How to Fix the Housing Crisis

0:00Today I wanted to talk about something that is very much in the news and has been in the news for a long, long time. And there doesn't seem to be any end in sight to what I'm talking about, and that is the foreclosure crisis, the housing crisis. You know, this foreclosure crisis has crawled on for four years now. In fact, the latest Case-Shiller housing index fell 3.4% during October from a year ago. Despite the fact that every year all the pundits say this is the bottom in housing. In fact in June of 2009 CNBC's Jim Cramer, and I know you get all of your news from Jim Cramer, he told his Mad Money viewers that the residential real estate had finally found a floor. The next year the CEO of Toll Brothers, Douglas Yearley, he said in late 2010, the recovery is here to stay, yet Kay Schiller continues to fall and fall and fall.

1:10And you know, if that wasn't bad enough, I don't know if you read this, but in the last few weeks, the National Association of Realtors finally fessed up. They finally fessed up because they said they've been overstating sales for the previous, previous In 2010, it was 14.6% less than what they would say, but that didn't stop Jamie Dimon from JP Morgan Chase the other day. He sat down with NBC's Maria Bartiromo, and he also said that, again, the housing market has bottomed. Really? Well, the fact is, nobody knows how bad the housing market is, and they don't know how bad the housing market is going to be. And just think about this, core logic who does work in this area projects that the shadow inventory and shadow inventory being foreclosures waiting to happen but not yet on the market is 1.6 million homes throughout the United States.

2:441.6 sounds like a big number, but think about this, recently there was a deposition where There an attorney who was deposed, a bankruptcy attorney who was deposed, said under oath, and the attorneys I know, when they're under oath in an deposition, tell the truth. Now I don't know, you might have your opinions on whether lawyers tell the truth any other time, but when they're under oath they tend to tell the truth. What he said was that Fannie Mae representatives told him that there were 600,000 Fannie Mae homes mortgages in shadow inventory, 600,000 just with Fannie Mae, not in the United States, Just in the state of Florida, 600,000 shadow inventory, Fannie Mae only, not Freddie Mac, not JP Morgan, not B of A, but just in the state of Florida, Fannie Mae.

3:55So I don't think CoreLogic's estimation of the mortgage overhand is in any way, shape or form close to being reality. The fact is, housing prices have fallen from 2007-2009 33% below their 2006 peak. Now we haven't seen declines on this scale since the Great Depression. And what that means in dollars and cents is in the aggregate $7 trillion of household equity, home equity, the difference between the value of your home and what you owe on your home. The difference between that and the aggregate has fallen $7 trillion.

4:40That's more than half of the aggregate home equity that existed in early 2006. It's all been gone, wiped out. Now the Federal Reserve's doing a lot of work on this lately. I don't know if you've noticed, but they just came out with a white paper last week, and they say that there's 12 million homes underwater. Underwater, 12 million homes where the debt on the home is higher than the value of the underlying collateral. And the aggregate negative equity is $700 billion. Of these mortgages, 8.6 million of them are current. We continue to have people who are, there's probably people in this audience that continue continue to pay, and pay, and pay, despite the fact that they have negative equity of roughly $425 billion in the aggregate, but they continue to pay.

5:41But even the Federal Reserve knows, given this situation, there's continual problems in the housing market. Bill Dudley, president, he's actually my favorite Federal Reserve talking head because Bill Dudley from the Federal Reserve wrote that continued house price declines could lead to even more defaults, more foreclosures and distress sales, undermining wealth, confidence and spending. Breaking this vicious cycle is one of the most pressing issues facing policy makers. Of course I would contend and will contend during this talk that policy makers should just butt out, but he at least is aware of the potential for further fall in housing prices and the effect that that's going to have.

6:44Now Ben Bernanke figures he's done all he can do. He said, the Federal Reserve has made enormous efforts to try to help this economy recover and stabilize through the control of interest rates or monetary policy, he said. These policies have driven interest rates to record lows, record lows. Yeah, zero is pretty low. Monetary policy can do a lot, he says, but monetary policy is not a panacea. So on the housing crisis, Bernanke said strong government program to help the industry recover would aid the Fed's own efforts to boost the housing, boost housing by driving mortgage rates lower.

7:33He said, and the Fed white paper that I mentioned earlier mentions three problems in housing. Worthy borrowers cannot find mortgages, number two, the foreclosure process is costly and inefficient, and number three, the persistent excess supply of homes on the market. Those people at the Fed know exactly what's going on, they've identified there's excess supply of homes, it's amazing. Now the gang at the Fed writes that there's really, if there's no policy to action to to address these problems, then they say, and I quote, the adjustment process will take longer and incur more deadweight losses causing home prices, sending home prices lower and thereby prolonging the downward pressure on the wealth of current homeowners and the resultant drag on the economy at large.

8:32Now, of course, Austrian economists know that it's actually policy action that has prolonged this crisis already and more government intervention is only going to make matters worse. For instance, I can think of nothing worse than to have Fannie and Freddie be the largest land landlords in the United States. Can you imagine that they own the majority of of Rental Property, but that's what they're talking about doing, that they're talking about there's a policy initiative out there that Fannie Mae and Freddie Mac take ownership of these properties and rent them out just to get them out of the supply chain.

9:21Also I think it's terrible policy to get government more involved with the home modification Market. It clearly hasn't worked to this point, and it won't work going forward. Now, this has been a big, not a big issue on the campaign trail, but it has been mentioned at least one or two debates, and every one of the Republican candidates have been asked about what they would do with, about the housing crisis. And in fact, Newt Gingrich said he would rewrite Write the Rules to Make it Profitable for Banks to Renegotiate Loan Principle Amounts. That's Newt Gingrich's big idea.

10:07Good old Newt, he wants to make sure that his banking buddies can write off principle and come out smelling like a rose. After all, Gingrich earned $1.6 to $1.8 million working for mortgage giant Freddie Mac. His critics claim he was lobbying, but you know, Newt says that he maintains that he only offered strategic advice as a historian. Now we have some historians in the audience. I think Tom DiLorenzo is a historian, have you ever made $1.6 million dollars working for Fanny or Freddie, have they called you, would you, they have called you, and thankfully Tom DiLorenzo turned them down ladies and gentlemen, give him a big hand.

11:09Well, a reporter said that Newt disagrees with his Republican colleagues about the free market, that the free market will find a way to let the banks and the homeowners work things out. Well, you know, that remains to be seen. Now, President Obama, of course, has gotten in this fray, and his big idea, if you remember, He said he came in and was able to adjust Fannie Mae and Freddie Mac rules to allow people to refinance loans even when they are 125% loan to value. So that means if you are 25% underwater on your mortgage, President Obama made it easier for you to go ahead and refinance.

11:57He said that this policy would save homeowners thousands and thousands of dollars and this This is his way of solving the housing crisis. Princeton Professor Alan Blinder, he's of course, he's one of these go-to economic wise men. He penned an op-ed in the Wall Street Journal and his idea was to force lenders to reduce principal amounts and of course that's going to cost money and he believes that the banks and you guys should share the cost in that. tax payers and banks, only with the proviso that if the home does eventually go up in value that the government be able to get an equity kicker if the prices go back up.

12:53Now Blinder also thinks that the Federal Reserve and the Treasury should provide cheap financing to developers to go ahead and buy up properties with the intention of renting them out. Again, it's similar to that Fannie and Freddie being in the rental business. Martin Feldstein of Harvard, you always need a Harvard man to weigh in on this. He put in his two cents worth for the New York Times and he points out that homes have dropped 40% and the result, he said, less consumer spending. That's what he's worried about. But he claims that the government can stop the fall of prices by just slicing off the the amount of mortgage anyone has that is in excess of 110% of loan to value.

13:38So if you're 10% underwater, or if you're more than 10% underwater, then Feldstein would just come in and do away with anything above that, and he said that would fix things. He says the policy would cost $350 billion or less, and it would modify 11 million loans that are underwater in America. Now of course, who's going to pick up this cost? Well, the banks and the government are going to split, again the government is you and you and you and you and you is going to pick up the cost here. He said in the case of mortgages held by Fannie Mae and Freddie Mac, and this is a direct quote, the government would just be paying itself. Presumably, he wrote that with a straight face when he did this. So, and of course, if you had a mortgage that was underwater by over 10%, and you allowed the government to expunge that debt, that exceeded that, The borrowers would then accept full recourse for the rest of their mortgage.

14:56Now what that means is, I don't know what this law is in Texas, but in many states mortgages are essentially non-recourse. So if you're foreclosed upon and the home brings less than what you owe at a foreclosure sale, there is what's called a deficiency, and in non-recourse states then the lender Feldstein said, I cannot agree with those who say we should just let housing prices continue to fail till they stop by themselves, although some forest fires are allowed to to Burn Out Naturally, No One Lets Fires Continue to Burn When They Threaten Residential Neighborhoods.

15:56But the fact is that recovering 33% of a fall in housing prices from the 2006 peak is going to take years and years and years and years. It's not going to snap back anytime soon. This is going to take forever. So, I mean, despite the obvious policy makers and wonks, they think this trimming of mortgage principle down to just 10% underwater or allowing people to refinance when they're 25% underwater or more will somehow halt the slide in home values and somehow spur consumer spending. The belief is, is that if you know, if you're just kinda sorta underwater, then you're You're just going to keep faithfully paying Fannie and Freddie and B of A and JP Morgan Chase until the rest of time. Never mind that it's going to take years and years and years.

16:53In fact, you'll probably pass away before you ever have any equity in your home. So all of these ideas to save the housing market and supposedly to increase consumer Spending are doing just the opposite. These people keep people chained to the homes that they're still in. They can't move to where better jobs are. In fact, there's a great example of this that was brought out, I believe it was in a USA Today article, that there's a heavy equipment operator in North Las Vegas, Nevada, and he bought his home at the peak In 2006, there's very little need for heavy equipment operators in North Las Vegas anymore.

17:44They're needed in Oklahoma. He has the opportunity to go to Oklahoma and get a job, but he has $200,000 underwater on his home, so he can't leave. And he feels compelled morally to keep paying, but he's unemployed, and he's running out The Blinder and the Feldstein Proposals would take about $190,000 off his mortgage, but the problem is it's not going to get him a new job. So you can reduce principal amounts, but they're not going to be enough and they're not going to put him back to work. The idea that the too-big-to-fail banks are going to hold up their hand and say, sure, we'll cover half the cost of this is crazy, because that's going to come exactly out of their bottom line.

18:41They don't have enough capital to cover that, and if they did do that, they would immediately go to Washington, D.C. with a tin cup in their hand and say, we need another TARP bailout. So it would be TARP 2, TARP 3, and so on, just to accomplish that. And by the way, how much bureaucracy would be needed to manage a program of somehow cutting everyone's mortgage amount down to 110% loan to value? Imagine the appraisal duels that will go on. All of these plans are really nothing to aid underwater homeowners.

19:41The only thing it does is aid Fannie Mae, Freddie Mac, and the rest of the too-big-to-fail banks. Now, there's thousands of stories of people trying to do the right thing. People going to their banks, they're current on their payments, they walk in and want to renegotiate because they say, listen, we're $100,000 underwater on our home, we're $150,000 on our home, $200,000. And they go into their banks and what do the banks do? They refuse to negotiate with them. Why? Because these people are current. And they'll say, you're current, we're not going to talk to you about this. Why don't you go ahead and skip a couple three payments and then come back and we'll start talking to you about this.

20:28And then they go through this whole grind of trying to do the government renegotiation process. But all the time that the banks are not negotiating with these homeowners, they are holding these These mortgages on their books at a hundred cents on the dollar when there's no way the mortgage is worth that. Because if you have a $200,000 mortgage secured by a house that's worth $100,000, that mortgage is not worth, on a bank's books, $200,000. But that's what the banks want to pretend, and by pretending to do that, they're still and Business. Now Mitt Romney laid out his prescription for America's housing crisis when he was campaigning in Nevada a couple of months ago, and he said the policymakers shouldn't try and stop the foreclosure process.

21:30He said, let it run its course and hit bottom. In the state, Nevada, which has the highest foreclosure rate in the country, he took a lot of flack for this. In fact, the governor of the state, Brian Sandoval, had some very harsh words for Romney. But a few months later, or a few weeks later, the GOP had a CNBC debate. Mr. Romney again declared that as president he would do nothing to ease the housing crisis. Markets work, he says. Well, Mr. Romney is right. Markets do work. But any business dominated by entities only in business by the good graces of the government is not the free market.

22:28It cannot be considered the free market. The reason the housing market is not cleared is that the government stands in the way by propping up the large mortgage holders. No reasonable person sees Fannie, sees Freddie, which were seized by the government in September of 2008 as the product of spontaneous order. To stay in business, the two firms together have needed $169 billion to stay in business. That's $169 billion in taxpayer money to keep them in business. And there is no end in sight. Every quarter, Fannie and Freddie, Freddie, the friend of Newt Gingrich, Go to the tax payer, say, we've lost X billion dollars and we need X billion more, that's the only reason they're in business.

23:30Also, at the same time, there's been changes to FASB's Fair Accounting Standards Board rules, their numbers 157, 115, 124. Therefore, this essentially allows banks to value certain assets on their books at whatever they want to. Now, if you can allow banks to value these mortgages that are underwater at whatever they want to, you are essentially keeping them in business essentially by government fiat. They are in business because the government has just merely changed the rules for their benefit and they are essentially wards of the state.

24:17And that's the problem. Battle outs attempt to erase the effect of losses or economic failure. Profit and loss go together, it's like up and down, left and right, good and bad. We do away with losses, we wind up diluting the meaning of profit. After all, why strive for profits if Uncle Sam is just going to prop you up? Bailouts destroy the profit motive and the incentive to work with customers. And that's what it's done in the case of the mortgage market. The real help for homeowners will only arrive with Fannie and Freddie, and the rest will be allowed to fail. The equivalent of a Chapter 7 bankruptcy proceeding, liquidation, would put the underwater loans out forbid in the marketplace.

25:05Now I don't know this for a fact, but I'm guessing that when Mr. Romney says let the market hit bottom, he does not have in mind Fanny, Freddie and B of A being allowed to fail. I mean, I'm guessing that Mitt doesn't have that in mind, but that's what needs to happen. He believes that it's a free market for you and I. It's a free market for the people who who sign on the dotted line on their mortgage, pay X amount per month, you have 30 years to pay, the note doesn't say anything about the value of the collateral, you just keep paying until the very end. But 12 million households right now have a mortgage on something that isn't an asset anymore.

25:54It will never be an asset. It will continue to be a liability probably as long as they live, and there's no difference And if the rent of a similar structure is half that or a third that, then the only thing it makes sense to do is to walk away. Now you might say, whoa, wait a minute, wait a minute Doug, we believe in contracts, people must honor them for the market to work, but the market hasn't been allowed to work on On the other side of the equation, since the housing crisis began, in fact Bloomberg had to go to court to obtain documents to shed how much light or shed light on how much dough the Federal Reserve really provided the banks during 2008 meltdown.

26:50The banks and the Fed fought this so hard that it had to go all the way to the Supreme Court. And finally, the Supreme Court said, no, you have to hand over, you had to hand over these documents, 29,000 pages, and it revealed that banks worldwide made $13 billion on the difference between what they paid for their emergency funding and what they earned with that funding. When you total up, when you add up the guarantees and the lending limits that the Fed provided, the bailout wasn't $700 billion that everybody complains about in TART money.

27:36The total was $7.77 trillion as of March 2009 in rescuing the financial system. More than half the value of everything that was produced in the United States that year. Now here's just one example. Not only did B of A receive $45 billion in TART money, which most everybody knows about. What everybody doesn't know about is at the peak, Bank of America borrowed another $91.4 billion from the Fed to stay alive. Now they borrowed this from a very kind of alphabet soup of programs, there was dozens of them, just a few of them were AMLF, PDCF, TSLF, STOMO, TAF, you get the idea, it just goes on and on, it's like these guys strung acronyms together just for the heck of it to create these loan programs.

28:35that they borrowed 91 on top of the 45 billion in TARP money, they got 91.4 billion in loans secretly from the Fed that we didn't find out about until just the other day. And it wasn't like a daylight overdraft, just because B of A was a little short a dough, you know, for a day or two. Bank of America was in debt to the Federal Reserve for 518 days. During the dark days of March 2009, government bailout funds amounted to over 400% of Bank of America's market cap. There is no question the Bank of America was bankrupt, and probably still is.

29:28And that's not how the free market works. But they want the free market to work for the person who's paying on their mortgage, but they don't want the free market to work on the entity that owns the mortgage. Now let's say Bank of America, which by the way absorbed countrywide, so that was included in there. Let's imagine if they were allowed to go bankrupt as they should in a free market, in the free market that Mitt Romney wants to talk about. What would happen? What would these mortgages sell for if they were under the control of a bankruptcy trustee and put on the free market? Would they sell for 110% of the home's value?

30:17Would they sell for 125% of the home's value? Like the Feldstein and the Obama plans? No, when you're out looking for a mortgage, you better have it 20% down. You're looking for an 80% loan value mortgage. And in fact, if you look at what distressed sellers are receiving for assets and loans In fact, there's examples of this in the marketplace. Louis Rennery, who is a legend in the mortgage Business, worked at Salomon Brothers, for those of you who ever read Michael Lewis's great book, Liar's Poker.

31:18He has a new fund called Saleen Residential Mortgage Opportunity Fund, which is featured on the front page of the Wall Street Journal, buys up distressed debt, not to better society, but to make a profit. And they made the example of a couple in St. George, Utah that had been delinquent on their loan. They owed $421,000 on their mortgage. Saleen came to them immediately, restructured the loan, reduced the principal to $243,000, and reduced their payment from $3,500 a month down to $1,500 a month. All of a sudden, they had a performing loan on their hand, and both parties benefit.

32:0490% of the loans that Celine does modifications for involve reducing principle. Less than 2% of the modifications that the government does involve reducing principle. And while many upside-down borrowers can't find anyone to talk to when they're trying When they try to negotiate with their lender, when Celine buys a note, the first thing they do is reach out to the borrower very quickly. In fact, they will send them a FedEx package with a gift card in it that can only be activated once the borrower makes contact with Celine's debt specialist. It's hard to imagine that Fanny or Freddie might do something like that.

32:54Now this is much different than what Mr. Gingrich has in mind, where he's thinking that current mortgage holders can somehow write down loans and make a profit at it. That's not who should make a profit. The current mortgage holders should be allowed to go broke. Firms that lose money should be allowed to fail. Otherwise, precious capital continues to be wasted by these firms. The firms that should make money on this are the opportunistic firms like Saleen Capital. They must profit and they must benefit by buying these loans out of foreclosure, by making these loans performing and conforming, and going ahead and selling them into the secondary market.

33:46They Profit and the Homeowner Benefits. You know, Ludwig von Mises explained that one government intervention leads to endless successions of interventions to deal with the effects of the first and subsequent interventions. Ultimately, it comes down to two choices, he said, either capitalism or socialism. There exists no middle way. Likewise, there is no middle way in solving the housing crisis. For capitalism to work its magic, for underwater homeowners to be set free, mortgage holders must be allowed to fail.