Jan 4 2010

The 5 Percent Solution: How 5 Percent of the Workforce Generated 40 Percent of U.S. Business Profits and all of it was a Ponzi Scheme.

From 1948 to the early 1980s the financial industry in the U.S. generated from 5 to 15 percent of all U.S. business profits.  In the early 1980s this started to creep higher and higher.  It reached a triumphant climax generating over 40 percent of all U.S. profits at the height of our financial bubble.  The only problem of course is the financial sector generated the largest Ponzi scheme known to humankind.  The 2000s should go down as the decade of the Ponzi economy.  It is almost fitting that the poster child of this excess ended up being Bernard Madoff who ironically was chairman of the board for NASDAQ at one point in his career.

If we only look at the actual financial employment data we can easily see how the last decade created a culture of Ponzi employment.  While the smoke was blowing jobs were being erased off the paper of the U.S. economy.  In the U.S. we currently have 132 million people in non-farm employment.  Of this, roughly 7.7 million work in what is dubbed the “FIRE” sector (finance, insurance, and real estate).  But when we look at the profits from this industry the bubble becomes more prominent:

finance sector profits

It would be one thing if the financial sector actually produced a product.  They tried and tried to convince the public that “financial engineering” was the wave of the future.  After all, the public was able to go into massive debt to purchase homes and cars only to have them yanked away once the bubble imploded.  No need for that MBA when all that was needed was a simple signature to control hundreds of thousands of dollars.  Yet it was only on borrowed time.  Not only where the artifacts of wealth taken away from many Americans, their jobs were also disappearing.  Let us look at a few sectors:

information services jobs

The last decade was horrible for those that work in information services.  We have 20 percent less people working in this sector even though our population has added 27 million people.  Sure the tech bubble burst but the financial sector tried to convince the public that it was perfectly fine in letting good paying jobs slowly float away overseas.  After all, the financial sector was more than willing to take you on.  Apparently the core driving force of our GDP for the decade was selling homes to one another and allowing banks poetic license to create fancy Ponzi instruments to eventually implode the global economy.  Their sophistication in blinding the public got to the point where they didn’t even need to produce a product to be the top money grossing industry.  It was a casino economy.

As tough as the decade was for information service jobs, the manufacturing sector felt even more pain:

manufacturing jobs

We now have 35% less manufacturing jobs even though our population has added 27 million people.  The FIRE propaganda was that we would all be fine by simply off shoring every good producing industry in the country.  Everyone would put on a suit and sell homes to one another or bang away on a Bloomberg Terminal.  This was the new economy.  But of course anyone with an ounce of common sense realizes that a sustainable economy is both balanced in the jobs it provides to its citizens.  The FIRE economy cannibalized profits even though only 5 percent of the population works in this field.  How did this sector do for the decade?

usfire jobs

The FIRE economy still is net positive for the decade even though it is largely responsible for the credit and housing implosion that has devastated our economy.  The fact that there is no contraction in the sector over the decade should tell you something.  Did it fall from the peak?  Of course but it got to ridiculous levels.  It is the one sector where jobs are up for the decade.

This is a question we really need to examine.  Wall Street and D.C. have attempted to convince the public that bailing out the banks was the important thing to do.  But for who?  The cost has been incredibly deep and the majority of the population has seen no benefit.  But like the Wizard of Oz they tried to scare the public into handing over money with no questions asked or things would not go well.  Yet the public never wanted these bailouts.  Remember the early legislation for TARP?  The public was outraged and called up their local representatives and it was voted down.  The stock market imploded because the Ponzi game was up.  Yet it was passed anyway and not because the public wanted it.  Many politicians are simply puppets for the FIRE sector.

Most Americans probably think that these companies have their best interest at heart.  They don’t.  They are multinational.  They follow the money and it doesn’t have to be only in dollars.  Too bad for many since they are paid in dollars.  The folks at the helm of the FIRE sector have offshore accounts and move money freely across international banks.  They have no allegiance to anyone.  They are happy with slave wage labor in China so long as they have the laws of the U.S. protecting them and the wallets of American taxpayers bailing them out.

Do people still believe that the bailouts were to help the average citizen?  Just look at the above trends in employment.  It is rather clear how the decade played out.  And keep in mind things were “good” up until 2007!  The stock market peaked, housing peaked, and all was supposedly good.  But it was one giant bubble.  Yet somehow the FIRE sector has managed to keep its power and its profits incredibly high with taxpayer subsidies.  What is even more amazing is the corporatocracy has somehow managed to avoid any serious reform.

Noam Chomsky says it best:

“People cannot be told that the advanced economy relies heavily on their risk-taking, while eventual profit is privatized, and ‘eventual’ can be a long time.”

Something needs to radically change in this upcoming decade.

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Dec 28 2009

The New Mortgage Dynamics and the Anatomy of a Pay Option ARM Borrower. 850,000 Option ARMs Still Outstanding and 40 Percent in Distress. 4 Reasons to Walk Away from your Option ARM.

It is hard to believe that 13 percent of all mortgages are either in foreclosure or some other form of distress.  This can stem from a missed payment from an unexpected job loss or mounting pressure of servicing current debt.  To a large degree the allure of the option ARM product came from the ability to sell this idea that monthly cash flow will free up.  This free cash flow would have been useful if set aside in an investment account yielding a high interest rate but the stock market collapsed and savings accounts are essentially brick and mortar mattresses thanks to the corporatocracy.  Yet people never used the freed up money to save.  It was used to maintain a lifestyle that was unsupportable and full of consumption.  A case of musical mortgage chairs.

The option ARM world is now largely a historical story.  Option ARMs are now banned in states like California and rightfully so.  Yet these mortgages are still out in the market.  The OCC and OTS released their third quarter report covering 65 percent of all U.S. mortgages.  In their set they cover 850,000 active option ARMs.  The data on this loan is highly troubling:

option arm loan data

The above chart is telling.  Fewer and fewer loans are performing while foreclosure rates are soaring.  40 percent of option ARMs are in distress or in foreclosure.  And that leaves 580,000 loans that are performing.  But it is likely many of these loans will recast and end up in distress as well.

Nearly 60 percent of these loans are in California.  So a conventional look would estimate that 348,000 active option ARM loans are in one state.  These loans also carry higher balances.  Let us run a hypothetical scenario to show how insidious this mortgage really is.  Let us assume that you bought in 2006 a $500,000 home in California.  This was the median price in 2006 and 2007 so not uncommon at all.  You decided to go with only 5 percent down but took out an option ARM.  Here is what your financial situation would look like:

option arm calculation

Source:  Mortgage-Info

93 percent of option ARM borrowers went with the minimum payment.  So a $475,000 mortgage would cost you $1,939 a month.  This is for principal and interest.  You still have taxes and insurance but let us set that aside for the moment.  Now looking at the above, you notice that each year $10,572 is negatively amortized.  That is, your actual loan balance will increase.  Now here is the interesting thing.  The actual term on many of the option ARMs was five years or 60 months with the minimum payment.  But many had ceiling caps of 110 or 125 percent.  In the above, we are assuming a 110 percent cap.  So in fact, the borrower will hit a recast date in the fourth year because of the negative amortization.

The initial loan balance of $475,000 will grow to $522,500 if the minimum payment is made.  But once the recast hits, the loan will go to $3,708.  For many this is unsupportable.  And keep in mind that the home value in California might now be $250,000 or $300,000 depending on the area.  So the borrower now has a $522,500 balance on a home that is worth half that.  Walking away at this point makes absolute sense.  And here is why:

4 Reasons to Walk Away from an Option ARM

-A)  Banks are not moving on homes quickly.  So let us assume the borrower will hit the recast date starting in January of 2010.  What would they do?  Well if their new payment is $3,708 they can stop making their mortgage payment altogether.  It is likely that the way banks are moving, they can have at least 12 months of payment free living before getting the boot.  So how much can they save here?

$3,708 x 12 months = $44,496

That is a large amount of money.  In the mean time they can find a rental before their foreclosure completes and their credit is hit.  In California vacancy rates are high and rents are stagnant.  It is likely they can find a comparable rental for $2,000 a month.

-B)  The borrower is unlikely to recover the current lost equity.  If the home is worth $300,000 the borrower is now in the hole for $222,500.  When will they recover this?  It could be a decade or if we follow something similar to Japan it can be two decades.  Plus, it might be the case that the borrower simply cannot afford the $3,709 payment.

-C)  The borrower can buy the same home for half off.  If they manage to save some money and buy another home (all they need is a minimal amount with FHA loans) then they can move into another place and lower their mortgage payment.  Once the new home is secured the other home can be let go back to the bank.

-D)  Option ARMs do not qualify for HAMP.  These loans are much too underwater.  Banks like Wells Fargo and JP Morgan are trying to convert these option ARMs to interest only loans but you are basically paying the bank for their bad bets.  Is it any wonder why these loans are having such horrible stats?

Option ARMs are prime candidates for strategic defaults.  That is, even people that can pay refusing to do so.  This isn’t advice or a suggestion to do so but you can understand why so many people are using this strategy to bail on their mortgages.  And the moral argument is nonsense since the corporatocracy has walked away from many of their bad bets while saddling taxpayers with the bill.  You think Wall Street is honoring any of their debts?  In fact, they are using taxpayer money to avoid losing a cent.

When I read articles that option ARMs are of little concern this may be true for 46 states.  But this chart is more pertinent to the option ARM states of California, Florida, Nevada, and Arizona:


Those that are walking away are doing it for specific reasons.  I know this must rub many the wrong way.  The prudent reader is probably ticked off at banks and those that over extended themselves.  I sympathize.  Yet if we want to change this we need to push for a higher down payment.  After all, the mortgage market right now is all government backed (aka your money).  Then, say we require even 10 percent down, a borrower is leaving a good amount of their money on the table if they walk away.  With low down and zero down mortgages people will walk away in mass:

“(TIME) Boemio specializes in short selling, in a particularly Vegas way. Basically, she finds clients who owe more on their house than the house is worth (and that’s about 60% of homeowners in Las Vegas) and sells them a new house similar to the one they’ve been living in at half the price they paid for their old house. Then she tells them to stop paying the mortgage on their old place until the bank becomes so fed up that it’s willing to let the owner sell the house at a huge loss rather than dragging everyone through foreclosure. Since that takes about nine months, many of the owners even rent out their old house in the interim, pocketing a profit. (See pictures of modernist houses available for rent.)

Tons of people were doing this, but there were consequences. Renters were being evicted, through no fault of theirs, with a couple of days’ notice when the house finally went on the market. People are now paying a premium to live in apartment buildings, which in Vegas are almost always owned by a corporation. Sure, short selling damages the sellers’ credit rating, but they just bought a new house, so they don’t care.

It’s an entire city of John Dillingers, feeling guiltless for stealing from the banks. Boemio is well aware that short selling isn’t ethical and is exacerbating Vegas’ economic problems. People, she believes, should make their payments, accept their paper losses and ride out the crash. “Guess what, a______s of Las Vegas. That’s what gambling is about. That’s what investing is about,” she says. “It’s greedy. But we’re all doing it. Because why not?” It’s very hard, she says, to suffer as the one honest person in a town of successful con artists.”

When leadership is lacking in the financial markets people are going to quickly realize who is gaming the system.  I just don’t see why anyone would stick it out with an option ARM product especially those in California.  Those that think the bottom is here still don’t realize that we have many other dominoes to fall in the next few years.  A bubble constructed over multiple decades doesn’t clean up in two years.

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Dec 19 2009

FDIC and the Bank Failures of First Federal Bank and Imperial Capital in California. Two Banks Brought Down by Option ARMs and Commercial Real Estate.

First Federal Bank of California failed on Friday because of a heavy over indulgence on risky option ARMs.  Imperial Capital also failed on the same day because of an inability to raise capital and also mounting losses of commercial real estate loans.  These two bank failures, two of the 140 in 2009, show that the reason for defaults is shifting.  Option ARMs have brought down many lenders including IndyMac and Washington Mutual.  For the latter two banks, option ARMs were merely another toxic loan in a portfolio of years of horrible lending.  So who acquires First Fed?  OneWest.  Who is OneWest you ask?  The bank that emerged from the failure of IndyMac.

First Fed was a big failure.  It has $6.1 billion in total assets.  Imperial Capital has $4 billion.  This brings bigger issues for the FDIC since they are now in the red and these bank failures will cost additional sums of money.  Money the FDIC doesn’t have.  The failure of First Fed shows us the reality that option ARMs are still wrecking havoc on the balance sheet of banks.

You don’t need to be an expert to know First Fed was heading into trouble.  Take a look at their option ARM sheet sent to brokers during the boom:

first fed option arm sheet

Anyone reading the above will see that the sheet looks like a bullet point of toxic lending guidelines.  100 percent option ARMs for loans up to $500,000.  You also see gigantic cash out options being made at the peak of the bubble.  No income and no assets were no problem with the above.  Only 12 months of bank statements and even then there was room to fudge.  The bottom line is First Fed put decades of stability in front of risky toxic lending.  They are not the first and last to be lured by the Wall Street siren call.  The sheet above was issued in January of 2007.  Almost three years later they fully implode.

And let us look at how their balance sheet looked like in January of 2008:

option arms

So by January of 2008 First Fed had some $3.2 billion in one-year ARMs that included option ARMs and $1.1 billion in three-to-five year ARMs that also included option ARMs.  By this time First Fed was already feeling the brunt of its mistake in toxic mortgage lending.  Many of those one-year loans blew up in its face since First Fed has been losing money for seven straight quarters until Friday’s seizure.

Those that think option ARMs have a way out are mistaken.  The bulk of these loans sit in California.  60% of outstanding option ARMs are here in the state.  The vast majority do not qualify for HAMP or any other programs.  Wells Fargo and JP Morgan have gone ahead and pushed these loans into interest only products but 40% of the borrowers are already in some form of distress.  It is hard to see how these banks don’t have additional problems.  Just because they are too big to fail doesn’t mean money isn’t being lost.

What is happening with the FDIC is that they are creating even bigger banks that will have a harder time failing but have a direct lifeline to taxpayer money.  Take for example the above failures.  City National will now pick up Imperial Capital and will have $21 billion in assets while OneWest will pick up First Fed and have $24 billion in assets.  It is a twist of economic insanity that failing banks are only getting bigger.

Some might argue that seeing this fall with First Fed was hard to predict.  Actually some saw this back in 2006 and made big bets on it:

“(LA Times) Seiver recommended short sales of stock in the parent company, FirstFed Financial Corp. He wasn’t the first to suggest this strategy, which would turn a profit if the company’s stock price fell: In fact, the volume of such short-sale bets against First Federal nearly tripled from late 2004 to early this year, before dropping slightly in March after the thrift reported solid earnings.

The short sellers question whether First Federal’s financial results are being inflated by accounting rules, which they contend may overvalue risky loans. And they are among those predicting a meltdown in California’s recently superheated housing market.

Other critics accuse First Federal and other West Coast thrifts of overindulging borrowers’ lust for artificially low initial payments. By generating so-called exotic or nontraditional mortgages, they warn, these S&Ls have allowed speculators to buy homes they can ill afford — and will be unable to resell when the mortgage payments rise and home prices take a tumble.”

It was only a matter of time that these ticking time bombs would hit hard.  That is why banks like Wells Fargo, Chase, and Bank of America through their acquisitions of toxic mortgage lenders will be facing years of pain with option ARMs.  Not only with option ARMs, but with commercial real estate.

The failure of Imperial Capital shows us that CRE is now here and hitting California hard.  The big problem with Imperial Capital was with loans on apartments and commercial mortgages.  The CRE market is slated as the next big issue in the coming years.  With $3 trillion in CRE loans outstanding many regional banks such as Imperial Capital will face failure.  However with what occurred on Friday, it is disturbing to see the FDIC funnel these banks into larger too big to fail banks that have direct access to taxpayer money.  What they are inevitably doing is putting the taxpayer on the hook for additional losses.

What is clear with the failure of First Fed and Imperial Capital is we are in the middle innings of the option ARM and CRE fallout.  Those that doubted these loans as problems should put that notion to rest.

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