposits - talk about encouraging moral hazard!

Although most people think deposit insurance is intended to protect depositors, perhaps a more important reason for insurance is to prevent bank runs and maintain the stability of the financial system.

The problem with the current British system isn't the size of the insured deposit £35,000 (about $70,000) but the coinsurance feature above £2,000. The coinsurance idea is flawed, both in concept and in practice (see Northern Rock). The idea of having relatively small depositors assess the risk of a bank is absurd. In practice, small depositors will just move their deposits to another bank at the slightest hint of trouble.

Many other coinsurance programs work very well. As an example, a co-pay for a doctor's visit lowers the overall cost of medical care. Without a co-pay, some patients overuse the services of doctors (this isn't a discussion of health care, rather an example of a positive aspect of coinsurance). But the purpose of coinsurance for deposit insurance is to encourage the depositor to assess the risk of the institution - something perhaps beyond the capability of most depositors. And even if the depositor has the skill to assess the institution, and the access to adequate information, it is still easier to just move their funds.

There are Moral Hazard and Principal/Agent issues with deposit insurance. For those interested in this topic, I suggest this paper, written in 1999 by George Hanc at the FDIC: Deposit Insurance Reform: State of the Debate. Here is an excerpt on Moral Hazard:

When applied to deposit insurance, the term moral hazard refers to the incentive for insured banks to engage in riskier behavior than would be feasible in the absence of insurance. Because insured depositors are fully protected, they have little incentive to monitor the risk behavior of banks or to demand interest rates that are in line with that behavior. Accordingly, banks are able to finance various projects at interest costs that are not commensurate with the risk of the projects, a situation that under certain circumstances may lead to excessive risk taking by banks, misallocation of economic resources, bank failures, and increased costs to the insurance fund, to solvent banks, and to taxpayers.

Moral hazard is present because (1) a stockholder's loss, in the event a bank fails, is limited to the amount of his or her investment; and (2) deposit insurance premiums have been unrelated to, or have not fully compensated the FDIC for, increases in the risk posed by a particular bank. Moral hazard is particularly acute for institutions that are insolvent or close to insolvency. Owners of insolvent or barely solvent banks have strong incentives to favor risky behavior because losses are passed on to the insurer, whereas profits accrue to the owners. Owners of nonbank companies with little capital also have reason to favor risky activities, but attempts to shift losses to creditors are restrained by demands for higher interest rates, refusal to roll over short-term debt, or, in the case of outstanding longterm bond indebtedness, restrictive covenants required when the bonds were issued.

Probably the most effective counterforce to moral hazard is a strong capital position. Because losses will be absorbed first by bank capital, the likelihood (other things being equal) that they will be shifted to the FDIC diminishes as the capital of the bank increases. In addition, increased capital serves to protect creditors and helps reduce distortions in bank funding costs caused by deposit insurance. Capital regulation, therefore, tends to curb moral hazard, as do other forms of supervisory intervention--specifically the examination, supervision, and enforcement process. Moreover, risk-based capital standards and risk-based insurance premiums attempt to impose costs on banks according to the institutions' risk characteristics.

In the U.S., the insurance premium is based on the FDIC's evaluation of the riskiness of the institution. The FDIC is in a much better position to judge the riskiness of institutions than depositors.

Placing the burden on the depositor defeats the purpose of deposit insurance:

Proposals for exposing depositors to greater risk seek to induce depositors to increase their monitoring of bank risk and, by means of their deposit and withdrawal activity, discipline and restrain risky banks. However, increasing depositors' risk could defeat the very purpose of deposit insurance.

...one should bear in mind the following considerations: (1) the relative cost of acquiring the information and analytical skills needed to monitor bank risk as compared with the cost and/or inconvenience of shifting funds to alternative investments entailing little risk; (2) the ability of depositors (and other market participants) to monitor bank risk effectively on the basis of publicly available data, given the 'opaque' quality of bank loan portfolios; and (3) the threat to the stability of the banking system resulting when potentially ill-informed depositors have greater risk exposure.

If the U.K. is going to offer deposit insurance, my suggestion would be to set the limit to cover the total deposits of say 98% of all depositors (£35,000 might be sufficient), and eliminate the coinsurance feature (insure 100% to £35,000).

by Calculated Risk on 9/22/2007 02:41:00 PM

The WSJ reports: Limits on Fannie, Freddie Could Be Lifted

The top regulator for Fannie Mae and Freddie Mac said limits on both companies' investment portfolios could be entirely lifted in February if they begin filing timely and audited financial statements.
...
The Office of Federal Housing Enterprise Oversight imposed strict limits on the portfolio size at Fannie Mae and Freddie Mac last year after accounting scandals at both companies. ... Neither company has filed timely audited financial statements in several years, though both plan to do so by early 2008.

Ofheo Director James Lockhart said in an interview that much could change between now and February, but he indicated for the first time that the caps could be eased. "There's a reasonable chance that the caps will be lifted or changed significantly" by that time, Mr. Lockhart said.

This is a discussion of removing the portfolio cap limit, not the conforming limit for the size of a loan.

by Anonymous on 9/22/2007 11:59:00 AM

Um . . . because.

by Calculated Risk on 9/22/2007 12:50:00 AM

From the WSJ: Macklowes On a Wire

Mr. Macklowe and his son Billy paid $6.8 billion to buy seven New York buildings from Equity Office Properties Trust. ... the sale was one the most expensive real-estate deals in U.S. history, symbolizing the skyrocketing prices paid for buildings at a time of cheap debt and demand for office buildings.

The transaction was emblematic of the lax underwriting standards of the real-estate boom. Macklowe Properties put in only $50 million of equity and borrowed $7.6 billion, according to the documents. (Mr. Macklowe borrowed more than the purchase price to cover closing costs and other fees.) The deal also had "negative debt service," meaning that the rents from the buildings weren't expected to cover the debt payments for five years ...

Talk about a leveraged transaction: borrowing $7.6 Billion for a $6.8 Billion purchase on properties that have probably declined in value. Approximately $5.0 Billion of the debt must be paid off in February.

by Calculated Risk on 9/21/2007 07:35:00 PM

Wile E. Coyote UPDATE: Video of Paul Krugman interviewed by Georges de Menil on financial markets and global imbalances. (if this doesn't work, go to this page.)

From the Financial Times: Eurozone suffers ‘worst’ jolt since 9/11

The eurozone economy has this month suffered its biggest jolt ... with global financial turmoil hitting the services sector particularly hard, according to a closely watched survey.

The unexpectedly steep fall on Friday in the eurozone purchasing managers’ index – the third consecutive monthly drop ...

... financial markets have started speculating that the next ECB interest rate move will be downwards.

With the Euro at $1.41, and an ongoing credit crunch, it is no surprise that the Eurozone economy is slowing. Yesterday I argued that if the trade deficit has peaked - as seems likely - the dollar is probably much closer to the bottom than the top.

This would be the other side of the coin: with the weak dollar, trade from the Eurozone to the U.S. will slow, impacting the Eurozone economy (although the service sector took the biggest hit in this report). This will probably lead to rate cuts in Europe - and that would also support the dollar at the current level.

by Calculated Risk on 9/21/2007 04:25:00 PM

WSJ: Harman Says Buyout Scuttled

Harman International Industries Inc. learned this afternoon that Kohlberg Kravis Roberts & Co. and Goldman Sachs Group's GS Capital Partners VI Fund LP don't intend to complete their $8 billion buyout of Harman.
...
Harman said the private-equity companies informed [Harman] that they believe there was a "material adverse change" in Harman's business and that Harman breached the merger agreement.

Harman disagrees ...

The breakup fee is $225 Million. Perhaps that is why KKR is arguing Harman breached the merger agreement - to avoid, or at least negotiate, the fee.

by Calculated Risk on 9/21/2007 03:41:00 PM

Here are the Kennedy-Greenspan estimates of home equity extraction for Q2 2007, provided by Jim Kennedy based on the mortgage system presented in "Estimates of Home Mortgage Originations, Repayments, and Debt On One-to-Four-Family Residences," Alan Greenspan and James Kennedy, Federal Reserve Board FEDS working paper no. 2005-41.

Click on graph for larger image.
For Q2 2007, Dr. Kennedy has calculated Net Equity Extraction as $140.3 Billion, or 7.1% of Disposable Personal Income (DPI). Note that equity extraction for Q1 2007 has been revised upwards to $131.3 Billion.

This graph shows the net equity extraction, or mortgage equity withdrawal (MEW), results, both in billions of dollars quarterly (not annual rate), and as a percent of personal disposable income.

It is very likely that MEW will collapse in Q3 2007, based on the tighter lending standards and falling home prices, leading, most likely, to less consumer spending.

by Calculated Risk on 9/21/2007 12:57:00 PM

From the WSJ: HSBC to Close U.S. Mortgage Unit

HSBC PLC will close its standalone U.S. subprime-mortgage business and take $945 million in related charges ...

The London banking giant will close Decision One Mortgage, which originates nonprime mortgages through brokers. Instead, the company will focus on loan origination and servicing through its HFC and Beneficial bank branches.
...
Approximately 750 people will lose their jobs ...

The beat goes on.

by Calculated Risk on 9/21/2007 11:48:00 AM

From Fed Vice Chairman Donald L. Kohn: Success and Failure of Monetary Policy since the 1950s. An excerpt on the causes of the housing bubble:

"... it is far too soon to pass judgment on what went wrong in the U.S. housing market and why. I suspect that, when studies are done with cooler reflection, the causes of the swing in house prices will be seen as less a consequence of monetary policy and more a result of the emotions of excessive optimism followed by fear experienced every so often in the marketplace through the ages. To some extent, too, the amplitude of the housing cycle was heightened by the newness of the subprime market, the fragmentation of regulatory oversight responsibility for that market, and the complexity and opacity of the newer instruments for transforming and distributing risk. Low policy interest rates early in this decade helped feed the initial rise in house prices. However, the worst excesses in the market probably occurred when short-term rates were already well on their way to more normal levels, but longer-term rates were held down by a variety of forces. And similar, sometimes even sharper, trajectories of house prices have been witnessed in some economies in which the central banks said they were paying more attention to asset prices."

Many very lengthy papers will be written on the causes of the bubble. Agree or disagree, Kohn touches on a few key points: monetary policy definitely contributed to the initial surge in prices, lax oversight - Kohn says because of "fragmentation of regulatory oversight responsibility" - allowed the bubble to expand, and speculation played a key role. I'll post on what I consider the key causes this weekend.