Author: Daniel Indiviglio

RealtyTrac released its monthly data on foreclosure activity in the U.S. for February today. The news isn’t great, but it does provide a glimmer of optimism. Foreclosures continue to increase year-over-year, but last month saw the smallest annual increase since January 2006. As with all February economic data this year, weather might have been a factor, but is it entirely to blame for the decline?

There were 308,524 foreclosure filings in February. That’s 2% fewer than in January, but still 6% higher than a year prior. RealtyTrac CEO James Saccacio explains his take:

“The 6 percent year-over-year increase we saw in February was the smallest annual increase we’ve seen since January 2006, when we began calculating year-over-year increases, but it still marked the 50th consecutive month of year-over-year increases in foreclosure activity,” said James J. Saccacio, chief executive officer of RealtyTrac. “This leveling of the foreclosure trend is not necessarily evidence that fewer homeowners are in distress and at risk for foreclosure, but rather that foreclosure prevention programs, legislation and other processing delays are in effect capping monthly foreclosure activity — albeit at a historically high level that will likely continue for an extended period.

“In addition, severe winter weather appears to have temporarily slowed the processing of foreclosure records in some Northeastern and Mid-Atlantic states.”

While it’s good to see foreclosures slowing, they’re still pretty bad. As Saccacio says, it’s still the 50th consecutive month when we’ve seen more foreclosures than in the prior year. That’s not particularly comforting.

How meaningful is it that last month had the smallest increase in foreclosures since at least January 2006? While a positive sign, I wonder if it’s more indicative of the housing bubble’s cycle. The market peaked late 2005/early 2006. The wacky subprime mortgages started well before that, so it makes sense that foreclosures have been increasing since 2006 — credit underwriting had been relaxed for some time leading up to the market’s climax. And since foreclosures were so low to begin with up to then, it didn’t take many for a several percent increase.

What I think would be more tell is how the current number of foreclosures compares to the number that the U.S. was regularly experiencing before the housing market became overheated, say in the mid-1990s. Unfortunately, RealtyTrac didn’t keep foreclosure rates back then and neither did anyone else to their (or my) knowledge.

Then, there was snowmageddon. It had some effect, but can’t be held solely responsible for the decline from January. Some of the foreclosure capitals, which were unaffected by the snow, saw their month-over-month rates decline too: Nevada down 7%, Arizona down 21% and California down 5%. In fact, the only top-5 states that saw their rates increases in February were Florida and Michigan, by 15% and 14%, respectively.

Moreover, the Northeastern and Mid-Atlantic states haven’t been driving foreclosures. Maryland is the only one that makes it into the top-10 worst — and its foreclosures increased by nearly 10% in February. If you add up Maryland, Virginia, DC, New York, New Jersey, Delaware, Connecticut, Pennsylvania and Massachusetts they only made up 9% of foreclosures in January. But those states’ foreclosures did decline, on an aggregate basis, by 17%. The remaining states declined by only 1%. So the snow did have some effect, but the rate of foreclosures definitely declined even if the effect of snow is taken into account.

Finally, I think that Saccacio is right about delays slowing down foreclosures more than housing market health. Until we see some steeper drops, it will be hard to conclude that the housing market is clearly on the mend.

Big news today on the financial reform front: Banking Committee Chairman Senator Dodd (D-CT) will be proposing a revised bill to the committee on Monday — without Republican support. This is a dramatic reversal from what had been happening. For the past month, Dodd appeared to have an ally in Senator Bob Corker (R-TN) to try to create a bipartisan bill, which would have a distinctive Republican influence. News today indicates that Dodd has abandoned his attempt to make the bill acceptable to Republicans. This is not a good sign.

At 11:00am, Corker held a press conference indicating his disappointment that Dodd has decided to go ahead with a revised bill without Republican support. To me, that indicates that passing the bill in the Senate will be very difficult. Corker appeared to be one of the only Republicans willing to seriously work with Dodd on getting something the right could stomach. We’d been receiving reports all month about the progress being made. Without Corker on board, it may be very difficult to get any other Senate Republicans to vote for the measure.

But it does depend on whatever this revised proposal looks like — and we won’t know that until Monday. Dodd released a statement this morning as well. He said:

“On Monday, I will present to my colleagues a substitute to the original financial reform package, unveiled last November.”

“Over the last few months, Banking Committee members have worked together to try and produce a consensus package. Together we have made significant progress and resolved a many of the items, but a few outstanding issues remain.”

“It has always been my goal to produce a consensus package. And we have reached a point where bringing the bill to the full committee is the best course of action to achieve that end. I plan to hold a full committee markup the week of March 22nd.”

“I have been fortunate to have a strong partner in Senator Corker, and my new proposal will reflect his input and the good work done by many of our colleagues as well.”

“Our talks will continue, and it is still our hope to come to agreement on a strong bill all of the Senate can be proud to support very soon.”

So it may, in fact, contain some of the Corker compromises. But given Corker’s disappointment with Dodd’s announcement, it’s pretty clear that Corker didn’t consider their work done. That indicates that there must be some issues where Dodd refused to compromise. If those are significant issues for Republicans — and I assume they are or a compromise would have been achievable — then that could spell trouble for the bill’s fate.

Whether he likes it or not, Dodd needs some Republican support. Even if he can get a bill out of committee, he needs 60 votes to prevent filibuster, and Democrats only account for 59. And given how close even the House’s vote was, it’s pretty plausible that even a few fiscally conservative Democrats could be apprehensive about voting for a bill that still has some controversial provisions.

Naturally, I’ll dig into Dodd’s new proposal on Monday as soon as I get it.

I grew up on radio; I love it. I missed my local radio station so much when I went to college that my long-distance girlfriend at the time once sent me a cassette tape of the radio station to listen to (oh the days of cassette tapes!). So when the other day, when I heard my favorite radio station run an ad explaining that there was legislation in Congress that threatens local radio, I decided to look into it. Congress is seeking to grant artists radio performance rights. That would require radio stations to pay royalties to artists who perform the songs — not just those who hold the copyright (typically the songwriters). But after doing some digging, I’m pretty confident that my beloved radio stations would be just fine if the legislation passes.

Broadcast Radio vs. Artists and Record Companies

The battle has been heating up recently. Earlier this week, the New York Times reported on the conflict. It all started last year when the House and Senate judiciary committees both passed resolutions which would require broadcast radio stations to pay fees to artists and their record labels. As you might guess, radio stations were not amused. They claim the legislation would hurt local radio stations, limit the variety of music listeners hear and harm smaller artists.

At first, I was confused. Why didn’t artists and record companies just demand royalties to allow radio companies to play their content? I saw it as analogous to what has been happening recently with the broadcast television and the cable companies. There, the content providers are demanding a payment from service providers and have had significant success in their effort.

Why can’t recording artists and their labels do the same? Because they have no legal standing to demand royalties. The legislation being considered by Congress would provide performers and record companies would begin to provide that. The reason why broadcast television can make such a demand on cable companies is based on the Cable Act of 1992 (.pdf). Music performers have no such luxury.

Is Publicity Enough?

Radio says that the relationship that exists in its current form is perfectly fair: stations can play whatever music they want without compensating the performer, because she benefits through the publicity. Now, people will go out and buy her album or go to her concerts. While a benefit definitely exists there, it’s a little hard to see why radio stations should be able to keep the profit off advertising dollars based on listeners enjoying a product performed by artists who they aren’t giving a cut.

Moreover, those record sales aren’t doing particularly well these days. Here’s a graph that my colleague Derek Thompson used in a post last month (from a CNN/Money article):

I should point out, to be fair, that this chart was poorly constructed to be misleading. Sales are bad, but not quite as bad as this chart looks. The vertical axis should start at zero, not $6 billion. It does, however, demonstrate that music sales have declined by 57% in the last decade. There are a lot of culprits, from online music piracy to more sophisticated custom Internet radio stations. But one thing is clear: the record sales that artists and record labels used to rely on are a far less significant means of income.

Less Music Variety, Fewer Stations?

So you can see why artists and record companies are more concerned than ever about getting paid royalties. But if it will really destroy broadcast radio, as the industry’s ads indicate, then that’s a problem too. The “NoPerformanceTax.org” website threatens:

If you’re one of the 235 million people who listen to radio each week, a tax could reduce the variety of music radio stations play, and all but eliminate the possibility of new artists breaking onto the scene. The tax could particularly affect smaller, minority-owned stations, some of which may have to switch to a talk-only format or shut down entirely.

It also affects your community. Radio stations are major contributors to public service – generating $6 billion in public service annually, providing vital news and community information and free airtime to help local charities. If a tax were imposed, stations’ critical community service efforts could be reduced.

As mentioned, I love radio and doubt I’m alone. So I’m probably not the only listener who finds this claim troubling. But I spoke to the House Judiciary Committee to set the record straight. Judiciary staff provided me with the following breakdown of what the bill would cost radio stations:

77% of all radio stations would be eligible for fees as low as $500 per year

Specifically, sliding scale creates an annual, flat fee based on a station’s annual revenue (guaranteed by statute that cannot change without change in law). Based on annual revenues:

– Stations that gross less than $100,000 per year pay a $500 fee
– Stations that gross more than $100,000 and less than $500,000 per year pay a $2,500 fee
– Stations that gross more than $500,000 and less than 1.25 million per year pay a $5,000 fee
– Non-commercial radio stations (like public radio, college radio, and religious non-profit radio) that gross less than $100,000 per year pay a $500 fee
– Non-commercial stations that gross more than $100,000 per year pay a $1,000 fee

Broadcasts of religious services and talk stations that use only pieces of music during their programming are wholly exempt from all royalty payments.

So the claim that small radio stations would be hurt seems pretty well handled by the bill, assuming the judiciary staff I spoke to wasn’t misleading me. I appealed to the National Association of Broadcasters (the biggest opponent of the measure) for comment, but after more than 36 hours, they have yet to return my call (if they do, I’ll be happy to update this post with their response).

Obviously, radio stations would prefer not to pay any more fees, as they’ll eat into profits, no matter how small. But it does seem pretty reasonable that performance artists get a cut of the profits that result from their songs playing on radio stations. Although the Judiciary Committee didn’t give me any estimates for how much the bill would cost those other 23% of (big) radio stations, I would suspect that they’re the ones really fighting, since the fees would fall more heavily on their shoulders. I should add, the channel on which I heard the advertisement was owned by radio giant Clear Channel.

Better For Small Artists

In fact, the way I see it, the performance royalties could actually help small artists. Once the performance fee is enacted, new artists who aren’t associated with any label might be more willing to give away their music for free promotion — and radio stations would be more willing to take it without having to pay a royalty.

One feature of the bill that the radio stations also complain about is that music labels will get a cut of the profits. If only artists got the royalty proceeds, then the measure would probably be a little less controversial. But, again, this probably helps undiscovered artists. If record companies have more money, they’ll be able to search and sign more new talent. Think of a record company as being like a pharmaceutical company. Just like pharmaceuticals have to spend a lot of time and money to find a miracle drug, record companies need to use a great deal of resources to find the next Lady Gaga.

Eventually, It Won’t Much Matter

As concerned as I am about artists getting royalties from broadcast radio stations, eventually it’s an issue that will fade into obscurity anyway. Once all radio goes to the Internet, the discussion will be moot. The Digital Millennium Copyright Act requires (.pdf) radio stations streaming online to provide performance royalties. Since we’re already beginning to see mobile Internet radios, it’s just a matter of time before broadcast radio is history. (Ironically, I was listening to the broadcast channel through the Internet when I heard the anti-performance fee commercial!)

Let The Market Work

Just yesterday I argued that fair negotiations make for an ideal economic outcome. I was then referring to the talks between cable companies and broadcast networks, but the same logic applies here. Since the performance rights bill would still provide the government with some price setting power, it isn’t ideal — but it is a step in the right direction. Under current law, performers and their record companies don’t even have a seat at the table to try to profit from their music being played on broadcast radio. So I see this legislation as a step in the right direction.

(Image Source: Wikimedia Commons) 

Update: I just heard from Dennis Wharton, spokesperson of the National Association of Broadcasters. He provided me with some more on their side of the argument.

First, I asked him about their estimate of the cost a performance fee would place on broadcast radio. At this time, it’s impossible to know, because the Copyright Royalty Board (CRB) will decide the details. But most estimates agree that it will be at least hundreds of millions of dollars per year. One analyst from Wells Fargo, Marci Ryvicker, estimated that it could cost radio between $2 and $7 billion per year. He noted that broadcasters only make in the ballpark of $14.5 billion per year as it is, so that’s a sizable chunk.

It sounds to me like a major objection is the role that the CRB would play. He mentioned that, regarding the Internet radio royalty law that started several years ago, the CRB demanded royalties so high that lawmakers stepped in and sought new negotiations between the broadcasters and those representing the recording industry to set a fairer rate. I think this is a valid point — that’s probably who the negotiations should be between anyway, potentially arbitrated by a disinterested party who understands the market (if necessary).

Finally, he reiterated their contention that they didn’t like the money going to record companies, as the labels sometimes take advantage of artists. He says that broadcast radio has always been a big advocate for artists. He reiterated that providing free promotion is something that all artists, especially new ones, benefit from.

British bank Barclays, PLC may be in the market for a U.S. consumer unit. It already has a significant presence in U.S. investment banking, which was much enhanced with its lucrative acquisition of the scraps Lehman left behind. But that’s not enough: the bank wants more of a one-stop shop that could serve consumers and businesses alike. This might sound good in theory, but I think it’s a pretty bad idea.

BusinessWeek reports:

The London-based company is interested in buying a U.S. consumer bank to increase customer deposits, the Wall Street Journal reported yesterday, citing unidentified people close to the situation. Barclays spokesman Alistair Smith declined to comment on the story.

“It does not make a lot of sense,” said Jane Coffey who helps manage $51 billion of investments including Barclays stock at Royal London Asset Management. “Very few European banks have made a success of buying U.S. retail banks and almost all have lost their shirts doing it,” she said, citing HSBC Holdings Plc’s acquisition of subprime lender Household International Inc.

Coffey is exactly right. There are few times when it’s quite easy to identify the single worst decision that a firm has ever made. But it’s rather uncontroversial to say that HSBC has never regretted anything as much as it does getting involved in U.S. banking. Its ill-advised acquisition of Household resulted in the bank issuing its first profit warning in its 142-year history back in late 2006. That marked the beginning of the credit crisis. If HSBC was in trouble, no one was safe. Billions in losses for the bank, related to bad loans in the U.S., followed.

Now don’t get me wrong: HSBC isn’t Barclays. But they are the #1 and #2 British banks. And British banks are historically quite conservative. U.S. banks, traditionally, haven’t been. Now that may change for the time being, given current credit conditions, but this new attitude on the part of U.S. banks probably won’t last long.

If Barclays is serious about buying a U.S. consumer unit, then it needs to be very, very careful. It probably can’t afford a big bank, so it will need significant management oversight, as the operation won’t be as well-developed as, say, a Citi, Chase or Wells Fargo.

That means that it should seek as conservative a U.S. bank as possible. This was HSBC’s big mistake. The British behemoth pretty much defines what it means to be a conservative bank, yet it purchased a subprime consumer unit. This was a very poor decision. If a bank was ever involved in subprime lending for example, then it’s probably a bad fit for a British bank’s acquisition. That doesn’t leave many options for Barclays to choose from if it wants a bargain, but for there to be any chance that the cultures of the two institutions click, I think this condition must be met.

I’m pretty unconvinced that right now is a good time for bank acquisitions in general, however. Sure, banks are still relatively cheap. But many assets on banks’ balance sheets still have unclear values. More importantly, regulatory uncertainty has probably never been greater. If the framework that a business competes in is subject to drastic change, you can’t determine how much money it can make going forward. Without knowing that, how would you know the right price to pay? As long as asset prices lack stability and broad financial reform is pending in Washington, Barclays will find it impossible to determine how much a potential target is worth.

No one seems to be too thrilled with what President Obama has done for the economy since his term began last year. Conservatives blame him for everything from wasteful stimulus spending to killing the dollar. Liberals say he’s catering to Wall Street and has failed to attack unemployment with enough vigor. Mike Dorning at Bloomberg doesn’t think this is fair. But no one ever said the intersection of economics and politics was fair.

Here’s some of what Dorning writes:

“We’ve had a phenomenal run in asset classes across the board,” said Dan Greenhaus, chief economic strategist for Miller Tabak & Co. in New York. “If he was a Republican, we would hear a never-ending drumbeat of news stories about markets voting in favor of the president.”

The economy has also strengthened beyond expectations at the time Obama took office. The gross domestic product grew at a 5.9 percent annual pace in the fourth quarter, compared with a median forecast of 2.0 percent in a Bloomberg survey of economists a week before Obama’s Jan. 20, 2009, inauguration. The median forecast for GDP growth this year is 3.0 percent, according to Bloomberg’s February survey of economists, versus 2.1 percent for 2010 in the survey taken 13 months earlier.

First, let’s think about the stock market, as Dorning does. He’s absolutely right: it’s done wonderfully during Obama’s reign. It’s up around 42% since January 20th through yesterday. And Greenhaus is right too: if a Republican accomplished this feat, conservatives would be hanging “Mission Accomplished!” banners from their rooftops. Of course, Republicans’ disapproval should surprise precisely no one: that’s just politics.

But Democrats aren’t celebrating this fact either. That can also be easily explained: Obama has yet to accomplish their economic priorities. They want a crackdown on the financial industry; they want unemployment lowered to alleviate suffering. Although Obama has done much that should satisfy those with big stock portfolios, he’s accomplished far less to help average Americans.

So you’ve got this kind of odd situation where the most of the economic progress that the Obama administration has made would satisfy the wrong side of the aisle, so it’s providing him with very little political capital to work with. I’m pretty sure this wasn’t on purpose. It was unavoidable.

The reality is the stock market and GDP growth lead economic recovery, while unemployment lags. In order to have any recovery at all, the President had to stabilize the financial industry. In other words, he had to make Wall Street healthy before the broader economy could recover. After all, it was banking that made the economy sick to begin with.

The most legitimate criticism to be made here is that Obama could have placed financial regulation higher up in his list of priorities, say above health care. But I don’t know that there are many liberals willing to concede that point: health care reform is pretty important to them.

That leaves the most alienated Americans the ever-important moderates. They aren’t nearly as passionate about health care reform to begin with, but are probably angry that Wall Street appears to be back to business as usual, while one out of five of their friends is underemployed. And unfortunately for Congressional Democrats — who have followed the same course as Obama, by the way — moderates will matter most in midterm elections this November.

You might think one of the chief purposes of a new consumer financial protection agency (CFPA) would be to shield Americans from lenders that charge people incredibly high interest rates for loans. You’d be wrong, according to sources close to the legislation being drafted in the Senate. The New York Times reports:

Under the proposal agreed to by Mr. Dodd and Mr. Corker, the new consumer agency could write rules for nonbank financial companies like payday lenders. It could enforce such rules against nonbank mortgage companies, mainly loan originators or servicers, but it would have to petition a body of regulators for authority over payday lenders and other nonbank financial companies.

Consumer advocates said that writing rules without the inherent power to enforce them would leave the agency toothless.

And they’re right. This provision would significantly limit the effective reach of the CFPA.

On one hand, this couldn’t be more absurd. If any type of firm appears to be guilty of usurious loans, it’s nonbank, nonmortgage finance companies that dole out payday loans and the like. The annual interest rates on these products often well exceed 100%.

Yet, there’s a reason why these companies charge such insane rates: because they must. They provide credit to individuals with poor credit histories. That means the chances of them getting back the money they loan out is quite low. And therein lies the reason why they must charge so much interest.

The CFPA could eliminate these businesses altogether if it deems such loans as too dangerous for borrowers. While that might seem just from a consumer protection standpoint, do we really want an environment where consumers with poor credit can’t obtain such emergency loans?

I’m not sure, but I would err on the side of letting these lenders charge what they want — so long as borrowers fully understand what they’re getting into. I’m lucky enough to never have been in a situation where I where I needed money so badly as to accept a 300% APR loan, but if I were so desperate, I’d want the option to do so. I would, however, be sure I understood all of the terms of the loan. So if better disclosure is a major goal of a CFPA (and it should be), then these nonbank finance companies should not be exempt from enforcement.

The route the CFPA appears to be taking is about what I expected. Whatever is eventually agreed on will be so watered down that Congress might as well not have bothered. First, we hear that its independence may be compromised, as it will be housed in an existing regulator like the Fed. Now we’re beginning to see just how limited its enforcement powers will be. From the reports we’re hearing, whatever the Senate eventually comes out with will likely feature a CFPA that’s a mere shadow of what its supporters originally hoped.

House Financial Services Chairman Barney Frank (D-MA) sent a letter to the four biggest banks asking them to write down second-lien mortgages to assist the modification effort and prevent foreclosures. These second liens have posed a big challenge to the modification push. Underwater borrowers probably can’t pay their second mortgage if they can’t pay their first. But for obvious reasons, banks aren’t thrilled with admitting that these second liens are worthless: it will cost them billions of dollars. Should they listen?

The Financial Services Committee confirmed that the letter was sent. They’re forawrding me a copy, but for now, you can find it in full on Zero Hedge. It’s addressed to Bank of America, Citigroup, JP Morgan Chase and Wells Fargo. Here’s the central point:

Large numbers of these second liens have no real economic value – the first liens are well underwater, and the prospect for any real return on the seconds is negligible. Yet because accounting rules allow holders of these seconds to carry the loans at artificially high values, many refuse to acknowledge the losses and write down the loans, which would allow willing first lien holders to reduce principal and keep borrowers in their homes.

The four organizations you lead are major participants in the second-lien market. Failure to modify these debts has become a major and unnecessary obstacle to thousands of Americans being able to stay in their homes. I urge you in the strongest possible terms to take immediate steps to write down these second mortgages and allow principal reduction modifications of the underlying first liens to take place. If there are legal obstacles to your doing so, we will work with you to remove them.

First, Frank is actually partially right. In the case of underwater borrowers facing foreclosure, the second liens are probably worthless. Once foreclosure begins, those second liens are generally wiped out anyway, depending on state law.

So what kinds of losses are we talking about? Financial Times blogger Tracy Alloway says that they could be as much as $442 billion, since that’s the total value of the second liens on the books of these four banks. That, I think, is a rather lofty estimate. I don’t take this letter to mean that Frank wants banks to wipe out all of their second liens — just those associated with mortgages that they could otherwise successfully modify. I haven’t the foggiest clue what the value of all those liens would be, but I doubt they’re anywhere near the full $442 billion. Just in thinking about some big numbers, if we are talking about preventing one million foreclosures for homes with second liens and the average second lien size is $50,000, then that would be $50 billion. I think that’s a pretty liberal scenario.

Whatever the actual value of write-downs that these banks would have to incur in order to comply with Frank’s request, there’s definitely some pain involved for the banks. It’s interesting that Frank isn’t offering these banks any kind of carrot — because let’s face it: he hasn’t got any kind of stick other than trying to shame them into it.

The reality, however, is that it may be in banks’ best interest to write off these liens. If they do have essentially no economic value, and a bank thinks it will be better off modifying a mortgage than foreclosing, then it should want to eliminate the second lien. The problem, of course, is the associated loss. Right now, banks have an incentive to prevent these write-offs for as long as possible, so to spread them out and be able to better sustain them as the financial markets continue to stabilize. Banks don’t want billions more in write-downs this year related to second mortgages. That’s why something like I suggested in conjunction with principal reductions, where banks could be permitted to amortize these losses over the course of several years, could make Frank’s request a little easier to stomach.

It’s interesting that Frank is calling for this now, several months after the government had given up any control it had over these banks with their bailout repayments. During the days prior to repayment, Frank or others in Washington could have more easily strong-armed banks into fulfilling such requests. These days, however, their power is greatly diminished. So unless Frank brings any interesting solutions to the table to reassure the banks that these massive losses won’t hurt them, I can’t see them taking his request very seriously.

(Image Source: Wikimedia Commons) 

Last Sunday, Cablevision customers in the certain areas of New York were denied the first 12 minutes of the Oscars. This was the breaking point in negotiations between ABC and the cable company, after talks stalled for the fee ABC would be paid for its content. Reports indicate that ABC mostly conceded, mostly due to political pressure. But service providers see the incident as an opportunity to call for change. Now they are banding together to push for legislation to prevent such negotiations from resulting in another denial of service like this in the future.

The coalition is a robust one. The Financial Times reports:

The coalition cuts across systems and platforms, bringing together rivals that include DirecTV, Dish Network, Verizon, Cablevision and Charter, according to one person familiar with the matter.

That covers satellite, broadband and cable TV services — basically everyone. According to sources, one major request is for government arbitration to resolve stalled negotiations. I don’t think this is a sensible idea.

Right now, the system is as it should be: broadcast networks can negotiate directly with these service providers. There’s significant competition that makes these negotiations fair: several broadcast networks, hundreds of cable networks and dozens of service providers make for a robust market. What’s at stake if negotiations stall? Really, very little.

First of all, we’re talking about entertainment here — not necessity. The Oscars, for example, can be enjoyable to watch. But the idea that viewers would somehow be harmed if deprived of watching Hollywood stoke its own ego is kind of ridiculous. It’s rather absurd that the government needs to swoop in to save Americans from a lack of missing television entertainment.

In reality, anything truly vital will remain uninterrupted. First, it’s highly unlikely that all broadcast stations would all be locked out at the same time. So the public will always have access to important news if some catastrophe hits. That’s the kind of concern the government should have. If it wants to step in during such a scenario — when all local broadcast networks are in stalemate simultaneously — then I might be able to live with that. Of course, that would almost certainly never occur.

But the problem with government arbitration between service providers and networks has to do with bias. The government will almost certainly side with the service providers. That’s what we saw with the ABC-Cablevision dispute. The service providers know this, which is why they’re recommending government arbitration in the first place. If they didn’t have some confidence that their lobbyists were more influential than those of the broadcast networks, then they wouldn’t have suggested such legislation. As a result, government arbitration would weaken networks’ bargaining power in getting what they should be paid for their content.

The market forces in these situations are already sufficient to conduct reasonable negotiations. Broadcasters know they can’t charge absurd fees, because they need a service provider’s subscribers to boost the ratings of its content. Service providers want the broadcast channels, because they have unique and entertaining programming. This government arbitration demand is like if the supermarkets banded together because broccoli producers wanted too much money for their vegetables. Customers could just eat spinach in the meantime, while market forces eventually result in a solution both parties can live with.

Today, Bank of America announced its intention to end its automatic overdraft fees on debit and ATM transactions this summer. Instead of incurring a fee, the transaction will just be denied, unless a customer has chosen to opt-in* to overdraft “protection.”* Bank of America’s press release gloats that this shows its “commitment to provide more control, choice and clarity for its customers.” Pardon my skepticism.

First, Bank of America isn’t doing this by choice: the Federal Reserve had already ruled that on July 1 banks must ask customers to opt-in in order to charge overdraft fees on debit and ATM transactions. So it’s really just following the law. Indeed, BofA’s changes aren’t taking effect until the summer — as the new rule dictates.

Second, these millions of dollars in lost overdraft revenue will hardly just be shrugged off by bank executives. Banks’ response to last spring’s new credit card regulations demonstrated this fact well, as they began increasing interest rates to make up lost profits. There are two ways they could make up for the revenue lost without overdrafts: increase fees elsewhere or cut costs accordingly.

These additional fees could manifest themselves in the form of fewer people qualifying for free checking, higher maintenance fees for those without free checking or a variety of other ways. It could also signal the return of ATM fees under certain circumstances.* If we know anything about banking, it’s that there’s no lack of imagination when it comes to banks dreaming up new ways to extract money from customers.

Cost cutting could take a few forms. It could mean customer service representatives will be laid off or outsourced. Less productive branches could close. Whatever the method of cutting costs, some customers will likely feel it one way or another.

The winners here are those who often attempted to make unnecessary purchases exceeding their account balance. For anyone needing to make a purchase without sufficient funds, unless they have some other form of payment (or opted-in to overdraft protection), they’ll be out of luck. And the costs just explained above will now be imposed on all customers, instead of just those who attempted to spend more money than what was in their account.

* Update: I just spoke to a Bank of America spokesperson who contacted me regarding this post. He asked I clarify a few things:

First, he wanted to differentiate between traditional overdraft fees and the service they would be offering going forward for customers who still want to be able to exceed the funds in their checking account. The old way was an overdraft fee (~$30) every time a transaction occurred that exceeded your balance. The “overdraft protection” that BOA offers is different: it will establish a link between a checking account and some other account to transfer money in order to cover the transaction. This does still involve a fee, but it will be smaller than traditional overdraft fees and cannot be incurred more than once a day.

Second, he didn’t like the “opt-in” language that I used. Current BOA customers will no longer have the ability to exceed their balance, unless they request overdraft protection (which I just explained). This is different than what most banks offer, as their opt-in would still subject customers to the traditional high, every-transaction overdraft fees.

Finally, he wanted to make clear that Bank of America has no plans at this time to add new fees. This announcement did not allude to any new fees. I didn’t mean to imply otherwise, but only theorize that banks rarely just cut their profits without trying to make them up elsewhere. And new overdraft policies like this are expected to cut into profits.

Last year, I wrote several times about how hard hit the rich were from the housing bubble’s pop. Well, the Cristal will be flowing a little more freely this year: a new survey indicates that the number of millionaires in the U.S. grew by a whopping 16% in 2009, according to the Spectrem Group. That’s after falling by at around 27% in 2008. This actually isn’t that surprising, as the recovery thus far as been better for wealthier than poorer Americans.

The press release elaborates that U.S. households with a net worth of $1 million or more grew to 7.8 million, from 6.7 million in 2008. It should be noted that this is still well below (~18%) below the all-time high number of millionaires in 2007 of 9.2 million Americans. So the ultra-rich are still fewer than they were before the recession. Here’s an informative chart on the survey breaking out some sub-categories by Spectrem Group:

As you can see, there were some pretty big upticks in 2009, but not nearly as large as the drops from 2007. Indeed, most of these categories remain below 2005 or earlier levels.

Back in August I wrote about the decline millionaires in 2008. At the time I noted economist Simon Johnson’s explanation of how new bubbles help the rich earn their wealth back quickly after a recession. Is that happening here?

Maybe. Clearly, the huge rebound in the stock market helps boost net worths. After all, the S&P 500 was up 23% in 2009. Some key commodities also rallied. Gold was up by about 25%. Residential real estate was down only slightly — about 3% according to the S&P Case-Shiller home price index.

So where might a bubble come in? Well, it depends if you think that this increase in asset prices was justifiable given the fundamentals. I’m unconvinced. I think that irrational exuberance paired with government intervention fueled the recovery. Loose monetary policy also could be helping to create an asset bubble. That could be responsible for much of this creation of wealth. If a bubble is the cause, then that probably means inequality also increased.

(h/t: Bloomberg)

Those fighting for the consumer financial protection agency just got a new ally with unparalleled battle strategy know-how, literally. The Defense Department has come out in support, according to Politico. It’s reportedly worried about U.S. armed forces getting ripped off by banks and finance companies. I’m a little confused as to why.

Politico says:

Auto dealers, a powerful local constituency with outlets across the nation, won the first round of their own battle against new consumer protection rules, successfully lobbying House members for an exemption from oversight by the stand-alone consumer financial protection agency.

The Pentagon’s concerns were raised in a Feb. 26 letter from Clifford Stanley, undersecretary of defense for personnel and readiness. He said that “unscrupulous” lending by auto dealers has hurt troops — and has even prevented them from being deployed, as some groups have documented. That may blunt the sympathy the National Automobile Dealers Association members received during the House debate.

“Predatory lending affects our military preparedness. That’s how outrageous it is to not include these guys” in the consumer entity’s oversight, Mierzwinski said. “It explains that this is not just some liberal position.”

Firstly, if you’re going to have a consumer financial protection agency, the idea that auto dealers would be exempt is rather ridiculous. Auto loans are easily among the top three largest areas of consumer finance, along with mortgages and credit cards.

But what’s odd is that the military would be so concerned with consumer protection. I find this strange because all U.S. armed forces are eligible to do their banking with USAA, a special bank founded by Army officers, which seeks to provide high quality, low cost banking products to members of the military and their families. Its website explains its mission:

The mission of the association is to facilitate the financial security of its members, associates, and their families through provision of a full range of highly competitive financial products and services; in so doing, USAA seeks to be the provider of choice for the military community.

From what I have heard, USAA is pretty great. And I would also note that auto loans are among its robust product offerings. So if the U.S. armed forces are aware of this alternative (and they generally are), why is the Defense Department so concerned about other bad lenders? If anyone should be relatively content with consumer lending practices, it’s the Pentagon since the military has the benefit of using USAA.

Fannie Mae and Freddie Mac’s mortgage-backed securities are trading at yields that are the closest ever to Treasury bonds, reports Bloomberg. That means investors are differentiating less between these agency mortgage bonds and Treasuries. And that makes sense.

Bloomberg explains:

The difference between yields on Washington-based Fannie Mae’s current-coupon 30-year fixed-rate mortgage bonds and 10- year Treasuries was unchanged today at 0.63 percentage point, matching the smallest spread since at least 1984, according to data compiled by Bloomberg.

To the naïve observer, this might be surprising. Shouldn’t investors be shunning anything related to mortgages and the agencies? The mortgage market has been a disaster over the past few years. Fannie and Freddie collapsed and had to be rescued by Uncle Sam to the tune of untold billions of dollars.

But therein lies one reason why the spread between the yields on agency mortgage bonds and Treasuries has shrunk to near nothing: Fannie and Freddie are essentially owned by the U.S. government. Investors now see little difference between the credit quality of agency issued debt and that the government directly issues. After all, the government is on the hook for those bonds as well now, more explicitly than before. The only characteristics investors really need to worry about with agency mortgage bonds at this time are prepayment risk and structural differences.

That prepayment risk is also seen as minor currently. Rates are currently quite low, so the prospect of many borrowers refinancing to achieve lower rates than what they’re getting now isn’t very likely.

This news is both good and bad. If you’re someone who hopes to obtain a so-called conforming mortgage — one that adheres to the agencies’ criteria of what they can purchase or guarantee — then this should keep your rates relatively low. As long as Fannie and Freddie can continue to provide liquidity, those mortgages won’t be too hard to get. Of course, that’s of no help to anyone who wouldn’t qualify for a conforming mortgage: the non-agency mortgage-backed security market remains closed.

Anyone who hates Fannie and Freddie also has reason for disappointment. The success of these bond sales means that Fannie and Freddie continue to thrive on government life support and grow in size. The more investor appetite that exists for their bonds, the more mortgages Fannie and Freddie can guarantee or purchase. If you wanted to see the agencies’ role in the housing market decline, then you probably aren’t thrilled that they’re still getting funded so easily. But that’s mostly thanks to having the U.S. government standing behind their obligations.

It seems like the new fees and surcharges by airlines keep growing and growing. First, they started charging for food. Baggage soon followed. Then, they started having “premium” seats in coach. The latest way for airlines to squeeze customers takes that one step further: they are beginning to charge more for exit row seats. While I understand the airlines’ rationale for thinking up creative ways to attain more revenue, as a consumer, I’m not thrilled with this change.

The New York Times reports on this development today:

Last week, Continental Airlines said it would begin offering exit-row seats in coach to anyone who wanted to buy “extra legroom.” Continental said the per-seat price would depend on the route and the demand. Members of the two top elite-status levels would continue to be able to book the seats without charge, the airline said.

The airline industry generally exhibits usual oligopolistic behavior. Once one major airline changes a policy the rest usually follow. So I’d expect to see most airlines who offer exit row seats with additional legroom also make this change in the months to come.

As someone who once traveled several times per month as a consultant, racking up several hundred thousand frequent flyer miles, I learned as well as anyone the joy of the exit row. Savvy travelers know that you can often fully open your laptops and stretch your legs a little in those seats — but for a coach fare.

Still, I can see where airlines are coming from. If the seats offer a better in-flight experience, then they can probably get away with charging a premium. Their perspective seems logical, except for the fact that the exit row isn’t just any other seat with a little extra legroom.

The Times article notes this distinction and disapproves:

Evacuation is the sole purpose of the exit rows, which abut emergency doors. So in selling exit-row seats to all comers, airlines may raise concerns about who, exactly, is sitting in those seats — and whether they are able to perform the specified emergency duties, chief among them that they have “sufficient mobility, strength or dexterity” to open the emergency door and help with the evacuation.

Exit-row seats have usually been occupied by frequent fliers who often booked them in advance, free, as perks. “The presumption has been loosely that elite fliers at least had the experience to know what the drill is in an emergency, which is basically that you have to be prepared to get that door popped open,” said Joe Brancatelli, who publishes the subscription business-travel Web site Joesentme.com.

I found myself scratching my head after reading this. The article starts off on the right track, but then takes an odd deviation. Frankly, I think newcomers are more likely to pay attention to the flight attendant’s presentation than seasoned flyers, who have heard the spiel a million times. But the freshness of those directions probably outweighs any supposed expertise that experienced flyers have obtained. Unless they’ve actually done it before, I’m not sure how having passively heard the directions dozens of times outweighs having actively listened to them just moments ago.

My concern is a different one: if the exit row passengers have responsibilities demanded of them in case of emergency, why would they be expected to pay more — don’t those responsibilities earn them the extra legroom? That’s always how I had viewed it. I assumed that the premium I paid for the pleasure of sitting in the exit row was the role I had promised to play if necessary. Other than handling the physical and psychological stress of removing the 40+ pound door during an emergency, it’s my understanding that the exit row passengers might also assist the flight attendants with evacuation. Finally, exit row passengers also face the risk of getting trampled by others rushing to get off the plane.

That varies vastly with first class passengers, who simply pay for a more pleasant experience. The exit row passengers may get a better experience as well, but there’s a chance that they would have a far more stressful time than even the regular coach passengers in the case of emergency. Isn’t that a high enough price to pay for a little extra legroom?

The Federal Reserve is going through a historic time on several levels. First, there were the unprecedented actions that it took to save the financial markets in 2008. Now, it has the difficult job of unwinding all that this year. As if that’s not enough, it has to contend with sweeping new financial regulation being drawn up by Congress, which may either limit or expand its power. Throw in some significant changes to its leadership team and you’ve got an incredibly difficult and tumultuous time for the Fed.

Success Breeds Skepticism

There’s a broad spectrum of opinion on how the Fed did during the crisis. Some believe that the Fed saved the day. Others think the Fed went too far and should not have acted as aggressively. I believe those in the latter group are misguided: if any party should be credited with rescuing the U.S. economy from drifting into the abyss, it was the Fed.

Of course, its job is not over. Winding down all that action puts it in uncharted territory. Its balance sheet is enormous, and it has to figure out a way to slowly tighten credit so not to disturb the recovery and create a double dip recession. But that’s a challenge that lies ahead, not a reflection of its success over the past two years in stabilizing the U.S. markets.

Yet, Americans deeply disapprove of the Fed. This summer, a Gallup poll indicated that that the Federal Reserve Board’s approval was at just 30% — lower than the IRS! And for what? Saving the economy? The truth is that people don’t like what they don’t understand, and when it comes to transparency and simplicity, the Fed doesn’t get very high marks.

Financial Regulation’s Effect

Financial reform efforts in Congress hope to address some of that. The House bill includes some changes to enhance transparency of the Fed. But there’s little Congress can really do for simplicity: the Fed, by its very nature, handles very complex financial matters. Average Americans aren’t likely to fully grasp all it does, but the hope would be that better transparency could alleviate some of their fears.

Of course, financial regulation also has an awful lot to say about what the Fed’s role will be going forward in the financial markets. The House’s bill would provide the Fed with a great deal more power. It would have most systemic risk regulatory authority. The Fed chairman would also lead the systemic risk council.

But the Senate’s version may take a very different route. According to news out today, the bipartisan measure being drafted by the Banking Committee may actually strip the Fed of most of its bank supervising. We’ve already learned that Senate might also want to limit the Fed’s role in systemic risk regulation, as the treasury secretary may lead the council with the executive branch obtaining most of the power instead. The Fed may, however, be provided consumer protection responsibility.

The Power That Must Remain

Interestingly, the Obama administration supports the House’s conception of financial reform: it doesn’t want power taken from the Fed, but actually wants the Fed to be granted more systemic regulation authority. In yesterday’s Treasury blogger briefing, it was clear that senior officials worry about legislation which would strip the Fed of its emergency stabilization powers. But I wonder whether the Senate’s plan really does that.

We don’t know all of the details yet of what the Senate will propose, but it is possible to consolidate banking regulation, stripping it from the Fed, while allowing the central bank to maintain its emergency stabilization authority. The trick, I think, would be ensuring that the new bank regulator had very direct communication with the Fed and provided it with timely information regarding the health of banking. But if the Fed is also deprived of its power to put out fires, then that would be bad. It has the ability to act more quickly and decisively to stabilize markets than any other government entity.

Leadership’s New Face

Finally, there’s the additional complication of some faces changing at the Fed in the months to come. It’s set to get a new vice chairman with the current veteran Donald Kohn retiring. That and a few other openings will provide the Obama administration the opportunity to give the Fed a makeover. Given the administration’s political objectives, I think it’s unlikely we’ll see any Wall Street bankers strongly considered. Instead, I’d expect nominees to have strong academic credentials and some experience with regulation. Of course, the administration could wait to see how the powers of the Fed are changing to decide what types of economists would best fit its new duties.

The Fed has become surprisingly controversial over the past few years. It used to be a quiet government entity, only paid attention to by bankers. But the financial crisis thrust it into the spotlight: Chairman Bernanke was even named “Person of the Year” by Time Magazine. The most radical edges of either party have unexpectedly found some common ground through their dislike of the Fed. Conservatives, led by Ron Paul, think it has too much power and not enough supervision. Some progressives worry that the central bank has never truly been independent, since it has a lobbyist. Both ends of the spectrum want the Fed’s responsibility limited, not increased. The way the Senate’s bill appears to be shaping up, it’s a battle they may win.

(Image Source: Wikimedia Commons)

As I just mentioned, I attended a blogger session today at the Treasury, with lots of senior officials, including Secretary Geithner. A variety of topics were discussed, and many interesting things said. One topic that they spent a short time on was the housing market. I didn’t get the question in I wanted to ask (so I’ll try to contact the Treasury in the days to come for clarification), but someone asked if the Treasury is going to be following the FDIC’s lead when it comes to considering principal reductions for mortgage modifications.

Much to my surprise, the answer was a pretty unambiguous yes. The official speaking said that in the days to come we will likely see the Treasury moving more towards principal reduction as a tactic to modify mortgages. I found this a little surprisingly, mostly because the current Treasury modification program has little to say about principal reduction. While it certainly allows for it, the program relies more on carrots for servicers and banks to make modifications happen. Those modifications usually just involve term extensions and interest rate reductions.

I’m curious as to what changed the Treasury’s course here. Perhaps it was the dismal results of its modification program thus far. The Obama administration may have come to the realization that you can’t modify many mortgages in this environment unless you find a way to encourage banks to stomach principal reductions. It remains unclear how the Treasury intends to reduce principal, however.

The question I didn’t get to ask was how Treasury’s philosophy towards the housing market has changed over the past year, and what its strategy is at this time. This morning, I noted that the Treasury is starting another program meant to encourage more short sales. That appears to conflict directly with the idea that struggling homeowners should remain in their homes. Indeed, if principal reductions begin, then the pendulum swings back in the other direction away from encouraging short sales. There appears to be a sort of scattershot approach at this point, and I am curious whether there’s some unifying strategy that I’m just missing. I’ll try to find out this week.

Update: One of the other bloggers there, Shahien Nasiripour, got an e-mail from a Treasury Spokesman after-the-fact indicating that any new principal reduction approach would be more of a tweak in existing modification programs than a major, new program.

I just attended a blogger briefing at the Treasury, with several prominent senior officials present, including Secretary Timothy Geithner himself. They had some pretty interesting things to say. The topic I was most interested in was financial regulation. I was curious where the Obama administration stood, given the progress (or lack thereof) thus far. In particular, I asked whether the President was holding a very hard line on any specific provisions being included for the bill to get his signature. Their responses were subtle, but sufficiently revealing of their position.

It was pretty clear that the President knows better than to demand a perfect piece of legislation. While there are clearly some priorities that the administration views as extremely important, I didn’t get the sense that the absence of any specific provision was a sort of deal breaker. I don’t think we’ll see a standoff here where the President threatens to veto whatever bill Congress eventually passes if it lacks certain components of his plan.

For example, when it came to the Consumer Financial Protection Agency, officials made pretty clear that, while they prefer it be a new, independent agency, they weren’t necessarily against the idea that it be housed in an existing entity like the Treasury of the Federal Reserve. They did, however, insist that it must exhibit sufficient independence so that the regulator can accomplish its mission effectively.

I got the same sort of feeling for the so-called Volcker Rule. I have said that I don’t think it has a chance at this point. Given the difficulty the Senate is having with less controversial measures, I just can’t see much of this recent proposal making it into the final bill. The Treasury officials, however, didn’t appear as pessimistic. They even hinted that they had reason to be optimistic about the Volcker Rule’s fate and implied that recommending it wasn’t just a political maneuver. The President really expects action on it.

The officials present also indicated that we should remember that it’s relatively early in the process. Even though the House passed its bill (which the Treasury strongly approves of), the Senate is drafting its version in committee. Then it has to pass committee; then it has to be debated and passed by the broader Senate; then there’s conference. A lot can happen between now and when it reaches the President’s desk. So despite the Senate’s struggles, the Treasury remains cautiously optimistic. But this also highlights the fact that it could still be some time before a financial reform bill crosses the President’s desk.

FDIC Chairwoman Sheila Bair affirmed her support for the creation of a non-bank resolution authority that would rely on a fund to pay for its winding down of failed financial institutions today. Speaking at the National Association for Business Economics Washington Policy Conference, she explained what we’ve learned from the crisis and what regulation needs to do to correct those problems. In doing so, she spent some time on the role of a resolution authority, which makes sense since the FDIC will likely have this duty. I’m a little unclear on whether Bair thinks this authority should consider options other than just winding down troubled institutions.

Here’s an expert of what Bair said after stressing the importance of higher capital requirements:

But what we need most is a pre-funded resolution mechanism, similar to the FDIC’s receivership authority for failed banks … and a clear mandate to close large, systemically important firms when they get into trouble and to quickly sort out the claims against them so that key financial relationships can be preserved and the taxpayer and can be protected.

Let me be clear – this would not be another bailout mechanism.

Shareholders and creditors would bear the losses, not the public.

But, the process would be orderly and help prevent a catastrophic collapse of other firms.

If you’ve read much of my writings on financial regulation, then you know the creation resolution authority is a pet cause of mine. I also support the conception that the mechanism is pre-funded, as it doesn’t make sense for the good guys to pay for those that failed after-the-fact.

But I also think that a resolution authority should keep troubled firms if possible by restructuring capital. I wrote about this a few weeks ago when explaining another article by some executives from Credit Suisse. The idea is that some troubled institutions could simply restructure capital, like swapping debt for equity in some manner, so to prevent failure. Under the current system, that would be very difficult to do quickly. But I believe if an institution’s failure plan featured a way to restructure capital if the firm ran into problems, then the resolution authority could consider restructuring capital as the plan dictates first, before simply winding down the institution.

From this speech, it’s a little unclear whether or not Bair has a more simplistic view, where a resolution authority would just close troubled firms. Right now, most banks are just wound down by the FDIC with failure looming. While that’s one option, if the market could be saved from some additional losses associated with outright failure without taxpayers bearing the cost of keeping a firm going, then I don’t see why regulators wouldn’t want to include that option as well. This isn’t currently an explicit alternative according to what I understand about the FDIC’s bank resolution practices, but there are other options considered before just winding it down. Any new resolution authority should also have the power to consider alternatives, including capital reallocation to keep a firm afloat.

Up to now, the Obama administration has had a pretty clear goal of doing whatever it could to keep struggling homeowners in their houses. Today, however, the New York Times reports that a new Treasury program will seek to do the opposite: it would encourage underwater borrowers to leave their homes more quickly. Is the Obama administration changing course?

The new proposal relies on short sales. That’s where there’s a buyer willing to buy a house with an underwater mortgage — but for less than the borrower’s outstanding balance. As you can probably imagine, most of the struggling homeowners can’t afford to make up that difference, so the bank generally has to agree to stomach some or all of the loss.

Short sale is often a sensible option for the bank. If the borrower were to foreclose anyway, then additional legal and administrative costs would be incurred. The bank would have to put the home on auction and eventually sell it. If the short sale offer is in the ballpark of what the bank believes it would get at the auction anyway, then it might as well consent. In such cases, the bank is better off short selling than foreclosing.

The Treasury wants to encourage banks to do more of this. Here’s how the program would work, according to the Times:

To bring the various parties to the table — the homeowner, the lender that services the loan, the investor that owns the loan, the bank that owns the second mortgage on the property — the government intends to spread its cash around.

Under the new program, the servicing bank, as with all modifications, will get $1,000. Another $1,000 can go toward a second loan, if there is one. And for the first time the government would give money to the distressed homeowners themselves. They will get $1,500 in “relocation assistance.”

Frankly, $1,000 probably isn’t enough in most situations for a bank holding a first mortgage to agree to short sale if it wasn’t willing to before. That’s sort of like if a potential buyer had offered $140,000 for a home with a $200,000 outstanding mortgage, now she would effectively offer the bank $141,000 instead. Sure, that’s more, but if the bank wasn’t comfortable selling the home before, I’m pretty unconvinced that another measly $1,000 is going to do much. At best, this could help in the cases where short sale is on the border line.

But the government’s real target might not be the first mortgage holder, but whoever owns the second. The incentive for this subordinate party is an interesting idea. In cases where a second loan exists, this party needs to consent to short sale too, since it holds a second lien on the property in question. This could help. Many of those second mortgages will be total losses: if an underwater homeowner can’t pay his first mortgage, he certainly can’t pay the second. Moreover, foreclosure will generally wipe out the second mortgage altogether. Many of those second mortgage holders may jump at the chance to get even just $1,000 — it’s better than nothing.

From the borrowers’ perspective, I’m completely unclear why they need any carrot at all. Usually, short sale is a pretty great deal for them: they don’t have to go through foreclosure. If they’re going to lose the home anyway, short sale is usually the most attractive option at their disposal. Honestly, this $1,500 feels like more of a transfer payment from the sympathetic federal government. It may make homeowners more willing to consider short sale more quickly, but most of them probably would have ultimately done so anyway.

In fact, I worry a little about this encouraging short sale for those who don’t need to foreclose. Some friends of a friend living in Florida recently completed a short sale on their home because they were annoyed their home was so underwater; they could have continued paying their mortgage if they had chosen to. They decided to short sell and rent a nicer place for less than their mortgage payment. Should people like this really get an additional $1,500 incentive?

Right now, short sale isn’t incredibly uncommon, but it happens much less often than foreclosure. If this program works as anticipated, it would shift that proportion. The only major consequence that I see on the real estate market here is that housing inventory might turn over a little more quickly. All of these homes that would have eventually gone through foreclosure and auction will be purchased a little bit sooner. That would be a good outcome, as it would help the housing market to hit the bottom more quickly. But I’m a little surprised that the Treasury is now putting speed to the bottom ahead of keeping people in their homes. That’s definitely a change in direction from what I understood to be its philosophy.

(Image Source: morisius cosmonaut/flickr)

I’m in the midst of reading former Treasury Secretary Hank Paulson’s book “On The Brink.” It’s pretty fascinating so far on several levels, but I’m only about a hundred pages in.* The other night, I came across a passage that I found profoundly troubling. It demonstrates all too clearly the lack of economic leadership exhibited by bank management. Rather than making intelligent decisions, they look for the government to regulate them.

The story I’m referring to starts on page 69. The context is Paulson’s discussion of how there was too much leverage in the financial system. That was partially caused by a massive credit bubble, which extended far beyond just the mortgage market. He had a discussion at a dinner at the New York Fed in June 2007 with the heads of some of Wall Street’s biggest banks. They were complaining about so-called “Covenant-lite” loans, where bankers eased restrictions to allow borrowers (like private equity firms) more flexibility on repayment. Paulson writes:

Chuck Prince, the Citigroup CEO, asked whether, given the competitive pressures, there wasn’t a role for regulators to tamp down some of the riskier practices. Basically, he asked: “Isn’t there something you can do to order us not to take any of these risks?”

Not long after, I remember, Prince was quoted as saying, “As long as the music is playing, you’ve got to get up and dance.”

This strikes me as sheer lunacy. Several other banks decided to stop making these covenant-lite loans, but by the time they did, it was already too late. Yet, banks felt “pressured” to continue making them. What does this mean exactly? If they believed that these loans were dangerous and a poor practice, why would it matter how much pressure they felt from competition? I’d challenge Prince’s analogy: if you don’t like the music that’s playing, you don’t have to dance to it. Doing so will just make you look foolish.

I can’t get over the fact that banks would knowingly do something they believed would harm them. That’s sort of like saying, “Gosh everyone else is eating rat poison. We’d better too!” And then saying, “Geez, this rat poison isn’t good for us — but it’s so delicious that we just can’t help ourselves. Maybe the government can make rat poison illegal so we won’t have to eat it anymore.” Right, or you could just use your senses and stop eating it since it will eventually kill you. After all, then when the rest of your competition is dead, you’ll be alive and thriving.

It’s crazy to say that the government should step in and stop banks from doing something that they recognize to be stupid. The government shouldn’t have to. The leaders of the banks should heed prudent risk management and refuse to make bad loans that they think will lead to huge losses. In doing so, they will, in fact, have an advantage over their competitors who will incur deep losses due to their poor choices.

Competition isn’t about acting like sheep and just following the flock — it’s about outsmarting others. If banks recognizes that a loan product is harmful, then there’s no rational pressure that can encourage them to continue selling it.

I found this passage very disturbing. I’m a strong advocate for providing business as much freedom as reasonable, but that only works if their leaders act rationally. This episode reveals that they don’t. They knowingly act irrationally in the name of competition, while hoping the government will save them from themselves through regulation. If these are the industry’s leaders, then it’s no wonder the financial industry is so screwed up.

* I have this annoying habit of reading at least three books at once, so it takes me forever to get through one. So expect more posts about this book in the weeks (not days) to come.

Today, the Federal Reserve released consumer credit data for January. Credit grew at an annualized pace of 2.4% during the month. The nonrevolving portion grew at a more rapid pace — 5.0% annualized. Revolving credit, however, declined further, an annualized 2.3%. Yet, this data appears to indicate that overall credit conditions may be improving somewhat — or is it just a blip?

This might be easiest to see with a few charts. First, here’s the month-over-month change, annualized, for the trailing 12 months:

Even though credit continued to decline in December, the rate of change has switched directions since then. But this is a very jumpy chart. So let’s smooth it a little by averaging each month’s rate with the trailing two months:

Here, December appears to be the inflection point. So it may be premature to conclude that credit is definitely on an upward trend, though it may be.

These charts also highlight just how much revolving credit has been shrinking. They both clearly show that all of 2009 consisted of deeply declining revolving credit. Nonrevolving, however, entered positive territory at times, and grew significantly in January — at approximately the same rate it for the same month last year.

Also from the report, it’s interesting to note that credit held by the federal government continued to increase remarkably, at a 66% annualized pace. Meanwhile, credit held by nonfinancial businesses declined very substantially — at a 40% annualized pace.