Scott Johnson

The Fed made two significant moves in the last 24 hours. Yesterday the Federal Reserve announced the unprecedented move of offering major companies access to their discount window, to borrow directly from the Federal Reserve (truly making them a lender of last resort), and bypass the major banks.

The major banks continue to hoard cash and will not put it back into circulation, no doubt frustrating the Federal Reserve. It may be time to call for aggregious penalties for member banks that borrow from the Fed (whose motivation is to stimulate the economy), but only put those proceeds into their own coffers.

Today the Federal Reserve Board of Governors voted to reduce the Fed Funds target rate from 2.00% to 1.50%. So far, this has only moved mortgage rates a net 25 bps in price for the day, or a rate adjustment of about 0.065% to the end customer.

Sales in August in California were up 86% in August from a year ago. Prices were down about 40%... but at least we have people in the showroom so to speak.

The Housing Bill, which was supposed to fix the real estate market last July, only takes effect now, starting October 1, and authorizing the FHA to start refinancing an enormous number of homes.. Inevitably, we are seeing a bottom now - finally.

So where do we go from here? Do I see a real estate boom coming? Heavens no.. but at least we should see regular movement in the real estate industry again. It doesn't help those that are under water... although we have new programs for that now... but it does end the awful cycle of foreclosures.

Here in Sacramento, we are regularly selling homes for basically under $125,000 that were in foreclosure at the $240,000 level. At $125,000 with your basic FHA or VA loan, the payment works out to be around $750. There isn't much of a reason for the young kids to start moving out of the apartments and into a home of their own.

I personally think we will see this in a tidal wave, and it should absorb everything on the market very quickly.

We will then see prices rise, as the foreclosures are no longer in stock, and the existing home owners won't have an interest in selling.. as the values will still be low compared to what they paid for the home, we should see a period, after the foreclosures, of very, very tight inventory for a year or two.

- Scott

The media has done a fine job of distorting what the Economic Stabilization Act is intended to do, and how it will accomplish the mission.

The following is the purpose of the program, and the authority empowered into those to operate it:

"Purpose" - Provide authority to the Treasury Secretary to restore liquidity and stability to the US financial system and to ensure the economic well-being of Americans.

Title I. Troubled Assets Relief Program (TARP)

- Authorizes the Secretary to establish a "TARP" to purchase troubled assets from the financial institutions. Establishes an Office of Financial Stability within the Treasury Dept. to implement the TARP in consultation with the Board of Governors of the Federal Reserve. Includes provisions to prevent unjust enrichment by participants in the program and congressional oversight.

- Insurance of Troubled Assets - If the Secretary establishes the TARP program, the Secretary is also required to establish a program to guarantee troubled assets. The Secretary is required to establish risk-based premiums for the guarantees sufficient to cover any such claims.

- In using the authority, the Secretary is required to take a number of considerations into account, including risk to tax payers and the national debt, providing stability to financial systems, and preserving homeownership. The Secretary is also required to gauge the longterm viability of the financial institution in determining whether or not to purchase assets.

- Financial Stability Oversight Board - Congressional oversight intended to review actions of the Secretary to protect taxpayers. The board is comprised fo the Chairman of the Board of Governors of the Federal Reserve, the Secretary of the Treasury, the Director of the Federal Home Finance Agency, Chairman of the Securities and Exchange Committee, and the Secretary of HUD.

- Reporting - monthly reports of exercise of authority, Tranche Reports for each $50 billion spent including a list of transactions and a description of the pricing mechanism used, and Regulatory modernization reports to prevent future problems.

- Rights; Management; Sale of Assets - Establishes the right of the Secretary to exercise authority at any time, and provides the Secretary with the authority to manage troubled assets, including the ability to determine the terms and conditions associated with the disposition of troubled assets. Requires all profits from the sale of assets to be applied toward the national debt.

- Contacting Procedures - allows the Secretary to waive provisions of the Federal Acquisition Regulation which requires a compelling reason to purchase assets.

- Conflicts of Interest - The Secretary is required to issue regulations to deal with conflicts of interest in the administration of the program.

- Foreclosure Mitigation Efforts - For mortgages and mortgage-backed securities acquired through TARP, the Secretary must implement a plan to mitigate foreclosures and to encourage servicers of mortgages to modify loans through Hope for Homeowners and other programs. Allows the Secretary to use loan guarantees and credit enhancement to avoid foreclosures. Requires the Secreatary to coordinate with other federal entities that hold troubled assets in order to identify opportunities to modify loans, considering net present value to taxpayers.

- Assistance to Homeowners - Requires the federal entities that hold mortgages and mortgage backed securities, including the Federal Housing Finance Agency, the FDIC, and the Federal Reserve to develop plans to minimize foreclosures. Requires federal entities to work with servicers to minimize foreclosure, encourage loan modifications, and consider present value to taxpayers.

- Executive Compensation and Corporate Governance - Provides that the Treasury will promulgate executive compensation rules governing financial institutions that sell it troubled assets. Where the Secretary buys assets directly, the institution must observe standards limiting incentives, allowing clawback and prohibiting golden parachutes. When the Treasury buys assets at auction, an institution that sells more than $300 million in assets is subject to additional taxes, including a 20% excise tax on Golden Parachute payments to executives triggered by events other than retirement, and limits tax deduction to compensation up to $500,000.

- Coordination With Foreign Authorities - Requires the Secretary to coordinate with foreign authorities and central banks to establish programs similar to TARP.

- Minimize Long Term Costs - In order to cover losses and administrative costs, as well as allow the taxpayer to share in equity appreciation, requires that the Treasury receive non-voting warrants from participating financial institutions.

- Market Transparency - 48 hour reporting requirement - the Secretary is required within 2 business days of exercising authority under the Act to publicly disclose all details of a transaction.

- Graduated Authority to Purchase - Authorizes the full $700 Billion for implementation of TARP. Allows the Secreatary to immediately use up to $250 Billion. Under Presidential certification of need, the Secreatary can accesas an additional $100 Billion. The final $350 Billion may be accessed if the President transmits a written report to Congress requesting such authority. The Secretary may then access this authority if Congress within 15 days does not deny such authority by resolution.

- Oversight and Audits - Requires the Comptroller General of the United States to oversee and audit the program.

- Study and Report on Margin Authority - Directs the comptroller general to provide a report to congress on the role in which leverage and sudden deleveraging played in the financial crisis.

- Funding - Provides the authorization and appropriation of funds.

- Judicial Review - Provides the standards for judicial review, including injunctive and other relief.

- Termination of Authority - Provides the authorities to purchase and guarantee assets terminate on December 31, 2009.

- Special Inspector General for Asset Relief Program - Establishes the Office of the Special Inspector General for the Troubled Asset Relief Program to conduct, supervise, and coordinate audits of the program.

- Increase in the Statutory Limit on the Public Debt - Allows debt ceiling increase from $10 Trillion to $11.3 Trillion.

- Credit Reform - Details the manner in which the legislation will be treated for budgetary purposes under the Federal Credit Reform Act

- H4H (Hope for Homeowners) Amendments - Strengthens the Hope for Homeowners program to increase eligibility and improve the tools available to prevent foreclosures.

- Congressional Oversight Panel - Establishes a Congressional Oversight Panel to review the state of the financial markets, the regulatory system, and the use of the authority under TARP.

- FDIC Enforcement Enhancement - Prohibits the Misuse of the FDIC logo and name to falsely represent that deposits are insured.

- Cooperation with the FBI - Requires any federal financial regulatory agency to cooperate with the FBI and other law enforcement agencies investigating fraud, misrepresentation, and malfeasance with respect to development, adverisement, and sale of financial products.

- Acceleration of Effective Date - Provides the Federal Reserve with the ability to pay interest on reserves.

- Disclosures on Exercise of Loan Authority - Requires the Federal Reserve to provide a detailed report to Congress, in an expedited manner, upon the use of its emergency lending authority.

- Technical Corrections - Makes technical corrections to the Truth in Lending Act

- Exchange Stabilization Fund Reimbursement - Protects the Exchange Stabilization Fund from incurring any losses due to the temporary money market mutual fund guarantee by requiring the program created in this Act to reimburse the Fund.

- Authority to Suspend Mark to Market Accounting - Restates the Securities and Exchange Commission's authority to suspend the application of Statement Number 157 of the Financial Accounting Standards Board if the SEC determines that it is in the public interest and sufficiently protects investors.

- Study on Mark to Market Accounting - Requires the SEC in consultation with the Federal Reserve and Treasury to conduct a study on mark-to-market accounting standards including the effect on balance sheet, impact on the quality of financial information, and other matters and report to Congress within 90 days.

- Recoupment - Requires that in 5 years, the President submit to Congress a proposal that recoups from the Financial Industry any projected losses to the taxpayer.

- Temporary Increase in Deposit and Share Coverage Insurance - Temporarily increases the FDIC and the National Credit Union Share Insurance Fund limits from $100,000 to $250,000.

Title II - Budget Related Provisions

- Information for Congressional Support Agencies - Requires the information used by the Treasury Secretary in connection with activities under this Act be made available to the CBO and JCT.

- Analysis in the President's Budget - Requires that the President include in the annual budget submission to the Congress certain analyses and estimates related to costs incurred as a result of the Act

- Emergency Treatment - Specifies the scoring of the Act for purposes of budget enforcement

Title III - Tax Provisions

- Gain or Loss from the Sale of Exchagne or Certain Preferred Stock - Details certain changes in the tax treatment of losses on the preferred stock of certain GSEs for financial institutions

- Special Rules for Tax Treatment of Executive Compensation of Employers Participating in the Troubled Assets Relief Program - Applies limits on executive compensation and golden parachutes for certain executives of employers that participate in the auction program

- Exclusion of Income From Discharge of Qualified Principa Residence Indebtedness - Extends the current tax law foregiveness on the cancellation of mortgage debt

Let's preface my feeling that I'm a strong Republican, and conservative in values.. but also an environmentalist.. so I'm probably a "Paulson Republican". Hank Paulson spends a lot of time on environmental causes... so not all of us like the SUV's and smoke stacks.

I also believe in free markets, and the ability for the market to make sound judgements. If you look at the former Soviet Union, it was a very good indicator of what a "managed economy" looks like. If you have a government weenie sitting in an office somewhere, debating between coffee break and a walk to get a soda down the street, or which to do first, do you really want that person making decisions about what products are offered in the market place, or whether a car dealership should stock 100 Toyota Priuses and nothing else, or let the dealership determine what it needs? Keep in mind, the govie gets paid either way, and whether they go home at 1 or 10 pm, probably doesn't matter.

Profit incentive, referral customers (fair dealings), and survival of the fittest determine the market place.

Where we got off track was deciding that somehow banks and mortgage brokers are consumer advocates to get the absolute best deal for the clients. It's an incorrect assumption. We (the financial industry) have a fiduciary duty to the client and fair dealings with them, but we also make a living too (which is always a concept that people that don't work on a commission fail to understand). And we are not so much "obtaining" money for a borrower, as we are providing an investment opportunity for the final mortgage investor. While the borrowers come and go, the investment community -must- be there and be interested for any financing to happen.

That is what has currently happened now in the market... the real estate market is really only weak because there is very little financing availabe. We have more buyers than we know what to do with... but only about 1 out of 7 or so qualify currently, and no one that is self employed, a farmer, etc., can obtain any financing.

How did we get here? Well, let's see... we had a general deflating of the real estate boom.. followed by people that can -afford- their home, but simply choose not to and walked away from it in droves. At some point, it almost became fashionable to do so. Many of them started a thing called "Buy and Bail"... hurry up and buy a foreclosure down the street, say you are going to rent out the old house, and then dump it... thus turning a single foreclosure on the block into 2. This was so common that the industry changed underwriting standards to require an appraisal on the previous property, proof of rent received -before- closing on the new home, and at least 30% equity in the old house.

We also have the flat out demonizing of the mortgage industry by the media... demonizing of banks... and general suspicion. Thanks for the Option ARMS Countrywide... They will probably burn in hell and none of us in the industry will shed a tear. They invented that thing and pushed ENORMOUS commissions to loan officers to produce them. A typical loan pays about a 1% commission from the bank to the loan officer... those things paid at least 3.5%, and up to about 5% with a 3 Year -HARD- Prepayment Penalty. The penalties were about what the commission paid on the deal was. On a $300,000 loan, a typical loan officer, literally made almost $20,000, compared to about $3500 on a typical transaction. It was no mistake how quickly the option ARM became "One size fits all". Once they hit critical mass, it was like crack on the streets. Pretty soon homeowners were calling in droves wanting the $400 payment deal their neighbors had, and it was soon self-perpetuating.

At the same time, we (mortgage professionals) could hardly make a living on the Fannie Mae fixed-rate stuff. They paid very little, nothing at all, or even charged a fee to the homeowner for one (and we would also have to charge fees to stay in business). The market "demanded" alternative products, and would only pay for those.. so that is what was produced. If you make automobiles, and gas is $5.00 a gallon, even if you make a lot of money on an SUV, you are probably not going to sell many, and the market determines what you produce (by creating a demand).

Those of us that continued to produce basic home loans, and having suffered for a while, are suddenly getting a little busy again.

The issue is... we definitely got us ourselves here, but we (as a nation) have to get past it and move on. Consumers spent way too much money by borrowing against their homes, getting addicted to spending, and kept going on credit cards when the home equity ran out.

Now we are paying the price... the country is extremely over-leveraged, and the market is fixing itself again. Consumers have cut back, restaurants are starting to struggle, stores are starting to struggle, and gas prices have trimmed back travel.

We need a big mover though, without shareholder responsibility, to fix this.. the government is really the only one that can do that. They can buy the slow-performing mortgages for maybe half price, offer a refinance to the homeowners with that discount in there as well to something they can afford... but no cash out... and if done in droves, the government will actually make some money on this... how?

- Buy a 300,000 mortgage for say.. 60%... or about $180k.

- Offer a refinance to about $200,000 to the home owner that is struggling and write off the other 100k. The government only paid $180,000 and is now collecting a new $200,000 note. Buyer is now making the payments.

- Government borrows money on t-bills at about 2% to do this, and will charge closer to 7% on FHA loans that it will get... plus mortgage insurance paid to the FHA, etc. Realistically, they will earn about 5% on the $750B annually, while also making the profit in the notes themselves.

- They later (3 years or so) sell the new $200,000 note (performing) for about $205,000 on the market to a new mortgage investor, and in the 3 years, make about $75,000 on the original $170,000 investment (profit on interest versus money borrowed, plus the increased value of the note over the original $180k investment.

On distressed notes, they would make even more... paying about 25 cents on the dollar for them.

With the homeowner population less financially stressed, with cheap loans they can afford, and won't want to give up... you suddenly will see a return to steady, predictable financial growth, and the taxpayers also benefit from new taxes coming in. Keep in mind, that with foreclosures, less driving (gas tax), lost jobs, no capital gains, etc., the government gets much, much less in tax receipts than they anticipate... so instead of $3 Trillion or whatever, they are only taking in maybe half-that during a recession.

Does that mean that the retail and restaurants come back? Sadly.. no ... they are over built just like the housing sector was. Many of them will die. But.. the stronger ones will thrive when some disposable income comes back to consumers.

Do I think we should bail out the student loans, credit cards, etc., ? Hell NO. Banks charge 30% interest for that stuff for a reason, and the quality student loans are already backed by the government. Let the banks sort out their mess there. It might teach them not to send credit card offers to 5 year olds and non-humans (canines & such). I have never understood the need for a college kid to have a $5000 citi bank card... that is just irresponsible (for the bank) they can suck the wind on those.

The Subprime Meltdown has been going on for well over a year... and Congress basically had done nothing.

What happened on September 19, 2008, scared the daylights out of the government.

In a single day, on September 19, 2008, a record $140 Billion was withdrawn from US Money Market accounts... long considered the safest of safe investments.

Investors were moving money from Money Markets to US Treasuries so rapidly, that it rolled the Treasury yield down to 0... they didn't care if they got any return at all, they just didn't want to lose principal and had lost faith in the dollar.

Money Markets provide cash for short term loans between banks, top credit institutions, and the like. The rapid withdrawals evaporated liquid capital available to major banks and triggered essentially a run on the US financial system. It threatened to collapse the economy.

Banks have been hoarding cash.. too scared to lend to each other, or their customers.. they normally have around $2 Billion in cash on hand, and currently have an unprecedented $200 Billion, which should be circulating in the economy (and now is not).

The government wasn't afraid of a run on the banks by depositors, but by corporate institutions, and threatened to collapse the banking system.