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This needs to be read by more people, so more people can contact congress to let them know what they think of it.  I’ll post the reasons for my own thoughts later (I think it sucks!) but for now, here’s the text of the proposed plan according to the NY TImes.  Please read it and let congress know what you think!

gk

LEGISLATIVE PROPOSAL FOR TREASURY AUTHORITY

TO PURCHASE MORTGAGE-RELATED ASSETS

Section 1. Short Title.

This Act may be cited as ____________________.

Sec. 2. Purchases of Mortgage-Related Assets.

(a) Authority to Purchase.–The Secretary is authorized to purchase, and to make and fund commitments to purchase, on such terms and conditions as determined by the Secretary, mortgage-related assets from any financial institution having its headquarters in the United States.

(b) Necessary Actions.–The Secretary is authorized to take such actions as the Secretary deems necessary to carry out the authorities in this Act, including, without limitation:

(1) appointing such employees as may be required to carry out the authorities in this Act and defining their duties;

(2) entering into contracts, including contracts for services authorized by section 3109 of title 5, United States Code, without regard to any other provision of law regarding public contracts;

(3) designating financial institutions as financial agents of the Government, and they shall perform all such reasonable duties related to this Act as financial agents of the Government as may be required of them;

(4) establishing vehicles that are authorized, subject to supervision by the Secretary, to purchase mortgage-related assets and issue obligations; and

(5) issuing such regulations and other guidance as may be necessary or appropriate to define terms or carry out the authorities of this Act.

Sec. 3. Considerations.

In exercising the authorities granted in this Act, the Secretary shall take into consideration means for–

(1) providing stability or preventing disruption to the financial markets or banking system; and

(2) protecting the taxpayer.

Sec. 4. Reports to Congress.

Within three months of the first exercise of the authority granted in section 2(a), and semiannually thereafter, the Secretary shall report to the Committees on the Budget, Financial Services, and Ways and Means of the House of Representatives and the Committees on the Budget, Finance, and Banking, Housing, and Urban Affairs of the Senate with respect to the authorities exercised under this Act and the considerations required by section 3.

Sec. 5. Rights; Management; Sale of Mortgage-Related Assets.

(a) Exercise of Rights.–The Secretary may, at any time, exercise any rights received in connection with mortgage-related assets purchased under this Act.

(b) Management of Mortgage-Related Assets.–The Secretary shall have authority to manage mortgage-related assets purchased under this Act, including revenues and portfolio risks therefrom.

(c) Sale of Mortgage-Related Assets.–The Secretary may, at any time, upon terms and conditions and at prices determined by the Secretary, sell, or enter into securities loans, repurchase transactions or other financial transactions in regard to, any mortgage-related asset purchased under this Act.

(d) Application of Sunset to Mortgage-Related Assets.–The authority of the Secretary to hold any mortgage-related asset purchased under this Act before the termination date in section 9, or to purchase or fund the purchase of a mortgage-related asset under a commitment entered into before the termination date in section 9, is not subject to the provisions of section 9.

Sec. 6. Maximum Amount of Authorized Purchases.

The Secretary’s authority to purchase mortgage-related assets under this Act shall be limited to $700,000,000,000 outstanding at any one time

Sec. 7. Funding.

For the purpose of the authorities granted in this Act, and for the costs of administering those authorities, the Secretary may use the proceeds of the sale of any securities issued under chapter 31 of title 31, United States Code, and the purposes for which securities may be issued under chapter 31 of title 31, United States Code, are extended to include actions authorized by this Act, including the payment of administrative expenses. Any funds expended for actions authorized by this Act, including the payment of administrative expenses, shall be deemed appropriated at the time of such expenditure.

Sec. 8. Review.

Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.

Sec. 9. Termination of Authority.

The authorities under this Act, with the exception of authorities granted in sections 2(b)(5), 5 and 7, shall terminate two years from the date of enactment of this Act.

Sec. 10. Increase in Statutory Limit on the Public Debt.

Subsection (b) of section 3101 of title 31, United States Code, is amended by striking out the dollar limitation contained in such subsection and inserting in lieu thereof $11,315,000,000,000.

Sec. 11. Credit Reform.

The costs of purchases of mortgage-related assets made under section 2(a) of this Act shall be determined as provided under the Federal Credit Reform Act of 1990, as applicable.

Sec. 12. Definitions.

For purposes of this section, the following definitions shall apply:

(1) Mortgage-Related Assets.–The term “mortgage-related assets” means residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was originated or issued on or before September 17, 2008.

(2) Secretary.–The term “Secretary” means the Secretary of the Treasury.

(3) United States.–The term “United States” means the States, territories, and possessions of the United States and the District of Columbia.

I was responding to some comments to a post I made to www.seekingalpha.com a few minutes ago, when I said something that I think needs to be explained further.  I mentioned “leverage” and since that’s been in the news (especially regarding financial stocks) quite a lot over the past few months, I decided to expound on it a bit.

In the comment I referenced above, I said “Let’s say you have $1 million equity in your house, and you take it out in a HELOC. You take that $1 million and put 10% down on 10 other $1 million properties - and you depend on the renters to make your payments.“

That’s leverage.  I just took $1 million in assets (my home equity) and used it to gain control on $10 million in assets.  I used the words “gain control” rather than saying “to buy” because I don’t actually own them - the bank I borrowed the other $9 million from actually owns those properties.

It’s an important distinction, because what happens to my $10 million in assets if just one renter falls behind on their payments?  Suddenly I can’t make my mortgage payments.  It’s only 10% less income, but it causes me to suddenly have to sell the whole $10 million in leveraged assets - because I can’t make the payments.

That’s what happened to Bear Stearns.  They had some assets which they leveraged (borrowed against) in order to buy (with other peoples money) other assets.  When one small part of the initial asset didn’t make their payment, the whole house of cards fell.

In my example, I used a leverage ratio of 10 to 1.  Bear Stearns was leveraged over 30 to 1.  I’ve sen some arguments from pundits (including Ben Stein) where they say the markets have over reacted; that a 10 percent jump in the rate of defaults doesn’t warrant a 20 or 30 percent drop in the stock price of financial companies. 

They’re wrong.  And they’re wrong for the reason above.  When you’re that highly leveraged; when you have 20 (or more) dollars of debt for every dollar of assets; you are hosed when just one percent of the underlying assets doesn’t pay up.

Suddenly you can’t make your payments on all the debt you’ve borrowed.  And since you really didn’t make much of a down payment anyway, you have no equity in the investment.  If you had some equity, you’d have a little breathing room.

But you don’t.  You need every dollar that you’ve counted on to make those payments - because you’ve leveraged your equity. 

And what happens when the value of thoseleveraged assets turns out to be too high?  You’re fucked.  Not only are you highly leveraged, but the base value of thoseassets has dropped, so now you are more leveraged than you were just a monthago.  And so you’re even more vulnerable when there’s a small rise in loan defaults and bankruptcies.

It’s a wild, wild world right now.  I can’t think of a single bank or REIT that I’d touch with a 10 foot pole.  Go ahead and Google the news results for the 3rd quarter of last year.  Check out all the stories that claimed that the 4th quarter was the “kitchen sink” quarter.  Be sure to read how damn near everyone thought that the banks and investment houses have finally fessed up and come clean.

Now watch the headlines during the week ahead.  Let’s se how many additional write-downs there are.  A lot of people have written me saying that I’m overestimating the impact of the sub prime stuff.  Many have told me that all of those losses for the upcoming rate adjustments (for the Option ARM’s and ARM’s written in 2005 through 2007) have been accounted for, and that there’s no where to go but up.

They may be right, but I don’t think so.  I don’t think people truly understand the impact of leverage.  I don’t think they truly understand that just a 3 or 4 percent drop in the base asset (mortgages) can cause a company to disappear.  

I’m not putting my money back into the market until I’m sure that risk has been priced in.  Given the (in my view) extremely optimistic earnings forecasts for 2008 and 2009, that risk is being ignored right now.  I may be wrong (I often am!) but I think I’ll be getting 2 or 3 percent in my money market funds while the optimists are losing 10 to 20 percent (or more) trying to bottom fish the market.

Any questions?

gk

It was quite a day today in the financial media.  I’ve read stories tonight about why it’s great for everyone that the Fed bailed out Bear Stearns, I’ve read stories about why it’s bad that the taxpayers are bailing out Bear Stearns, and I’ve read stories where I don’t think the author had a clue what he was talking about.

But one of the best of the bunch has to be an article at Minyanville.com about why the housing market is nowhere near a bottom yet.  On page 2 of the article John Mauldin has a good synopsis of the current situation.  He states:

• 8.8 million homeowners will have mortgage balances equal to or greater than the value of their homes by the end of March.
• 30% of subprime loans written in 2005 and 2006 are already underwater.
• Nearly 3 million homeowners were behind on their mortgages at the end of 2007, with 1 million at risk of imminent foreclosure.
• As of the end of last year, 5.82% (!) of all mortgages were delinquent, the highest level in 23 years.
• 0.83% were in the process of foreclosure, also an all-time high.
• When you look at just subprime mortgages, you find that 20% are delinquent (the number is rising rapidly), and almost 6% were in foreclosure.
• Finally, the average American’s percentage of equity has fallen below 50% for the first time since 1945.

That pretty much sums up the current state of the market, but he goes on to explain why it’s going to get worse.  I’ve said much of this before, but he says it better:

Mortgage lending standards became progressively worse starting in 2000, but really went off a cliff beginning in early 2005. The worst loans are those with two-year teaser rates. As the subsequent pages show, they are defaulting at unprecedented rates, especially once the interest rates reset. Such loans made in Q1 2005 started to default in high numbers in Q1 2007, which not surprisingly was the beginning of the current crisis.”

 It’s an excellent article and I encourage you to check it out if you like knowing what’s probably going to happen over the next few years.

gk

Here’s another case of someone buying more house than they could afford and now they’re whining.  According to the story “She has had to take extreme measures to pay for her interest-only mortgage of $2,500 a month.”

Let’s take a second and do the math on this.  Which is something Patricia Guerrero should have done before she bought the house.

According to the article, she made $70,000 per year - great money!  I’m assuming that was her gross pay, so let’s deduct 8% for SSI and Medicare taxes, another 15% for Federal taxes, and 9.3% (!) for California income tax according to BankRate.com.

$70,000 x 8% = $5,600 in SSI and Medicare taxes.  $70,000 x 15% = 10,500 in Federal income tax, and (assuming CA allows you to deduct Federal taxes) her CA taxable income was $53,900 x 9.3% state tax = $5,012.

Add it all up, and she had about $49,000 per year in take home pay - assuming she wasn’t putting anything into a 401K or company stock, health insurance, etc.  In other words, that’s about the most she could take home under any circumstances.

$49,000 per year is $4,083 per month.  I don’t know about you, that’s pretty good money where I come from!  But anyway, the standard rule of thumb is that your house payment should be no more than 25% of your gross pay, or no more than 33% of your take home pay.  A $2500/month house payment is way above that - it’s 43% of her gross and a whopping 61% of her take home pay!

When you factor in utility bills, a car payment or two, insurance, property taxes, etc, she couldn’t afford that house when she had a job!  Although the article doesn’t mention other bills, she almost had to be ringing up credit card debt each month just to stay afloat - kinda like banks borrowing from the Fed to stay afloat, but that’s a different topic….

To top it off, she has an interest only loan, so she wasn’t making any progress in paying down her mortgage.   But I guess we’re supposed to feel sorry for her, because now she’s broke.  To be honest, she was broke before - she was simply refusing to recognize what was staring her in the face.

Sorry, I have no pity for Patricia.  She spent more than she made for too long, and now she has to face the music.  She wasn’t a home owner, she was a squatter, and that home will be auctioned off when it goes into foreclosure.  Why should we (taxpayers) pay to bail her out of her self-made mess?

gk

Given the posts I made earlier tonight, I’ve been thinking that instead of just outlining the problems of today (and how much worse it’s going to get) I should talk a bit about what to do with your money to allow you to keep more if it during this downturn - or worse - of the economy.  So shooting from the hip, here are my thoughts.

1) Pay down debt.  If you’re one of the idiots who bought more house than you could afford, or who took out HELOC’s and second mortgages to “access your home equity” this doesn’t apply to you.  You’re toast.  You’re the problem.  For anyone who has a reasonable amount of debt - which I’ll arbitrarily define as totaling no more than 50% of your gross annual pay - I suggest paying it down as fast as possible.

When the shit hits the fan, you need to be able to live as long as possible on your savings.  Just imagine how much money you’d have each month if you didn’t have any payments!  If you’ve got a car payment, sell the freaking car to get rid of the debt and payments.  Buy a cheap car that runs good. Build up a small emergency fund by making minimum payments on everything and saving every dime you can.  You need at least one month’s worth of expenses saved up. 

Then (as Dave Ramsey would say) “act your wage”.  Live on less than you make so you can start paying off the debts.  Stop eating out, stop renting movies, get rid of your cable or satellite service, collect coupons, etc.  Cut your bills to a minimum and get out of debt.

2) Pile up cash.  Continue your frugal budget and save at least 6 months worth of expenses.  This money needs to be in your local FDIC insured bank in a simple savings account.  I don’t care about the interest rate - the object here is to save money, not grow it.  It needs to be easily accessible, so that means no CD’s or other investments.  This is your cushion for the dismal day when you don’t have a job.

That 6 months of expenses you save gives you time to plan, to look for a better job, to avoid despair, if and when you don’t have an income.

3) Fund your retirement.  Save at least 10% (and you’re much better off if you can save 15 or 20%) of your gross pay in an IRA.  Use your 401k at work if you have one.  Most employers have some sort of matching program, so be sure to contribute enough to get the full employer match.  Put the rest into a self funded IRA - you can open an account online with for as little as $50.  I use Scottrade and TD Ameritrade, but there are dozens of others.  Just do it!

I think a Roth IRA is best - taxes WILL be going up over the coming decades.  A Roth IRA is funded with after tax dollars, and the earnings are tax free.  That might not be much difference right now, but it will when tax rates hit 50 and 60%.  (If that seems extreme and alarmist to you, just wait.  I’ll have more to say later!)

If you’re putting in a big pile of money, be sure to spread it out among various large funds.  Be sure to include international funds (to take advantage of the tanking dollar) and I don’t think you can go wrong in the long run by putting a decent chunk (say 10%) into a gold or silver fund.  10 years from now you’ll be glad you did. 

Personally, I’d stay away from Asia, as the tightly regulated economy (and zero transparency in the numbers the governments provide) will eventually drag them down.  The China bubble may be popping now - although most “experts” say that the Chinese government will keep things propped up through the Olympic games later this year.

If you’re just starting out, pick a few good index funds and contribute each month.  You’ll be automatically dollar cost averaging, which in effect allows you to buy at a lower average price.

4)  Invest in staples.  No, not the office supply company (I don’t have an opinion on them) I mean consumer staples - the things everyone needs regardless of the economy or job situation.  This is stuff like food and clothing.  As times get tougher, people will spend as little as possible on everything - but they have to eat. 

Where’s the cheapest place to buy food and clothing?  Wal Mart.  As sales go down at the Gap, Dillards, Kroger, etc, look for them to go up at Wal Mart.  Target might be ok as well, but I think Wal Mart sales will grow faster - so the stock price should rise more over time.  McDonalds and other cheap fast food should also do better than average.

5)  Stuff.  I don’t have time to get into this in the detail it deserves right now, but “stuff” will become more valuable as the dollar is inflated away.  By stuff I mean things like farm land, apartment buildings, and rental property.  We’re nowhere near the bottom yet in the real estate market, so there’s no hurry on this one.  But in a year or two you should be able (if you’ve saved and invested) to pick up valuable property for 50 to 60% off today’s prices.

Look for property in retirement areas, such as Florida, southern California, and Arizona.  Look for farm land in Nebraska and Kansas - possibly areas of Texas and Oklahoma that receive adequate rain.  If it’s in a windy area, so much the better, as you may be able to lease small sections to energy companies for wind turbines.  It may sound crazy right now, but there will be fortunes made in wind energy over the next 20 years.  There’s too much to go into here, but Google “peak oil” sometime.  We’ll need energy, and wind is relatively cheap.

6) Tin foil hat stuff.  I don’t know what the price of gold or silver will be next month or next year.  But in my opinion, we are watching an epic devaluation of the dollar.  Until we stop spending more than we make (at the personal, local, state, and federal levels) the dollar will continue to lose value.  Conversely, things priced in dollars will continue to rise long term.  Things like gold and silver and oil.  It’ll be a bumpy ride, but 20 years from now, all of these will be much higher than they are today.

1/10 oz gold coins on eBay are going for about $100, while 1 oz silver coins are about $20.  Pick one and buy a coin or two every month.  This isn’t something to turn around for a quick profit - this is your insurance against a 1930’s type depression, or (more likely IMHO) hyperinflation like 1930’s Germany, or Argentina in the 1980’s.  We’re inflating the money supply faster than ever, and the law of supply and demand hasn’t been repealed. 

Remind me to talk more about inflation, deflation, and peak oil sometime.  It involves M3 and the huge unfunded Social Security and Medicare mandates - which are the major reasons the dollar will continue down.  Deficit?  You ain’t seen nothing yet!

gk

I was reading about Bank of America’s buyout of Countrywide this morning, and I happened upon this article at The Wall Street Journal:

http://blogs.wsj.com/marketbeat/2007/11/30/we-are-all-subprime-borrowers-now/?mod=sphere_ts

I normally read a lot of opinions and I can respectfully disagree with those who look at things from a different angle than me, but this really ticked me off.  The writer (David Gaffen) says: “Expect lots of talk of the moral hazard, particularly now as it extends its reach (as it’s no longer just dumb bankers being covered for their financial engineering through the creation of the Entity, but a lot of regular people), and even a bit of snide, boorish comments from those saying everyone should take responsibility for their own actions (remarks most likely to come from millionaire commentators who have personal assistants to manage their lives).“

Pardon me Mr. Gaffen, but I’m not a millionaire, I don’t have a personal assistant, and I don’t happen to think that people who believe in personal responsibility are “snide” or “boorish” - but I am going to comment on your article.  I’ve heard and read many comments on the subprime meltdown, but most leave out the role of the person who ASKED FOR the loan in the first place.  I’ll use myself as an example.

I had to relocate for my job in March, 2007.  I’m not a saver by nature (thankfully my wife is and she keeps my spending in line!) but we had managed to pay off our old house in about 15 years, so we had a good bit (about $140K) to use as a down payment on our new home.   I couldn’t find a decent house in the area we wanted for that, so I needed to get a loan.  I talked to Wells Fargo and Bank of America, and decided to go with Wells Fargo because they had a lower interest rate for a 15 year fixed rate mortgage.

Both Wells Fargo and Bank of America pre-qualified me for a loan of up to $200K on those terms.  Both encouraged me to get an adjustable rate loan with a low (teaser) interest rate fixed for the first three years - they said they could loan me up to $350K if went with an ARM.  “You can get a much nicer home” was a recurring phrase I heard.  The realtor was also pushing me to look at more expensive homes, and had to be persuaded that I really did want to live in a house that was less than I “can afford”.

I found a nice 30 year old home for about $190K, so I borrowed $50K on a 15 year fixed rate mortgage.  My house payments - including property taxes and insurance - are about $500/month, and I’m working on paying that off early, hopefully within about 7 or 8 years.  Had I listened to those selling me the mortgage and the house, I might be writing this from a very nice $450K house in Knoxville, TN - that’s a huge house here - with a payment of about $1500/month with the teaser %3 interest rate for the first 3 years.  I could afford it, so why didn’t I do it?

Because that teaser rate resets in 3 years.  I don’t know what interest rates will be 3 years from now, but I guarantee that they won’t be 3%.  Let’s just assume that it resets to 6% - which is probably on the low side.  That would make the payments go to over $2000/month.  I don’t know what I’ll be making in 3 years, but no matter what, paying an additional  $500/month won’t be fun.

So I’m in a decent house, with payments I can afford - anyone who can tell the difference between “a bottle in front of me” and a “frontal-lobotomy” could have done the same.  Am I supposed to feel sorry for the dumb asses who bought more house than they can afford?  Or for the dip shits that bought a house when they can’t keep a steady job and are surprised when the bank tells them they have to make payments?  And they expect me (via the government) to bail them out because they can’t do math?

Perhaps this is “boorish” and “snide”, but I don’t ask for money that I won’t be able to repay.  I expect the same responsible behavior from others.  When someone asking for a loan LIES about their income, expenses, debt load, or whatever in order to get money from someone else, they are committing a fraudulent act at the least - and plain stealing at the worst.   These home “owners” (perhaps squatters is a better term) are getting the least that they deserve - they should go to jail for fraud or theft.

And lest you think I’m one of the fortunate ones born with a silver spoon, I’ll add this: I left home in 1980 with $20 in my pocket and a change of underwear in a brown paper bag.  Everything I have today I’ve EARNED with my brain and muscles.  I’m tired of people saying they just can’t get ahead, or they weren’t as lucky, or they never had a chance because the convenience store or fast food restaurant owner (where they work) is greedy.  That’s bullshit.  Most of them are just too damn lazy to do what it takes to get out of their current position - they don’t expand their knowledge, they don’t go to school at night, they don’t work 2 jobs to pay off their cars, they can’t (or won’t!) do the math that says they can’t afford that big-screen TV, that new car, those designer jeans, purse, or sneakers. 

This type of person (you know who you are) habitually spends more than he/she makes - and then complains of bad luck when they lose a job or have a medical problem that prevents them from working and servicing the debt that they’ve accumulated.  Dave Ramsey says “act your wage” and it’s excellent advice.  If you spend less than you earn and put 5% or 10% of your take home pay into savings each month, you can ride out any temporary issues that come your way.  And you CAN’T be taken advantage of by hucksters promising you a great house for super low payments.

Because of jerks who didn’t think about the long term consequences of what they were doing, my house will be going down in value for the next few years as thousands of homes in this area go into foreclosure and are put on the market.  But guess what - because I bought less house than I could technically afford - I’ll still be ahead.  And maybe your stupidity will turn me into a millionaire when I buy your house at a rock bottom price because you can’t make the payments. 

Any questions? 

gk