The Segmented Society

The Segmented Society

 

This is an updated version of something I wrote in 2006.  This discusses how American society became segmented and discussed the movie “Crash” which had won the Academy Award for Best Picture and the 1975 book The Segmented Society: An Introduction to the Meaning of America by Robert Wiebe.

There has been much talk lately about the United States being a divided nation.

The only Oscar nominated movie which I saw was "Crash." When I saw it I hardly thought of it as an Oscar winner but certainly felt that it was an excellent movie. Post award commentary refers to "Crash" as a movie about racism. That misses the point of this movie. Racism is nothing new. What "Crash" is about is the segmentation of society. In "Crash" racism is a surface issue. If there is racism in L.A. then everyone there is a racist. The movie stereotypes white cops, Koreans, Iranians and blacks. The people in "Crash" are clueless about race. They are clueless because they understand only those in the segment of society in which they have chosen to live. Korean grocers are referred to as "Chinamen." They do not understand that the Iranian is not an Arab. The black cop is having a fling with his Latina partner but cannot remember what country her relatives are from. Ludacris acts like a college student complaining how white folks are looking at him as if he is a criminal and then whips out a gun and does a carjacking. No one really trusts anyone outside their segment. Rodney King's "Can't we just get along?" question is answered vociferously with a resounding "No! And by the way, Rodney, we really don't want to all get along!"

"Crash" is not simply about racism. It is about the effects of segmentation - the deliberate choice of folks to isolate themselves from all but a small part of society with whom they feel comfortable. The homicide cop (David Cheadle) nailed the concept. "It's the sense of touch. In any real city, you walk, you know? You brush past people, people bump into you. In L.A., nobody touches you. We're always behind this metal and glass. I think we miss that touch so much, that we crash into each other, just so we can feel something."

Some of our modern technology is segmenting. Cars isolate us from those nearby. Cell phones make people walk down the block inattentive to those physically proximate while they talk to someone far away. Ditto instant messaging. With these technologies not only can we ignore fellow citizens in other neighborhoods but we can ignore coworkers in the same room and people we are standing next to. Technology has made segmentation easier.

For me this was not a story just about L.A. but relevant to America in general. We are a segmented society. This is a notion spelled out in Robert Wiebe's 1975 book The Segmented Society: An Introduction to the Meaning of America. The segmentation of society is most noticeable regarding politics. You can live in a community where Rush Limbaugh is regarded as the dispenser of the truth. You can live in a community where Michael Moore is regarded as a sage. You can a visit left wing web site. You can visit right wing web sites. Doing so serves to reinforce one's beliefs.

We have new segmenting forces in cable news and the internet. The folks who run cable news networks know full-well what they are doing. Segmentation exists and they are monetizing it and, by doing so, reinforcing it. Ratings = Income. No one understands segmentation better than advertisers. While Fox was always a Republican supporting network and MSNBC was a Democrat supporting network what has happened recently is that CNN, which had been closer to the center, decided to monetize Trump. As Larry King recently said:  CNN no longer does news, they do Trump.

The Internet has become a bizarre example of segmentation. I find this strange because the Internet should be a desegmenting force. It is an equal opportunity, equal access thing. The internet has become a sort of alternate reality where segmentation is blatant.  Not so much an alternate reality but a small subset of reality in which only certain opinions are tolerated. People use social media to have their opinions reinforced.  That makes no sense to me.  If you want to grow and expand you do so by exposing yourself to people with ideas different from those you hold.

Getting back to Wiebe, his point was that segmentation has almost always been part of American society. The exception was the period from the 1940's to the 1960's. There was largely a single popular culture with nationwide appeal then. Everyone loved Lucy. My own personal experience is that this acceptance of culture somehow ended the day that President John Kennedy was assassinated. In fact I would offer that the cohesive American cultural society lasted precisely from the day Pearl Harbor was attacked until the day Kennedy was shot. There was shock that this Southerner (LBJ) who was really from a different culture than Kennedy had come to power in such tragic circumstances.

The 1960s' encouraged segmentation: black power, hippies and the woman's movement. Instead of trying to all get along and think of ourselves as one group (Americans) we were encouraged to choose our segment. This segmentation has economic and political values.

The segmentation American society has a simple and obvious root. We are a nation of immigrants. In the early 20th Century Italian and Irish immigrants segmented themselves by choosing to live in certain neighborhoods in the cities. It felt safer to be around people who spoke the same language and could relate to the "old country." More recently we see Latin immigrants doing the same thing. "Crash" worked because segmentation in L.A. is so blatant. Latinos, Koreans, blacks and whites all in their neighborhoods not quite trusting each another. The immigration of Mexicans into the U.S. may be a different issue than these previous examples of immigration because, for some, it is a temporary thing - they go back and forth.  But one truth is that all immigrants came here seeking a better life.

This segmentation is not merely about skin color or ancestry. There is political/social segmentation. There arose a segment of what are  Progressives a group fueled by University intellectual elites and the professional middle class which was espousing an ideal that government had to protect the consuming public against the inherent evils of greedy capitalistic robber barons.

The person who best expressed this is Camille Paglia: "The basic Leftist premise, descending from Marxism, is that all problems in human life stem from an unjust society and that corrections and fine-tunings of that social mechanism will eventually bring utopia. Progressives have unquestioned faith in the perfectibility of mankind. The horrors and atrocities of history have been edited out of primary and secondary education except where they can be blamed on racism, sexism, and imperialism — toxins embedded in oppressive outside structures that must be smashed and remade. But the real problem resides in human nature, which religion as well as great art sees as eternally torn by a war between the forces of darkness and light."

We preach the wonderful multicultural nature of American society but like the multicultural folks in "Crash" we then voluntarily decide to live in segmented sub-societies. These are determined by personal choices and deliberately maintained. The fact is that any of these places may be penetrated by anyone who chooses to live there. The only barrier is real estate prices.

This notion of segmented society is many times more serious in nations such as Afghanistan or Iraq than it is here in the U.S. Strangely, while not recognizing the reality of segmentation here we have attempted to establish something resembling democracies in two of the most segmented countries on the planet. Of course this was not an "out of the blue whim" but a reaction to a dramatic event here with little mind to the cultural difficulty of these tasks.

Here we openly discuss our differences, argue, vote and then argue some more but I do not think that we are in serious danger of a civil war among the segments. Better the battle is fought in cyberspace than at Gettysburg.

Segmentation has economic value. If folks chose to identify with a subset of society it makes it easier to decide how to market a product to them. This is a large part of why Facebook and Google make money.

Segmentation has political value. A politician can be given a punch list of what the constituents want to hear and parrot those values. 

There are instances in which the rules of segmentation change. When we go to a baseball or football game we set aside the notions of segments which exist outside the stadium and we all root for our team. We do not care about the race, age or economic status of our fellow fans. We have a common agenda: root, root, root for the home team. The enemy segment is the other team and, sometimes, the officials.

For now and in the near future segmentation will exist and have its embarrassingly awkward moments captured nearly perfectly by "Crash." For me there is one foolish thing about choosing to be segmented - it makes you ignorant. The irony is that a simple guy like Rodney King would have asked the right question. Strange. Very strange.

Rate Watch #1099 – The Fed and the Liquidity Crisis.

August 28, 2017

by Dick Lepre

[email protected]

www.loanmine.com

 

 The Fed and the Liquidity Crisis

People generally are ill-informed about what happened after the Lehman bankruptcy and the mortgage mess.  This poor information consists of two things 1) how much the government actually lost on TARP and 2) the fact that TARP was not the important this.  What was important was the swift reactions of the Fed to a liquidity crisis.

Between February 2007 when HSBC was the first large bank to make a large write-off ($10.5 billion) and August 2008 banks worldwide had written off $500 billion. Banks had a dual problem. One was a capital problem but the persistent one was a liquidity problem. The capital problem was partially fixed by raising more capital and diluting the value of equity position of banks. The liquidity problem was more nefarious. Banks became suspicious of one another and their normal flow of interbank lending stopped. When interbank lending dries up lending dries up.

Liquidity implies that an asset can be sold quickly without affecting the price. The underlying reality was that if banks started to sell their stakes in mortgages the prices would be driven constantly down creating cascading losses as the value of their stakes deteriorated and their new worth decreased.

The salient point was this: banks needed an extended period of time to get rid of their lousy assets of pools of bad mortgages. This required two things: 1) relaxation of accounting rules to not force banks to genuinely mark these assets to market 2) a massive injection of liquidity on a scale never before seen.

What follows are brief synopses of the various Fed created programs to provide liquidity.

TAF

One solution was the Term Auction Facility. The TAF was not merely a Federal Reserve thing. It was the coordinated effort of the Federal Reserve, the European Central Bank, the Bank of England, Bank of Canada, and the Swiss National Bank.

Under the Term Auction Facility program, the Federal Reserve auctioned term funds to depository institutions by taking of a larger set of assets as collateral that the Fed would normally take at its discount window. Cash was provided with a broader set of assets as collateral.

I am going to sidetrack here with comments on some of what I have read about this. The Fed was not giving money to anyone. It was lending money. All of these loans were secured. The Fed lost zero. In fact it made money. It most certainly took risks because it lowered the standard of the collateral it took.

Primary Dealer Credit Facility (PDCF)

Some of the entities damages by the liquidity crisis were primary dealers. There are currently 18 primary dealers. These are the entities which the Treasury department uses to wholesale Treasury auctions. One of the most important elements of this is what is called a "Triparty Repurchase Agreement." A repurchase agreement (repo) is the sale of securities and the agreement by the seller to repurchase those securities for a given price on a given date. These are Wall Street versions of a pawn shop. A Triparty Repurchase Agreement is a repo where there is a third part which acts as custodian for the securities. With these entities damaged and lacking the trust of counterparties, the Fed established PDCF as an overnight loan facility for primary dealers. It was to primary dealers what the Fed window is to member banks. The dealers of immediate concern were Goldman Sachs, Morgan Stanley, and Merrill Lynch. Details of all of the PDCF transactions are in this spreadsheet.

The facility was announced on March 16, 2008, and was closed on February 1, 2010. All loans were repaid with interest.

It should also be noted that the big Wall Street investments banks were subsequently either acquired by commercial banks or redefined themselves to become bank holding companies and can now borrow from the Fed window.

Term Securities Lending Facility (TSLF)

This was another type of support for primary dealers and loaned liquid Treasury securities with less than totally liquid securities as collateral. These "less than totally liquid securities" were agency MBS, CMO and bonds with ratings from AAA to Baa/BBB. The TSLF was announced on March 11, 2008 and closed on February 1, 2010. All securities loans made under the facility were repaid in full, with interest.

Agency Mortgage-Backed Securities (MBS) Purchase Program

This was the facility for purchasing residential mortgages. This helped Main Street not Wall Street. These was FNMA, FHLMC and GNMA (FHA and VA) mortgages. The Fed purchased these mortgages in bulk from primary dealers. Most of these remain owned by the Fed and each transaction has its own CUSIP number. In addition to the interest received there has been much principal repayment as homes are sold and as those Fed owned mortgages were refinanced at lower rates this year. Understand that the Fed paid zero for the money. It created these fund out of thin air. All of the interest received (less what is paid to the servicer) is profit. The notion that this was a dramatic increase in money supply which could create asset bubbles especially with low interest rates is valid. Asset bubbles are a collateral effect.

Commercial Paper Funding Facility (CPFF)

Commercial paper is short-term (<270 days) borrowing usually by businesses and governments to fund short-term operating expenses. Some commercial paper is backed with assets and some is unsecuritized. This is a critical source of funding for many businesses. While a business can issue commercial paper itself, most commercial paper is sold to broker-dealers (investment banks and bank holding companies) and those entities find retail buyers for this paper. To a large extent is was money market mutual funds which provided the cash for commercial paper. On September 16, 2008, consequent to the Lehman BK investors started moving money out of money market mutual funds and these funds had to liquidate assets at a bad time. On that day the Reserve Primary Fund, the oldest money fund in existence, and a holder of $785 million in Lehman Brothers commercial paper "broke the buck" meaning that every dollar invested there was worth less than $1.00. Before that day, in the entire 37 year history of money market funds this had only happened twice. The notion that other than cash and bank deposits money market funds were the safest investments had gotten a serious jolt.

When the liquidity crisis happened the money market funds were reluctant to purchase commercial paper. We were facing a serious recession and the sources of credit to many businesses disappeared almost overnight.

The Federal Reserve created the CPFF and the Federal Reserve Bank of New York provided three-month loans to the CPFF LLC, a specially created limited liability company (LLC) that used the funds to purchase commercial paper directly from eligible issuers.

The facility was announced on October 7, 2008, began purchases of commercial paper on October 27, 2008, and was closed on February 1, 2010. Net portfolio holdings of the CPFF LLC peaked at $351.4 billion on 1/23/2009. The CPFF LLC was dissolved on August 30, 2010. All loans that were made to the CPFF LLC were repaid in full.

This is a link to the CPFF page at the site of the Federal Reserve Bank of New York. This is a spreadsheet of all CPFF purchase transactions. This is a spreadsheet loans that FRBNY made to the CPFF.

Term Asset-Backed Securities Loan Facility (TALF)

This addressed asset based securities (ABS). Asset based securities are what banks, for example, use to finance auto loans, credit card debt and student loans. When the liquidity crisis happened investors were reluctant to purchase ABS. While TALF lending was done through intermediaries the people who benefited were everyone who wanted an auto loan, a credit card, a student loan or a small business loan. TALF loans were collateralized by assets. The value of the assets always exceeded the value of the loan. This helped Main Street not Wall Street.

The facility was announced on November 25, 2008, and began lending operations in March 2009. TALF lending was authorized through June 30, 2010. The only info I can find says that 60% of the loans were paid off this September and that "All loans that have not been repaid in full early are current in their payments of principal and interest and no collateral has been surrendered in lieu of repayment."

Central Bank Liquidity Swap Lines

These are foreign exchange swaps. Two types were enabled one for foreign banks wanting to temporarily exchange their currency for U.S. dollars and one for providing liquidity for foreign currency assets of U.S. banks. The later were never activated. Since I am bad at explaining FOREX in my down-to-earth fashion I will merely plagiarize the Fed.

"To address severe strains in global short-term dollar funding markets, the Federal Reserve established temporary central bank liquidity swap lines (also referred to as reciprocal currency arrangements) with a number of foreign central banks. Foreign central banks then could draw on those lines to provide dollar liquidity to institutions in their jurisdictions. In the swap transactions, the Federal Reserve deals only with the foreign central bank. The transaction is structured so that the Federal Reserve does not bear any foreign exchange risk. In May 2010, dollar swap lines were reestablished with certain foreign central banks because of the reemergence of strains in dollar funding markets.

The FOMC authorized temporary dollar liquidity swap arrangements with 14 foreign central banks between December 12, 2007, and October 29, 2008. The arrangements expired on February 1, 2010. All transactions were executed in full, in accordance with the terms of the swap arrangements.

In May 2010, in response to the reemergence of strains in short-term dollar funding markets abroad, the FOMC re-authorized dollar liquidity swap lines with five foreign central banks through January 2011."

So What?

Since this was announced I have read countless criticisms of the Fed's actions as detailed in this report. The fact is this: the Fed acted independently in most of these cases. It acted under authority granted to it by of Section 13(3) of the Federal Reserve Act, which permitted the Board, in unusual and exigent circumstances, to authorize Reserve Banks to extend credit to individuals, partnerships, and corporations. If these were not unusual and exigent circumstances then I am not sure what constitutes such.

The Fed did not give money away to any entity. It reacted in a most dramatic way to a massive liquidity crisis which, if not immediately addressed, could have created a worldwide depression. The Fed provided liquidity for funding mortgages, credit card debt, student loans and auto loans. As far as I can tell the only long term loans are the mortgages purchased by the Fed from FHLMC, FNMA and GNMA. There are still positions in TALF loans which are also consumer oriented. The Fed helped Main Street as well as Wall Street. All of the loans made to increase liquidity to commercial banks and investment banks are repaid.

The Fed acted boldly and may someday be judged to have averted a worldwide economic catastrophe and the end of 2009 transferred more than $45+ billion in profit to Treasury. The discussion about whether the Fed should have the dual mandate of controlling inflation and keeping unemployment low misses the fact that real mandate of the Fed is preservation of the banking system. The elements of the dual mandate are secondary and we do not normally think about the Fed's first purpose because things such as this liquidity crisis do not occur often.

The Fed gets criticized by folks of all political beliefs. To me criticizing the Fed is like criticizing the fire department. Building owners complain that they do water damage and the arson squad complains that they destroy evidence. Like the fire department, as the Fed puts out economic fires it does create collateral damage. That collateral damage takes the form of asset bubbles created by low interest rates and large increases in money supply. The Fed quite possibly averted a major worldwide depression and it so doing made enough money that is gave Treasury $45 billion in 2009. So before anyone bitches about the Fed they should perhaps think about that.

The liquidity crisis unfolded with such speed that there was no time for any entity other than the Fed and other central banks to act. The Fed needed to act without proximate input from politicians. Congress gave the Fed its agenda. Listening to people in Congress and comedians on TV question Bernanke was, to me, laughable. With these programs the Fed helped Main Street and Wall Street. When it helped Main Street it also helped Wall Street. When it helped Wall Street it also helped Main Street. The notion that Wall Street and Main Street have opposing interests is one of the dumbest fallacies to come from all the discussion about what the Fed did.

What is happening with the budget in Illinois has the possible beneficial side-effect of creating awareness of the massive underfunding of public pension debt. This and on a national level the underfunding of Medicare and Social Security represent by far the greatest threats to our economic and social well-being.

Below are links to a recent piece I wrote as well as an article from Bloomberg:

http://www.loanmine.com/CustomPage434.x

https://www.bloomberg.com/graphics/2017-state-pension-funding-ratios/

Mark-to-Market

Zerohedge has a piece suggesting that the Dallas Fed has, in effect, suspended mark-to-market accounting for banks valuation of their energy debt.

http://www.zerohedge.com/news/2016-01-16/exclusive-dallas-fed-quietly-suspends-energy-mark-market-tells-banks-not-force-shale

It was mark-t0-market accounting which was in no small part responsible for the Great Recession as it forced holders of subprime mortgage debt to sell simultaneously.

 

I have always believe that there is sometimes value in suspending mark-to-market for the purpose of not causing disorderly selling as long as all market participants are aware of this suspension.

Rate Watch #832 Grecian Formula?

June 15, 2012

by Dick Lepre  

[email protected]
www.loanmine.com

 

  

Where Do We Go Next?

Since we hit dead center the call for 1.46% 10-year Treasury note yield, folks have been asking, "What's next for Treasuries and home loan rates?" The fact is that the U.S. economy is in a dismal state despite averaging $1.518 trillion in deficits per year for the past 3.5 years. We are not exactly in an austerity mode. Massive deficit spending has not really been Keynesian but is more the result of structural problems with Social Security and Medicare/Medicaid. Gigantic spending on wars in the middle-East have also hurt but these are not structural.

Accommodative fiscal policy has been accompanied by accommodative monetary policy - low rates and ineffective increases in money supply by the Fed.

Suggestions that we need a QEII to get the economy going are absurd. Why? Because the banking system has already more money that it knows what to do with. Banks have been under enormous pressure from politicians. This week the head of Chase had to explain a $2 billion trading loss. This is the same Congress which has created the fiscal cliff calling for large tax hikes and decrease government spending when this calendar year ends.

Banks have no idea what to do with their cash until Congress and the President settle the fiscal cliff issue and they are reticent to do anything which they will later be taken to task for. Keep in mind that 90% of the money banks have belongs to depositors. That money is sitting idle in part because banks are still lacking confidence in the economy and part because the regulations consequent to Dodd-Frank have not all been spelled out. Excoriating banks and bankers may be politically exigent but it has the effect of making them less likely to lend the $1.5 trillion in excess reserves they have parked at the Fed.

A QE III would prop up equities and keep Treasury yields low but this is merely another monetary fix for the fiscal junkie. It would numb the pain but when it inevitably wore off the problem would be worse. Another QE will have the effect of monetizing more Treasury debt and, consequently, two problematic side effects: 1) keeping Treasury yields low which is great for you as a borrower and great for me as a loan officer but has the effect of allowing narcotizing the economy to the pain we will suffer when the large national debt needs to be serviced at traditional yields and 2) making very difficult the task the Fed will have in drawing down this excess money supply before it can cause very serious inflation.

In short a QEIII would be a formula for high inflation, high interest rates and disastrous debt servicing costs.

The blueprint for what we should be doing is either Simpson-Bowles or the idea of a debt commission proposed by Professor Brauer and myself. We need to start thinking long-term. Absent a plan for fiscal sustainability, all we are really doing is applying Grecian Formula to a graying economy. 

---

Dick Lepre

[email protected]
Web site: www.loanmine.com
Blog: economy.typepad.com
Phone: (415) 244-9383 | Fax: (866) 488-2051
1400 Van Ness Avenue, San Francisco, CA 94109
CA DRE # 01143973 | NMLS # 302379
California Department of Real Estate - Real Estate Broker License #01818035, NMLS #9472. Equal Housing Opportunity.

Federal Income Tax. Who Pays What.

Rate Watch #823 Federal Income Taxes - Who Pays What?

April 13, 2012

by Dick Lepre  

[email protected]
www.loanmine.com

 

Income Taxes

Since it is that time of year and there is so much talk about who should pay what let's see who paid what in the most recent year for which we have data.

 

Federal Income Tax Paid by Percentile 2009 ("AGI"= Adjusted Gross Income)

	Number of Returns	AGI ($ millions)	Income Taxes Paid ($ millions)	Group's Share of Total AGI	Group's Share of Income Taxes	Average Tax Rate
All Taxpayers	137,982,203	$7,825,389	$865,863	100.00%	100.00%	11.06%
Top 1%	1,379,822	$1,324,572	$318,043	16.9%	36.7%	24.01%
Top 1-5%	5,519,288	$1,157,918	$189,864	14.8%	22.0%	16.40%
Top 5%	6,899,110	$1,960,676	$507,907	31.7%	58.7%	20.46%
Top 5-10%	6,899,110	$897,241	$102,249	11.5%	11.8%	11.4%
Top 10%	13,798,220	$3,379,731	$610,249	43.2%	70.5%	18.05%
Top 10-25%	20,697,331	$1,770,140	$145,747	22.60%	17.0%	8.23%
Top 25%	34,495,551	$5,149,871	$755,903	65.8%	87.3%	14.68%
Top 25-50%	34,495,551	$1,620,303	$90,449	20.7%	11.0%	5.68%
Top 50%	68,991,102	$6,770,174	$846,352	86.5%	97.7%	12.5%
Bottom 50%	68,991,102	$1,055,215	$19,511	13.5%	2.3%	1.85%

 

 

AGI = Adjusted Gross Income

  

Source: Internal Revenue Service

  

IRS changed the format of the presentation of this data. I find that it is better presented in this clear table at Tax Foundation.

  

The 1%'ers

  

Lately there has been a gigantic amount of political and media talk about the top 1% of income earners, how much they make, how much they pay and how much they should pay.

 

Comparing the 2009 data with 2008 and 2007 the total AGI of the top 1% dropped significantly. In 2007 the 1%'ers earned a total of $2,008 billion. In 2008 they earned a total of $1,685 billion. In 2009 they earned a total of $1,326 billion. The total AGI of the 1%'ers fell 34% from 2007-2009. These folks have a lot of capital gains and interest income and it is likely that decrease in capital gains and low interest rates were responsible for the decline in their income.

 

The populist narrative about the 1% making a larger percentage of total AGI is not supported by recent IRS data. The year-by-year breakdown is in Table 3 of this page.

 

If you have something to add to this discussion please post a comment on the blog.

---

Dick Lepre

[email protected]
Web site: www.loanmine.com
Blog: economy.typepad.com
Phone: (415) 244-9383 | Fax: (866) 488-2051
1400 Van Ness Avenue, San Francisco, CA 94109
CA DRE # 01143973 | NMLS # 302379
California Department of Real Estate - Real Estate Broker License #01818035, NMLS #9472. Equal Housing Opportunity.

Presidents and the Economy

I need a break from writing about the mortgage mess so...

With this being an election year I have tried to not discuss politics at all but I would like to discuss the economy and suggest that political rhetoric serves little purpose regarding the economy.

Politicians find out what concerns folks and then suggest that they have solutions regarding those concerns. One thing folks are concerned about is the economy so it is natural that Presidential candidates address that issue.

The problem is that the President of the United States has virtually no significant effect on the economy. The only person who is part of the Federal apparatus who can significantly affect the economy is the Chairman of the Federal Reserve. The fact is that the President is affected by the economy to a vastly greater extent that the economy is affected by him.

Presidents do not create significant numbers of jobs. Jobs are created by a coming together of businesses, labor and capital. We have a gigantic system in place which does this. Folks see opportunities for profit and create and expand businesses and create jobs in the process. This also has the annoying effect of creating business cycles which go with those opportunities. It works like this: opportunity knocks, people see a situation where a product or service can be provided at a profit, business expands, jobs are created, at some point supply exceeds demand and a downturn occurs. This is what happened in the dot-com thing and this is what is happening in the present housing cycle.

To be fair there are marginal cases when political intervention does effect the economy. Tax cuts spur short-term economic growth. The recent stimulus package will provide some economic growth. But these are aberrations not the normative methods for job creation.

In short, when any of the Presidential candidates describe how they will create jobs pay no attention to them. They cannot create jobs and their ability to help business and workers create jobs is rather limited.

All that said, this has to be one of the strangest Presidential elections I have witnessed. There are three people still contending and they are all fairly liberal so the conservative agenda is not exactly having a good year. At present this is all about Obama. It is amazing that someone with so little political experience can be doing so well. It is not merely about Obama-mania or his being a sort of cult hero. The stark political fact is that he has made all the right moves while the experienced Clinton machine has made all the wrong moves.

He certainly has engaged the youth of American and that is a good thing. Getting young people involved in politics and interested in finding out what the government does is good. It is too easy to dismiss young folks saying that they are so inexperienced that it is easy for them to be swayed by someone such as Obama merely because of his speaking ability and his appeal to the liberal notions common to youth. There is more here than that. This guy really has engaged people. Folks feel a lot closer to him than they do the other candidates and certainly closer than they do to anyone who has been President in a long time. That by no means certifies that he will be nominated or elected but this is one darn interesting election.

In my view one effect of the potential nomination or election of Obama would be the perception that foreigners would have of what the U.S. is and what opportunities exist here. This is a guy with one black parent, one white parent and a Muslim name. Foreigners will conclude 1) that this is really a land of opportunity where a guy with mixed race and a Muslim name can get elected 2) we are totally insane and this is just a sort of extension of American Idol or 3) both 1) and 2) are true.

In no way do I suggest that we tailor our vote to what pleases foreigners. That makes little sense.

No matter what - whoever is elected will have little effect on the economy.

Data vs. Opinions

aThe news of the day is BofA's acquisition of Countrywide (CWF). This is an interesting story. It could be a 1) good money after bad story 2) a bargain because BofA has an incredible ability to offer retail banking products (credit cards) to all those CWF customers 3) a really, really bad disaster if the costs of the litigation losses from the lending practices of CWF prove gigantic rather that large.

This is my perspective: BofA is deadly serious about increasing its retail mortgage profile. One of the core beliefs of BofA's present management is that mortgage loan customers can be cross-sold other banking products such as credit cards and can, consequently, become profit centers.

So what BofA is getting is CWF's servicing portfolio and the database of clients and what they are risking is the potential of some gigantic losses associated with the litigation which will result from potential class action lawsuits regarding CWF's lending practices.

The losers are the folks who created CWF and worked to make it the great company which it was. They made the one mistake of getting heavily into subprime because it was short-term profitable. In a sense the story of CWF is a capsule of the mortgage disaster. The winners are litigation attorneys. Litigation law firms now have BofA to pay the cost of potential litigation rather than suing a bankrupt CWF and counterparties.

The mortgage business is still in a state of chaos. The most important thing is getting credit insurance for Jumbos. It does not appear to me as is anyone is really addressing this issue but rather papering it over.

Let's go bank and examine what insurance is. Insurance is the exchange of a relatively small loss (the principle payment) in place of the possibility of a potential large loss. Looked at over time one can personalize this by regarding it as a payment plan for disasters. In essence whet we get out is equal to what we put in, It's just that we put it in in small amounts and take it out in large amounts.

In short there is no mystery. Credit default insurance must be built into the cost of the loan - either up front or in the cash stream or both. In the subprime disaster the money to cover the credit insurance is not there because the risk was, as Mr. Bush would say, misunderestimated.

The present credit insurers are - how to put this? - uhh, bleeped. The alternatives are 1) have the lenders pump more money into them so that the insurance can be paid 2) have the debt issuers take the loss because the insurers fold 3) let 2 happen and create new credit insurers.

V) Data and Analysis

Last December I was at a meeting with a bioscientist (this is something which I will write about in a future newsletter). One topic we were discussing was how a scientist deals with the large amount of research published in his field. He picked up a journal which had been sitting on his desk and made an insightful comment. He said, essentially, "The thing to do is read these articles and just look at the data and pay no attention to the conclusions drawn by the researchers."

His notion was that anyone reading any such publication was just as capable of drawing his own conclusions from the data than the authors were.

Of course with science there may be cases where profound conclusions are drawn but they are, in fact, rare.

We live in a media-rich era. Economic data is treated like yesterday's sports scores - not really important. The savants and the people who play fantasy baseball want to guess what is going to happen tomorrow or, at bare minimum, draw conclusions from yesterday's data.

A few weeks ago I commented that I found it strange that the NYT defined Christmas Retail Sales gains of +3.6% as "weak." To me, a gain of +3.6% in face of the mortgage crisis was indicative of strength. The NYT points out that sales grew 6.6 percent in 2006 and 8.7 percent in 2005 so, yes, the rate of growth was smaller in 2007 than in the pervious two year but the 3.6% growth in 2007 was compounded on the growth of the previous two years. In short, Retail Christmas Sales are 120.04% of what they were three years ago.

The point here is that the data is the data and while the New York Times and Dick Lepre may have varying opinions about what the data implies you should look at the data and draw your own conclusions. What I mean is that markets may work best if individuals look at the data, draw their own conclusions and make market decisions accordingly.

At the opposite end of the spectrum one has things such as the CIA. These are folks who amass large amounts of data, draw conclusions, and then only share the conclusions with the public not the data. Perhaps it is more accurate to say that they only share that part of the data which supports the conclusions.

I am in no way suggesting that the CIA should share everything of even anything. I am simply stating that the process of presenting the conclusions without presenting data may well be flawed simply because the data is much more important than the conclusions.

My belief here is in keeping with the fact that I value the technical interest rate forecasts. The technicals do not really draw any conclusions except for the thesis that it is that data that drives the data. The stochastic seeks no rationalization of what happened or what is going to happen. It is a notion that markets have cycles and it seeks to quantify those cycles. It does not forecast economic fundamentals.

Markets

Another issue is that markets tend to trade based not on data but on guesses about data. The typical scenario is that a company announces its quarterly and the earnings and sales are great and the stock gets hammered because the data was presumed.

So we have an unfortunate paradox. It is the data that is important to the economy but it is the opinions about what the data will be and the difference between the forecast and the actual data that moves markets.

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Dick Lepre

The Invisible Hand of the Free Market Is Rewriting the Guidelines

The mortgage industry has suffered a severe liquidity problem. It is not as if there is not a lot of money out there it is that there is an enormous amount of doubt about the true value of mortgage backed securities. Lowering the Discount Rate may have helped perception but it has not reestablished liquidity for Jumbo mortgages.

The problem has an easy solution - going forward. I proposed it last week.

1) No loans to folks with bad credit (<640 credit score) without full documentation that they at least have the potential to make the payment.

2) stated income A-paper (good credit) should be bumped up about 0.625% in RATE above full doc.

I am going to add a third point. The GSE's (FHLMC & FNMA) must be more adequately capitalized and the Federal government should clarify whether or not it is standing behind FHLMC/FNMA debt. It literally is not but everyone acts as if it it. That make absolutely no sense.

Adequately capitalized GSE's need to up their loan limits and securitized jumbo mortgages.

That is it. The bump in rate for stated may be a bit excessive but what we need is liquidity. Corrections can be made later.

This problem was cause by irresponsible lending. It is not the result of exogenous forces.

Q: But Shouldn't the Fed Solve the Problem by Lowering Rates?

A: This gets confusing. Today, the Fed lowered the discount rate which is the rate at which bank can borrow money directly from the Fed. That is largely symbolic because because very few people borrow money directly from the Fed window because there is a stigma associated with it. Banks believe that it is a great way to get scrutinized. In addition the Discount rate is evey now higher than the Fed Funds rate.

What is much more important is the Fed funds rate. That is an open market rate at which banks lend money to one another for 1 day. The Fed sets a target and intervenes with open market operations to keep that target. The most important thing the Fed did today was not to lower the discount rate but to indicate that they will start lowering the target for the Fed funds rate. Check out this language: "Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth,'' the Federal Open Market Committee said today. ``The committee is monitoring the situation and is prepared to act as needed to mitigate the adverse effects."

In English "prepared to act as needed" means lower the Fed Funds target at the next FOMC meeting. At least that is what I think.

Is the Fed bailing the mortgage industry out? No. Fed bailouts are not appropriate to undercapitalized companies which take undue risks. A Fed bailout sends the wrong message and only encourages risk in the future. As William Poole of the Fed says, "everyone knows that a policy of bailouts will increase their number."

The Fed also injects money with repurchase agreements whereby short term cash is loaned in exchange for securities which are then repurchased by the borrower. What is of paramount importance is banking liquidity and the Fed will provide that as necessary by injecting massive amounts of cash into the system with repos and outright purchases.

How Did All of This Start?

I answered that last week. I said that for the most part this started with a relaxation of lending standards and that was created by greed and stupidity. But greed and stupidity are forces which are always present.

The question I will address is "Why did this happen now?"

This happened because we have been living in an "Age of Abundance" and too much money has been available to lend and lending standards in the mortgage industry and elsewhere were lowered. Strangely, we try to disguise this. Our notion of poverty is strange if many people below the poverty line own a car and a cell phone. But I am not trying to comment on society except to say that this abundance of wealth engendered bad lending. The wealth is not merely here in the US. There has been a massive decrease in worldwide poverty recently and there are massive wealthholders all over the world. Most of these wealthholders had a piece of the MBS market.

An end to bad lending may be a temporary inconvenience to most mortgage folks and a downright disaster to the folks who capitalized on bad lending but, going forward, it will be entirely good and hopefully the economy will be a little smarter.

For me the truly interesting thing is the functioning of this free market. It is not about the Fed or the mortgage business per se this is an absolutely perfect example of the free market working to correct a very serious problem. The invisible hand of the free market is rewriting morgage guidelines right now.

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Dick Lepre

Offshoring

Bush has by both by default as well as due to his conservative values had to take the position that offshoring is good and will lead to long-term benefit. Interestingly he had backers like Alan Greenspan.

Populist politicians such as John Edwards and populist, brain-dead commentator Lou Dobbs have railed against offshoring for its simplistic notion, "You need me looking out for you 'cause companies don't care about you they care only about the bottom line."

Edwards as well as any other politician wanting to score some points is no fool. Concerns about trade and offshoring are (according to CNN & NYT exit polls of last November) issues more important than Iraq. At present with the economy doing very well there is little political traction to be gained by doing an "it's the economy stupid" thing but the offshoring thing is simplistic. You and always scare a certain number of people into believing that their jobs will be offshored by contending that you cane prevent it.

But offshoring has been a longstanding issue and what do the effects of this look like at present?

With unemployment low, GDP growing (albeit at at too slow pace), it is difficult for me to see that offshoring has caused any sort of economic catastrophe. Of course it has hurt some folks but that is something that happened in any changing economic paradigm. Blacksmiths lost jobs with the invention and popularity of the car.

My point merely is that the harm done to date by offshoring has not been on any dramatic scale.

The following is something I wrote a couple of years ago about offshoring.

1) offshoring is going to happen, so learn to deal with it. If you think that your job may get offshored don't wait and be a person who goes to the doctor and finds that he has 3 months to live. Instead, get started by getting training for another job. Maybe, people in India will start doing mortgages and my job will be offshored. I will find something else to do. I got started as a loan officer in 1992 because I found that the set of computer skills that I had was nearly obsolete. I chose to do what I now do because I had, from doing computer software for an S&L, learned about the mortgage business.

2) suggesting that the government pay companies to keep jobs here is absurd. Why should tax dollars support someone's price inefficiency? In all likelihood the money would be ripped off by people who have skills at scamming the government. The U.S. government cannot do things like this correctly.

Recognizing that some people are going to be jobless for an extended period as a result of this shift, perhaps the federal government needs to help them by extending unemployment benefits.

3) businesses that, for whatever reason, decide not to offshore when their competitors do offshore may lose 100% of their jobs by going out of business.

A broader view might be this: if offshoring is a bad idea because of inefficiency or some such thing then the marketplace will determine the fate of those who offshore. If it is a good thing, those who offshore will be more successful (greater profits or market share).

4) the number of jobs being offshored is not so great when taken as a percentage of the labor force. This would be a problem if offshoring went on forever but it will not.

5) complaining that somehow foreigners are "unfair" and taking advantage of our open market and we should somehow lead a jihad to keep these jobs here misses the fact that there are a lot of domestic US workers who work for foreign-owned companies. This is a 2-way street. If you want to lead a jihad against offshoring, be willing to tell Sony and the Japanese car manufacturers to take their jobs back first.

6) there is an almost sinister irony of unintended consequences at work here. A few years ago we were talking about "the new economy" wrought by the Internet. What resulted was the laying of a large amount of fiber-optic cable so that the same infrastructure that you use to check out Paris Hilton's adventures on the little screen enables some person in India to access the database that the title companies to create preliminary title reports.

As an aside here there are three areas in which offshoring has touched the mortgage business - and I am only talking about what I know firsthand:
1) the preparation of preliminary title reports which, at least here in California, are now done almost totally in India
2) appraisal reviews and
3) software.

7) There is a strange "second order" effect at work here, at least in regard to programming jobs going to India. About seven years ago, when I was president of Homeownmers.com, I needed programmers. I went to a large employment agency. I interviewed about 6 people. They were all from India. The fact was that the US did not produce a large enough supply of skilled programmers to fill the demand. We reached out. Folks with the training came here and, in a sense, took the jobs back home with them.

8) I am conscious of the fact that real people who are my neighbors are losing their jobs. This is sad, but this is also inevitable. I would rather encourage them and help them to find new training, new careers and new jobs then commiserate about the forces that took these jobs away.

9) Offshoring produces advantages:
a) less expensive goods and services
b) political-economic stability that comes from working together. I don't intend this to
be glib, but maybe if we could get North Korea to take some of these jobs then we won't have to worry about them nuking us.
c) it brings the nations of the world together in a way that has meaning. It is literally "working together." More sociopolitical advantage will come from offshoring than from the United Nations.

10) if you don't believe me, here is what Greenspan once said: "As history clearly shows, our economy is best served by full and vigorous engagement in the global economy,"... "new protectionist measures" were being proposed, without specifying what he was referring to, and said they could be self-defeating.

"These alleged cures could make matters worse rather than better," he said. "They would do little to create jobs and if foreigners were to retaliate, we would surely lose jobs."

In 1900 America was on the verge of an Industrial Revolution. An equal amount of dissatisfaction about the loss of jobs by farmers and blacksmiths likely existed. Somehow, we got over it.

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Dick Lepre