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Ten Financial Institutions on the Brink?

Mary Kane — Fri, 22 Aug 2008 19:09:34 GMT

Like many people, financial blogger Michael Shedlock has been worried for a while about the stability of the financial system. He's made it clear in Mish's Global Economic Trend Analysis that he thinks banks and lenders are in bigger trouble than they're letting on. Shedlock, an investment advisor for SitkaPacific Capital Management and a contributor to Minyanville, has a strong following. He's not alone in his worries; other financial experts are beginning to say out loud that things are getting pretty scary. Earlier this week, Kenneth Rogoff, the respected former chief economist of the International Monetary Fund, predicted that a large U.S. bank will fail within months, due to the deepening credit crunch. Shedlock is going further, and he's naming names, with a list of ten financial institutions he thinks are close to going under. You can read his post to see why he thinks so, but to save you the suspense, here's the list:

Lehman (LEH)

Washington Mutual (WM)

Fannie Mae (FNM)

Freddie Mac (FRE)

Corus Bank (CORS)

BankUnited (BKUNA)

Downey Savings (DSL)

Wachovia (WB)

Regions Financial (RF)

MBIA (MBI)

Ambac (ABK)

And yes, you counted right; there are 11. Shedlock said he threw in an additional troubled institution because of deflation.

The Reach of Redlining

Mary Kane — Thu, 21 Aug 2008 21:31:56 GMT

This is the second in a two-part series. Part One, Fraud Worsens Foreclosure Crisis, here.

The foreclosure scams that have found a foothold in Prince George's County, Md., these days have a long history. Despite the wealth here, the county has for years been underbanked for its market, with an inadequate number of traditional financial institutions.

There has always been been an opening for predatory lenders, within and without the community, who count on a long-held mistrust of lenders to seal deals made outside the traditional banking system, said Doyle Niemann, a state legislator who represents Prince George's County and who sponsored the state's recent anti-foreclosure fraud law. That's why people sign loan papers brought to their homes; or rely, as many did here, on an ex-police officer turned foreclosure specialist; or trust in recommendations from a friend alone for a mortgage deal.

Illustration by: Matt Mahurin

The mistrust has a long history. When the Federal Housing Admin. was created in 1930s, loans were specifically prohibited in integrated neighborhoods, and all during the New Deal, blacks were excluded from housing programs. In the 1960s, the civil-rights movement brought the landmark passage of the Fair Housing Act, outlawing discrimination in lending. But banks frequently refused to lend in minority neighborhoods throughout the 1960s and 1970s. This continued even into the 1980s -- when The Atlanta Journal-Constitution used federal mortgage data to document continued redlining.

But by the 1990s, access to fair housing and credit seemed on the upswing. The Community Reinvestment Act, created to counter redlining and ensure banks invested in their surrounding communities, was strengthened, and banks couldn't get mergers approved without showing they had complied with it. Other anti-redlining lawsuits and efforts grew, and credit became more widely available to minorities and to people with modest incomes.

In defiance of all that progress, the subprime mortgage crisis brought with it a form of reverse redlining -- in which lenders provided a glut of credit to neighborhoods once underserved by banks. Minorities also preyed on their own communities.

In Prince George's, mortgage brokers in the sizable Latino community routinely falsified incomes on applications without the knowledge of the borrowers, qualifying them for homes they could never afford. One loan listed two house cleaners as doctors for their occupations, said Mosi Harrington, executive director of the Housing Initiative Partnership, a non-profit developer in Prince George's that also counsels homeowners. "It's very sad," she said. "They thought they were doing the right thing, reaching for the American dream."

Now there are the foreclosure scams, a second wave of the reverse redlining. Within the black community, they are conducted on both large and small scales, employing different "levels of badness," as Neimann explains.

The most notorious case is the Metropolitan Money Store scam, a $35-million foreclosure ripoff of homeowners and lenders engineered by a Prince George's County couple, and the largest mortgage fraud case in Maryland history. The couple, charged in the case in June, had earlier thrown themselves an $800,000 wedding using equity stolen from foreclosed homes.

But what struck investigators most about the case was a kind of targeting authorities had never seen before. Usually, mortgage lenders use a whiteboard to keep track of a potential customer's name, address and phone number. In the Money Store case, however, the whiteboard listed the amount of equity to be had in a person's home.

"Predators knew where they were more apt to find their victims," said Rob Strupp, director of research and policy at the Community Law Center in Baltimore, which represents Prince George's County homeowners in mortgage and foreclosure fraud cases. "They knew what their target was."

The next level of fraud involves local people who use their community standing to run their scams, Neimann said. Sometimes it's the ex-policeman or trusted friend. They play on the solidarity of the neighborhood, using the pitch that "you can't trust them, but I can help you," and running deals under the table. On another level, the referrals are simply well-meaning, offered by the local clergy or community leaders who just want to help.

In Accokeek, the construction of new subdivisions beginning in 2005 is cited by many as the cause of the high foreclosure rates. Major lenders, from Countrywide to Washington Mutual, offered what Mosi Harrington described as a step-up style loan to the new homeowners. They sold the loans at an initial low rate and explained that while the rate would increase each year, so would the buyer's salary -- so the loans would remain affordable. But any salary increases couldn't keep up with the escalating costs of the loans.

When their loans go bad, people often come to The Barber's Chair to share their troubles, rather than seek help elsewhere. When the talk turns to foreclosures and where to get help, the conversation quickly yields the name of Frank Purcell, described around the shop as "a friend who helps families facing foreclosure." Give him a call, people say, and he can help you out.

According to Maryland court records, Purcell, a Prince George's County native, has three lawsuits filed against him over foreclosed houses and is currently under investigation by state fraud officials in the case of Laurie Lewis, whose family lost its Laurel, Md., home in a scam.

Lewis, 38, a mother of two, said she and her husband had health problems and ran into trouble keeping up the payments on their home. She turned to a long-time friend, Maria Hairston, who was also a real-estate agent in Accokeek. Hairston said she could help, and showed up at the Lewis home with Purcell. Hairston introduced Purcell as someone who works with people facing foreclosures, Lewis said. She learned much later that Hairston and Purcell are married.

Lewis' suit charges that Purcell promised to buy their home and keep it for a year, taking $32,000 in upfront rent payments and fees. The Lewis' were supposed to work on improving their credit and then buy the house back. Lewis quickly figured something was amiss when she learned Purcell had refinanced the home. He began ignoring her phone calls and asking for more money. She and her husband refused. By the end of the year, they had to move out because the house was being foreclosed on.

They now live in a cramped, two-bedroom apartment. "You never know who is really in one these scams," Lewis said. "You never think a friend would do that to you. I was shocked."

In an interview, Purcell, who once ran a real-estate company called America's Dream, said he still helps people try to save their homes, but he no longer buys them and promises to sell them back, because the new anti-fraud law enacted earlier this year makes it illegal. Instead, he refers to himself now as a "loss-prevention specialist.

If someone has missed a payment or two, he aids them in negotiating with the bank, though later in the interview he clarified that he does not do the actual negotiating. Instead, he helps them figure out how to do it themselves.

"If someone is at foreclosure's door, I can only help them if they are able to afford their house payment," Purcell said, "The question I ask now is, 'Can you show me that you can afford a $1,900 a month payment?' or whatever it might be. Because if you can't show me that, there's nothing I can do about it. The reality is that not everyone can be helped. I do turn people away."

As to the lawsuits and charges, Purcell said they are the result of personal disputes with friends he tried to help. In the Lewis case, he contended the family left with money in their pockets. He doesn't want to point fingers. "If that's how they feel, that's fine," he said. "You live and learn. They didn't really understand what it was."

Purcell said he continues to buy foreclosed houses -- which is allowed under the law. He thinks the new restrictions make it harder for people to keep their homes and instead benefit investors, who profited from bad loans in the first place and will be the ones to scoop up foreclosed homes at low prices. The foreclosure business is marked by "a lot of bad apples," he said, but he does not consider himself one. "Have I made money?" said Purcell, who lives in Accokeek. "Absolutely I have made money. I have no apologies for that."

Despite the new law, foreclosure scams continue. People charge for seminars on how to get into the foreclosure business without running afoul of authorities. One purpose behind the regulations was to push people into the marketplace, where the transactions can be regulated. But the law can't address the off-the-record arrangements that continue.

Neimann said the ex-police officer, whose foreclosure scams inspired the legislator to write the law, regularly shows up at legitimate community housing-counseling sessions to offer foreclosure help, peddling a Xerox copy of a booklet on foreclosure and trying to charge $100 for it.

The fallout from the scams and the subprime loans will have long-term effects in Prince George's County. Already, nationwide, homeownership rates among minorities have fallen -- which translates into a drop in overall wealth.

Minority communities, even upper-income neighborhoods, were hit hard because of the "shallow assets" problem, Harrington, the housing counselor, explained. First-generation black homeowners who got in trouble couldn't easily bail themselves out, without having built-up wealth to tap into. In her view, subprime and home-equity loans should come with some warnings about their side effects -- like losing your home -- in the same the way medicines are advertised on television.

She and others, however, weren't particularly surprised that predatory lending and foreclosure fraud continues. The targeting of black neighborhoods for all sorts of financial scams has gone on for years, and this latest wave is yet another unfortunate chapter in the long story of redlining, Squires of George Washington University noted.

The difference now is that many people think enough racial progress has been made that there's a level playing field out there. The foreclosure crisis in places like Prince George's proves that it's not.

As Niemann put it: "People don't recognize this for the scandal that it is."

Still, Niemann thinks the new law banning some foreclosure scams is a sign of progress -- proof that something positive is coming out of this crisis. If lenders step up to the plate to help restructure loans for troubled borrowers, he said, they can make a positive difference and create a new trust among residents.

So far, things aren't going that way. Harrington said that the lenders her organization works with increasingly are limiting the extent of mortgage loan restructurings to five, three or even two years -- instead of converting mortgages to 30-year-fixed loans. "I don't see how we're not going to be right back where we started in a few years," she said.

Until then, foreclosures and mortgages dominate the talk at The Barber's Chair. People in trouble keep coming in, looking for some way out.

Swift Boaters and the Housing Crisis

Mary Kane — Thu, 21 Aug 2008 20:21:05 GMT

Since housing and politics are so intertwined today, it's worth noting this post from The Big Picture, which details the role of swift boaters in a new development regarding the failed IndyMac Bancorp.

There's a lot to explain here, since swift boating and the housing crisis haven't exactly been linked previously. But via a Reuters report, The Big Picture says that 51 former IndyMac employees sent a letter to the California Attorney General's office, requesting an investigation into Democratic Senator Charles Schumer's role in possibly causing the bank's failure. Schumer sent a letter in June to federal regulators questioning the financial stability of IndyMac, a troubled subprime lender hit hard by the mortgage crisis. Shortly after the letter was made public, the bank experienced a run by account holders. The FDIC took over IndyMac on July 11, and it became the third-biggest bank failure in American history. The problem here, as The Big Picture notes, is there wasn't exactly an authentic and sudden groundswell of indignation from former IndyMac employees. Here's what really happened:

Who is behind this "groundswell" of (former) IndyMac workers? It turns out that the employee letter was distributed to the media by CRC Public Relations -- yes, the group whose clients include the National Republican Congressional Committee, National Republican Senatorial Committee and the Republican National Committee.And, CRC was the PR firm behind the company that published a book questioning 2004 Democratic presidential candidate John Kerry's Vietnam service on a swift boat. Yes, those despicable, embarrassing festering boils on the Americans body politics: Liars, cheats & traitors all. Let's review: It wasn't the conflicts of interest, the outright fraud, or management's rampant criminality that sent Indy Mac belly up. It wasn't losing nearly a billion dollars this year alone. It wasn't the share prices tumbling 87% in 2007, and then losing another 95% this year-to-date. And of course, the loss of ~$30 billion dollars had nothing to do with this. It was the Senator's letter in June that was the cause of the collapse. Man, these swift boat guys are a dangerous combination of rabidly partisan, utterly ethicless, economically clueless -- and about as dumb as lawn furniture. They make you proud to be an American.

Looks like the housing crisis is about to become an even bigger political issue, and it's going to go well beyond the debates over foreclosures and rescue plans.

Keeping the Roof Over Your Head

Mary Kane — Thu, 21 Aug 2008 19:28:16 GMT

Just in time for our series starting today on foreclosure and foreclosure fraud in Prince George's County, Md., the Orange County Register's Mortgage Insider offers some tips on avoiding scams. The post notes that homeowners are unnecessarily losing their properties to foreclosure fraud. And a commentator points out that many people can negotiate with banks themselves, rather than hiring a specialist or a firm to do it. Just something to think about the next time you see one of those "I pay cash for houses" on the side of the road.

Fraud Worsens Foreclosure Crisis

Mary Kane — Thu, 21 Aug 2008 12:10:05 GMT

ACCOKEEK, Md. - At The Barber's Chair, in the small, quiet community of Accokeek at the far end of Prince George's County, Md., the talk often turns to the foreclosure crisis -- for good reason. Here, in the nation's most affluent majority black jurisdiction, a remarkable example of the growing wealth of the new black middle class, foreclosures are growing at one of the fastest rates in the country, and foreclosure fraud is increasing right along with it.

With locals constantly in and out, Leo Harrington, the owner, hears it all. How people who bought homes once valued at $800,000 down the the road at upscale subdivisions like The Preserves or at the one- and two-acre homesites of St. James have friends and relatives living in their basements to help pay the mortgage.

Illustration by: Matt Mahurin

How lenders pushed deceptive and high-cost loans on first-generation homeowners, without disclosing the consequences, assuring them that home values only go up. How people bought expensive cars, timeshare vacations and boats -- and put their homes at risk. How lenders continue to target the community and push loans. And how homeowners, with years of mistrust in mainstream lenders, wait too long to get help when they fall behind on their loans, wary of trying for a short sale or a loan workout, and so fall prey to foreclosure scams.

"A lot of people moved out here from the District because they wanted to be in the 'burbs and raise their kids here," said Harrington, 49, who also is an associate minister at a nearby church. "You find you can get a bigger house that's in pretty close, and a yard. But there were all these predatory loans. That's all it was. They didn't realize how the loans worked because when folks are lying to you, you don't know any better. Then, when they find out they are in trouble, they start to panic, and they end up losing their homes."

Harrington's views are one explanation of many for the unexpected rise in foreclosures in Prince George's County and in other Washington-area communities, which had, until recently, been largely immune to the housing crisis. Overall, foreclosures in Prince George's and in the Washington area remain lower than in national hot spots, like Florida or California, but the area experienced a six-fold increase in foreclosures from February 2007 to last spring -- a jump that has local officials worried and perplexed. Why here, and why now?

All told, Prince George's and Prince William counties, in suburban Virginia, outpaced the rest of the area in foreclosures. And in Prince George's, Accokeek, of all places, has been hit the hardest, said John McClain, deputy director of the George Mason University Center for Regional Analysis, who wrote a report detailing the foreclosure rise. It has so puzzled the Federal Reserve Bank of Richmond that its members and economists drove around Prince George's and Prince William, home to a large immigrant population, to see the crisis for themselves.

They found no easy answers. Foreclosures here are spread across all income levels, from $150,000 houses to $750,000 McMansions, from newly built townhouses to refinancings of long-time residences.

To make it worse, foreclosures aren't even the biggest problem right now. As more people lose their homes, foreclosure fraud scams have spiked, with Prince George's recording the most cases of fraud in Maryland, said state mortgage fraud investigator Stephen Prozeralik.

Most scams involve a "helpful" buyer who promises to save a troubled homeowner's property, by purchasing it from him to stave off foreclosure. The buyer usually collects rent up front and promises to sell the house back to the homeowner eventually, but instead strips any equity and fails to pay the mortgage, victimizing the owner once again. "We were surprised," Prozeralik said. "We figured most of our cases would come from Baltimore. But the majority of the cases were are investigating are in Prince George's County. PG County is at the top of our list."

That Prince George's should wind up at the top for foreclosures, and the resulting scams, is particularly troubling to many. At the start of the housing crisis, subprime loans were seen as a problem largely for low-income and minority communities. But as the crisis continues, there's increasing evidence that for minorities, the higher up the income ladder, the worse it gets -- with racial differences in lending more pronounced as income increases. New research by the National Community Reinvestment Coalition found blacks in upper- to middle-income neighborhoods were more than twice as likely than whites in similar neighborhoods to have high-cost subprime mortgages.

In Prince George's, housing counselors began complaining as early as 2005 about a proliferation of subprime loans. Roughly 43 percent of the county's homeowners who refinanced three years ago wound up with a high-cost subprime loan, compared to 24 percent of homeowners nationwide, The Washington Post reported last year -- using an analysis of Federal Reserve data. About 43 percent of new homeowners also took out the higher-cost subprime loans, compared to 20 percent of buyers nationwide. Yet credit scores in Prince George's rank higher than the state and national averages.

While it hasn't received much attention during the housing crisis, places like Prince George's County were targeted aggressively by lenders,. These lenders heavily advertised loans on black radio stations and other minority media outlets and used unconventional methods like selling these loans door-to-door, housing advocates and residents said. This marketing continues unabated, despite the downturn.

Florence Thomas, a single mother from Upper Marlboro, Md., who had to turn in July to the Neighborhood Assistance Corp. of America, a housing-advocacy group, for help in saving her home, said she tells lenders she's unemployed and they still want to sell her loans and foreclosure help. "They call three for four times a day, and they leave something in my mailbox almost every day," she said. "Sometimes I end up talking to them, because they say, 'Florence, how are you?' and I answer before I realize who they are. They've called on my cell phone. It just doesn't stop."

This kind of marketing goes far beyond the selling of loans and foreclosure assistance in upscale white neighborhoods, said Gregory Squires, a George Washington University sociology professor who has studied redlining. "This is clearly disproportionately a minority problem," he said. "And it's striking that despite all the news about this problem, we still see people going out and using these high-pressure and predatory tactics."

A sign on the side of the road saying "I pay cash for houses" might be the extent of the foreclosure advertising in a white community. In Prince George's, by contrast, at the same moment housing counselors at a recent meeting were warning worried homeowners of the dangers of foreclosure scams, the people perpetuating the fraud plastered the windshields of cars in the parking lot outside with fliers for their services. A counselor taking a break for fresh air noticed the fliers and rushed to remove them before the meeting ended. "We do have our share of foreclosure fraud in white neighborhoods, but it doesn't seem to be the same frenzy we have in Prince George's County," said Prozeralik, the state fraud investigator.

The second in this series will run the afternoon of Aug. 21, 2008.

Subprime Everything

Mary Kane — Tue, 19 Aug 2008 13:30:00 GMT

At least one large U.S. bank is likely to fail as the credit crisis deepens, a Harvard economics professor says, offering the latest gloomy assessment of the country's financial prospects. Kenneth Rogoff, who also is the former chief economist at the International Monetary Fund, told a conference in Singapore that a recession will be more severe than predicted, Bloomberg says. From Rogoff:

``The worst is yet to come in the U.S. The financial sector needs to shrink; I don't think simply having a couple of medium-sized banks and a couple of small banks going under is going to do the job.''

If that's not depressing enough, there's the outlook from Dr. Doom, or Nouriel Roubini, a New York University economist and widely-followed blogger. Roubini is famous in economic circles for having predicted the current meltdown, including the troubles at Fannie Mae and Freddie Mac, way back in 2006. He's not exactly any more optimistic now, according to a profile in the New York Times magazine:

“Reckless people have deluded themselves that this was a subprime crisis. But we have problems with credit-card debt, student-loan debt, auto loans, commercial real estate loans, home-equity loans, corporate debt and loans that financed leveraged buyouts.” All of these forms of debt, he argues, suffer from some or all of the same traits that first surfaced in the housing market: shoddy underwriting, securitization, negligence on the part of the credit-rating agencies and lax government oversight. “We have a subprime financial system,” he said, “not a subprime mortgage market.”

Interestingly, Roubini refers to himself as a realist, rather than a pessimist. Try digesting that. And then enjoy your day!

The New Language of Subprime

Mary Kane — Mon, 18 Aug 2008 13:30:00 GMT

As the mortgage crisis drags on, the New York Times offers a handy glossary of subprime terms so you can easily keep up on the latest developments. The Times notes that the term subprime actually encompasses "a whole glossary of often-colorful expressions that could be described as sub subprime. They reflect the deceit, cynicism and scandalous exploitation that are taking the homes of many thousands, perhaps millions, of families."

Here's just one example: Foreclosure rescue. From the Times glossary:

Foreclosure rescue sounds benevolent but it’s not, says Sarah Ludwig, director of the Neighborhood Economic Development Advocacy Project in New York. On the contrary. “Typically, it’s a scam to steal a home,” in which the owner is gulled into signing over title to the house in exchange for promises to pay off the arrears.

The glossary, part of the On Language column, also includes explanations for ninja loans and one-stop shops. It's a helpful guide for once-obscure mortgage industry terms that are making their way into the headlines.

Skipping the Drive

Joel Kotkin — Mon, 18 Aug 2008 12:04:13 GMT

The rapid spike in energy prices has led politicians, urban theorists and pundits to pontificate about how Americans will be living and working in new ways. A favorite story line is that Americans will start trading in their suburban homes, move back to the city centers and opt to change everything they have wanted for a half-century --- from big backyards to quiet streets to privacy --- to live a more carbon-lite urban lifestyle.

Yet, there has been little talk about what could be the best way for families and individuals to cut energy use: telecommuting. For more than a decade, the number of telecommuters, both full-time and part-time, has been growing rapidly, gaining more market share than any other form of transportation.

This seems certain to continue with the proliferation of broad-band technology -- as well as the effect of high gas prices. By 2006, the expansion of home-based work doubled twice as quickly as in the previous decade, and now is close to nine million, according to the National Highway Travel Survey of the Federal Highway Assn.

Nationwide, according to the Gartner Group, in 2007 13 million workers telecommuted at least one day a week, a 16 percent leap from 2004. That number was expected to reach 14 million this year. In addition, more than 22 million individuals, according to Forrester Research, now run businesses from home.

Last year’s skyrocketing energy prices appears to have pushed employers in this direction. A CDW survey of private sector employers this year found that 76 percent now provide technical support for remote workers, up 27 percent from a year earlier. Federal IT support, however, has lagged at roughly 58 percent.

In some regions, like the San Francisco Bay Area and Los Angeles, as many as one in 10 workers are part-time telecommuters. In the Greater Washington Area, more than 450,000 employees telecommuted at least one day a week in 2007, 42.5 percent more than in 2004, according to a survey by Commuter Connections, a regional network of transportation organizations coordinated by the Metropolitan Washington Council of Governments. The percentage of employees who telework surged to 19 percent from 13 percent during that time period.

Not surprisingly, home offices, particularly in upscale homes, have become a necessity for many buyers -- demanded ahead of security systems. A recent study by Rockbridge Associates suggests that more than one-quarter of the U.S. workforce could eventually participate full- or part-time in this new work pattern.

The potential energy savings --- particularly in terms of vehicle miles traveled --- could be enormous. Telecommuters naturally drive less, not only to work but for the numerous stops to and from work. According to the 2005/2006 National Technology Readiness Survey (NTRS), the United States could save about 1.35 billion gallons of fuel if everyone who was able to telecommute did so just 1.6 days per week. That calculation is based on a driving average of 20 miles per day, getting 21 miles per gallon.

A more recent study by Sun Microsytems, which uses telecommuting extensively, found that, by eliminating commuting half the week, an employee saves 5,400 kilowatt hours --- even accounting for home office use. They also can save some $1,700 a year in gasoline and wear and tear.

Related technologies, like teleconferencing, according to another survey, could save another 200 million tons of jet fuel, if 10 percent of air travel were reduced over the next 10 years. There are other signs of a shift to substitute the web for the road -- some college on-line classes report a 50 percent to 100 percent boost in enrollment over last year.

In comparison, the talk of a huge “surge” in transit riders as a result of rising gas prices, represents a welcome, but relatively minor, trend, since transit still accounts for under 1.5 percent of all travel. The vast majority --- perhaps as much as 98 percent ---- of the recent reduction in gas consumption came as a result of people simply reducing their driving, not switching to the rails.

Some of this is structural. Most metropolitan regions are simply not set up for efficient public transit; work patterns are increasingly dispersed as opposed to centralized. As a result, the ranks of telecommuters are greater in every metropolitan area in the country outside of the New York, Chicago, Philadelphia and Boston areas.

This trend is particularly marked in growing regions in the South and West. In Portland, the mecca for light rail, there are nine telecommuters for every rail commuter. In 2008 Nustats survey, covering Austin, Dallas-Ft. Worth and El Paso telecommuting (at 12 percent) was cited four times as much as using public transit to reduce gas consumption.

Perhaps even more important, telecommuting and related technologies represent a potential sea change for the future shape of families and communities. Already women are well-represented among telecommuters, in part so they can stay home with their children. In a world with fewer permanent employees and longer hours, telecommuting could help mothers stay in the workplace even while rearing children. A growing number of fathers are also looking to work at home to participate in child-rearing.

In many ways, this represents a return to patterns that existed before the Industrial Revolution. In pre-industrial societies, members frequently worked at home or walked to work. The Industrial Revolution changed all that, with its need for mass standardization -- demanding the efficacy of office and factory. Marx, the ultimate chronicler and prophet of the Industrial age, saw how “agglomeration in one shop” was “necessary” for human progress.

Writing a century later, Alvin Toffler foresaw how the rise of the “electronic cottage” would return work to the home -- where it had been before. As he put it, “social and technological forces are converging to change the locus of work” --- back to the home, neighborhood and village. This is part of what Toffler envisioned in his “Third Wave” society, a breaking away from the “behavioral code” of “second wave” industrialism, where work and family were segregated

These trends will continue as economic relations between business firms become less constrained by proximity. Information inputs can come from any source, and increasingly, any place. Of course, there will be serious constraints to this development. Perhaps, most important, will be the reluctance of managers ---both private and public --- to allow this dispersed work

There are also interests, like urban office developers and real estate developers, who might find these trends troubling. Many new urbanists and environmentalists, who one would think would favor this energy-saving trend, tend to ignore or downplay the digital frontier -- preferring a return to the dense, transit-dependent patterns common a century ago.

Even telecommunications firms, which logically should be pushing this shift, seem unable to tailor their products for home-based work, according to a recent Forrester Research study. Morley Winograd, a former AT&T executive, says these companies have persisted in separating their “consumer and business customers.” As a result, they have been slow to abandon what he calls “the obsolete gene” in their corporate DNA, and target the home-based business

Yet in the future, Winograd, now executive director of the Institute for Communication Technology Management at USC's Marshall School of Business, says that developers, corporate executives and, presumably, telecommunications companies will be forced to focus more on this growing segment.

Indeed, new suburban developments, like Ladera Ranch in Orange County, have incorporated such mixed usage into their floor plans -- with separate entrances for business clients. Suburban historian Tom Martinson, believes that the Ladera plan will “be in the history books in 20 years” because it anticipates “an incredible change in the way we live and work.

Many leading companies also see the potential of full-time and part-time telecommuting. Particularly amenable to this trend are leading technology and business-service firms. At IBM, for example, as much as 40 percent of its workforce operates full-time at home. Other companies, including Siemens, Compaq, Cisco, Merrill Lynch and American Express, have expanded their use of telecommuting, with increased productivity

As more companies let go of their “command and control” approach to management, this practice seems likely to increase. Certainly the employee demand is there; one-third, according to one survey, would choose this option, even if it meant somewhat less pay. Teleworkers also generally show a higher job satisfaction

This is also being adopted in some states and cities. Georgia, for example, approved tax credits this year for creating and expanding telework.

But perhaps the biggest impetus, suggests Winograd, the former telecom executive, is the gradual ascendancy of younger workers. The millennial generation --- the subject of his recent book, "Millennial Makeover," co-written with Mike Hais --- “have grown up up with the Internet and stay connected to the world on their laptops or cellphones 24/7” and sees “distinctions between work and life as arbitrary and unnecessary.”

These younger Americans will likely see no reason to spend an hour in a car, bus or train to get from one computer screen to another. Once adopted by employers, this shift may do more to reduce the carbon imprint than all the current calls for largely unwelcome shifts in the daily lifestyles of many American

Joel Kotkin is a presidential fellow at Chapman University and executive editor of www.newgeography.com

Trump to the Rescue!

Mary Kane — Fri, 15 Aug 2008 19:09:17 GMT

Here's one solution to the foreclosure crisis: Get Donald Trump to come along and buy your home. That's the deal for Ed McMahon, who quickly has become the poster child for delinquent celebrity homeowners. McMahon, still remembered for his "Tonight Show" fame, defaulted on $4.8 million in loans from Countrywide Financial Corp. and is slated to lose his home. But it's Trump to the rescue! Trump told the Los Angeles Times that he doesn't know McMahon personally but that he feels helping out is the right thing to do:

When I was at the Wharton School of Business," Trump said, "I'd watch him every night. How could this happen?"

Probably because McMahon bought an expensive house, had an illness and couldn't work, and fell behind on his payments, just like many non-celebrities facing foreclosure. Nonetheless, Trump will lease McMahon's mansion back to him, thereby becoming his landlord. Another solution might have been for McMahon to accept the foreclosure, give up his house, and rent a small apartment in a cheaper neighborhood than Beverly Hills. But, hey, things don't happen that way in the entertainment world.

Should Trump renege on the deal somehow and wind up kicking McMahon out, it will be the most famous celebrity case of foreclosure fraud ever.

Advertising to Lose Your House

Mary Kane — Fri, 15 Aug 2008 12:37:55 GMT

The biggest ally banks and lenders had in pushing lucrative home equity loans and lines of credit was advertising agencies, the New York Times says today. Ad executives found unusually creative ways to make piling on so much debt that you could lose your house seem desirable, and something to which you should be entitled. Working with banks, ad agencies changed the name "second mortgage," with its negative consequences due to the fact that such products had been used only by people in dire circumstances, to "home equity loans." The word equity made it seem like the loans were fair, something equal to what you, as the consumer, deserved. Citicorp went with the slogan "live richly" for its loans. This requires no explanation. The Money Store coined the polite phrase "less than perfect credit" to dress up the previous term for people who didn't pay their bills on time, which would have been "deadbeat."

All the advertising did its job. Prior to the 1980s, second mortgages were a tiny slice of the market, and taking out debt against your house was seen as both dangerous and desperate. Home equity lending changed that. Mortgage burning parties were passe; debt was in. From The Times:

Since the early 1980s, the value of home equity loans outstanding has ballooned to more than $1 trillion from $1 billion, and nearly a quarter of Americans with first mortgages have them. That explosive growth has been a boon for banks. Banks’ returns on fixed-rate home equity loans and lines of credit, which are the most popular, are 25 percent to 50 percent higher than returns on consumer loans over all, with much of that premium coming from relatively high fees.

But here's the flipside:

The portion of people who have home equity lines more than 30 days past due stands 55 percent above its average since the American Bankers Association began tracking it around 1990; delinquencies on home equity loans are 45 percent higher. Hundreds of thousands are delinquent, owing banks more than $10 billion on these loans, often on top of their first mortgages.

The Times notes that some bankers did worry that slogans like "live richly" and ads encouraging people to use their home equity for luxury vacations might be sending, um, the wrong message. But they were in the minority. Banks in the 1980s stole away ad executives who previously pitched breakfast cereals and other consumer goods and the advertising rolled on. Now it's being fingered for its part in the mortgage crisis.

In case you might have forgotten some of the ads - it's hard to do, since they were relentless - the story summarizes one of the most famous, from Ameriquest, a subprime lender now out of business:

Ameriquest ran an ad in 2004 during the Super Bowl, one of the biggest advertising events of the year, that has come to symbolize the excesses of subprime lending. The ad showed a woman on an airplane climbing over the man sitting next to her to reach the aisle. The plane’s lights go off during turbulence and the woman slips, landing on the man’s lap. Other passengers gasp because it looks as if they were in a sexual embrace. “Don’t Judge Too Quickly,” the ad said. “We Won’t.” Two and a half years later, Ameriquest went bankrupt.

Another State Moves on the Mortgage Crisis

Mary Kane — Thu, 14 Aug 2008 17:04:00 GMT

Add West Virginia to the list of states suing Countrywide Financial Corp., alleging its loans were predatory and harmful to consumers, Housing Wire reports. California, Connecticut, Florida, Illinois, and the city of San Diego already have filed similar suits against the troubled firm, which once claimed the title of the nation's top subprime lender but has since been bought by Bank of America. Now West Virginia is stepping in, saying that foreclosures drag down home values for everyone, and blaming Countrywide loans for the problem.
From West Virginia State Attorney General Darrell McGraw:

“Countrywide made loans to West Virginia consumers on terms that were unaffordable and unconscionable. These loans exposed consumers to foreclosure and loss of their homes. Countrywide also used unfair and deceptive acts or practices to make loans and service loans.”

Because Congress took so long to approve a mortgage rescue plan, states have moved aggressively to address the foreclosure crisis. States are not being shy about going after big lenders directly, fingering them for loans they say were predatory and unfair, and trying to force them to pay for it. What's interesting to watch is whether lenders will seek protection or help from the federal government if the suits continue.

He's Back and He's At It Again

Mary Kane — Thu, 14 Aug 2008 14:15:00 GMT

Alan Greenspan draws some renewed attention with comments in the Wall Street Journal today that he expects U.S. house prices to stabilize in the first half of next year. Greenspan, a longtime critic of Fannie Mae and Freddie Mac, also summarizes his opinion of government efforts to shore up the two mortgage giants as, simply, "bad." From Greenspan:

"They should have wiped out the shareholders, nationalized the institutions with legislation that they are to be reconstituted -- with necessary taxpayer support to make them financially viable -- as five or 10 individual privately held units," which the government would eventually auction off to private investors, he said.

Greenspan's views will be noted and debated throughout the day by the business press on cable and in the blogosphere. But, as usual, The Big Picture puts it all in perspective. In a post entitled "Greenspan Calls a Housing Bottom (Again), TBP analyzes Greenspan's housing prognostication skills this way:

Recall Greenspan's first Real Estate bottom calling attempt came in late 2006 "I suspect that we are coming to the end of this downtrend, as applications for new mortgages, the most important series, have flattened out. I don't know, but I think the worst of this may well be over." (Greenspan Says `Worst' May Be Past in U.S. Housing) He repeated the calls many times since then. Most recently, in April 2008, when he said "the drop in U.S. home prices will probably end well before' early next year as the number of houses on the market diminishes, aiding an economic rebound." Wow, that's three strike in just one swing: Inventory remains high, home prices continue to fall, and we are still waiting for the economic rebound.

The WSJ article goes on to note that Greenspan remains busy defending his tenure at the Federal Reserve over criticism that his unwillingness to regulate the markets led to much of the subprime mess. He's even including a new chapter in the paperback version of his book that comes out next month, arguing his side of the story.

The spin continues.

Going God Over Gas

Mike Lillis — Wed, 13 Aug 2008 18:15:00 GMT

Here's a valuable use of time: A group called the Pray at the Pump Movement will congregate at a Shell gas station in DC this afternoon to -- you guessed it -- pray in celebration of falling gas prices. Seems this group launched its plight in April, encouraging motorists to pray for lower fuel prices as they filled their vehicles. Now that oil prices have dropped to roughly $114 a barrel -- the lowest tally in months -- they want to give God a shout-out of thanks.

(Back on planet Earth, economists attribute the falling prices largely to the fact that Americans are driving much less. The Energy Information Administration reported Tuesday that U.S. demand in the first six months of 2008 dropped further, relative to a year ago, than it has since 1982.)

The group also says it plans to "pray for comedian Jay Leno for his comments against the Pray at the Pump Movement," according to one daybook entry announcing the event. That's because of remarks Leno made last month during his stand-up monologue:

Hey, have you heard about this group called Prayer at the Pump? They're a prayer group that springs up, and they go to gas stations and they hold hands and they pray for lower gas prices. Otherwise known as the Bush energy plan.

Seems pretty tame to us, but what the hell, maybe the push will gain traction. As Columbia University political scientist David L. Epstein said this week: "There are no atheists in a hurricane."

More Green Affordable Housing Successes

Suemedha Sood — Wed, 13 Aug 2008 13:55:00 GMT

Just wanted to flag this informative comment from one of our readers regarding our story, Affordable Housing Goes Green. Reader pierced talks about an affordable housing project in Rohnert Park, Calif., about 40 miles north of San Francisco:

Green affordable housing seems so rare that I wanted to mention another project in California called Sonoma Mountain Village. Sponsored by One Planet Communities and a local developer, Codding Enterprises, this project will have about 380 affordable for-rent/sale units in a 1900-unit mixed-use development.

Like Trolley Square, this project puts residents within a five minute or less walk of community and commercial places. In Seattle, High Point, New Holly and Rainier Vista are green mixed-income communities that also have commercial and open space amenities.

A unique goal of Sonoma Mountain Village (and other One Planet Communities) is to reduce the community ecological footprint by 80% from a conventional development by using on-site renewable energy, reducing waste, using alternative transportation, creating a local food and materials network, and creatively working with local businesses and residents to create an extremely diverse green community.

Find out more about Sonoma Mountain Village here.

More From the Latte Index

Mary Kane — Wed, 13 Aug 2008 13:16:00 GMT

An unofficial measure of what's going on with the economy is the Latte Index, or trends in discretionary spending when it comes to Starbucks. When people cut back on pricey, frothy coffee drinks they probably didn't need in the first place, the theory goes, it shows they're taking steps to curb their spending. And less consumer spending means slower economic growth.

With Starbucks already closing 600 stores due to lower sales, it's fair to say the Latte Index carries some weight. But now The Big Picture spots another Latte Index-style trend: Discounts at Starbucks:

As you may have heard, Starbucks has canned their DVDs and CDs. At a recent visit, I picked up Juno (which I have been meaning to see), and for Mrs. Big Picture I grabbed The Kite Runner -- for $7.95 each. They also had the new James Hunter CD (Official site, Amazon, NPR interview) and the latest John Mellencamp disc (Official site, Amazon) were also $8. But the big thing that caught my eye was their $2 special. Bring your receipt in from any purchase in the am, and after 2pm any Grande Cold drink is just $2. Value maximizers may want to go for the Iced Frappucino Double Chocolaty Chip Frappuccino Crème at $4.80 but it weighs in at 510 calories. Or, the Java Chip Frappuccino is 460 calories. I went for the Iced Caramel Macchiato, which cost less, but is practically dietetic at 230 calories.

I cannot recall Starbucks being this promotional since . . . well, ever.

The Big Picture wonders if anyone else is seeing new promotional discounts. The $2 special - a new economic indicator?

Big Oil Ties Could Hurt GOP

Mike Lillis — Wed, 13 Aug 2008 13:05:48 GMT

Monday night, after weeks of pressure from Republicans to lift a federal moratorium on new offshore oil drilling, House Speaker Nancy Pelosi (D-Calif.) abandoned her adamant resistance, indicating that she's now open to a vote on expanding exploration.

"[Republicans] have this thing that says drill offshore in the protected areas," Pelosi told CNN's Larry King late Monday. "Well, we can do that. We can have a vote on that. But it has to be part of something that says we want to bring immediate relief to the public and not just a hoax on them."

Illustration by: Matt Mahurin

The sharp change of position arrives as Republicans, who face a potentially disastrous November election, think they've found a lifeline in offshore drilling. Indeed, with gas prices near historic highs, polls indicate that most Americans now support more drilling. In a continuing Capitol Hill revolt, dozens of House Republicans have circulated through Washington over Congress's August vacation, taking to the dim and empty chamber floor with demands that Pelosi call a vote on the controversial measure.

The Republicans hope to portray the Democrats as the party of callousness on the issue of towering gas prices. In retaliation, Democrats accuse the GOP of cozying up to big oil interests. The debate has evolved into a blame-game over which side is blocking the process -- and which is fighting hardest for the needs of constituents.

Yet if a Republican primary in Tennessee last week is any indication, GOP leaders might want to reconsider their strategy. In an upset victory Thursday, GOP challenger Phil Roe defeated freshman Rep. David Davis in a contest where Roe portrayed the incumbent -- one of the House Republicans giving energy speeches -- as an oil company minion. It marked the first primary defeat for a Tennessee incumbent of either party in 40 years. Many political experts say the Republicans' defense of the thriving oil industry may haunt other GOP candidates in November.

Rep. David Davis (U.S. Congress)

"Offshore drilling is by no means a big winner," said Gary C. Jacobson, a political science professor at the University of California at San Diego. "Being seen as in the pockets of big oil is not where you want to be as a candidate."

"I do believe that it's a seismic event in Congress," David L. Epstein, political science professor at Columbia University, said of Davis's loss, "and everyone in Washington has taken notice. It certainly could be a harbinger of things to come."

During the primary, Roe, the conservative mayor of Johnson City in eastern Tennessee, attacked Davis for accepting donations from oil company political action committees, even as gas prices were soaring and the companies' profits were at historic heights. Roe had refused PAC money throughout the campaign.

Challenger Phil Roe (Campaign photo)

"While East Tennesseans have been struggling with out-of-control gas prices," one TV ad charged, "David Davis has pocketed thousands from oil companies. Why is 'Big Oil' trying to buy our seat in Congress, and why is Davis accepting their cash?"

Anthony J. Nownes, political science professor at the University of Tennessee, said that it's tough to gauge the absolute effect of the oil campaign on the primary, but considering the outcome it probably helped Roe.

"You would think that in a Republican primary attacking your opponent as a fan of big business would not work," Nownes wrote in an email. "But the proof, as they say, is in the pudding."

Other factors, of course, were also at play. Nownes described Roe as "a credible challenger," with both money and name recognition feeding his chances. Jamie Osborne, a consultant for the Roe campaign, downplayed the effect of the oil debate on the election, saying it was just one of many deciding issues.

"It was a way to cue people into the differences between the candidates over influence and money," Osborne said. "To say [the election] was a referendum on big oil, I would say, is a stretch."

Indeed, though Roe's attacks highlighted Davis's association with oil companies, Roe also supports a drilling expansion as part of a broader energy strategy, Osborne said. The distinction was not between attitudes toward big oil, but in each candidate's stand on corporate donations.

In the 2008 election cycle, Davis accepted $9,000 from oil and gas interests, according to the Center for Responsive Politics, a non-partisan campaign watchdog group. Roe took in $1,500 from the same industry, though not from any PACs.

"The anti-PAC stance is what resonated," Osborne said.

The issue of offshore drilling has dominated the domestic political debate over the last few weeks, dividing lawmakers along mostly partisan lines. Republicans have argued that removing the moratorium on new drilling will lower prices at the pump. Pelosi has pushed instead to tap the government's emergency reserves and increase funding for the development of alternative fuels.

Bolstering Pelosi's position, a report from the Energy Information Admin., a branch of the Energy Dept., issued a report last year revealing that expanded offshore drilling would have no significant effect on domestic production or fuel prices before 2030. Yet Democrats have had a tough time convincing the public of this. One recent national poll put support for increased drilling at 69 percent.

The drilling debate has also gained traction on the presidential campaign trail, where both Sens. Barack Obama (D-Ill.) and John McCain (R-Ariz.) are trumpeting plans for energy independence. Not doing Pelosi any favors, Obama said last month that he would support some expanded drilling if it were wrapped up in a larger energy reform package -- a stance Pelosi said Monday she would not rule out herself.

"That is not excluded," she told King.

House GOP leaders on Tuesday welcomed Pelosi's comments, but have vowed to continue their empty-chamber revolt until a drilling vote is called.

Putting more pressure on Pelosi and Democratic leaders, the congressional moratorium on new drilling expires at the end of September, meaning lawmakers would have to extend it before leaving Washington for the year. GOP leaders have threatened to shut down the federal government if the expanded offshore drilling doesn't come up for a vote next month.

Nownes said the combination of factors seems to predict some drilling expansion this year.

"The Republicans are vulnerable … to the charge that this move will enrich the oil companies but have no discernible impact on prices," said Nownes of the U. of Tennessee. "But in the end, I think the Republicans will win this one. Obama has already softened his stance on the issue, and many Democrats in Congress will go along. I think we are in store for more drilling, no matter what happens."

Much will hinge, however, on the price of gas in September, when Congress returns to Washington -- not to mention how the issue is ultimately digested by voters. Some experts say the lines in the debate were drawn long ago.

"People who aren't already committed Republicans," said Jacobson of UC-San Diego, "aren't going to see this as a solution to their energy problems."

Flying the Unfriendly Skies

Spencer Ackerman — Tue, 12 Aug 2008 20:31:11 GMT

Hopefully I don't sound jingoistic but American Airlines is dead to me. The Washington Times reports:

American Airlines is charging troops for their extra baggage, a practice that forces soldiers heading for a war zone in Iraq to try to get reimbursement from the military. One of the country's largest veterans groups is asking the aviation industry to drop the practice immediately.

More Than A Division's Worth Of Mercenaries In Iraq

Spencer Ackerman — Tue, 12 Aug 2008 18:27:41 GMT

Via Andrew Tilghman at TPMm, the Congressional Budget Office has identified over a division's worth of private security contractors working in Iraq:

Total spending by the U.S. government and other contractors for security provided by contractors in Iraq from 2003 through 2007 was between $6 billion and $10 billion, CBO estimates. As of early 2008, approximately 25,000 to 30,000 employees of private security contractors were operating in Iraq. Those contractors worked for the U.S. government, the Iraqi government, other contractors, and other customers. private security contractors (PSCs).

Now, the report doesn't break it down further. Just because someone's an employee of a PSC doesn't mean s/he's performing mercenary quasi-combat functions. Could be a driver or something. But still -- that's a lot of private security contractors.

Mortgage Giants Need Dose of Reality

Charles R. Morris — Tue, 12 Aug 2008 13:09:42 GMT

Last week’s announcements of first half results from Fannie Mae and Freddie Mac exposed the dire straits they are in. By its own rosy fair-value accounting, Freddie is already insolvent. Fannie is in better shape, but a string of heavy losses may have left it fatally weakened. Since both anticipate falling house prices through 2009, their futures grow blacker by the day.

A collapse of Fannie and Freddie would be a huge blow to an already-comatose housing market, so Washington is in full panic mode. Last month, Congress and President George W. Bush pushed through emergency legislation authorizing Treasury Sec. Henry Paulson to supply federal cash infusions of up to $300 billion to the mortgage giants, in almost any form he chooses.

Illustration by: Matt Mahurin

Paulson says he has no current plans to use that authority. But there is no possibility that he could allow a default on senior Fannie and Freddie debt. It is widely held by foreign central banks, and U.S. officials, including Paulson, have consistently reassured holders when doubts about the reality of the guarantee have surfaced.

But if the government is forced to bail out Fannie and Freddie, many other important decisions would have to be made. How do you treat the shareholders, or subordinate bond holders? How much can you curtail Freddie and Fannie without trashing the economy? Do we need a Fannie and Freddie at all? A fundamental question is why is the government propping up house prices amid a glut of unsold houses.

The bitter truth is that by conventional measures, like the ratio of house prices to rentals or to incomes, prices are still too high. Home prices nearly tripled over the eight years from 1998 to 2006, but have so far fallen only by about 18 percent.

There is a growing consensus that prices will fall by another 15 percent or so. The projections made by Fannie and Freddie economists, though they use different market indices, anticipate proportionally that level of decline -- bottoming out toward the end of 2009. Even generous federal refinancing programs for home mortgages make little sense when prices are dropping. Working people would be better off renting instead of being chained to falling assets.

Officially, we classify residential housing as an "investment." Sometimes that’s true. The shift of the nation’s economic center to the technically dynamic Southeast and Southwest in the 1980s and '90s was possible only with vast new housing and infrastructure construction.

But the "McMansions" at the heart of the 2000s construction boom look like economic millstones, their wraparound entertainment centers and multiple bathroom-spas monuments to conspicuous consumption. Big houses on large lots are energy hogs – both heating and driving – and impose heavy additional costs extending local sewage, sidewalks and other amenities.

A cold-eyed view of Fannie and Freddie suggests that they’ve long since outlived their usefulness. This is a country with low personal savings, extraordinarily wasteful consumption habits and big deficits in pensions, health care, roads and airports. Yet the new housing bill raises their permissible guarantee ceiling from $417,000 to $729,750 -- as if bigger houses were a national priority.

A realistic approach to a collapse of the mortgage giants might be: Federalize their outstanding senior debt, upholding the implicit guarantee. Recognize all their likely losses in fell swoop, which will wipe out current shareholders. (The taxpayer owes no obligation to investors who let their company run rampant.) Then create a new federal entity, with a high-quality board of directors, to run off the existing business in an orderly way, perhaps over the next 5-10 years, to minimize market disruptions.

The total effect would be to increase mortgage rates, and force new buyers to build more savings to become mortgage-eligible. Consumption of big-ticket furniture and electronic appliances would probably drop. None of those is a bad thing.

From 2000 through 2007, the United States spent 105 percent of what it produced. The resulting trade deficits have put some $5 trillion into the hands of foreigners, so the dollar has been falling and commodity prices spiking. Worse, a huge share of the overseas dollar trove is in the hands of states like Russia, China and the Middle Eastern petro-kingdoms -- which have little love for the United States, and often shadowy ties to terrorism.

Everyone knows that we have to change our ways. The way we deal with Fannie and Freddie will show how serious we are.

Charles R. Morris, a lawyer and former banker, is the author of "The Trillion Dollar Meltdown: Easy Money, High Rollers and the Great Credit Crash." His other books include "The Tycoons: How Andrew Carnegie, John D. Rockefeller, Jay Gould and J.P. Morgan Invented the American Supereconomy" and "Money, Greed, and Risk: Why Financial Crises and Crashes Happen.”

Mortgage Giants in Critical Care

Charles R. Morris — Mon, 11 Aug 2008 17:00:00 GMT

Both Fannie Mae and Freddie Mac , which have been almost single-handedly keeping the U.S. home mortgage markets afloat, announced their first half-year results last week. If they were cancer patients, the doctors would transferring Freddie into hospice care. Fannie is probably terminal as well, but is in better shape and might have a fighting chance.

Illustration by: Matt Mahurin

Fannie and Freddie are "government-sponsored entities," or GSEs. (There is a third GSE, the Federal Home Loan Bank system, that has been almost the sole support of Countrywide Bank over the past several years.) Fannie and Freddie don’t originate mortgages directly, but create liquidity by either guaranteeing mortgages for other lenders or buying them up for their own balance sheets.

The chart below shows the lending and guarantee activity for the GSEs for the five quarters through March, 2008. For comparison, it also shows the volume of ABS, or "asset-backed securities," that are a good proxy for private, unguaranteed mortgage activity. By 2007, almost all such mortgages were packaged up and sold to investors as ABS, while most ABS were backed by mortgages.

Source: Federal Reserve Flow of Funds Report (June, 2008)

The chart shows how the GSEs leaped into the breach when the private mortgage markets collapsed in mid-2007. By the third and fourth quarters, they were virtually the sole support of the markets, but were digging deeper and deeper financial holes. The first-quarter 2008 tightening shown in the chart continued in second quarter. Both Fannie and Freddie say it will do so for the foreseeable future.

Why are they in such trouble? Fannie and Freddie were created to lubricate the home mortgage market by buying mortgages from lenders; wrapping them with a guarantee, and packaging them up as tradeable securities sold to long-term investors -- like pension funds and foreign central banks.

The guarantee works because there are strict rules about the credit quality of the mortgages they buy. "Conforming," or guarantee-eligible, mortgages must be well-documented, conservatively structured and held by borrowers with good credit. Default rates are low, so guarantee fees are modest.

Together, Fannie and Freddie guarantee $4.1 trillion in mortgages. The business is profitable, but not egregiously so, and almost everyone agrees that it works fine.

What got them into trouble is their other business, that wags call their "$1.6 trillion hedge fund." Because global investors assume that Fannie and Freddie debt is "implicitly" guaranteed by the government, they can borrow at below-market rates. After all, their executives reasoned, if Goldman Sachs can make so much money trading for their own account, why shouldn’t they? They had stockholders, they sincerely lusted after Goldman-scale paychecks and the implicit government guarantee would let them tap almost unlimited capital.

So, between the two of them, they have now borrowed $1.6 trillion to build positions in mostly mortgage-backed assets, including good dollops of risky subprime and Alt-A mortgages, and "structured" mortgage-backed securities. So, of course, the housing market collapse that is destroying careers and balance sheets all over Wall Street is wreaking havoc at Fannie and Freddie.

Freddie is already a walking corpse. It ended the half with its balance sheet leveraged up 68:1, or more than twice as high as Bear Stearns just before its collapse. And that’s only if you assume their books are truthful. Though that’s unlikely.

One item deep in their financial footnotes is especially ominous. Accounting valuation rules usually classify mortgages and mortgage-backed securities as "Level 2" assets. While they don’t have daily market prices, like IBM stock, they can be usually valued by a combination of "observable" market values and internal judgments.

When the market for complex securities backed by high-risk mortgages collapsed last year, many banks shifted their holdings down to "Level 3," which allows you value solely by "internal models." In real life, that means almost any way you please. Accounting standards bodies led a concerted drive to move such assets out of Level 3 back up to Level 2, for greater transparency.

Freddie has gone the other way. During the first half of the year, they moved $154 billion of securities backed by high-risk mortgages from Level 2 to Level 3. A reasonable guess is that they’re carrying them at 80 cents on the dollar, or thereabouts.

But these are the same class of instrument that Merrill Lynch recently cleared off its books for 22 cents on the dollar. At a minimum, Freddie may be sitting on another $30-$50 billion in losses. Freddie ended the half with only $13 billion in equity supporting $879 billion in assets. If a beam of sunlight hits those Level 3 assets, the walking corpse instantly shrivels into ashes.

Almost laughably, Freddie plans to solve its problems by raising another $5.5 billion in capital -– or will as soon as its investment bankers tell them the time is "propitious."

Don’t hold your breath. Freddie’s total stock market value is now only about $3.8 billion. What percent of a $3.8 billion company do you sell to raise another $5.5 billion? And, oh, by the way, their chief executive, Richard Syron, was paid $20 million last year.

Fannie has been pulling in its horns faster than Freddie and raised substantial capital in the first half of the year. Their overall leverage is now only about 22:1 -- or about a third of Freddie’s. But their future is still bleak. Like Freddie, their stated equity includes huge deferred tax assets, which they may never realize. Normal bank accounting rules would assign much lower values.

Fannie has absorbed $6 billion in net losses so far this year, and expect losses in that range to continue for the rest of the year. The losses should continue well into 2009, but they hope at a lower level. A normal company could not survive.

Is a rescue on the way? Congress recently authorized the Federal Reserve and the Treasury to lend as much as they want to bail out Fannie and Freddie. That is the topic for Part II of this article.

Charles R. Morris, a lawyer and former banker, is the author of "The Trillion Dollar Meltdown: Easy Money, High Rollers and the Great Credit Crash." His other books include "The Tycoons: How Andrew Carnegie, John D. Rockefeller, Jay Gould and J.P. Morgan Invented the American Supereconomy" and "Money, Greed, and Risk: Why Financial Crises and Crashes Happen.”

Economy from The Washington Independent - U.S. news and politics - washingtonindependent.com

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The Reach of Redlining

Swift Boaters and the Housing Crisis

Keeping the Roof Over Your Head

Fraud Worsens Foreclosure Crisis

Subprime Everything

The New Language of Subprime

Skipping the Drive

Trump to the Rescue!

Advertising to Lose Your House

Another State Moves on the Mortgage Crisis

He's Back and He's At It Again

﻿Going God Over Gas

More Green Affordable Housing Successes

More From the Latte Index

Big Oil Ties Could Hurt GOP

Flying the Unfriendly Skies

More Than A Division's Worth Of Mercenaries In Iraq

Mortgage Giants Need Dose of Reality

Mortgage Giants in Critical Care

Going God Over Gas