Mass Layoffs Soar

Reuters is reporting Lay-offs surge 85 pct in Aug vs July.

Planned U.S. lay-offs rocketed in August as the housing slowdown and subprime mortgage debacle led to record job cuts in the financial sector, an independent report showed on Wednesday.

Announced lay-offs surged 85 percent to 79,459 in August from 42,897 in July, according to Challenger, Gray & Christmas Inc, an employment consulting firm. August's job cuts were the highest since February, when they totaled 84,014.

"Nearly half of the August cuts came from the financial sector, as dozens of mortgage and subprime lenders caved under the pressure of a sinking housing market," Challenger, Gray & Christmas said in a statement.

Financial job cuts totaled 35,752 in August, the highest monthly total for the industry since Challenger, Gray & Christmas began tracking in 1993, the firm said.

One of the most spectacular collapses occurred when Melville, New York-based American Home Mortgage Investment Corp., which had been the No. 10 U.S. mortgage lender, filed for bankruptcy in early August and fired nearly all of its work force.

Temporary Employment Trends

There were many excellent charts on employment trends in the latest Contrary Investor Market Observations.

As you’ve probably heard in consensus commentary lately, many a pundit has stated, “there isn’t going to be a recession as long as unemployment is low and payroll growth continues”. .... If you don’t believe trouble in mortgage credit markets will impact consumer spending quite negatively, maybe trouble in payroll employment will do the trick.

The first stop on this journey is the very meaningful correlation between temp employment numbers and headline payroll trends. THE major importance of this relationship is that temp employment trends lead the headline payroll employment numbers and rate of change trends. History is more than clear on the subject. Have a look.



... As you can see in the chart above, over the last few months, the year over year change in temp employment has gone negative.

Another lead/lag indicator for headline payroll trends just happens to be the trend in the household survey of payroll employment. For those unaware, each month the BLS (Bureau of Labor Stats) really conducts two payroll employment studies. One is the headline (as reported in the financial press) report whereby the BLS seasonally adjusts data and estimates new business formations and hiring. Since the headline payroll report is really based quantitatively on payroll tax records, and new businesses file these with a lag, the BLS employs the infamous birth/death model to come up with the headline number by estimating jobs already created for which payroll tax records have not yet been received. The second survey, if you will, is the household survey whereby the BLS literally polls folks on the phone. As such, this survey picks up new business formation and hiring trends before the institutional headline report. For now, the year over year rate of change in the household survey is below that of the headline, implying more headline payroll experience downside to come. ....



As a brief tangent, through July, headline payroll growth in the US has totaled 955 thousand new jobs. Not bad. But of this, 773 thousand of these newly created jobs are as a result of birth/death model estimates – 81% of the total.

The B/D model is consistently strong during the February through June period each year. After that, its influence trails off rather markedly, with the exception of August. On an average seasonal basis, the B/D estimation tailwind is about to subside in a big way over the second half of this year. In conjunction with a slow economy of the moment, and the fact that so many indicators we discussed above continue to point south for forward payroll growth, is the headline payroll report headed for tough sledding in the second half of the year if indeed the prior first half strength in estimated job creation subsides? We expect as much.

On September 2 I talked about much the same thing in Implode-O-Meter Stats vs. the BLS. Here is the pertinent chart:



(click on chart for a sharper image)

Private Sector Employment Slowest In Four Years

MarketWatch is reporting U.S. hiring slowest in four years, ADP says.

Private payrolls grew by 38,000 in August, following a 41,000 gain in July, ADP said. "A deceleration of employment may be under way," the company said in a release. The report suggests nonfarm payrolls may have grown much less in August than the 120,000 anticipated by economists.

The slowdown in hiring was not related to last month's credit market turmoil, said Joel Prakken, chief economist for Macroeconomic Advisers, which computes the index for ADP. Rather, the slower pace of hiring largely reflects the lagged impact of slower economic growth over the past year, he said.

Some other employment indicators for August also have been weak. Jobless claims rose in August, while fewer consumers said jobs were plentiful in the consumer confidence survey.

"All of this points to an August payroll figure, which is lackluster at best," wrote Josh Shapiro, chief economist for MFR Inc.

Adding in some 27,000 government jobs not covered by the ADP report, the report suggests the government's figures on nonfarm payrolls probably grew by about 65,000, which would be the smallest payroll growth in nearly three years.

After a few big misses compared with the Labor Department figures in its first few months, the methodology for the ADP report has been tweaked and the sample size increased.

The ADP report is crafted from anonymous payroll data culled from about 383,000 payrolls representing 23 million workers. The sample is matched to the Labor Department's sample of 160,000 businesses and government offices at about 400,000 work sites.

ADP is the one of the largest payroll providers in the world, with more than 570,000 business clients worldwide.

Here is the key idea from the above article: "The slowdown in hiring was not related to last month's credit market turmoil"

The next five month will show us just how strong (or weak) employment is. It will be especially interesting watching the next few sets of birth/death numbers from the BLS. One of these months there is going to be a massive "unexpected" downward jobs revision. More than likely that will be used as an excuse by the Fed to cut (or further cut) rates. It won't help.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Still More Ideas To Fix Housing

I keep wondering when absurd housing proposals are going to stop. As of right now it appears the list is endless.

I started compiling a list in Absurd Housing Bailout Proposals :

• Bill Gross started things off when he proposed to Bush "Write some checks, bail ‘em out, prevent a destructive housing deflation that Ben Bernanke is unable to do." Please see Bill Gross Wants PIMCO Bailout and A Gross Challenge for more details.
• Bernanke soon followed with his Congressional Bailout proposal as outlined in Bernanke Proves he is a Complete Fool.
• Barack Obama proposed a bailout proposal that is best described as from "Outer Space". I talked about Obama's proposal in ARM Interest Rates Jump Most on Record.
• This was followed by Bush's proposal to bailout lenders as outlined in Bush Moves to Aid Lenders.
• That was followed by a "Twilight Zone" proposal from Steven Pearlstein at the Washington Post as outlined in Forestalling Foreclosures.

Well here is yet another one for the list with the Fed Urging Loan Holders to Avoid Defaults.

The Federal Reserve and other banking regulators issued special guidance Tuesday urging loan service companies to work with borrowers in danger of defaulting on their home mortgages. Sheila Bair, chairman of the Federal Deposit Insurance Corp., said that mortgage collectors have the authority under existing accounting and tax rules to help deserving borrowers.

"More and more consumers with subprime and hybrid mortgage products are facing the very real prospect of losing their homes through foreclosure as their payments reset and become unaffordable," she said in a statement. "It is vital that mortgage servicers work proactively with borrowers facing much higher payments as their interest rates reset."

The guidelines were aimed at addressing the fact that in many cases the company in charge of collecting monthly mortgage payments is not the same company that originated the loan.

Question of Authority

Since when do service providers have the authority to reduce interest rates, allow delayed payments, or change loan terms in any way?

Just to be sure the Fed was not misquoted, please take a look this September 4th 2007 joint press release entitled Statement on Loss Mitigation Strategies for Servicers of Residential Mortgages.

The keyword in that press release on loss mitigation is of course "servicers". But let's take a look inside. The Bolding below is mine.

The federal financial regulatory agencies and the Conference of State Bank Supervisors (CSBS) on Tuesday issued a statement encouraging federally regulated financial institutions and state-supervised entities that service securitized residential mortgages to review to determine the full extent of their authority under pooling and servicing agreements to identify borrowers at risk of default and pursue appropriate loss mitigation strategies designed to preserve homeownership.

Appropriate loss mitigation strategies may include, for example, loan modifications, deferral of payments, or a reduction of principal. In addition, institutions should consider referring appropriate borrowers to qualified homeownership counseling services that may be able to work with all parties to avoid unnecessary foreclosures.

Service providers generally get paid to service loans not make decisions. Yes they do have a stake in the matter, as the longer they service the loan the more they collect. But that typically is the extent of the contract because of obvious conflict of interest issues that would arise if the servicer could change the terms of the loan just to keep servicing it.

Real Word Example

Some random bank, big or small, makes a mortgage commitment. More often than not the loan is securitized (sold to investors like pension plans, foreign investors, life insurance companies etc). The originator may or may not service the loan but most often not. Typically the servicing is outsourced to an additional party. That party may again outsource it to someone else.

Now the Fed is proposing some second, third or even fourth removed party that services the loan, make "loan modifications, defer payments, or a reduce principal".

The idea is silly given the fact that the servicer may not have the slightest idea as to who owns the loan and likely has no ability (and should have no ability) to modify the terms of the loan because of conflict of interest issues.

Is the Fed really this clueless?

There was a great rant by Prof. Fil Zucchi on Minyanville this morning called When will they stop kidding themselves?

When will they stop kidding themselves?

If I hear one more time that the Fed needs to move because the housing market is crashing - and it is - my head is going to explode. People are not buying homes because:

1. Everyone with a pulse bought one or more homes during the bubble.
2. Everyone with a pulse bought one or more homes during the bubble.
3. Everyone with a pulse bought one or more homes during the bubble.

The "demographics and employment" arguments are a farce. I've quoted this stat too many times: 85% of individuals with income above the median already owned a home as of the middle of last year; the U.S. fertility rate is 2.02, which means that new births are barely replacing deaths; and if one wants to roll the dice on the veracity of the employment or inflation figures, then I suppose that one will also believe that the subprime mortgage problem is well contained - because the sources of both data are the same.

The Fed can lower rates to zero and the same people who could not afford their house for the last three years are still not going to be able to afford it ; the newly coined droves of "real estate investors" - the reason for the insanity we witnessed - are out of the picture, and they are not coming back.

More than a year ago everyone knew exactly the "movie" they were watching but it was much more fun to envision a different ending. Well, surprise: the end is here and it looks like the end of all other bubbles - only this one is way bigger.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Fed Blamed for Asset Price Inaction

Bloomberg is reporting Fed Blamed for Asset-Price Inaction.

Federal Reserve officials, wrestling with a housing recession that jeopardizes U.S. growth, got an earful from critics at a weekend retreat arguing they should use regulation and interest rates to prevent asset-price bubbles.

Otmar Issing, former chief economist at the European Central Bank, and Stanley Fischer, head of the Bank of Israel, were among guests at the Fed's summer symposium in Jackson Hole, Wyoming, to challenge the hands-off approach. Fed Governor Frederic Mishkin reiterated his view in a paper at the conference: Officials should only respond to the effects of asset prices on the outlook for economic growth and inflation.

"The position that `this isn't an issue for central banks' has lost some support,'' Issing said in an interview at the gathering, which ran from Aug. 30 to Sept. 1. "The tide is turning.''

The criticism -- one academic paper gave the Fed an `F' for its handling of housing -- may spur policy makers to strengthen regulation of lending practices that helped fuel the three-year mortgage boom that's now unraveling. Chairman Ben S. Bernanke, 53, has promised to draft new rules by year-end.

[Mish Comment: Just what we need ... New rules by someone as clueless as Bernanke. For more on this idea please see Bernanke Proves he is a Complete Fool]

By cutting rates to a four-decade low in 2003, the Fed inflated property values, Ed Leamer, head of an economic forecasting group at the University of California at Los Angeles, said at the conference. The ensuing housing slump, the worst since 1991, and the credit-market turmoil that followed, threaten to undo the six-year economic expansion.

"Central banks, probably on more occasions than they would like to admit, should respond to asset-price bubbles," said Fischer, who taught economics at the Massachusetts Institute of Technology when Mishkin, 56, and Bernanke worked on doctorates there in the 1970s. Fischer, 63, also served as deputy managing director of the International Monetary Fund.

The Fed had its supporters. Allan Meltzer, author of a history of the central bank, said "regulation induces innovation to offset regulations" and endorsed the "market discipline" approach.

"There's reason to doubt that central banks can in fact identify bubbles accurately," added Meltzer, a professor at Carnegie Mellon University in Pittsburgh.

Light Touch

Bernanke first appeared at Jackson Hole in 1999 with a paper arguing that central banks shouldn't target asset prices except when they affect the economy. Mishkin, who has collaborated on research with Bernanke, said much the same in his paper: Policy makers should respond to housing swings ``only to the extent that they have foreseeable effects on inflation and employment.''

Mishkin's argument provoked a challenge from William White, head of the monetary and economics department at the Bank for International Settlements, who said the Fed should indeed "lean" against asset prices when they start to climb.

"Rick is basically saying, `We can't lean, but we can clean up,'" White said, referring to Mishkin by name and raising his voice to make his point. "I think we can make equally strong arguments for `You can lean and you may not be able to clean up.'"

The Crux of the Matter

• Miskin is the problem.
• Bernanke is the problem.
• The Fed is the problem.
• Central bankers in general are the problem.
  

Why is it that Miskin, Meltzer and other Fed apologists say the Fed cannot foresee asset bubbles while believing the Fed has magic powers in regards to price inflation, interest rates, derivatives, housing, education, peak oil, productivity, capacity utilization, and a dozen other things the Fed offers opinions on?

The plain fact of the matter is the Fed is the Fed has never in history met a bubble it did not embrace. Greenspan talked of irrational exuberance in 1994 but by 1999 was caught up in his own ideology and fully embraced the "productivity miracle" right at the tip of the bubble. Greenspan yet again, at the very bottom in interest rates embraced ARMs.

Meltzer: "There's reason to doubt that central banks can in fact identify bubbles accurately". Reason to doubt? What doubt is there? There is absolutely no doubt about the Fed's inability to identify bubbles correctly. Nonetheless Meltzer used that half-baked logic as a reason to support the Fed. The real question is "Can the Fed identify anything accurately?"

History suggests otherwise. This is yet another reason on the growing list of reasons the Fed should be abolished. Instead we see clear deficiencies of the Fed are being used as arguments in support of the Fed. Orwell would be proud.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Collateral Crunch

Jeff Saut in Housing Making You "Homesick"? is proposing we are not in a "credit crunch" but a "collateral crunch"

For the last few years I have argued that the housing situation was likely going to get worse. I also roiled against the increasingly complex “fancy financing” vehicles that allowed many home buyers to “lever” into homes they really could not afford. Still, the housing/financing bubbles continued to expand driven by the mantra, “you can’t lose money in real estate.” As with all bubbles, however, this one too has burst.

Nevertheless, I have opined that historically real estate has never pulled the economy into recession since it is an “effect” and not a “cause.” For example, in the early 1970s I moved to Atlanta and considered buying a $200,000 condominium. By 1975 that same condo was selling at bankruptcy auction for under $30,000. What happened? Well the “cause” was a rise in the price of crude oil with a concurrent rise in interest rates. The “effect” was a crash in real estate prices accompanied by a severe recession. Therefore, to think that real estate is going to pull the country into a recession one has to believe real estate has become so entwined in the economic fabric of the country that it has morphed from an “effect” into a “cause.”

In fact, according to some econometric models the odds of a recession are currently more than 50%. Plainly the country’s intelligentsia is worried as the Federal Reserve cut the discount rate a few weeks ago and took some pretty unusual “collateral” steps to help shore up the asset-backed commercial paper market (ABCP).

Those measures were designed to grease the rusty wheels of the credit system and allow the major banks to increase the amount of capital they can lend to the broker-dealer (B/D) complex, which is where much of the problem resides since the securitization of loans has transferred the risk from the banks to the B/Ds, hedge funds, etc. Interestingly, however, there has been only a token amount of borrowing at the discount window, suggesting that the banks seem to be more willing to tighten credit than to open the “money spigot.”

Such actions have raised cries of a credit crunch; however, I have argued that it is more of a “collateral crunch” than a real credit crunch. Verily, I have lived through credit crunches and by my pencil we are not yet in a true credit crunch. A credit crunch is when the banks quit lending money. So far, people with good credit can still get a conventional mortgage or loan just as easily as they could two years ago.

The risk is that the contagion spreads and morphs the collateral crunch into a full-blown credit crunch.

...

So why is everyone so worried? Well, in addition to the recent seizing up of the ABCP market, which comprises 50% of the over $2 trln commercial paper market, this housing cycle looks different than any I have seen. To this point, I have included two charts. I suggest studying them carefully. What you find is that the 1988–1992 housing cycle peaked in the first quarter of 1988 (1Q88) followed by a decline in “For Sale Inventories” until the cycle troughs in the 4Q '91 (some 15 quarters later, which is typical).

Housing Inventory 1988-1992 vs. 2004-Present



Housing Vacancy Rates 1968-2007



A final observation: “Curiouser and curiouser,” cried Alice as she followed the rabbit down the hole... and in addition to the curiouser and curiouser action of T-bills, whose yield recently collapsed by an unprecedented weekly amount totally unconfirmed by a similar decline in the LIBOR rate, for the first time I can recall in nearly 40 years of looking, the Fed’s “free reserves” reading was negative (-499) last week as seen in Barron’s “Market Laboratory” on page M65.

Leasing Terms

In regards to Jeff Saut's observation "So far, people with good credit can still get a conventional mortgage or loan just as easily as they could two years ago." I heard a similar observation from a neighbor two houses away in regards to commercial leasing just this morning. I was out watering my lawn and my neighbor just finished his morning jog.

My neighbor works for the Royal Bank of Scotland, one of the largest banks in the whole world. In spite of a credit crunch, spreads on corporate leasing deals have collapsed. A couple of years ago deals were 400 basis points over cost of money, and although the RBS can obtain funds cheaper than most US banks and certainly lower than most US leasing corporations such as General Electric (GE), RBS just lost a corporate jet leasing bid to GE that went at 47 basis points over cost of funds. If anything goes wrong with that deal it will be a money loser.

What has driven leasing spreads lower as spreads elsewhere are rising? It turns out that the number of corporations with good credit is not only shrinking, but the number of deals they want to do is shrinking as well. Competition is intense for new corporate leasing deals for customers with excellent credit.

And also in the “curiouser and curiouser”, department although GE "won " the bid, it was a larger piece of the pie than they wanted for from that particular customer. RBS was offered half the deal.

GE Weekly Chart



For now, the uptrend is still intact.

So, no problem yet borrowing money or getting good lease terms if your credit rating is top notch, but in regards to leasing there is little profit in the deals. And in regards to both mortgages and leasing, there is a dearth of customers with good credit risks that want to borrow.

And regardless of whether or not one calls this a collateral crunch or a credit crunch, (I think the former term works just fine given a Sudden Demand For Cash in many places) evidence continues to mount that profits from financing and financial services have peaked.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Hiring Machine is Idle

MarketWatch is reporting Wall Street hiring machine goes idle.

After years of buildup, employment levels flatten and cuts loom. The turbulent environment for stocks and bonds has stalled another booming market: the one for jobs on Wall Street.

Hiring has slowed or seized up at many firms including Lehman Brothers Holdings Inc. (LEH) and Citigroup Inc.(C) where 17,000 job cuts were announced in the spring. And more layoffs loom in many areas in the investment- banking industry in the wake of the August credit crunch, particularly in businesses such as credit trading and structured products, analysts and job recruiters predict.

"Substantial losses from this credit debacle are unquestionable," said Sean Springer, chief executive of Napier Scott Executive Search Ltd., a London-based firm that helps banks, hedge funds and law firms track down talent in debt, credit, currency and emerging markets. "If investment banks hire when their profits increase, it's fair to assume the reverse is true when they suffer unforeseen losses."

Investment banks have already started cutting jobs and some firms have imposed hiring or headcount freezes, said Springer. U.S. banks usually stop hiring towards the end of the year, in late September or October, he explained. But this year, some stopped in August, he said.

Now that housing is dead I keep asking "what is the next big source of jobs?" No one has yet come up with an answer.

It clearly is not Wall Street, financials, credit card growth, consumer spending, retail, commercial loans, leveraged buyouts, or capital spending. Whatever it is (if it is indeed anything at all) can it possibly make up for expected declines in housing, financials, credit card growth, consumer spending, retail, commercial loans, and capital spending?

Health care has been strong. But can it make up for declines in all the other areas? It does not take a genius to figure out the answer to that question is no. We all can't get rich off Medicaid and Medicare can we?

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Implode-O-Meter Stats vs. the BLS

Lost in the turmoil of credit cards, derivatives, commercial paper, and Fed manipulations on options expiration days, etc are the latest jobs numbers.

MarketWatch is reporting Initial jobless claims highest since mid-April.

First-time claims for state unemployment benefits crept up in the latest week, hitting a high last seen in mid-April and signaling some weakening in the nation's labor market.

Including a revision to the prior week's claims data, initial claims have now risen for five straight weeks, according to a report from the Labor Department issued Thursday.

Claims for the week ended Aug. 25 rose by 9,000 to 334,000, the highest since April 14. Meanwhile, the four-week average of those claims climbed by 6,250. At 324,500, it was the highest reading since April 28.

The four-week average smoothes out distortions in the data caused by one-time events such as strikes or holidays. Economists say initial claims in a range of about 300,000 to 325,000 are consistent with the creation of about 100,000 to 150,000 jobs in the U.S. economy each month.

"The underlying pressure on claims may well be turning upwards," wrote Ian Shepherdson, chief U.S. economist for High Frequency Economics.

Unemployment has Bottomed

Like it or not, unless there are mammoth manipulations in the participation rate, unemployment has bottomed. On August 21 Reuters reported Financial job cuts soar on housing woes.

A deepening U.S. housing slump has caused an alarming surge in job losses at U.S. financial services companies, and the end is nowhere in sight, consulting firm Challenger, Gray & Christmas Inc. said on Tuesday.

The industry has announced 87,962 job cuts so far this year, 75 percent more than the 50,327 recorded for all of 2006, Challenger said. Nearly one-fourth of this year's cuts have been announced in August alone.

Of this year's cuts, 35,830, or 41 percent, were tied to housing market troubles, including riskier subprime mortgages. Job cuts by real estate and construction firms totaled 21,620, more than twice the number for all of 2006, Challenger said.

"Many companies expected the mortgage situation to implode; they've just been wondering when the bubble would burst," Chief Executive John Challenger said in an interview. "But many are stopping on a dime, shutting down operations.

"Companies are not surprised by what's happening, but the reality of the situation and the speed with which it occurred is shocking," Challenger added. He said it could be months before housing-related job cuts peak.

April has been the year's busiest month for financial job cuts, Challenger said. That month, companies announced 33,789 cuts, including 17,000 by Citigroup Inc and 3,200 by bankrupt mortgage lender New Century Financial Corp.

Meanwhile, home foreclosure filings in July surged 93 percent from a year earlier and rose 9 percent from June, to 179,599, according to a Tuesday report by research firm RealtyTrac.

John Challenger said it's understandable for mortgage workers to feel whipsawed. Countrywide, for example, cut 500 jobs last week after having added 6,931 jobs from January to July, with increases in every calendar month.

"It's devastating (for morale)," he said. "It's hard to keep morale up, given the boom-bust nature of the mortgage sector."

Birth / Death Model Flashback

A new monthly jobs report will be coming out soon, but let's take another look at the previous Birth Death Model adjustments. Here is the table:

(click on chart for a sharper image)



I talked about construction jobs in Fed questions the BLS jobs model and Employment on Pluto Rises but now it's high time we start seriously questioning a model that assumes new businesses are actually adding jobs in the financial services sector.

Implode-O-Meter Stats vs. the BLS

A quick check on the Mortgage Lender Implode-O-Meter shows that 145 major US mortgage lenders have gone out of business or stopped making certain loans since December 2006.

Perhaps Aaron Krowne at Implode-O-Meter can give an official count on this, but recollection serves that over 100+- of those lenders stopped lending one way or another sometime in 2007.

Meanwhile back at the BLS, I see the stats show more jobs in financial services are assumed to be created by new businesses as opposed to being lost by firms going out of business for the months of....

• February - 11,000
  
• March - 8,000
  
• April - 26,000
  
• May - 7,000
  
• June - 6,000
  
• July - 6,000
  

Gosh. That's quite an achievement by the BLS Birth / Death Model is it not? Are bankruptcy counseling services growing faster than mortgage lenders and originators are going bust? I doubt it, especially if one adds in all the small 2-5 person mortgage origination businesses that are now out of business as well.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

List of Absurd Housing Bailout Proposals

How can seemingly bright people keep proposing absurd bailout plans one right after another after another after another?

That is the question on my mind today as still another absurd proposal comes rolling in. The latest is from Steven Pearlstein at the Washington Post. Before we get to his proposal, let's quickly list the proposals to date.

This started with Bill Gross who I am sure is extremely intelligent but still managed to propose to Bush "Write some checks, bail ‘em out, prevent a destructive housing deflation that Ben Bernanke is unable to do." I talked about this in Bill Gross Wants PIMCO Bailout and again in A Gross Challenge.

Bernanke soon followed with his Congressional Bailout proposal as outlined in Bernanke Proves he is a Complete Fool. I am sure with his PhD he is actually a brilliant man, but nonetheless his proposal is complete foolishness.

Barack Obama who is both very intelligent and extremely articulate offered a bailout proposal that is best described as from "Outer Space". I talked about his proposal in ARM Interest Rates Jump Most on Record.

This was followed by Bush's proposal to bailout lenders as outlined in Bush Moves to Aid Lenders. Bush at least has an excuse. No one has ever accused him of being bright.

The latest bailout proposal comes from Steven Pearlstein at the Washington Post as outlined in Forestalling Foreclosures.

[Existing] initiatives, including the plan to be announced today by the Bush administration, have been pretty much limited to modest expansion of existing state and federal programs to help the easiest cases -- those in a position to refinance loans on a sustainable basis.

But even if the majority of problem loans can be refinanced or renegotiated, which is what some officials now believe, that would still mean that hundreds of thousands of families will be forced from their homes and hundreds of thousands of properties will be dumped on an already glutted real estate market.

So I offer here a market-based proposal to deal with the hardest cases -- those in which homeowners find themselves with no equity in the house and incomes so low they cannot possibly sustain their current level of mortgage debt.

The Pearlstein workout process starts where things should have started in the first place -- with the household income of the borrower. Using standard formulas, figure out how much they can afford to pay each month toward interest and principal on a fixed-rate, 40-year mortgage. Then, adjusting for credit score, calculate how large of a mortgage those payments can support.

The size of this new mortgage will be smaller than the old one (otherwise, a simple refinancing would have been possible). The difference between the old amount and the new would define the extent of the problem, the financial gap that now needs to be closed.

.....

But while this is a market solution, it is not one that the market is likely to serve up without the intervention of Fan and Fred. No other entities have the knowledge or the market influence to set the standards for the new instruments or the resources to create a liquid market for them. It is what they were invented for and what they do better than anyone else.

But the companies probably couldn't launch such an initiative without the approval and encouragement of the Bush administration, which hasn't come up with any better ideas but somehow still can't seem to get past its free-market hangups about government-sponsored enterprises.

So, over this Labor Day weekend, when you hear the president or Treasury secretary or their fellow travelers at the Federal Reserve declare they are doing everything they can to deal with the mortgage crisis, remember the old Gershwin song: It ain't necessarily so.

I am actually stunned by the above proposal. For starters Pearlstein claims to have a "market solution" that the market is "unlikely to serve up without the intervention of Fan and Fred".

Excuse me, but if it takes intervention, how the heck can it possibly be called a "market solution"? As for Fannie Mae and Freddie Mac, they were NOT a "Market Idea" in the first place but rather a misguided proposal by Congress to make housing more affordable.

There have been some 300+ government initiatives to make housing more affordable and every one of them failed including Fannie Mae and Freddie Mac. The reason they failed is because by promoting housing with tax breaks, cheap loans, the ownership society, etc etc home prices are bound to rise. And rise they did until a blowoff top was reached which is exactly where we are now.

Who Owns the Mortgage?

Let's start with a simple construct. Many of those in trouble have subprime mortgages not owned by either Fannie Mae or Freddie Mac. In fact it might be next to impossible to decide who owns them to see if the lenders are willing to renegotiate the terms of the loan.

Collateralized loans were sliced and diced into tranches, further pooled and sliced again into "CDOs squared" with some investors buying a single tranche and others buying a slice of all tranches. Roughly 18-20% of those debt packages to foreign investors, 18-20% going to pension plans, 18-20% of it going to life insurance companies, and 18-20% of it going to hedge funds (some of which are now bankrupt). I defy anyone to straighten that all out.

To top it off, Fannie Mae cannot state earnings for three years yet a claim is made "No other entities have the knowledge or the market influence to set the standards for the new instruments or the resources to create a liquid market for them. It is what they were invented for and what they do better than anyone else."

Wow! The fact that no one is better than Fannie Mae is either shocking or scary depending on how one looks at it. Nonetheless, let's assume a miracle occurs. Let's assume the complete derivatives mess is untangled immediately (both at Fannie Mae and everywhere else in the universe) and all parties in the mess agree to implement Pearlstein's solution. That's quite an assumption is it not? But I am a known optimist willing to assume nearly anything for the sake of an argument. Are we out of the woods yet?

The Pearlstein Formula

"Using standard formulas, figure out how much they can afford to pay each month toward interest and principal on a fixed-rate, 40-year mortgage. Then, adjusting for credit score, calculate how large of a mortgage those payments can support.

The size of this new mortgage will be smaller than the old one (otherwise, a simple refinancing would have been possible). The difference between the old amount and the new would define the extent of the problem, the financial gap that now needs to be closed."

Under this proposal a person making $25,000 who took out a liar loan on a $500,000 home would only have to make payments based on a $25,000 salary. Brilliant! The bigger the lie, the bigger the reward. No doubt Pearlstein wants to change his proposal already to exclude liar loans. So I will let him. Liar loans are deemed excluded.

But what about the person who decides to lose his job to take advantage of the process? Certainly if one does not have a job one cannot afford to pay a dime. Handling this "properly" requires still more government intervention to decide who can afford to pay what and who is losing a job on purpose.

And what about the obvious drawbacks of discouraging someone from seeking higher paying jobs, working overtime etc etc out of fear of being bumped into a "you can afford a bigger mortgage payment" bucket.

Is there a monitoring agency that keeps track of job status, kids, health, etc etc etc to decide whether or not a mortgage can be adjusted and/or if someone should be working overtime to pay off the original mortgage?

And what happens on a home sale where a guy making payments on a $500,000 home, now worth $250,000 but is making payments based on a $25,000 salary? Untangle that for me.

Which finally leads us to the guy that just says "screw this"! Are there going to be laws preventing someone from moving away? And so on and so forth.

Those are just the easily seen problems. On second thought, those are the problems that should be easily seen by any intelligent person. Yet I see now that they are not easily seen. And what about the unseen consequences of such proposed intervention?

If Obama's proposal was from outer space, then Pearlstein's proposal is perhaps best described as being from the Twilight Zone.

So why do seemingly bright people (obviously excluding Bush) keep proposing absurd bailout plans one right after another after another? It can't be to make the "Mish List of Absurd Housing Bailout Proposals" can it?

Why then is it so hard to simply let the market correct itself?

Questions for Steven Pearlstein

I am really curious. My questions are:

• How can you possibly label "intervention of Fan and Fred" a "Market Solution"?
• Why is it that when it should be perfectly obvious the Fed, Congress, and Fannie Mae etc caused this problem that the proposed solution (yours and others) is still more intervention by the Fed, Congress, and Fannie Mae?

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/