Mish's Global Economic Trend Analysis

New Rule: Banks Exempt from New Mortgage Rules
Holy Grail of Investing
Misguided Views of Libertarian Economics and the Alternative "Regulation" Model

New Rule: Banks Exempt from New Mortgage Rules

Posted: 28 Mar 2011 06:09 PM PDT

Long awaited FDIC "skin-in-the-game" mortgage rules are out. Amusingly, banks are largely exempt from the new rules. On one hand it's hard to make this stuff up, on the other hand it seems laughably easy to believe. My ears say the proposal sounds like it came straight from "The Onion".

Please consider FDIC's plan for 'skin-in-the-game' loans

Federal regulators drafting tighter underwriting standards for mortgages are planning to exempt banks from a key rule if they sell loans to two seized mortgage-buying giants.

The long-awaited proposal is due to be publicly released by the Federal Deposit Insurance Corp. Tuesday, and the proposal was obtained ahead of that by MarketWatch. At issue is a provision in the Dodd-Frank Act that requires banks to have "skin in the game" — namely, by retaining 5% of the risk of loans they package and sell.

The goal is to eliminate what had been a problem underlying the financial crisis, where lenders packaged and sold subprime mortgages of dubious quality. But lawmakers who drafted the legislation also included a measure that would exempt certain high-standard mortgages from the risk-retention rule if their loans met certain high underwriting standards.

According to the proposal obtained by MarketWatch, loans sold to mortgage-refinance giants Fannie Mae and Freddie Mac would carry no risk-retention requirement as long as the mortgage giants remained in government conservatorship. Fannie and Freddie were both taken under conservatorship in September 2008, at the height of the financial crisis.

These loans wouldn't have to meet new strict underwriting standards for exemption set out in the proposal, but they must already meet underwriting standards that Fannie and Freddie generally require. Roughly 90% of all new loans today are sold to Fannie and Freddie.

"New Rule" Math

90% of loans are sold to Fannie and Freddie . Thus, 90% of loans will be exempt from the new rule.

90% seems like a high number and it is. However, why would banks accept any "skin-in-the-game" risk, when they can easily dump all the risk onto taxpayers via Fannie and Freddie?

Clearly, the effect of the new rule and its exemption will put upward pressure on the already astronomical percentage of loans going to Fannie and Freddie.

If the intent of this regulation is to get someone other Fannie and Freddie back in the mortgage business it will fail. If the intent of the regulation is to force more risk on banks, that will fail too.

If you are unemployed, look on the bright side. The FDIC will no doubt need to hire a few extra "regulators" to enforce this "brilliant" piece of regulation.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Holy Grail of Investing

Posted: 28 Mar 2011 12:01 PM PDT

Reader "David" wonders why he went wrong in the last two years and asked me to do an article on the "Money Trail" to help him understand why.

David writes ...

Hello Mish

I am not stupid but based on what has happened with the stock market, I certainly feel stupid. I realize that my inability to profit over the last two years was due to a lack of understanding about the money trail that the FED creates.

Have you ever thought about building a visual representation of the money trail from step 1 of the FED actually buying bonds to where that money goes and then to where that money might go?

I would think if I had a better understanding of the money trail and the money changers, maybe, just maybe, a little guy like me might be able to be more successful in investing.

There is No "Holy Grail"

Hello David. You are not asking for a "Money Trail" but rather the "Holy Grail". It does not exist, especially over short-term time horizons.

If the Fed could prevent stock market declines, the S&P 500 would never have hit 666 in the first place.

If the Japan could prevent plunges the Nikkei would not be down 75% 25 years later.

We are all Guessing

The idea that there is a "money trail" that will tell you what to do is fallacious. Discard it.

People are selling all kinds of ideas. The fact of the matter is simple: They don't know, and I don't either.

However, I can tell you with reasonable accuracy whether the market is historically overvalued or not. On that, please consider a recent pair of articles.

Negative Annualized Stock Market Returns for the Next 10 Years or Longer? It's Far More Likely Than You Think

Anatomy of Bubbles; Negative Returns for a Decade Revisited; Is Gold in a Bubble?

No One Can Possibly Know

Bear in mind that one of the best market analysts and authors I know says the Fed will "print and print and print" and the U.S. stock market bottom is in.

He may be right. However, I can assure you he will admit that he does not "know" either (and he would be the first to admit it).

No one can possibly "know". This is uncharted territory. What will China do? Congress? The ECB? The Bank of England? The Bank of Japan? How will sentiment change?

That latter question is the crucial one. Stock prices move much further and much faster on sentiment than on actual earnings. The willingness to bid PE ratios to the moon is a measure of sentiment.

PE ratios go through cycles of expansion and contraction. During expansion cycles it is difficult to do anything wrong. During major contraction cycles it is difficult to do anything right. However, there are counter-cycles. I believe we are in the mother of all counter-cycles one now.

History is certainly on my side, but no one "knows" when the current state of massive overvaluation matters.

What Country Blows Up First?

We are all guessing what major country blows up first. Many think the US and the US dollar with it. I happen to think Japan. Ironically, that means that Yen-Hedged investments in Japan are at bargain basement prices.

However, you can find any opinion you want.

I am bearish on China, others aren't. For my China outlook, please consider World's Biggest Property Bubble: China's Ghost Cities Revisited; 64 Million Vacant Properties

Tomorrow's Gold

The closest thing to a "Holy Grail" is to buy reasonably priced things totally and completely out of favor (gold and energy in 2000 are perfect examples) and hold on to them until they are fully valued. However, things can stay out of favor for decades then take decades longer to reach full value.

It is not easy to hold on! Heck it's not easy to recognize the turn in the first place. Moreover, mistakes are costly.

The best book on explaining the concept of buying things out of favor is one of my favorite books of all times and number one on my recommended reading list: Tomorrow's Gold by Marc Faber.

Unfortunately, the current state of affairs has little that one can call exceptionally undervalued. Stocks, bond yields, energy, and commodities all seem hugely overvalued and prone to a sharp pullback.

Yen-hedged Japanese equities are the closest thing to "value" that I can find. Japan is hugely out of favor and has been for decades. When or if that trade works, I have no idea.

I like gold but it is certainly not the bargain it was at $250 in 2000. Is it fully valued? The answer depends on what central banks do and how sentiment plays out. The former suggests gold can run a lot longer. The latter? I don't know. Nor does anyone else.

Sometimes the best thing to do is nothing (taking a significant portion of cash to the sidelines). I am reasonably confident that for most things, far better opportunities await those who are patient.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Misguided Views of Libertarian Economics and the Alternative "Regulation" Model

Posted: 28 Mar 2011 01:25 AM PDT

One of the brightest regulars who comments on my blog has a totally distorted view of what Libertarian economics is all about. Unfortunately, I am quite confident that her view is mainstream.

Tin Hat writes ...

Here is the core premise behind libertarian economics:

The private business sector will put ethics, morality and public employee good above profits, shareholders, bonuses, golden parachutes and CEO compensation -- IF they were completely unfettered from any government imposed rules, laws, and regulations.

And IF the private sector entity failed in its fiduciary duty to the public, Main Street would rise up and kick them out.

That's Corporatism.

Regulation Model vs. the Libertarian Model

Sorry Tin Hat but that is not what Libertarian economics is all about or stands for at all.

First let's ponder the "Regulation" Model.

The "Regulation" model assumes Barney Frank (feel free to substitute your least favorite representative) will write responsible legislation and Congress will stop taking bribes for legislation they want.

Here are some examples of what the regulation models has wrought.

The regulation model sponsored Fannie Mae and Freddie Mac.
The regulation model gave huge tax breaks written by GE for GE
The regulation model encourages flight of jobs overseas
The regulation model supports corrupt public unions that have bankrupted cities and states
The regulation model gave us the Fed and its bubble blowing policies
The regulation model gave us thousands of affordable home programs all of which drove up the price of homes
The regulation model provides hundreds of billions of dollars of student loans the effect of which is to make those graduating from school now, perpetual debt slaves.
The regulation model gave us a healthcare bill we literally "had to pass to find out what was in it" according to Nancy Pelosi. Congress did not write that bill, it was entirely written by a consortium of special interest lobbyists.

I can provide thousands of more examples of what the "regulation" model has given us.

The very best financial regulation will ever do is prevent the last crisis. However, we are not going to have another housing bubble for decades. At worst, and far more likely, new financial regulation is highly likely to sow the seeds of the next crisis.

Regulation sponsoring Moody, Fitch and the S&P did just that. So did thousands of affordable housing programs. So did the Community Reinvestment Act. So did sponsorship of Fannie Mae and Freddie Mac. So did HUD. So did thousands of financial loopholes. And most importantly so did the legislation that created the Fed and FDIC.

The legislation model has been disproved in spades yet otherwise intelligent people keep clamoring for more of it as if we could find, hire, and listen to some "all-knowing" super-regulator that can identify the next crisis in advance and write timely legislation that the likes of Barney Frank would deem wise and pass.

The idea is ludicrous given we cannot even get consensus about what to do after the housing bubble has already burst. Also bear in mind the Fed is supposed to regulate the economy. How well did that work out?

It's preposterous to believe that Congress can identify and appoint some sort of super-regulator because no such person exists in the first place.

Sure, many people identified the housing bubble in advance. I did, so did other bloggers and so did people like Elizabeth Warren.

What good did it do?

I am quite certain a huge number of bight people can identify the next crisis. Indeed they already have. Some people are calling for hyperinflation, some are calling for deflation, some are calling for stagflation, some think Japan will blow up, and others think peak oil will send oil prices to the moon. Some think printing money is a good idea, others don't.

Lots of people are going to be right because there are lots of people in every one of those camps, and one of them is guaranteed to happen. When one of them does, many people will say "I told you so".

So who do you want the Fed to believe?

I don't want the Fed to act on any of those calls because there should not be a Fed in the first place. The Fed failed as a regulator, again, and again, and again.

Libertarian Economic Model

The Libertarian model does not end all regulation. Indeed the basis of the Libertarian economic model is that we need to protect private property, prevent fraud, protect human rights, and give everyone an equal chance under the law.

Had we done that, and "just" that we would not be in this mess.

In the Libertarian model, Fannie Mae and Freddie mac would not have existed. Nor would there have been a Fed keeping interest rates too low, too long. Without the loose lending model of the Fed, and without banks being able to lend more money than they have, the housing securitization model that blew up would not have happened or if somehow it did, it would have been less problematic by orders of magnitude

In the Libertarian model, there would not have been government sponsorship of the rating agencies Moody's, Fitch, and the S&P.

In the Libertarian model the construct of "Too big to fail" does not exist. Indeed, allowing failure is one of the tenants of the Libertarian model.

Note that something like Glass-Steagall would work in the context of a Libertarian model because its purpose is to put a firewall to prevent fraud. Pollution laws would still be needed to protect private property. Child labor laws would still be needed to protect human rights. Public safety laws are fine. No one would be allowed to yell "fire" in a movie theater.

If you want to take that model and add some social safety nets, all but strict Libertarians might agree.

Failure of Regulation

All the corporatism, all the bank failures, the credit bubble, the housing bubble, and all the warmongering is a direct result "of" regulation that Libertarian economics has nothing to do with.

Indeed most of those those things could not happen in a Libertarian model. To the extent that any of them could happen, they would not occur to the same magnitude.

Libertarian Solution

The solution is to throw away all legislation except what is needed to protect private property, prevent fraud, protect human rights, and give everyone an equal chance under the law.

That means all tax breaks that favor GE as well as all tax breaks for homes, have to go. Tax code should not favor any group or thing. Drug imports from Canada would be allowed in this model and warmongering would stop. Subsidies to home builders would stop. Subsidies for ethanol would stop. In fact, subsidies for everything would stop.

Government would not be allowed to spend more than it takes in, banks would not be allowed to lend more money than they have ownership of, and the Fed would be abolished.

Instead, those in the regulation camp want to patch a million misguided pieces of legislation that should not even exist, and worst of all they expect Barney Frank to get it right.

One model has been tried and failed a million times. One model has never been tried.

Yet misguided souls want more of the model guaranteed to fail. Quite frankly it is preposterous.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

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Mish's Global Economic Trend Analysis

Mish's Global Economic Trend Analysis

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