Brother, Can You Spare a Home?
It's hard to let go
Of all that we know
As I walk away from you
Hurled from my home
Into the unknown
As I walk away from you
-Crowded House
Last week, the Federal Housing Finance Authority (FHFA), which has the esteemed position of regulator for Fannie Mae, Freddie Mac and the Federal Home Loan Banks, suggested a plan to assist homeowners. The agenda of keeping folks in their homes will not be fully accomplished with this program, but in Washington, honorable mention sometimes feels like a blue ribbon.
The program, called the "streamlined modification program" asks mortgage servicers to modify existing loans for borrowers to get payments on first mortgages down to 38 percent or less of their monthly gross income. It is suggested that servicers lower interest rates, extend terms or defer required payments in order to achieve this objective.
Hurdles to qualify include: missing at least three mortgage payments, occupying the property as a primary residence and not filing for bankruptcy. Of course, the loan must be a Fannie or Freddie loan to begin with, but the kicker is that borrowers must certify that they "experienced a hardship or change in financial circumstances, and did not purposely default."
Sounds good, right? Only a few problems exist, including the following. Fannie and Freddie, while accounting for about 58 percent of total mortgages, only account for about 20 percent of serious delinquencies. So, right off the top we know this solution will accomplish little toward addressing the problem in the market as a whole.
In addition, showing "hardship" and proving one does not "purposely default" are subjective at best. Will we create a review board with the power to determine case-by-case who is experiencing a hardship? Will that individual's personal life decisions determine if they've experienced a hardship or if their current circumstance is simply a result of their own poor decision making? Anyone who has ever dealt with their local city council or school board will immediately see the potential for abuse of power here.
Third, and most important, why is this authority given to the loan servicers as opposed to the lenders? Ah, because the "lenders" are mortgage conduits — nameless, faceless entities who can surely take some of the blame for the state of the mortgage market.
Unfortunately for the populace, they are the "lenders". After all, who holds mortgage securities but pension funds, endowment funds, charitable foundations, and, yes, even 401(k)s? The only good thing is most people don't scrutinize their own investments closely and are much quicker to criticize the investment choices of others without realizing the enemy is within.
A more appropriate solution is to simply pay off the current mortgage holders at par and create new loans for whoever qualifies (certainly subjective requirements need to be eliminated). This would provide a much cleaner path to mortgage modification and at the same time punish mortgage investors in the sense they will receive their cash back today with limited investment choices at similar mortgage yields. Changing the rules after the game is in progress will discourage future investments in the mortgage sector — something we cannot afford today.
— Joe Morgan, Chief Investment Officer, SVB Asset Management
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Last Weekend's G20 Meeting
The leaders of the G20 countries met in Washington over the weekend. Collectively, their economies make up 90 percent of global GDP and consequently, are more representative of the global economy than the G8, which no longer has the economic and political dominance it did when the name was formally coined in 1997 upon the inclusion of Russia.
Expectations were low for a meaningful outcome and the outcome largely matched those expectations. The statement that followed their five-hour meeting on Saturday called for a broader policy response to recent events and made a plea for lower interest rates, lower taxes and more government spending in the weeks and months ahead. Each country was asked to respond to their individual set of conditions as they saw fit.
Other "noteworthy" items included: a call for more ammunition and a larger toolkit for the International Monetary Fund (IMF), a promise not to erect new trade barriers, a March 31, 2009 deadline for new recommendations on greater market oversight and regulation, tighter accounting standards and improved functioning of the credit derivatives market. They said they would meet again in April to review their progress on decisions made on November 15. Several countries including France were pressing for explicit steps towards a centralized global authority to oversee financial markets, but the U.S. was not supportive. Faced with a choice between more market support and greater controls, the group chose to mention both, with slightly greater emphasis on supportive measures in the near-term.
While the list of action items and expressions of harmony and cooperation sounded impressive, the statement has no real teeth, nor was it ever likely to. Mr. Bush brings new meaning to the phrase "lame duck president", given his approval ratings and the election results. Mr. Obama stayed away, even though his lieutenants were sent to keep an eye on the proceedings. It is more than likely that he will put his own stamp on global coordination shortly after January 20. It is also likely that if financial markets implode again, some of the emerging markets represented at the table (Russia, India, China, Brazil, Mexico, Saudi Arabia, South Africa, Turkey, South Korea, Argentina and Indonesia) will take unilateral action that might well fly in the face of Saturday's communiqué.
Finally, with a dominant and increasingly vocal Democratic majority, an economy in a downward spiral, an automobile industry on life support and our trade deficit with China continuing to soar, it may not be long before protectionist sentiment rears its head once again. The Doha Round of the World Trade Organization was given verbal support, but it is doubtful whether it will ultimately yield meaningful results.
The road ahead
The dollar and JPY rallied towards the end of last week, as weakness in the equity markets undermined sentiment. Heightened risk aversion benefited those two currencies, following the pattern established in recent months. Overall, the dollar's pace of appreciation has slowed, but not the direction. In my opinion, the dollar's strength is increasingly only a function of position liquidation and risk aversion now, and not a reflection of underlying fundamentals.
Earlier, it was helped by a downward repricing of European growth and a realization that even Asia was vulnerable. Most forecasts now see a deep recession in the UK, with rates falling to one percent (currently three percent) and Europe falling into recession as well, with the ECB likely to cut rates to below two percent (currently 3.25 percent). Currency positions probably reflect these revised forecasts or soon will. Therefore, once the deleveraging process ends, there is likely to be little fundamental support for further USD gains. I suspect most hedge fund liquidation to fund 2008 redemptions will end shortly; other flows will depend on the performance of equity markets.
Predicting the timing of a trend reversal for the dollar is difficult, as it depends on many factors. However, with financial markets appearing to be on the path to (relative) stability and global economic forecasts converging gradually towards a consensus view of subpar 2009 growth for the global economy (and negative growth for the major economies for the first time since World War II), equity volatility should abate over the next few months. I expect the dollar to turn in the first quarter of 2009, but the pace and magnitude is likely to vary by currency.
The GBP has been especially hard hit and there are reasons for GBP weakness to continue in the short-term: a deep recession, deleveraging of the most leveraged consumer society outside the U.S. and lower rates. However, there is also reason to expect the economy to recover somewhat sooner, thanks to a proactive Bank of England. The euro's fall has been less severe, but it is likely its rebound will be slower, as the European Central Bank is behind the curve and needs to play catch-up. In my opinion, the stronger Asian currencies will lead the pack as their banks are largely unscathed, reserves remain adequate and economic growth (and interest rates) should rebound sharply once global demand recovers. The JPY is stronger than its economic fundamentals justify and will probably underperform as risk appetite returns and equities stabilize.
Overall, I expect the dollar to make new highs (or retest recent highs) over the next couple of months. I think it will be weaker by the end of 2009 — just barely vs. the euro, more sharply vs. some of the Asian currencies and somewhere in between for most others. In my opinion, any dollar gains between now and the end of 2009 will be limited to the JPY and some of the weaker emerging market currencies, whose economies will continue to suffer from the fallout of the financial crisis.
— Dave Bhagat, Senior FX Advisor, Silicon Valley Bank's Global Financial Services
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November 18, 2008
An Offer They Couldn't Refuse
By now it is certain that Hank Paulson's command performance in Washington a month ago will win a place in the banking hall of fame. Nine of the largest financial firms in the country were summoned to be told that they would be receiving money from the recently created $700 billion rescue fund. In the meeting, Paulson explained the Treasury's new Capital Purchase Program. Most were happy to be invited as the alternative was worse. So, like a group of errant school boys, they listened carefully to the headmaster and accepted their punishment. The sole exception was Richard M. Kovacevich of Wells Fargo who complained that he did not need the government's capital and did not want to be tied down by the strings that might be attached. Mr. Paulson explained in no uncertain terms that for those present the program was not optional. It was a scene familiar to Don Corleone or, perhaps, Hugo Chavez.
To be fair, the Treasury deal is financially attractive. The dividend rates are relatively modest and, at least on paper, there are no control features. The dilemma for the rest of the banking sector is to decide whether to take the money or not. According to news reports 67 banks have applied and been approved so far. The point of including some "good banks" in the deal was to try to eliminate the taint that would become attached to the "bad banks" if that was the only place the money landed. Including the good banks in Secretary Paulson's leveraged roll-up of the financial sector will also mitigate the public outcry when some of the "saved banks" go under anyway. So let's be clear, the Treasury is picking winners and losers. First National City was rumored to have asked for money, but after losing some $4 billion in the last year, the financial system's new central planners preferred a shotgun marriage to PNC. The marriage, of course, paid for by the proud parents of the bride: you and me.
Like any great magician, success depends on misdirection. In this case it seems to be working. Banks getting TARP money are perceived as the chosen ones. CEO Mark Furlong of Milwaukee-based Marshall & Ilsley with $65 billion in assets stated, "Being chosen by the Treasury Department underscores M&I's strength as a financial institution." In sharp contrast, First Commonwealth Bank went its own way rejecting the Capital Purchase Program (CPP) and instead pulled together a $100 million IPO. Wells Fargo topped up their $25 billion from the Feds with a cool $11 billion secondary this month. The deal was oversubscribed by $1 billion, indicating that private capital is readily available for well managed institutions. So, as taxpayers and new multibillion investors in the U.S. banking system, I suppose we should be happy that Hank put our money on a few easy bets.
So what happened to the Troubled Asset Relief Program (TARP)? Recall that TARP was the plan to buy $700 billion of dodgy mortgage assets from the banks to improve liquidity in the banking system. Well, as we learned last week: never mind. Three Republican senators were upset enough about this change they fired a shot across Paulson's bow in a letter last week stating:
"Although the legislation was passed on October 3, the program was never implemented and now has been officially abandoned in favor of alternative plans after little more than a month. Such a rapid reversal raises questions about the TARP's original design as well as the propriety of future plans."
- U.S. Senator Tom Coburn, M.D., U.S. Senator Richard Burr, U.S. Senator David Vitter
The good senators want Secretary Paulson to get congressional approval for any new changes to the program. As we predicted some weeks ago, government slush funds, especially slush funds of this magnitude, fall under the exclusive purview of the legislative branch.
The thinking at Treasury is that putting new capital into banks gives taxpayers more bang for the buck. So $250 billion with eight times leverage will create $2 trillion in lending capacity. Unfortunately, leverage does not work the other way as $250 billion in new capital will only cover $250 billion in losses on dodgy mortgages. So, the real question becomes will the banks actually increase their lending or simply keep the new capital in reserve to help soften the impact of the next economic cataclysm on offer. Their actions post-CCP investment will be carefully scrutinized by congressional overseers.
The recent 180 degree volte-face on buying troubled mortgage assets should serve as ample warning to bankers that the government is a fickle partner. This is especially true with a new administration taking over in January. While the new banking masters of the universe in D.C. may own only preferred stock and be absent from board meetings, they will make their presence felt eventually. Indeed, our innumerate congresspeople are happily looking forward to the day when they can direct the lending activities of the entire industry. After famously "wanting to gamble a little bit and roll the dice" with Fannie Mae, Barney Frank, Chairman of the House Financial Services Committee, is no doubt ready to double down for a little gaming action with the assets of Goldman Sachs, JP Morgan and Citibank.
Obamaland Lexicon
The president-elect's Luo tribe surname is giving rise to some new idioms. Having spent a couple years teaching students with names like Mukendi, Mbuyi and Kasanganayi, it is easy for me to understand how people are drawn to the rhythm and lyrical tonality of African names. So the obamanomenon is in full swing with one reader wondering whether obamanomics would be an obamanation.
— Jim Anderson, President, SVB Analytics
Investment Strategy Outlook is published each week to highlight issues we hope you find relevant and topical. The views expressed in this newsletter are solely those of its authors and do not reflect the views of SVB Asset Management, Silicon Valley Bank, or any of its affiliates.
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The TED Spread measures the difference in U.S. Treasury rates and the Eurodollar deposits rate for a like maturity (typically three months). It is a proxy for the level of confidence in or fear of the financial markets in general and the U.S. in particular. A narrow spread indicates increasing confidence. When the spread is wide, fear is the dominant sentiment. The expansion of the spread beginning in August 2007 is unprecedented and marks the jump in anxiety in the credit markets.
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