First, I went to the summary of the Barney Frank Town Hall event, which explained what Frank wanted to discuss:
"He will discuss various proposed reforms, including a ban on 100 percent securitization of loans, elimination of incentives to game the system at enormous risk to investors and taxpayers, and means to monitor and limit overall "systemic risk." The financial crisis had its roots, Frank said at Harvard, in one phenomenon – the ability to make large loans outside the banking system and resell them. The need is to repair a broken system so that investors dare to return, institutions dare to make loans once again, and citizens and businesses dare to take on debt."
Well - we clearly have a significant disagreement there: the problem wasn't securitization: nearly all of our capital markets are composed of various securitized products. The problem was an ignorance of risk, a misunderstanding of correlation, and an overabundance of leverage which enabled firms to take positions where a small negative event could have large negative consequences, and a large negative event could have cataclysmic consequences.
Then, my friend MO sends me this article from today's WSJ titled "Should You Buy a Home Equity Protection Plan?"
"Watching a home's value plunge by double-digit percentages in a matter of months is enough to unnerve even the most financially secure homeowner. And, as the real estate market continues to reel concerns are growing that the free fall is far from over.
Playing into that anxiety are two companies – EquityLock Financial, based in Austin, Texas, and Lighthouse Group based in Charlotte, N.C. – that are selling products promising to put a little more control in homeowners' hands. Their pitch? That homeowners could spend a little now to hedge against declines in the value of their home later.
Here's how it works: For a fee of 1% to 3% of their home's value, homeowners buy a contract that protects them against the loss of equity in their home if the market takes a turn for the worse. The contract, which should not be confused with an insurance policy, pays the homeowner when he sells his home in a market where average home prices have dropped since their purchase. The amount he receives is tied to the size of the market's decline, as measured by one of two home price indexes (both of which are based on sales of single-family homes).
Say you buy a home in Denver for $300,000. Five years later, after Denver's home price index falls 10%, you sell it for $290,000. At closing, the company you bought the equity protection from pays you $30,000 – your original purchase price times 10%. Even if you sold your home for more than what you paid to buy it, you can still make the claim – as long as the index fell. (If the index rises, however, you can't make a claim and you're out the $6,000 you spent buying the contract.)"
Hmmm.. First off, why shouldn't this product be confused with an insurance policy? Is it not seeking to provide insurance against a decline in the price of my home? Of course it is - and if there's one thing we should have learned in the past year, it's that no one can offer this type of insurance! How will EquityLock Financial provide this insurance? They'll use their correlation matrix to determine that if only they can sell enough insurance in different areas, it will be impossible for home prices to decline all over the country at the same time? Or they will assume that since home prices have already fallen 20-odd percent, they must be near a bottom? I hope my readers are well educated enough by now to realize that this is almost exactly what brought down mortgage backed securities - the theory that things couldn't go wrong everywhere at once.
This is exactly the kind of product Barney Frank should be looking at regulating, as it's pretty apparent to me that the sellers of this insurance cannot possible hedge against their risks.
Then, I get to this story, about banks lobbying to be allowed to buy assets in the PPIP program. For your PPIP refreshers, including an explanation of why this idea would be blatantly fraudulent, check out the pieces I wrote when the PPIP was first announced. The reason the banks cannot be allowed to bid on assets sold in the PPIP is so simple that I could explain it to Maxine Waters, in fact, I already did explain it.
Today's article has an audacious claim:
"Banks may be more willing to accept a lower initial price if they and their shareholders have a meaningful opportunity to share in the upside," Norman R. Nelson, general counsel of the Clearing House Association LLC, wrote in a letter to the FDIC last month.
Ummm.. No - in reality, the banks wold be more willing to bid above the true value of the assets because the taxpayer would be eating the majority of the loss since the government is providing the majority of the capital!
So I'll have to ask Barney Frank about that one too...
Finally, there's this WaPo article about the possibility of a Value Added Tax, aka, a national sales tax. What I found interesting about this article was that there were multiple references to the unsustainability of our current budgets, but they all came to similar conclusions:
"But advocates say few other options can generate the kind of money the nation will need to avert fiscal calamity."
"Everybody who understands our long-term budget problems understands we're going to need a new source of revenue, and a VAT is an obvious candidate."
"The federal budget deficit is projected to approach $1.3 trillion next year, the highest ever except for this year, when the deficit is forecast to exceed $1.8 trillion. The Treasury is borrowing 46 cents of every dollar it spends, largely from China and other foreign creditors, who are growing increasingly uneasy about the security of their investments. Unless Congress comes up with some serious cash, expanding the nation's health-care system will only add to the problem."
Note that all these solutions mention ways to increase revenues for the government, but none of them mention the other side of the equation - CONTROL SPENDING! We can't have budgets that are only balanced when the revenues are based on bubble economies (see: California dot com bubble, then California real estate bubble, NYC Wall Street compensation bubble). In case you missed it in the article, the numbers they are talking about for VAT taxes range from 10% to 25%! I'm not a macro economist, but I'm pretty convinced that if you imposed this kind of tax on all consumption in America without drastically reducing other taxes (ie, corporate, income), it would choke our already fragile consumer to financial death.
The article also mentions the political difficulty of enacting such a tax, which is counterbalanced by the political difficulty of making spending cuts. This is especially scary for America because it's clear that any solution is politically difficult, which is why we're not solving the problem! We're kicking the can down the road by preventing pain, failures, and accounting for flawed financial models by printing new debt and new money to cover up the past losses (PONZI!). On that note, I recommend this piece from NakedCapitalism by Pension Pulse's Leo Kolivakis which looks at the inflationary risks of current fiscal policy.
I especially like this observation from Kolivakis, regarding the equilibrating tendency of deflation:
"History demonstrates that deflation is not a permanent condition. Market forces, unencumbered by fiscal and monetary intervention, eventually restore pricing equilibrium. At a certain point prices of major durables such as homes are low enough to encourage new categories of consumers to enter the marketplace. As demand is restored, prices stabilize and then resume their upward ascent. It is all a question of time. However, key decision-makers in the United States are not paragons of patience. They want deflation cured immediately, which explains why the U.S. Treasury and Federal Reserve are hell-bent on policies that are guaranteed to be inflationary. The question is how bad will inflation ultimately be."
When SnL has the best advice, you know you're in trouble: