FedUpUSA

Archive for the ‘Geithner’ Category

I was disappointed with the Christmas Eve ditties from Treasury and
FHFA re: the Agencies. To be honest, I was appalled. The two releases
contained significant information. The timing was obviously an attempt
to slip in some bad news while everyone is drinking eggnog.

Of course that backfired. The blogs, and yes, the MSM disintegrated
those that sent the emails out on Christmas Eve. The smell that these
announcements have created is not likely to go away anytime soon.

If you are reading this you know the story. Treasury ponied up for
another $200b for Fannie and Freddie and the management of these
entities are getting serious paychecks.

The former clearly establishes that Fannie and Freddie have been
nationalized. I don’t care what they say any longer. The numbers speak
for themselves. The $400 billion the taxpayers have signed up for far
exceeds any theoretical value for these two important institutions.
Sadly, ‘the people’ own these things at this point.

The notion that the Agencies are private sector companies with
influential shareholders is over. These entities are no longer big shot
players on Wall Street. There is no earnings prospect for these
behemoths. There is no upside. There is no justification for
multimillion dollar salary packages.

The Agencies fund themselves with lines of credit from Fed and
Treasury. The Fed is buying 1.45 Trillion of their dodgy paper. Why in
the world do we need to pay someone $6mm per year to run that mess?

A question for Mr. Geithner; What are the salaries and bonuses being
paid to the people who run FHA? These are government salaries. FHA is a
part of HUD. Compensation for Fannie and Freddie Exec’s should conform
to those guidelines. Not the other way around. We need to end the myth
that F/F are private sector entities. They are not.

We are not stupid Mr. Geithner. We watch what you are doing very
closely. There are a significant number of us who flat out do not trust
you. You have given us good reason in the past and you have proven
again that you are not trustworthy. You tried to ‘Sneaky Pete’ some
important information past us. In my view you owe us an apology and
explanation, or better still, a letter of resignation. This
Administration has promised a much higher standard than you have
delivered.

As everyone is engrossed by assorted groundless Christmas (and other ongoing bear market) rallies, and oblivious to the debt monsters hiding in both the closet and under the bed, Zero Hedge has decided it is about time to present the ugliest truth faced by our ‘intellectual superiors’ and their Wall Street henchman who succeeded in pulling off Goal #1 for 2009 – the biggest ever bonus season (forget record bonuses in 2010… in fact, scratch any bonuses next year if what is likely to transpire in the upcoming 12 months does in fact occur).

If someone asks you what happened in 2009, the answer is simple – two things. There was a huge credit and liquidity crunch, and then there was Quantitative Easing. The last is the Fed’s equivalent of band-aiding a zombied and ponzied corpse, better known as the US economy. It worked for a while, but now the zombie is about to go back into critical, followed by comatose, and lastly, undead (and 401(k)-depleting) condition.

In 2009, total supply of all USD denominated fixed income, net of maturities, declined by $300 billion from $2.05 trillion to $1.75 trillion. This makes sense: the abovementioned crunches stopped the flow of credit from January until well into April, and generally firms were unwilling to demonstrate to the market how clothless they are by hitting the capital markets until well into Q2 if not Q3. What happened was a move so drastic by the Fed, that into November, the worst of the worst High Yield names were freely upsizing dividend recap deals (see CCU) – the very same greed and stupidity that brought us here. Luckily, so far securitization and CDOs have not made a dramatic entrance. They likely will, at which point it will be time to buy a one-way ticket for either our southern or northern neighbor, both of which, in the supremest of ironies, transact in a currency that will survive long after the dollar is dead and buried.

Back to the math… And here is the kicker. Accounting for securities purchased by the Fed, which effectively made the market in the Treasury, the agency and MBS arenas, but also served to “drain duration” from the broader US$ fixed income market, the stunning result is that net issuance in 2009 was only $200 billion. Take a second to digest that.

And while you are lamenting the death of private debt markets, here is precisely what the Fed, the Treasury, and all bank CEOs are doing all their best to keep hidden until they are safely on their private jets heading toward warmer climes: in 2010, the total estimated net issuance across all US$ denominated fixed income classes is expected to increase by 27%, from $1.75 trillion to $2.22 trillion. The culprit: Treasury issuance to keep funding an impossible budget. And, yes, we use the term impossible in its most technical sense. As everyone who has taken First Grade math knows, there is no way that the ludicrous deficit spending the US has embarked on makes any sense at all… none. But the administration can sure pretend it does, until everything falls apart and blaming everyone else for its fiscal imprudence is no longer an option.

Out of the $2.22 trillion in expected 2010 issuance, $200 billion will be absorbed by the Fed while QE continues through March. Then the US is on its own: $2.06 trillion will have to find non-Fed originating  demand. To sum up: $200 billion in 2009; $2.1 trillion in 2010. Good luck.

As we pointed, the number one reason why 2010 is set to be a truly “interesting” year is a result of the upcoming explosion in US Treasury issuance. Fiscal 2010 gross coupon issuance is expected to hit $2.55 trillion, a $700 billion increase from 2009, which in turn was  $1.1 trillion increase from 2008. For those of you needing a primer on the exponential function, click here. But wait, there is a light in the tunnel: in 2011, gross issuance is expected to decline… to $1.9 trillion.

And while things are hair-raising in “gross” country (not Bill…at least not yet), they are not much better in netville either. Net of maturities, 2010 coupon issuance will be about $1.8 trillion, a 45% increase from the $1.3 trillion in FY 2009 (and the paltry $255 billion in 2008).

Now everyone knows that the average maturity of the UST curve has become a big problem for Tim Geithner: nearly 40% of all marketable debt matures within a year (a percentage that has kept on growing). In fact, the Treasury provided guidance in its November 2009 refunding, in which it stated that it intends “to focus on increasing the average maturity” of its debt after relying heavily on Bill issuance in H2. Once again, we wish Tim the best of luck.

Why our generous best intentions to the US Treasury? Because unless the US consumer decides to forgo the purchase of the 4th sequential Kindle and buy some Treasuries (and not just any: 30 Year Bonds or bust), the presumption that the Bond printer will have the option of finding vast foreign appetite for its spewage is a very myopic one. We already know that China is a major question mark, and will aggressively be looking at pumping capital into its own economy instead of that of Uncle Sam’s – at some point the return on investment in its own middle class will surpass that of funding the rapidly disappearing US middle class. That tipping point could be as soon as 2010.

As for Japan – the country has plunged into its n^th consecutive deflationary period. Whether or not the finance minister announces yet another affair with the Quantitative Easing whore on any given day, depends merely on what side of the bed he wakes up on. The country will have its hands full monetizing its own sovereign issuance, let alone ours.

Lastly, the UK – well, with the country set to have zero bankers left in a few months, we don’t think the traditionally third largest purchaser of US debt will be doing much purchasing any time soon.

None of this is merely speculation: October TIC data confirmed these preliminary observations. It will only become more pronounced in upcoming months.

How about that great globalization dynamo: emerging markets? Alas, they have their hands full with issuing their own record amounts of both sovereign and corporate debt as well: in 2009 gross EM debt issuance reached an astounding $217 billion, $29 billion higher than the previous record in 2007. Gross EM issuance was particularly high in the last quarter at $73 billion, with October breaking the record for the largest ever monthly gross issuance of emerging market global bonds at $38 billion (January is traditionally the busiest month of the year.) With $81 billion, 2009 was notably a record year for sovereign bonds, while gross issuance of corporate bonds amounted to $136 billion, the second highest level after that of 2007 with $155 billion.

Bottom line: everyone has major problems at home, and is more focused on the supply than the demand side of the equation.

What options does this leave for the administration? Very few, and all of them are ugly. As we stated earlier on, the options for the Fed are threefold:

1. Announce a new iteration of Quantitative Easing. This will be met with major disapproval across all voting classes (at least those whose residential zip codes do not start with 10xxx or 068xx), creating major headaches for Obama and the democrats which are already struggling with collapsing polls.
2. Prepare for a major increase in interest rates. While on the surface this would be very welcome for a Fed that keeps hinting that deflation is the biggest concern for the economy, Bernanke’s complete lack of preparation from a monetary standpoint (we are surprised the Fed’s $200 million reverse repos have not made the late night comedy circuit yet) to a forced interest rate increase, would likely result in runaway inflation almost overnight. The result would be a huge blow to a still deteriorating economy.
3. Engineer a stock market collapse. Recently investors have, rightfully, realized there is no more risk in equities, not because the assets backing the stockholder equity are actually creating greater cash flow (as we demonstrated recently, that is not the case), but simply because taxpayers have involuntarily become safekeepers for the entire stock market, due to Bernanke’s forced intervention in bond and equity markets. Yet the President’s Working Group is fully aware that when the time comes to hitting the “reverse” button, it will do so. Will the resultant rush into safe assets be sufficient to generate the needed endogenous demand for Treasuries is unknown. It will likely be correlated to the size of the equity market drop.

If the Fed decides on option three, we fully believe a 30% drop (or greater) in equities is very probable as the new supply/demand regime in fixed income becomes apparent. We hope mainstream media takes the ideas presented here and processes them for broader consumption as indeed the Fed is caught in a very fragile dilemma, and the sooner its hand is pushed, the less disastrous the final outcome for investors. Then again, as Eric Sprott has been pointing out for quite some time, it could very well be that the US economy has become merely one huge Ponzi, and as such, its expansion or reduction on the margin is uncontrollable. We very well may have passed into the stage where blind growth is the only alternative to a complete collapse. We hope that is not the case.

Merry Christmas and Happy Holidays to all readers.

From The Daily Capitalist.

Dear Santa:

Since you give away stuff for free, I hope you aren’t a socialist and ignore my wish list during the annual potlach. By the way, it seems that the Obama Administration is way ahead of you in giving out free stuff to everyone. I hope you can catch up.

I think I’ve been a pretty good boy this year. I have regularly bitten my tongue in my commentary so as not to be accused of being a flamer. I don’t think I’ve defamed anyone. And I try to write as much original material as possible to avoid being labeled a “scraper” (lifting stuff off the Net and publishing it under my own name). And, I haven’t sold out my opinions for mere money. For a blogger, that’s a pretty good record.

Here’s my wish list. I couldn’t find where to post it on Amazon, so here goes:

1. Kill The Bill

No, not the Uma Thurman thing. I’m talking about the health care “reform” bill going through Congress right now. If your magical powers extend that far, please put economic sense into our politicians’ collective heads that government control over the system is not a way to “save money” or create “efficiency.”

2. Put in the Fix

Instead of eliminating market forces in health care, please convince Congress to fix it by peeling back the convoluted rules and regulations that have screwed it up in the first place. Suggest these four little things we could try first that actually would work, save billions, and cover more people:

Give Medicare enrollees a voucher and the freedom to choose any health plan on the market;

Give workers control over their health care dollars with “large” health savings accounts which would allow them to purchase secure health coverage from any source;

Break up state monopolies on insurance and allow insurance companies to compete across state lines; and

Block-grant Medicaid and the State Children’s Health Insurance Program to prevent massive waste and encourage states to target resources to the truly needy.

3. Turn the Sausage Makers into Sausage

I understand it’s Christmas and it would be kind of negative to wish political ill fortune on someone, but, there’s this especially despicable sentator, Ben Nelson, that I would like for you to arrange to catch him with a hooker or taking a bribe. Whatever you think would work, Santa. Make sure there are tapes. I have lots more names, but I’d be happy with Ben.

4. Firing Suggestions

Please arrange for Obama to fire Ben Bernanke, Larry Summers, Timmy Geithner, and Christina Romer.

5. Hiring Suggestions

To replace the above, how about Ron Paul at the Fed, and the following economic advisers: Walter Block, Russ Roberts, and Joseph Salerno. They are all fine economic scholars and would steer our President in the right direction.

6. Freeze Congress

Don’t let Congress pass any more bills until they’ve all read, and discussed with the No. 5 guys, Economics in One Lesson by Henry Hazlitt, the best little book on economics, ever. Televise it.

7. Bring Back the Real Constitution

Please have Obama appoint strict constructionists to the Supreme Court. Nominees who understand natural law, and that the Ninth and Tenth Amendments actually mean something. Maybe we’d get our individual sovereignty back.

8. Make Work is No Work

Let Mrs. Pelosi and Mr. Reid see the folly of the American American Recovery and Reinvestment Act of 2009, a useless $787 billion bill that is nothing other than intergenerational theft. Someone has to pay for it and I’m afraid it will be my children, grandchildren, and ten generations of my great-grandchildren.

9. Beautiful Sunsets

Require Congress to sunset every spending law they pass. You know how they promise that a program will be very effective and that it will only cost so much? Make them prove it, say every two years. If the bill fails to cure the perceived ill, get rid of it. If the program exceeds its budget, get rid of it. It will also provide us with a handy voting guide at election time.

10. Let a Thousand Flowers Bloom

Sprinkle some free market magic dust on the economics departments of our major universities. Maybe that will help the sheep break from Keynesian orthodoxy and actually begin to think.

Thank you, Dear Santa. I’m forever hopeful.

Econophile

From The Daily Capitalist

As my readers know, every so often I really get fed up with what comes out of Washington (Our Nation’s Capital) and feel the need to vent. My recent irritation is a letter Christina Romer, the president of Obama’s Council of Economic Advisers, published in the Wall Street Journal.

The letter is an apologia for the economic policies she and Summers and Geithner have been recommending to the president. She seems like such a nice lady, and she’s the wife of economist David Romer. Both were econ professors at Berkeley and both studied economics at MIT. But …

Here are some excerpts from her letter, with my comments:

Within a month of taking office, the administration had announced its Financial Stability Plan and signed the American Recovery and Reinvestment Act. The Recovery Act helped stem the decline in spending caused by consumers and businesses reeling from the fall in asset prices and the drying up of credit. Real GDP, which had fallen at a 6.4% annual rate in the first quarter of 2009, began to grow again just two quarters later. …

She seriously believes this. But she has a slight problem with the cause and effect, post hoc ergo propter hoc*, thingie. That is, there is no evidence, theoretical or empirical, that the Recovery Act did anything positive or lasting. Even assuming Keynesian stimulus works, the government hadn’t spent enough money to make it work according to the Keynesian formula. At least that’s what Paul Krugman said. Whatever, no one has ever offered any proof that such stimulus works.

And, as far as I know, PCE (consumer spending) is still very low, asset prices are still declining, and credit is worse.

We’ve already seen from the Recovery Act that spending on infrastructure—everything from roads and bridges to schools and municipal buildings—is an effective way to put people back to work while creating lasting investments that raise future productivity. …

Yadda, yadda, yadda. Again more spending on things the government wants, not the things that the market wants. The jobs are already fizzling. See this excellent article in the WSJ, ironically published on the same day as Mrs. Romer’s piece. The gist is that when the government money ends, the jobs dry up.

Subsequently the president pushed for the Cash for Clunkers program that was successful in boosting demand and job creation. …

All this did was to junk a bunch of good cars, fill the pockets of auto dealers, and appease the UAW. Auto sales are already declining again. It just accelerated future sales of people who would have bought cars anyway.

[A]bout a month ago the president announced the latest in a series of measures to encourage banks to lend to small businesses. …

As we all know credit is still shrinking, not growing. They have tried every trick in the Keynesian book to loosen credit but to no avail. I’m sure this new legislation will be different.

[I]n early November the president signed into law a measure that would provide relief and spur job creation by adding additional weeks of unemployment insurance, cutting taxes for businesses, and expanding and extending the home-buyer tax credit. …

That must have worked really fast, because unemployment, according to the Bureau of Labor Statistics, dropped from 10.2% to 10% in November. Wow, that’s great legislation. But, as we all know, Things Are Not What They Seem. As David Rosenberg pointed out in one of his reports, the government stats look funny because they are so different from what ADP reported. 

Despite these positive developments, the job market remains very weak. … American businesses appear hesitant to hire, and are producing more with fewer workers. …

Didn’t she just say that things are getting better?

Tomorrow [the President] will convene a meeting of business and labor leaders, small-business owners, economists and community representatives to discuss our ideas and solicit others for accelerating hiring. … [W]e need to harness the private sector, bringing large and small firms in off the sidelines to boost job creation. …

This is the part that really upset me. First, this is a typical political move. “Let’s all get together and come up with some great ideas!” No offense to the community organizers out there, but getting a bunch of people in a room like this gets nowhere. The best thing they could do is cancel all meetings, and get the hell out of the way.

But what really got me was the “harness the private sector” comment. I hope she didn’t mean it in the way I’m thinking, but if she didn’t then it’s even worse because she doesn’t realize the implications of her policies. When government gets together with business and labor to create policies for political benefit, it is called fascism, or national socialism. The words she used were rather telling: a “harness” is not something I would want to be in. You know who has the whip.

While the words seem innocent, it is all about losing our freedoms. Here’s the conclusion from a piece I wrote about the takeover of GM (in homage to Ayn Rand):

Sometimes it’s hard to see what is happening in front of your eyes. It seems rather benign and logical when you read about it, but it’s not. Nationalizing GM is just good old fashioned fascism–just like what happened in Italy in the 1920s and ‘30s … And now us. If you think I’m exaggerating, it’s probably because you think everything the government does is OK because we’re having a crisis. As Wesley Mouch said in Atlas Shrugged, “We’ve got to act!” That’s how we are losing our freedom, by a thousand cuts.

*Since that event followed this one, that event must have been caused by this one.

Treasury Department Releases Text of Letter from Secretary Geithner
to Hill Leadership on Administration’s Exit Strategy for TARP

WASHINGTON – The U.S. Department of the Treasury released the
text of identical letters sent today from Secretary Tim Geithner to
Speaker Nancy Pelosi and Senator Harry Reid outlining the
Administration’s exit strategy for the Troubled Asset Relief Program
(TARP) established by the Emergency Economic Stabilization Act of 2008
(EESA). The text of the letter to Speaker Pelosi follows.

December 9, 2009

The Honorable Nancy Pelosi
Speaker          
U.S. House of Representatives
Washington, DC 20515

Dear Madam Speaker:

I am writing to update you on the status of the Obama
Administration’s financial policies, including programs initiated under
the Troubled Asset Relief Program (TARP) established by the Emergency
Economic Stabilization Act of 2008 (EESA), the results they have
achieved, the challenges ahead, and our plan for exiting TARP.

These policies are working.  When the Obama Administration took
office, the financial system was extremely fragile and the economy was
contracting sharply.  The Administration’s financial and economic
policies have helped to shore up confidence in our financial system. 
Credit is starting to flow again to consumers and businesses, and the
economy is growing.  Further, private capital is replacing public
capital in our major institutions.

As a result of improved financial conditions and careful stewardship
of the program, losses on TARP investments are likely to be
significantly lower than previously expected.  We now expect a positive
return from the government’s investments in banks.  These banks will
soon have repaid nearly half of the TARP funds they received.  We also
expect to recover all but $42 billion of the $364 billion in TARP funds
disbursed in FY2009.  Further, we plan to use significantly less than
the full $700 billion in EESA authority.  As a result, we expect that
TARP will cost taxpayers at least $200 billion less than was projected
in the August Mid-Session Review of the President’s Budget.

But significant challenges remain.  Too many American families,
homeowners, and small businesses still face severe financial pressure. 
Although the economy is recovering, foreclosures are increasing, and
unemployment is unacceptably high.  Businesses are still cautious in
the face of uncertainty about the strength of the recovery, and many
small businesses face very difficult credit conditions.  Although bank
lending standards are starting to ease, many categories of bank lending
continue to contract.  This contraction has hit small businesses very
hard because they rely heavily on such lending, and do not have the
ability to substitute credit from securities issuance.  Commercial real
estate losses also weigh heavily on many small banks, impairing their
ability to extend new loans.

Further, the recovery of our financial system remains incomplete. 
And near-term shocks to that system could undermine the economic
recovery we have seen to date.

Exit Strategy for TARP

Our exit strategy for TARP balances the mandate of EESA to address
these challenges with the need to exercise fiscal discipline and reduce
the burden on current and future taxpayers.  There are four broad
elements to our strategy.

First, we will continue terminating and winding down many of the
government programs put in place last fall.  In September, Treasury
ended its Money Market Fund Guarantee Program, which guaranteed at its
peak over $3 trillion of assets.  The program incurred no losses, and
generated $1.2 billion in fees.  The Capital Purchase Program, through
which the majority of TARP investments in banks have been made, is
effectively closed.  Before this Administration took office, nearly
$240 billion in TARP funds had been committed to banks.  Since January
20, we have committed about $7 billion to banks, much of which went to
small institutions.  Major U.S. banks subject to the “stress test”
conducted last spring have raised over $110 billion in high-quality
capital from the private sector.  And banks will soon have repaid $116
billion of TARP funds

Second, we will limit new commitments in 2010 to three areas.

• We will continue to mitigate foreclosure for responsible American
  homeowners as we take the steps necessary to stabilize our housing
  market.
• We recently launched initiatives to provide capital to small
  and community banks, which are important sources of credit for small
  businesses.  We are also reserving funds for additional efforts to
  facilitate small business lending.
• Finally, we may increase our commitment to the Term
  Asset-Backed Securities Loan Facility (TALF), which is improving
  securitization markets that facilitate consumer and small business
  loans, as well as commercial mortgage loans.  We expect that increasing
  our commitment to TALF would not result in additional cost to taxpayers.

Beyond these limited new commitments, we will not use remaining EESA
funds unless necessary to respond to an immediate and substantial
threat to the economy stemming from financial instability.  As a nation
we must maintain capacity to respond to such a threat.  Banks are still
experiencing significant new credit losses, and the pace of bank
failures, which tend to lag economic cycles, remains elevated.  At the
same time, many of the Federal Reserve and FDIC programs that have
complemented TARP investments are ending.  This creates a financial
environment in which new shocks could have an outsized effect –
especially if an adequate financial stability reserve is not
maintained.  As we wind down many of the government programs launched
initially to address the crisis, it is imperative that we maintain this
capacity to respond if financial conditions worsen and threaten our
economy.  However, before using EESA funds to respond to new financial
threats, I would consult with the President and Chairman of the Federal
Reserve Board and submit written notification to the Congress.  This
capacity will bolster confidence and improve financial stability,
thereby decreasing the probability that it will need to be used.  This
is the third element of our exit strategy.

In order to accomplish these goals, pursuant to Section 120(b) of
EESA, I certify that I am hereby extending the authority provided under
the Act to October 3, 2010.  This extension is necessary to assist
American families and stabilize financial markets because it will,
among other things, enable us to continue to implement programs that
address housing markets and the needs of small businesses, and to
maintain the capacity to respond to unforeseen threats, as described
above.

While we are extending the $700 billion program, we do not expect to
deploy more than $550 billion.  We also expect up to $175 billion in
repayments by the end of next year, and substantial additional
repayments thereafter.  The combination of the reduced scale of TARP
commitments and substantial repayments should allow us to commit
significant resources to pay down the federal debt over time and slow
its growth rate.

Even with this extension, we expect that TARP will cost taxpayers at
least $200 billion less than was projected in the August Mid-Session
Review of the President’s Budget, including $25 billion in potential
costs from new TARP commitments in 2010.  We expect that the vast
majority of these potential costs would come from mitigating
foreclosure for responsible American homeowners as we take the steps
necessary to stabilize our housing market.

The final element to our exit strategy is how we manage equity
investments acquired through EESA while protecting taxpayers.  We will
continue to manage those investments in a commercial manner and seek to
dispose of them as soon as practicable.  We will exercise our voting
rights only on core issues such as election of directors, and we will
not interfere in the day-to-day management of individual companies.  In
addition, as the steward of taxpayers’ funds, Treasury will continue to
manage investments in a manner that ensures accountability,
transparency and oversight.  And we will work with recipients of EESA
funds and their supervisors to accelerate repayment where appropriate. 
We want to see the capital base of our financial system return to
private hands as quickly as possible, while preserving financial
stability and promoting economic recovery.

History suggests that exiting prematurely from policies designed to
contain a financial crisis can significantly prolong an economic
downturn.  We must not waver in our resolve to ensure the stability of
the financial system and to support the nascent recovery that the
Administration and the Congress have worked so hard to achieve. 
Improvements in the financial performance of EESA programs put us in a
better position to address the economic and financial challenges many
Americans still face.  I look forward to continuing to work with you to
achieve these
goals.                                                               

Sincerely,

Timothy F. Geithner

Identical copy of this letter sent to:
            The Honorable Harry Reid

cc:       The Honorable Barney Frank
           The Honorable Spencer Bachus
           The Honorable David Obey
           The Honorable Jerry Lewis

From The Daily Capitalist
December 3, 2009

Since the biggest financial collapse in world history was built on credit related to housing, it is pretty obvious that we should be paying very close attention to that market. The reasons are complex, but a recovery must be based on the liquidation of bad debt. The sooner that happens the quicker a recovery will happen.

When we mean “liquidation of debt” we are talking about a mountain of credit built on the housing bubble. This phony bubble wealth permeated the entire economy. When home owners saw the price of their home rising, they saw it as a source of capital to use for a variety of things, but let’s face it, most people spent it.

New stores opened, malls were built, financial institutions grew, cars and boats, second homes, vacations, and restaurants all flourished. Credit card debt mushroomed. Home mortgages were increased to pull cash out for spending. Yes, some of it went to good things, like our children’s education, helping our aged parents, and paying off bills. But the reality was that our debt kept growing.

The clever lads created even more phony wealth under the guise of insurance, but as we found out, companies like AIG really had no idea how large their obligations were for credit default swaps written against almost any financial risk. And these instruments were further leveraged without understanding the magnitude of these triple-counted obligations or their relationship to housing.

It all comes back to housing as the fuel for the 70% of our economy that was consumer spending. The thought was that housing has always gone up, and if it went down, it really never went down if you averaged growth since the post-WWII-period. A drop of 10%? Never has happened. 20%? Not even a 6th deviation possibility.

My thesis has been that this was all fueled by the Fed through monetary policies that created and supported the bubble. Aided and abetted by governmental policies and financing schemes that favored housing and risky loans. This was not a “free market” phenomenon. Far, far from it.

My thesis has also been that we can’t recover until all this bad debt is liquidated, and capital generated by savings is created and ultimately invested in profitable enterprises. It would be a mistake to rekindle the bubble. But, as we know, that’s what our government is trying to do. The government creates uncertainty as it flails around with programs, spending, and debt schemes to revive the economy. As a result mark-to-market accounting is thing of the past and banks are guarding their balance sheets, corporations are sitting on a lot of cash, cutting costs, and becoming leaner, and Mr. and Mrs. America still favor savings and debt instruments over equities and spending.

The big question: is the housing market bottoming out? Because once it does, debtors and debt holders will then have a handle on how great their losses are. When the bottom is falling out, it is difficult to get lenders to lend if they are afraid their remaining cash reserves will be needed to shore up the bank because of loan losses. The holders of subprime debt find it difficult to value their assets while housing values are still dropping.

Lenders have been shepherding their cash, reducing debt obligations, and cutting back lending and new investments because they do not know how deep their hole will be until housing bottoms out. Keynes called this a “liquidity trap.” More reasonable people, especially the Austrian school economists, call this a reasonable and necessary response to uncertainty.

The Fed and the federal government have been flogging this liquidity trap issue without let up and basically credit is still drying up. A 0.25% Fed Funds rate is basically a negative rate and they still can’t get banks to lend. The Fed’s balance sheet is at a record high. They have bought $850 million of mortgage backed securities. They are injecting cash into lenders. They have basically suspended mark-to-market accounting.

In Q3, the FDIC reported that bank lending still contracted by 3%:

Loans and leases held by U.S. commercial banks have declined for 10 straight months, falling to $6.7 trillion as of Oct. 28 from $7.2 trillion at the end of 2008, according to a separate statistical release from the Fed.

 

Commercial and industrial loans have dropped to $1.37 trillion from $1.6 trillion, commercial real-estate loans have declined to $1.66 trillion from $1.72 trillion, and consumer loans have fallen to $847 billion from $857 billion at the end of last year.

What do banks do? They have decided they would rather hold Treasury paper instead of make loans. This chart shows what’s been happening. No wonder T-rates have stayed so low despite massive deficit financing.

This is what makes Bernanke, Geithner, and Summers lose sleep at night. “It’s supposed to work, dammit!” Maybe this is why Summers is always falling asleep. No matter what they’ve tried, they can’t get banks to lend. I think they are very worried about this and while they say the economy is recovering nicely, they are crossing their fingers at the same time.

Back to housing.

I have been saying that I think the housing market is finding a bottom. I thought that low prices and rising affordability was the main driver of the housing market. If this were so, then housing prices would reflect real market valuations and this would finally bring about the liquidation of assets and debt wastefully invested during the prior artificial credit cycle. Lenders would know where they stood financially and would liquidate bad assets and rebuild their balance sheets. No more waiting around wondering what the Fed or the government would do to save housing.

I was wrong.

The housing market I now believe is being sustained almost entirely by the Fed and the federal government. This rekindling of the housing bubble is counterproductive and will hinder a real recovery of the economy because an artificially backed market will delay the necessary liquidation of the prior cycle’s malinvestment of capital.

Here is why I changed my mind:

First, 59% of new home buyers are relying on government-backed FHA, the Veterans Administration, and the Department of Agriculture loans. Most of these sales are driven by the first-time home buyers tax credit. The tax credit program has been extended through April, 2010.

Second, existing home sales are being driven by the tax credit and by foreclosure and short sales. Existing home sales are up 10.1%. Distressed sales — mainly foreclosures and short sales — accounted for 30% of transactions in the third quarter. And. according to the NAR, home sales are being driven by first time home buyers trying to make the previous November deadline.

This will have a negative impact on future sales. Like Cash for Clunkers, these government-driven sales may just be eating into sales that would have occurred in 2010. Many economists are referring to this phenomenon as “payback.”

Third, mortgage rates are now at 30 year lows. Another Fed related gift to home buyers. The average 30-year mortgage rate was 4.95% in October, down from 5.06% in September, according to Freddie Mac. Today, Freddie said the rate was down to 4.7%.

But … home prices are still falling. The S&P/Case-Shiller index of prices fell 8.9% for the July-through-September period from a year earlier. That was an improvement from the 14.7% drop in the second quarter and the 19% decline in the first three months of 2009. Median prices of existing homes fell in 123 of 153 metropolitan areas during the third quarter compared with a year earlier. The national median price was $177,900, down 11.2% from the third quarter of 2008. [Don't ask me to explain the disparity. Case-Shiller and NAR measure this differently.] Last month the median price for an existing home was $173,100, down 7.1% from $186,400 in October 2008.

Thus, despite record interference in the housing market by the government, home prices are still falling. There are several reasons why it is likely that home prices will continue to fall.

Almost 25% of home owners are upside down with their mortgages. Nearly 10.7 million households had negative equity in their homes in the third quarter, according to First American CoreLogic. This shadow market is huge:

Home prices have fallen so far that 5.3 million U.S. households are tied to mortgages that are at least 20% higher than their home’s value, the First American report said. More than 520,000 of these borrowers have received a notice of default, according to First American. …

 

But negative equity “is an outstanding risk hanging over the mortgage market,” said Mark Fleming, chief economist of First American Core Logic. “It lowers homeowners’ mobility because they can’t sell, even if they want to move to get a new job.” Borrowers who owe more than 120% of their home’s value, he said, were more likely to default.

 

Mortgage troubles are not limited to the unemployed. About 588,000 borrowers defaulted on mortgages last year even though they could afford to pay — more than double the number in 2007, according to a study by Experian and consulting firm Oliver Wyman. “The American consumer has had a long-held taboo against walking away from the home, and this crisis seems to be eroding that,” the study said.

This overhang will continue to drive prices down. There is no way the Feds can force lenders to modify enough loans to make a serious dent in this overhang. It’s imply too big. Eventually the losses from forced modifications will mount and the FHA or any other agency will not be able to pay off their guarantees to lender. Nor should they try.

Mark Zandi, who correctly predicted a crisis in the housing market, but not the Crash, said on Wednesday, “The housing crash is not over.” He said the lull in foreclosure sales for the past few months, due to the government’s pressure on lenders to modify loans, has resulting in higher prices. He expects Case-Shiller to bottom by Q3 2010 with an overall price decline of 38% (now at 32%).

“Foreclosure sales will increase, and home prices will resume their decline by early 2010 as mortgage servicers figure out who will not qualify for a modification,” he said.

 

Zandi said 7.5 million foreclosure sales will have taken place between 2006 and 2011. The majority of these sales, however, have not emerged yet, with 4.8 million foreclosure sales expected between 2009 and 2011.

What this means is that the housing supply, now down to a 7+ months supply, will rise again, and prices will continue to decline. We haven’t seen the bottom yet.