Question of The Day?

CNBC is reporting that sources close to Treasury Secretary Paulson indicate that there will be NO government money available (no explicit bailout) for the resolution of the Lehman Brothers collapse given that the market has had time to prepare, having been aware of Lehman’s troubles for at least six months, and that the Federal Reserve's credit facilities are available for liquidity and an orderly unwind.

Are the Feds about to learn a nasty lesson of the downside of creating a “moral hazard”?

The Almost Daily 2¢ - Moral Haphazard

If you Google around the web, especially the Federal Reserve’s site, you can find endless definitions and references as well as debate and discussion related to the term “moral hazard”.

One definition caught my eye which seems to precisely sum up the process that has taken place on Wall Street in the wake of the Bear Stearns collapse … although I’m taking it out of context just slightly.

As Donald Kohn, Vice Chairman of the Federal Reserve, put it in his February 2007 speech entitled “Financial Stability: Preventing and Managing Crisis” moral hazard:

“refers to the heightened incentive to take risk that can be created by an insurance system. “

In light of recent events, what better “insurance system” is there but the Federal Reserve itself?

The Bear Stearns bailout succeeded in calming the markets not because any of the fundamental precursors to its collapse had been addressed but merely because Bernanke’s Fed put its balance sheet up as a backstop for all the junk securities whose collapsing value instigated the panic.

But what really has changed since the Bear Stearns bailout?

The Fed funds rate is a bit lower and inflation, especially in fuel and commodities, seems to have become “unanchored” but more importantly the housing crisis is showing itself to be incredibly severe.

In some markets, home price declines seen in just the last year are comparable or even far exceed similar past declines seen over periods of five or more years.

But the current housing decline is still in full gear.

Home prices are continuing to slide, foreclosures are growing dramatically, rates of “walking away” and even arson are on the rise.

Lastly, it appears that nearly every macroeconomic indicator is showing the typical patterns of weakness indicating recession is either upon us or very near with the most notable data tracking non-farm payrolls, industrial production and retail sales (especially inflation adjusted) all clearly presenting a bleak outlook for the future.

Bernanke’s insurance policy has done more than to simply set up a potential “moral hazard” for the financial industry, it HAS created a PRESENT moral hazard for Wall Street investors, large and small alike, who firmly believe that the Fed will stop at nothing to prevent a calamitous decline and that the Bear Stearns bailout marked the bottom of the current turmoil.

As the housing crisis continues and the recession worsens though, home price declines and increasing unemployment will usher in a whole new class of disruptions with defaults eroding its way up the chain to the prime mortgaged “homeowner” and only then would it be appropriate to attempt to discover the bottom.

Constructing Capitulation: A Look Back at 2007

At the start of 2007, it was pretty clear that something had seriously gone wrong with residential housing markets in the United States.

After nearly a full year of declining home sales, widespread homebuilder and home “investor” trauma and some precursors of the mortgage-credit implosion, the backdrop was clearly set for a larger and more pervasive unveiling of one of history’s greatest economic debacles.

The Fed and chairman Ben Bernanke, though publicly reassuring and confident, promoting themes such as “containment” of the housing “slowdown” and the absence of “spillover” effects on the wider economy, were belatedly introducing new lending regulations sending some troubled lenders, such as New Century Financial and Countrywide Financial, scrambling to either adopt the changes or to sidestep them.

Realtors, on the other hand, presented a decidedly optimistic outlook both pushing a new ad campaign that promoted the false notion that “It’s a Great Time to Buy or Sell a Home” as well as having their then chief economist David Lereah report, through the traditional “dimwitted” and “bought and paid for” “make believe” news media, that the housing market was in the early stages of recovery.

Even some beleaguered yet not altogether beaten homebuilders such as “dancing” Bob Toll seemed to portray a sense of optimism, suggesting that the new home market was seeing some positive signs such as stronger than expected “commitments” in Maryland, Greater Washington DC and even portions of California, cancelations abating and evidence suggesting that consumers were simply sitting on the sidelines ready to buy at the first sign of price stability.

Unfortunately for scores of unlucky home buyers who were influenced by the National Association of Realtors and the other industry insiders onslaught of media propaganda, home purchases made at the start of 2007 had come nearly at the absolute zenith of home values… prices that, after having been artificially inflated by years of an unrestrained speculative frenzy and unchecked lending, will not be seen for many years to come.

Try as they might though, the false euphoria created by the real estate industry would last only moments as the housing collapse proved yet again that it was not going to go away silently.

To start the unwinding anew and with a decidedly ironic twist, New Century Financial, one of the nation’s largest subprime loan originator REITs announced that they needed to restate earnings for the majority of 2006 in order to “correct” improper accounting of an underestimated volume of “repurchase claims”, claims made by investors when loans purchased from the originator default unusually early.

Now, it appeared that all at once, and with the help of a handy dandy daily chronicle, lenders were dropping like flies as a flow of disclosures showed losses mounting quicker than any lending institution had anticipated and, for many, could reasonably manage.

The thick greenish gooey smog of the subprime slime was quickly descending, enveloping not just the nation but the worlds lending, housing and financial markets in a taint so pervasive and infectious that the losses would eventually be tallied in the tens of billions with conservative projections of many hundreds of billions.

Not all real estate industry insiders were so aware of the magnitude or consequence of the subprime debacle turning instead to other factors for explanation of the continued decline in buyer enthusiasm such as David Lereah’s suggestion that “El Nino” was the culprit of lagging sales.

Others though saw the writing on the wall quite clearly and accurately though and were not shy about admitting the extent to which the environment was going to “suck” for the remainder of 2007.

With scores of smaller, more risky, lenders and originators on the ropes and the lending-credit debacle escalating, the initial signs of a clever bluff could be interpreted from the statements of one of the nation’s largest lenders, the yet again even more ironically named Countrywide Financial (NYSE:CFC).

As the unfolding crisis had begun to cast a shadow of doubt over the whole of the real estate industry, many market participants found themselves fielding questions about the extent of its impact on their operations and even Congress began ratcheting up their investigations into the causes and possible outcome as well as debating possible plans for a public “bail out”.

The “second shoe” had dropped.

The budding false optimism from earlier in the year had correctly shriveled as the real estate industry resumed its downward spiral and now the mortgage lending industry, having come apart at the seams, degenerated into an ugly case of blame and finger pointing.

Heading into the summer of 2007 it was clear that there was a “perfect storm” on the horizon.

Try as they might, central bankers could no longer continue to ignore or downplay the significance of the lending meltdown that had now escalated into a wider credit crunch.

The economy that had just appeared “likely to continue expanding at a moderate pace supported by solid growth in employment and incomes” the day before was now experiencing “appreciable downside risks to growth” and requiring “facilitate the orderly functioning of financial markets”.

The cat was out of the bag, the subprime mortgage turmoil had now shown itself to be the tip of a far larger and more cataclysmic iceberg that would have credit markets reeling around the globe as the house of cards had begun to fold bit by bit.

Not even the superb bluffing on the part of “top conditioned athlete” such as Countrywide Financial’s Angelo Mozilo could prevent the outgoing tide of investor sentiment.

A single simple and now likely accurate forecast for possible bankruptcy amid a rising tide of delinquencies and foreclosure sent the nation’s largest lender down for the count as its stock dropped over 80% in value.

Along with it went all hopes that anything other than a complete washout was in store for the nation’s housing markets as the commercial lending markets collapsed and Jumbo loans, one of the major sources of fuel that served to inflate the massive housing bubble, all but disappeared.

Coming into the Fall Ben Bernanke and the Fed, although likely still not fully accepting the depth and enormity of the unwinding, were clearly in crisis mode.

Putting aside any caution of creating “moral hazard”, the Fed slashed the Fed funds rate and continued its other operations in an effort to stave-off widespread panic but at this point it seemed plainly clear that they were behind the curve essentially plugging holes that had sprung far in advance of their attention.

All home sales indicators now began to register resounding confirmation that the massive structural changes that took place during the summer would lead to a new leg down in the housing decline.

The new and existing and more leading pending existing home sales data all showed quite clearly that a significant percentage of buyers had been simply removed from the equation resulting in another 15%-20% falloff in demand for residential real estate.

Home prices too have suffered, showing the most negative and most widely felt declines to home prices ever recorded by the S&P/Case-Shiller home price indices.

As for the consumer, the initial signs now clearly show that the housing collapse has begun to spillover with confidence plunging to recessionary levels, weakening employment situation, real retail sales of discretionary items continuing to remain negative, and a significant pullback in the production of some consumer durables and even a possible collapse of commercial real estate as well.

2007 ended, in a sense, in a similar but altogether more severe state than it had begun.

A famous former president of the National Association of Realtor’s can still not sell his own home even with all the propaganda NAR money can afford, NAR’s predictions are no more accurate, and homebuilder sentiment is borders on depression.


The primary difference is that the ruse is over.

The housing bubble is in obvious collapse in America and elsewhere around the world and the mortgage meltdown is now fully recognized as a serious global credit crunch and with that nearer is drawn the specter of a calamitous downturn.

Will bankruptcy for Fannie and Freddie or bond insurers push things over the edge?

Or perhaps prime borrowers will fail in record numbers as recession sinks in and job losses mount?

No one truly knows for sure but what does seem certain is that 2008 will bring some monumental changes.

The Almost Daily 2¢ - Immoral Hazard?

While vetting some clips for this week’s BNN lineup it became painfully obvious to me that, although the consensus tide is slowly turning on many formerly fringe notions such as the existence of a national housing bubble, the impending mortgage-credit meltdown, or the absurdity of various containment arguments, those who would knowingly “spin” our current economic predicament in either an attempt to protect their own self interest or simply as a foolish prescription to stave off a national case of the “R-word” blues, have in no respect abated.

Whether it’s a fully invested Wall Street insider, a paid analyst, an economist, an actor who fancies himself an economist, a business channel pundit, a residential real estate-mortgage industry insider, a whole host of real estate industry trade associations, misguided administration officials, a tired old Fed chairman or an obviously struggling new one, there is no lack of individuals willing, for one reason or another, to push for optimism in lieu of accepting realism.

Now don’t get me wrong, I’m not suggesting that there is literally no wiggle room for interpretation.

Although my hunch is that the economy is headed for a pretty rough patch (i.e. hard and entrenched recession), I’m still aware of the fact that, on such matters, the exact outcome is in no way a foregone conclusion.

But what if an oncoming hard landing is truly all too obvious?

The list of bright flashing warning signals is a mile long (and getting longer everyday) yet it seems to me that consensus is continuing to play a dangerous game of denial that, years from now, may be interpreted as easily contributing to needless losses for many millions of individuals.

When supposedly credible authorities and organizations portray our current circumstances with optimism and skepticism of the obvious worsening trend, there is a solid chance they are affecting the behavior and actions of the many onlookers.

From the Federal Reserve continually pushing the notion of contained fallout from the housing debacle to the National Association of Realtors (NAR) shamelessly urging on home buying activity even in the face of dramatic weakness and depreciating home values or even foolish zealots like Ben Stein suggesting back August that there would be no real losses from the subprime meltdown, the message may be the same to many, that is… no need to be concerned… go on about your business… nothing to prepare for.

It’s exactly this lack of preparation that, like the related and equally dangerous collective behavior pattern of “over doing it in the first place”, will contribute to making any coming downturn significantly more severe.

So, are these optimists and charlatans creating in effect an “immoral hazard”?

That is... by purposefully or otherwise sidestepping reality, has a perception been created (and continues to be created) that has inevitably resulted in the economy’s participants feeling insulated from risk, thus preventing them from acting responsibly and fully accounting for the risks and consequences of their actions?

The Daily 2¢ - The New Dukes of Hazard

There has been a lot of discussion lately on whether, by moving too aggressively in shoring-up the market, the latest actions by the Federal Reserve constitute a “moral hazard” which inadvertently conveys to market participants a false sense of security and even impunity leading, ultimately, to inefficient behavior and careless risk taking.

Yet, given the policies of the Fed in recent times, it’s seems hard to differentiate the measures taken by “helicopter” Ben from the former “easy money” maestro in order to determine which era might be deemed hazard causing and which not.

I suppose the best way to judge is simply to watch the sentiment and actions of the market participants themselves to see if they appear to be relying on presumed assurances from a higher power when making their market bets.

To that end, witness this ridiculous clip of CNBC’s Dylan Ratigan closing the NASDAQ yesterday and see if you can divine the answer for yourself.

It’s subtle so I’ll give you a hint… the part towards the end of the clip where, surrounded by a large cadre of Wall Street goons, Ratigan, in a crescendo building cheerleading tone, states “Five days in a row… this markets been higher. You can thank the Federal Reserve for that. Ever since they stepped in this market has been [up up and?] away.”

So I guess the hazard is on, where it ends only time will tell but let’s just hope that it’s not with Bernanke hurling sacks of cash from the General Lee.

Possibly the old TV serial lyric holds a clue:

“Straightening the curves, flattening the hills
Well someday the mountain might get 'em but the law never will

Just two good ol' boys, wouldn't change if they could
They're fighting the system like two modern-day Robin Hoods”

Oh well… it’s just the economy…. By the way, I’m the spitting image of Cooter.