Category Archives: Economics

Commercial Mortgage Loan Turmoil

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I mentioned in a June 29, 2011 posting titled Financial Crisis–Part III that one component of the Dodd-Frank law was to create a new regulatory structure for credit rating agencies.  Erroneous credit ratings that were given to mortgage-backed securities resulted in billions of dollars of losses, and were one cause of the financial crisis.  The SEC has not fully staffed the new office mandated by the Dodd-Frank law that is supposed to address this issue, and the provision that would hold credit rating agencies legally liable for their ratings was reported to have been tabled. Of course the government is now angry at Standard & Poors (S & P) for downgrading U.S. debt from AAA. There was a recent event involving S & P that was given very little media attention, but shocked the commercial mortgage-backed security (CMBS) world into disarray. Goldman Sachs and Citigroup pulled a $1.48 billion dollar CMBS offering hours away from settling the issue after S&P announced they would not be able to deliver final ratings on the security. A Wall Street Journal article by Al Yoon quoted a man who has worked in real estate finance since 1995 as saying “I’ve never seen this happen, to the extent where a deal was so far along, ever.”

The process of issuing a CMBS involves issuers working with the rating agencies to determine final pricing based on a preliminary rating, which has been developed after months of diligence. As was the custom, Goldman Sachs and Citigroup priced the recent issue based on the preliminary rating. No rating agency has previously failed to issue the rating when the deal is about to close, but that string has now been broken. S&P muddied the issue even more by saying “…it won’t assign new ratings to transactions based on its current criteria” (whatever that might mean). Other deals had to be recently “sweetened” to reassure investors.

What does this mean, and why should we care? The drama of watching the President and Congress thrash around with how to come up with a way of keeping the government funded followed by a stock market swoon has consumed nearly all of the news reporting. The possibility that the commercial real estate mortgage market is in limbo has been hidden behind the screen of bureaucratic ineptness of our elected officials trying to figure out how to fund overspending by the government. I fear this mostly unnoticed event instigated by what must be a nervous S&P could further cripple an already fragile economy. For those who haven’t been watching, the real estate market hasn’t been doing very well, and killing the commercial market by causing funding to dry up will be harmful. I write that believing that I have mastered the art of understatement. One analyst was quoted as saying, “This is a debacle of epic proportions.”

Financial Crisis–Part III

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Parts one and two gave a historical perspective about government actions that paved the way for the crises that brought the economic system to the brink of collapse in 2008. In the spirit of “never let a crisis go to waste,” Congress reacted by passing the Dodd-Frank law after accusations such as, “See what happens when businesses aren’t adequately regulated.” The Dodd-Frank law requires 387 rules to be developed by 20 different regulatory agencies. The regulators have finalized 24 rules and have missed deadlines on 28. An article in ProPublica by Jesse Eisinger and Jake Bernstein details what the law was intended to accomplish and the problems that are being faced in developing the regulations. A few things the law was intended to accomplish have been at least partially put in place. A Consumer Financial Protection Bureau has been created, although the Obama administration hasn’t appoint a person to head the agency.  Outrage over executives being rewarded for taking risks that pushed their companies near or to failure resulted in rules that give shareholders a say on executive pay. The larger problem is in the 363 rules that remain to be developed and imposed.

Baring “proprietary trading” was central to the passage of the Dodd-Frank law. Banks leveraged heavily to speculate in bundled packages of subprime mortgage-backed securities and derivatives. The collapse of the value of those securities was central to the crisis. However, the rulemaking process for regulating derivatives has generated wide opposition. The Treasury Department has proposed some to be exempted from the regulations and the Securities and Exchange Commission (SEC) has issued an initial rule that will allow derivative trades under certain conditions. The rulemaking process has been so flawed that it “…has sparked a barrage of opposition, even from previously supportive legislators.”

Some believe that erroneous credit ratings given to mortgage-backed securities by the rating agencies was the root cause of the crisis, and losses from investments that had been given high ratings resulted in billions of dollars in losses. The Dodd-Frank law created a new regulatory structure for credit rating agencies, but the SEC has not fully staffed the new office. They also have indefinitely tabled a provision that holds the credit rating agencies legally liable for their ratings.

Regulators are dealing with complex issues while facing severe budget constraints, and many are saying they may not be able to carry out some key provisions. Wall Street is lobbying to blunt provisions it failed to defeat in the legislature. “Some wonder if Congress ordered regulators to do more than they could feasibly and legally accomplish.”

It is tempting to hope that the budget problems of the regulators and the intensity of lobbying will succeed at blunting the effects of the law, since there is a growing chorus of warnings that the law could damage American competitiveness. I would argue with the phrase “could damage.” I would replace it with “has damaged.” To fully appreciate how effective the government is, I only need to quote Milton Friedman, “If you put the federal government in charge of the Sahara Desert, in five years there will be a shortage of sand.”

The Financial Crisis–Part II

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Eamon R. Moran has written a comprehensive and well-referenced, 97-page article for the University of North Carolina School of Law’s North Carolina Banking Institute Journal about the causes of the crisis.  In Part I of this blog I focused on the role of the Community Reinvestment Act (CRA) of 1977.  This entry will focus on other regulations and acts that contributed to the mortgage meltdown.

Congress enacted many measures between 1980 and 2003 to make home ownership more attainable for moderate and low income borrowers.  Some of those measures included:

  • An act that preempted state ceilings on home mortgage loans and encouraged subprime loans
  • Another act that allowed adjustable rate mortgages, the loan of choice for subprime loans
  • Tax law was revised to made interest on home loans the only consumer loan that is tax deductible
  • HUD changed regulations so that borrowers no longer had to prove their incomes would remain stable
  • CRA was strengthened to impose fines and business penalties on banks that refused home loans to low income borrowers
  • Tax law was revised again to exempt most home sales from capital gains taxes

The outcome of these actions was that a borrower in California with an annual income of $14,000 was approved for a $720,000 home loan.  An investor in Minneapolis borrowed $2.4 million to buy ten properties, and all would go into foreclosure.  Financial institutions began bundling loans into complex packages, the rating agencies gave the packages AAA ratings, and the packages were sold around the world.  Millions of other examples such as these led to the eventual collapse of home values and created the crisis.

Congress leapt into action and passed a massive financial regulation while studiously ignoring the history of government’s role in creating the crisis.  The new laws will undoubtedly impede an economic recovery, and Congress will be given the opportunity to pass even more laws.


The Financial Crisis–Part I

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There are those who advocate there weren’t enough regulations (read Barney Frank) to prevent the financial meltdown in 2008.   My contention is that the crisis began with numerous government regulations that encouraged home ownership for people who couldn’t afford homes. The regulators decided encouraging wasn’t a strong enough approach and began demanding that lenders make loans to people who couldn’t afford to repay them.  Greedy speculators noticed opportunities for profits by creating packages of  “subprime” (read “risky”) loans and selling them to other speculators.  The real estate bubble grew because of the artificial increase in demand. The collapse probably began when the first home couldn’t sell for the original purchase price.

The march to the crisis began when the Community Reinvestment Act (CRA) was signed by President Carter in 1977.  That Act was the beginning of numerous actions by the government to encourage, or force, home loan agencies to make loans to borrowers in low income neighborhoods.  The intent was to open up the American Dream of home ownership to people who couldn’t previously convince their bankers they could repay the loans.  The Act was reinforced during the Clinton era by imposing penalties on loan agencies that didn’t meet requirements for loans in inner cities.  The CATO Institute warned in 1993 that the changes would be costly to the economy, and the warning was studiously ignored.

The push to make home ownership available to everyone continued into 2000.  The Government Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac were directed to devote a significant percentage of their lending to support “affordable housing.” Fannie Mae announced in 2001 it had a goal to finance $500 billion in CRA loans by 2010.  The Federal Reserve joined the party by lowering interest rates, which encouraged new borrowers to initiate loans and others to refinance their loans and use the proceeds to buy new luxury items.

There have been charges that racism is involved in deciding who is given home loans.  A Princeton study confirms the validity of that charge.  African-Americans were more likely to be offered subprime loans compared to whites who had similar financial backgrounds.

Japanese Nuclear Reactor Disaster

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I did an Internet search to learn the status of the containment structures of the damaged reactors, and the most recent posting I could find was April 6. Most of the articles were posted in March. I’m guessing major news media outlets are losing interest because a “China Syndrome” meltdown (although the exit point from Japan would be somewhere in or near Uruguay) hasn’t occurred. So what is the impact of the disaster if the containment structures hold? There is no doubt the disaster will further add to the fear of nuclear power generation. Japan is hydrocarbon deficient, and had been generating a third of their power needs with nuclear plants. They have stepped up their importation of liquid natural gas via tankers to fill the immediate needs, but that will undoubtedly add expense to an economy that doesn’t need additional expenses.

Do I continue to advocate that nuclear power generation should be a part of our future? You bet I do, and I write that despite Three Mile Island, Chernobyl, and now Fukushima. My favorite source of information about energy generation is Dr. Petr Beckman, who published the book “The Health Hazards of NOT Going Nuclear” in 1976. The primary point of the book, which is still very valid today, is that there is no safe way to make energy. “Energy is the capacity for doing work, and as long as man is fallible, there is always the possibility that it will do the wrong kind of work; to ask for safe energy, therefore, is much the same as asking for incombustible fuel.” Nuclear energy is “…far safer than any other form of energy.”

I’m baffled at how casually we accept risks from activities that don’t have the word “nuclear” in their title, even when we have no control over these risks. Anyone who advocates that no risk is acceptable should cut themselves off the power grid. About 1000 people die per year in the U.S. from electrocution. If you overlook the risk of electrocution, what about the risk from mining and burning coal to generate power? There have been 819 deaths in the United States and 52,785 in China from coal mining since 1990. That doesn’t consider the risks to people from the emissions and wastes generated from burning coal. As Dr. Beckman said, there is no method of making energy that is completely “safe.” He advocated that producing plentiful energy is required to preserve economic freedom and prosperity. China, India, Korea, and Russia are not delaying construction of new nuclear reactors, but the United States and some European countries are responding to the Japanese crises by rethinking plans for nuclear facilities. France generates 75% of its energy with nuclear power, and I haven’t found that they intend to shut down their plants.

One consequence of the reactor crises is an increase in “atomic tourism.” Attendance was up by 12 percent on a recent weekend at the Atomic Testing Museum in Las Vegas and by 20 percent at the National Museum of Nuclear Science & History in Albuquerque. A spokesman there was quoted as saying, “Folks definitely want information about nuclear reactors and nuclear radiation.” People pay $250 a person to tour Chernobyl and the nearby ghost town of Pripyat in the Ukraine. I didn’t find any indications that visits are up at the Nagasaki and Hiroshima museums. However nuclear engineer Joseph Gonyeau said that visits to his excellent and extensive web site was up by 119 percent in March. There are updates on that site about the Japanese disaster from the International Atomic Energy Agency, Japan’s Nuclear and industrial Safety Agency, and the Tokyo Electric Power Company.

The bottom line is that we should do everything possible to learn from this disaster to improve safety. We should not cripple our economic prosperity in decades to come by being the only country that decides not to use nuclear energy to produce electricity.

Global Warming Reporting

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This will be the third posting about the issue of global warming. The first point I will make is that the advocates for the idea that man’s activities are causing damage to the climate are moving to change “global warming” to “climate change.” They were wrong in the 1970s when they warned that a new ice age was a certainty, and they might be wrong that the temperatures are rising.  One of them was quoted as saying the fact that temperatures haven’t continued to rise the last few years with increasing levels of carbon dioxide as predicted by the computer models was “a travesty.”  (How dare nature to not comply with the computer models!) However, if they can complete the transition of the mantra to be “climate change,” they are assured of being right. The climate has always changed, and it would be quite safe to predict it will continue to change.

A majority of American people have been convinced that a climactic disaster is looming based on what they have heard about the certainty of coast lines being flooded, increasingly ferocious hurricane seasons, and famines.  I will admit that the level of the oceans has increased.  There was once a land bridge between Russia and the United States. In fact sea levels have increased by about 7 inches in the past 100 years. Of course that isn’t sufficiently dramatic to make a point in a movie, so you should show a depiction of most of Florida and other coastal areas being swallowed by water. The predictions of horrific hurricane seasons have not materialized, and some years have been exceptionally mild. That apparently wasn’t as news worthy as the warnings. And we should stop converting corn into ethanol if we are actually worried about food shortages.

Would you predict that there has been a continuation of the shrinkage of the Arctic sea ice based on recent reports?  Check out the National Snow and Ice Data Center and look at the charts.  The amount of ice coverage is well below the 1979 to 2000 average, but the line is bouncing along near the 2006-2007 level.  I previously printed their charts for 2005 to 2009.  Ice coverage decreased from 2005 to 2007, but there was a significant increase from 2007 to 2008 and 2009. Reading through the explanations of their data you will find that “this month had the sixth-largest snow cover extent since the record started in 1966.”  There is another statement that “Reduced sea ice extent and extensive snow cover are not contradictory…”  I admit I didn’t understand their explanation.

I want to close this by referring to an entertaining lecture given by Michael Crichton titled “Aliens Cause Global Warming.” I recommend reading the entire lecture, but I will mention a couple of points.  He dismisses the idea that there is “consensus.”  His discussion of that is brilliant. Later in the paper he discusses the United Nations International Panel on Climate Change (IPCC).  The draft of their 1995 report concluded, “No study to date has positively attributed all or part of observed climate changes to anthropogenic causes.”  That statement was removed and replaced in the final report with “The balance of evidence suggests a discernible human influence on climate.” Reread both statements and contemplate them.  The first draft said their studies hadn’t connected man’s activities to global warming.  The final report “suggests” a “discernible human influence…”

I want to emphasize that I am strongly in favor of showing good stewardship to the planet.  I favor conservation of resources and research into how to make us more energy efficient and less dependent on countries that don’t like us very much for most of the oil we burn.  I’ll stop doing blogs criticizing how the story is being reported when I believe the reporting is being done honestly.