Jan 6 2010

U.S. Dollar and the 1971 Shock: How Going off the Gold Standard is now Coming Back to Harm the U.S. Dollar. The 40 Years Spending Spree.

The U.S. dollar has been on a wild rollercoaster ride for decades.  Most Americans rarely concern themselves with currency markets or larger macro economic trends.  Yet this is such an important financial area to understand since Americans are paid in U.S. dollars.  It is fascinating to understand why the U.S. went off the gold standard to begin with in 1971.  As you might suspect, we were spending more than we could afford and the Vietnam War was costing more and more money so countries like Switzerland and then West Germany were worried about being paid and converted dollars to gold as was possible then.  Inflation was rampant.  Clearly this was unsustainable yet today we have taken the game to another level.  The banking sector with no restraints was then able to print and expand as much as it needed.

The critical problems we face today stem from decades of horrible economic policy.  Let us first look at the U.S. dollar over this time period:

us dollar

It is fascinating that after we went off the gold standard, the U.S. dollar remained rather steady for the decade.  In the early 1980s the dollar strengthened but this really had nothing to do with how we were managing our budget.  This was an era when the idea of deficit spending was somehow seen as a new miracle of finance.  The corporatacracy was finally unhinged to print and spend whatever it wanted.  And many Americans didn’t argue because they now were able to go into massive debt at the expense of the world.  This system is now failing.

If we look at our Federal surplus or deficit over the years it is rather clear when this mentality took hold:


This chart is downright astonishing.  Those years of spending have now come to catch up with a tanking U.S. dollar.  Now if we couple the charts you can see how this notion exploded quickly and re-coupled:

deficit and dollar

This spend more than you earn idea worked for the first decade with no problem.  But then the entire system started re-coupling.  Americans had the illusion that things were getting better and their quality of life was improving but this was all due to massive consumer debt spending:

household debt

U.S. households took on so much debt that they reached a peak of $14 trillion.  This is made up of all things including mortgages, credit cards, student, and auto loans.  Yet that game is quickly reversing as we are seeing with the bursting housing bubble.  But were Americans really better off?  Not exactly.  Because now our employment base is being destroyed and the artifacts of wealth are being taken back by the corporatacracy since you don’t own the item until the debt is paid off.  People that thought they owned their home no longer have possession with a few missed debt payments.  Even if we look at the graph above, if our annual GDP is roughly $14 trillion American households have this much in debt!  This was clearly unsustainable.

The U.S. dollar has taken a massive beating.  The Federal Reserve is eating up toxic mortgages and trying to keep the credit bubble going.  The world by their reaction to our dollar is clearly not buying this game anymore.  The Federal Reserve cares not about the typical American.  They would be satisfied if every American was out in the street so long as their elite group of cronies was able to maximize their banking profits.  What real innovation has come from the financial sector?

Now some might be saying so what if the U.S. dollar is declining.  For most Americans however I would imagine that they would like to keep their buying power as strong as possible.  Other countries are getting stronger (China now overtook Japan as the 2nd largest economy) and are growing their middle class.  You think we’ll keep buying cheap products forever?  This is unlikely especially when other economies start creating their own internal demand.

We can thank the banking system for ripping off the country and leaving a bucket of pain with 10 percent unemployment and massive amounts of debt.  Yet somehow they are the industry that gets bailed out.

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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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