The Political Smoke and Mirrors Solution to the Real Estate Crisis

I was very interested to hear what President Bush was going to say this morning concerning the mortgage crisis we are facing in America. I figured it would be more of a political answer than a real solution.

He actually identified the real problem being the adjustable rate mortgage. He also made a point of saying that it was not the government's job to bail out speculators. (read: we are not going to bail-out the homeowners who are in trouble)

The Government cannot just step in and bail out the mortgage crisis. It would be rewarding mortgage companies and banks for being irresponsible and greedy.

He made some references to a few changes that really would not help all of the homeowners who are facing this ominous situation in the future. He basically offered up the political smoke and mirrors solution.

He made a big speech acknowledging the problem. Then assured the America people that they were going to implement some changes that will help solve the problem. It is the political smoke and mirrors answer. In politics, you just have to look like you are solving the problem when really you are just crossing your fingers and hoping it will blow over. (read:Irag)

The mortgage crisis in America will have to work itself out over time. This is the bursting of a major debt bubble with the mortgage crisis being the final phase of the bubble. You don't just take 25 years of debt accumulation and expect that the problem is just going to go away. We will have to go through the "de-tox" process.

An Open Letter to Senator Dodd

Dear Senator Dodd,

I have been listening to your sound bites over the past year and have become quite confused. It appears that you are very concerned about everything that has happened to the homeowner. You have been quick to scream for reform and imply that the Federal Reserve Board should clean up this real estate and mortgage crisis. You seem to be positioning yourself as the Champion of the people during your run for a Presidential bid.

Last week there was a lot of hype over your meeting with Federal Reserve Board President Ben Bernanke and Treasury Secretary Paulson about the foreclosure problem. You held a press conference telling of your position and even suggesting that a hot line has been set-up for people who are in trouble. I will comment on that latter in the letter. First, I want to take a step back and talk about your role in the Senate.

You are currently serving as the Chairman of the Senate Banking Committee. Banks are in trouble. Banks have been at the heart of a great deal of this irresponsible lending. Maybe I am a little uninformed. Wouldn't the Senate Banking Committee have some oversight over the banking system? Are these problems a big surprise to you? Is it reasonable to think that there might be a future problem when lenders are lending money at 100% of the value of the home to people with horrible credit, lending money without verification of income, using teaser rates, and writing loans whose interest rates change over time? Well, maybe I am just taking advantage of the use of hindsight. However, it seemed years ago that this was a train wreck in the making.

It just seems like the Senate banking committee has some role in the supervision of the banking system. Thus, is it reasonable to suggest that a little responsibility could be taken by you and your committee for this mess since it was on your watch?

Now back to this solution. You talked about a number consumers could call. It is a program put together for those who are facing foreclosure. It was a number that had the word HOPE spelled out. After further investigation, I discovered that this number takes the consumer to a hot line for consumer credit counseling. Statistics, personal accounts, and even Congressional testimony conclude that these organizations just make the debt situation much worst.

Senator Dodd, how about some real solutions? How about you and the rest of your colleagues taking some responsibility for this mortgage mess. For those of you elected to the Senate, you are elected to protect the people from this type of thing. Yet, you allowed it to happen for a number of years.

Your ideas are at best band aid approaches. Your HOPE idea is nothing more than leading consumers to the lions den. It sure does sound good as you attempt to secure a bid as Democratic nominee for the President of the United States. Once again, how about some real leadership in Congress? That is the best thing that you can do for the American People who are struggling because Congress conveniently ignored the creation of potentially one of the biggest real estate busts on record.

Senator Dodd Turning Desperate Homeowners over to the “Sharks”

Congress is really scrambling. They just realized (or so they would like for you to believe) that we have a real problem in the housing markets. They are just now acting on the huge foreclosure problem that we are facing in America.

Of course, beyond bailing homeowners out, there is not much they can do to solve the problem. This problem could have been prevented had Congress acted years ago and set up proper regulations for the mortgage lending industry. However, that would not have been a good political solution . After all, those loose lending practices fueled economic growth. So the “party now and worry about the consequences later strategy” is now taking effect.

In a symbolic gesture, Senator Dodd held a press conference to discuss the foreclosure problem in America. He also suggested that the Federal Reserve Board should in a sense bail everyone out of this problem. He also announced that they have set up a program to help people out. He wants to make sure that no one goes through foreclosure. So, he announces a program for anyone that is going through this mess. Just call, 1-888-995-HOPE. This was a hotline for those facing foreclosure.

I called the number. To my disbelief, it was a number for an organization that feeds people into companies in the credit counseling business. Yes, the same industry that Congress investigated in 2004 and came to the conclusion that this industry needed reformed. (which little reform actually occurred following the announcement of their findings)

Senator Norm Coleman who headed up that investigation had this to say in his opening remarks:

“Over the past several years, however, the credit counseling industry has undergone significant changes. New and aggressive credit counseling agencies have changed the manner in which consumers are treated. These changes have resulted in consumer complaints about excessive fees, pressure tactics, non-existent counseling and education, promised results that never come about, ruined credit ratings, poor service, and in many cases being left in worse debt than before they initiated their debt management plan.”

“Make no mistake, these credit counseling agencies were designed to sell a product –the Debt Management Plan—not to deliver a service of education or counseling. “ He even referred to this industry as a bunch of "sharks."

Consumer Credit Counseling is just a part of an industry that markets HOPE and sells problems. I have a numerous examples of how in many cases these services not only make the problem worse but rip people off through the use of excessive fees.

So, this is the solution. The industry that Congress said needed reform and is ripping off consumers is now the answer to the country’s foreclosure problem. Although Senator Dodd has presented many bills to Congress and positioned himself as the Champion of the people when it comes to predatory lending, it appears that all of those presented bills as well as what he is currently doing is nothing more than political positioning and resume building. Talk is cheap until he can actually get something done in Congress. A true consumer champion would never have offered this as a solution.

This "solution" should be viewed as an insult to one’s intelligence. The list is a mile long of why these credit fix solutions are dangerous for consumers. These companies are of no value unless they can actually get the mortgage lender to re-structure the mortgage. It will take an act of Congress for that to happen. (literally and figuratively speaking)

Further Evidence of the Damage in the Credit Markets

Countrywide, your checks are no good! The Cuyahoga County in Cleveland Ohio said that they will no longer accept checks from Countrywide because they are concerned about their financial problems. "We're just trying to protect the assets of the county."

The biggest problem that we have regarding everything that is financial related is loss of confidence. This is how a bear market starts. I talked about this on my radio show yesterday. There is a big category 5 financial hurricane brewing. It might weaken and the damage to the economy and financial markets might be minimal. It might also hit the financial system hard (bear markets and recession)

You just need to know that it is brewing and risk is high.

There is a huge loss of confidence in the system. With the bursting of a debt bubble, you never know what news will come each day. Just be careful with your investments right now.

Ultra-Short Bond Funds in Trouble

This is what happens when debt bubbles burst. The problems start out with the low quality or riskiest debt first. Then it spreads to the higher quality debt.

Ultra-short bond funds also known as money market substitutes, are used by investors who want to attempt to make more interest than a money market or savings account. A little more risk is assumed through the use of these investments. However, they are generally considered to be pretty conservative.

Over the last four weeks, this has been the worst place to be. Apparently, many of these funds are have as part of their portfolios investments in sub-prime debt. How could that have happened? They placed client's money into investments that were rated high quality. How sub-prime debt could ever be rated high quality is beyond me.

One fund in particular is -6.26% over the last 4 weeks. This particular fund which has been opened since 1992 has never lost money.

Just when you think you are playing it safe, you find out otherwise. It is a real good idea to check out your money market account as well as your ultra-short bond funds to make sure that you are not taking unattended risk.

Shades of 1929

Some people get a little irritated when I make references to the great crash of 1929 because:

a) It is different this time.
b) Something like that could never happen again.
c) We are in a super bull market
d) Our economy is much different than in 1929

You can pick your own answer. I keep going back to 1929 because of all of the similarities. This morning Goldman Sachs announced that some wealthy individuals were going to pump in about 3 billion dollars into their failing funds in an effort to save them. It is a "great buying opportunity."

If you go back and read the history books, the exact same thing happened in 1929. The markets were getting into big trouble and a "pool" of investors would go in and buy tons of stock to prop up the stock market. Investors in the 20's would get a feeling of relief knowing that this group of wealthy individuals were pooling together to save the markets. It was the big name people back then and it is the big name investors this time around as well. Besides, what is a few billion among friends?

Now my favorite part of the press release about this influx of capital was the highlights from the Goldman letter sent to the clients (read: individuals losing a lot of money) into their funds. (read:ponzi schemes). Here is the excerpt:

....according to an Aug. 10 letter to clients from Clifford Asness, the firm's founder and managing principal. Asness blamed the losses on the ``strategy getting too crowded,'' rather than the models not working.

In other words, it wasn't our fault that we invested all of your money into sub-prime debt. I would argue the model was terribly flawed from the start.

This is the problem with Wall Street, politicians, the Federal Reserve Board, _____ (fill in the blank) - No one will take responsibility for the irresponsibility that has taken place.

This Isn't a Sub-Prime Problem

The headlines read that the stock market is heading for trouble because of the "sub-prime" mortgage problem. Ben Stein said last weekend that the sub-prime problem is grossly overstated. He points out that sub-prime mortgages make up such a small part of the entire mortgage universe. (I still cannot figure out how an actor turned economic commentator is qualified to give economic analysis.)

Well, that is a relief! That makes for a great soundbite and something that the fox commentators can argue over for an hour while whipping its television audience in the process.

This is a credit problem resulting from a 25 year busting of a credit bubble. This stems from lenders writing irresponsible mortgages to consumsers who could not ultimately afford them. At the root of the problem is the adjustable rate mortgage. These mortgages come due and consumers cannot make their new higher payment. Consumers are dropping like flies and homes are going into foreclosure. Incidentally, 120 billion dollars these loans are coming due the second half of the year.

AIG and Countrywide (the biggest of the biggest mortgage writers) both said in a statement that this is spreading to the prime loans. Adjustable rate mortgages were written on ALL types of loans and in great number. Mortgage lenders were (and still are) selling the American Dream for the low monthly payment.

Now these consumers are in a world of hurt.

So follow the smoke and you will see the problem. Irresponsible lending equals Consumer problems equal high foreclosures equal a worsening of the real estate bust equals problems problems in the credit markets equal problems in the stock market equals problems for the economy.

Good credit, not so good credit, and bad credit. It is all about the bursting of a credit bubble that has been building for 25 years. That is the problem.

My problem with pop culture analysis is that it has no substance. No one on financial television is brave enough to tell the real story. Many of these analysts work for big brokerage companies and have taken the creed. Repeat after me....We are always in a bull market and there are no problems ever. Even when there are problems we are still in a bull market. Bear markets don't exist.

Then some of them are just actors.....Bueller, Bueller, Bueller??

Dow Jones Drop of 387 points - A Mini-Panic?

I really get amused as to what the media writes about the stock market. The AP refers to the drop in the market as a "mini-panic." 387 points sounds like a big drop. That is about a 3% drop in the Dow. If the Dow was extremely negative for the year, I would start using words like panic. However, the Dow is well above normal averages and is positive for the year.

No, I have not turned bullish on things. I think that want we found out this morning in the news concerning banks in France is not good. The credit problem is a global problem. Unfortunately, this is a problem in the credit markets. Every day we can wake up to a new negative surprise.

I cannot stress enough the importance of understanding risk and making sure you are not in a situation where you could lose a ton of money. There are ways to invest in a declining market and make money. If you want more information, send me an e-mail at bob@prudentmoney.com.

My concern is everyone who is listening to financial media such as CNBC or Fox news (which is fair and balanced with everything except for the stock market) who is saying this is no big deal. This is a big deal.

Sub-Prime Mortgages (Predatory Lending) Still Being Marketed

I received an e-mail from a listener about an offer that he received. Now keep in mind, he has a 6.5% 30 year fixed mortgage. This is a good note. However, he called the number on the marketing piece because it sounded like a good deal. This what the note said:

Veterans's Savings Program
You DESERVE the lowest possible payment!
Recent purchase or refinance, OK! (Ask about Cash-Out Options!)
NO APPRAISAL! NOCREDIT QUALIFYING! NO HASSLE!
NO PAYMENTS UNTIL OCTOBER!
YES, WE WILL REPAIR YOUR ESCROW ACCOUNT AND REFUND YOUR CURRENT ESCROW TO YOU!!
NO OUT OF POCKET COST TO YOU!
CALL IF RATE IS HIGHER THAN 5.%

*CALL US TODAY AND SPEAK TO A VA LOAN SPECIALIST!

This has all of the qualities of a sub-prime loan. Plus, they were recommended that he go from a fixed note to an ARM where the interest rate changes in 3 years.

The listener asked the "loan specilist" (read:salesperson) if they had anything dealings with sub-prime loans. He actually denied that they even exercise such practice or suggest such loan to any one.

Predatory lending continues.......

One of the Most Anticipated Fed Meetings in a Long Time

Today the Federal Reserve Board met to determine the direction in interest rates. Due to all of the problems in the credit markets written about week after week on this web-site, the bulls were betting on the Federal Reserve Board bailing out the markets.

Although highly unlikely, they were hoping for an interest rate cut. If not, at least there was hope that the Federal Reserve Board to acknowledge that there is a problem and state that they are open to lowering interest rates.

Unfortunately for the bulls, none of that happened. In fact, the Federal Reserve Board is still aggressively fighting inflation.

Jim Cramer has been screaming every night on his stock show that the Federal Reserve Board should bail everyone out. He literally threw a 3 year old fit on television today following the fed announcement.

There is something that the bulls do not acknowledge in the desperate plea for someone to bail out these problems so the party can continue. The fed has every right to be concerned about inflation. However, it is not the type of inflation that they typically worry about during the meetings. They are worried about ASSET inflation getting out of control.

They cannot afford to lower interest rates here. If they do, the real estate markets will ignite again and a good possibility exists that all assets (Stocks, bonds, real estate, etc) would morph into an incredible out of control bubble environment. (See China) Remember bubbles don’t end very well. It would only be putting off the inevitable.

They cannot afford to ignite the speculative spirits of the markets. Thus they are forced to stay on the sidelines and do nothing.

Unfortunately, the economy is weakening and the real estate markets are making it tougher for the Federal Reserve Board to sit on the sidelines. They have to take the lesser of two evils. They are between the ultimate rock and a hard spot. So, they do nothing.

Only a very desperate situation will motivate the Fed to lower rates.

Desperate for Business?

Every morning the first stop of my business day is http://www.minyanville.com/. In fact, I am at this site all day long. It is the best market analysis site available.

I found this article on the site this morning and just looked at my computer with disbelief. This was the ultimate "insult to intelligence" article. The Overstock.com CEO has an ingenious business plan and motto. "Buy it on overstock, then sell it on E-Bay."

“Our motto is buy it on Overstock, sell it on eBay,” Byrne said on a conference call Tuesday with investors.

"If you compare the prices of the stuff on Overstock, it is cheaper than on eBay for commodity goods and such. In fact, there are people — there are lots of people who make their living buying on Overstock and selling on eBay.”

Let's take a step back for a minute. I want to let you in on a little secret. Instead of buying the merchandise on E-bay, you can buy it direct from Overstock.com and avoid paying the additional money.

This guy is getting paid big bucks for coming up with this game plan. In a conference call to investors, is this the best that he can do? Could this be sign of the times? Is business this tough? If I were a shareholder, I would be concerned.

On a side note, the writer of the above article points out that the advice to buy it at overstock.com and sell it on ebay doesn't even work. Apparantly, the prices are lower on e-bay.