The last, cold, short winter days of 2008 have brought precious little comfort and cheer. Almost two million people have fallen from the employment rolls this year, while the number of those too discouraged to actively seek work has grown by more than 800,000. The average workweek for hourly workers dropped to 33.5 hours, the lowest since the Bureau of Labor Statistics began keeping records in 1964. Hours worked and overtime hours dropped in nearly every industry during November, from mining to motor vehicles. The worst part is that we are nowhere near an end. The Society for Human Resource Management (SHRM) reported that significantly more servicing and manufacturing companies plan to reduce their workforces than to increase them. Recruiting difficulty has dropped significantly, with only about 10% of companies having trouble finding workers. So far, average wages have continued to increase, but less than 5% of the companies in the SHRM survey indicated that they are increasing compensation and benefits packages for new hires. An outright decline in wages seems likely early next year. Unemployment rarely peaks until economic expansion is well underway, so job losses will continue for many months to come and robust job growth could be years away. In a sign of the times, the National Football League announced plans to lay off 10% of its staff.
The Mortgage Bankers Association (MBA) released their third quarter mortgage performance data on the same day as the November employment report, and their news was just as depressing. The total mortgage delinquency rate of 6.99% was the highest on records that go back through several recessions to 1979. The percentage of loans past due more than 90 days or in foreclosure hit 5.2%, up from 4.5% in the second quarter. The subprime delinquency rate has now been above 20% for a full year. Loan modification programs have not made much difference. Comptroller of the Currency John Dugan announced this week that 53% of loans modified in the first quarter are now 30 days or more past due.
My favorite economist, Chris Low of FTN Financial, has concisely summed up the current situation. “Consumers have less money, are earning less money, can borrow less money and are worried about the future, which is always a good reason to cut back spending.” He concludes, “This is a consumer recession, and history tells us consumer recessions are much, much worse than corporate recessions” like those in 1990 and 2001.
Brighter days will eventually come. I, for one, am not ready to completely abandon belief in the time-honored adage, “Never bet against the American consumer.” A bit of good news—admittedly the only bit of good economic news lately—has been the rush of homeowners to apply to refinance their homes whenever mortgage rates head south. Generally, when mortgage rates rise, refinance applications fall; when mortgage rates fall, refinance applications increase. That’s common sense, but recently applications haven’t just increased, they have zoomed up instantly whenever rates drop. Two weeks ago, refinance applications more than doubled when mortgage rates fell from 6.50% to 5.50%. What would happen if mortgage rates were 4.50% instead of 5.50%?
A more intriguing speculation is what our economy will look like when those brighter days come. One thing is certain. Just as capitalism was never the same after the New Deal, finance will never be the same after all of this year’s federal programs, which, by the way, need a good collective name of their own. How about the No Deal, because the Federal Government will call the financial tune, leaving lenders considerably less room for maneuver.
Take automobile financing for example. And, take an old term that the business press has given a new connotation. To “have balance sheet” means to have the ability to carry an asset. An individual who withdraws $20,000 from a savings account to buy a car has balance sheet. An individual who must borrow $20,000 to buy a car, doesn’t have balance sheet. Of course, whenever a car is purchased or leased someone has to have balance sheet because the money has to come from somewhere. A hundred years ago, when Henry Ford sold Model Ts in any color you wanted as long as it was black, almost all car buyers were individuals who had balance sheet. Ford’s whole idea was to build a car that the average working family could afford. As car prices rose after the World War II, banks, finance companies, and the automobile companies’ captive financing arms provided the balance sheet. In truth, though, only the banks had real balance sheet; the others had to borrow money to finance the individual car buyers. The car companies often issued a type of bond called asset-backed securities or ABS, which are securitized pools of car loans. ABS are divided into classes, with the lower-rated classes absorbing losses and the protected higher-rated classes receiving lower yields. This year, the automobile financing subsidiaries lost balance sheet as the market for their ABS evaporated. A short-term government bailout isn’t going to solve that problem.
What might induce the markets to start buying automobile ABS again is some type of government guarantee, not on the whole ABS structure, but perhaps on the bottom 10% or so. Why would the government do this? Because it will have a vital interest in the companies. No matter the final terms of the bailout, the government will have taxpayer money at risk and management control through the “car czar”. The car companies will be told, “You can make any sort of vehicles you like as long as they meet strict mandated fuel efficiency and emissions standards.” The central premise that the car companies, and by extension manufacturers in general, can simply respond to customer demand will be permanently altered. The government will make its mandate stick not only by legislation, but by the greater and more direct power of controlling the companies’ ability to finance themselves.
Mortgage finance will be changed too, but it starts from the opposite end of the spectrum. Since late summer 2007, private mortgage securitization has been dead, and the longer something is dead, the more it tends to stay dead. Today the only effective mortgage securitizers are the government-owned Ginnie Mae and the government-controlled Fannie Mae and Freddie Mac. This is a makeshift situation that can’t last permanently; that is, the federal government can’t permanently guarantee all the mortgage debt outstanding in the entire country. The quasi-public, quasi-private hybrid model of the old Fannie Mae and Freddie Mac can’t be resurrected, so something new will have to be invented. My guess is that the new model for Fannie and Freddie will look something like the Federal Home Loan Bank System. Members of the Fannie/Freddie “system” will be the financial institutions that make and sell mortgages. These members will own the system, buying stock proportionately to their usage of services. But even a revamped Fannie and Freddie will require some backstop government debt guarantee, which would allow the government significant control.
The government is already showing its hand, as the following news article attests: “Dec. 10 (Bloomberg) -- Fannie Mae and Freddie Mac, the mortgage-finance companies seized by the U.S. government, are considering waiving a requirement for new appraisals on refinanced loans, their regulator said. ‘If they refinance someone, rather than doing a loan mod, do they need a new appraisal if they already have the credit?’ Federal Housing Finance Agency Director James Lockhart told reporters after a speech in Washington today. ‘That’s an issue that’s being discussed. They’re looking at it.’”
As any lender knows, you have to get a new appraisal on property you intend to refinance to determine if the property still has sufficient value. Clearly, the abandonment of this fundamental underwriting practice is not something that the professional managers at Fannie and Freddie just happened to think up. Their government masters are pushing it as a way to lower mortgage costs for existing mortgage holders. This may or my not be good public policy, but it is certainly not prudent lending. It shows how government may exercise its new power over lenders.
Similarly, the Treasury announced that, in conjunction with banking regulators, it will monitor how each bank is spending Troubled Assets Relief Program (TARP) funds received from the government. The Senate unanimously passed a bill giving the TARP inspector general the authority to investigate any use of TARP funds he deems questionable. These actions came in response to a call by the Government Accountability Office for formal internal controls to ensure that TARP funds are used in accordance with the government’s intent.
The government’s new power over the financial world can also be exercised indirectly. Chicago’s Republic Windows & Doors factory was forced to shut down when Bank of America refused to extend additional credit. Outraged workers refused to leave their factory and hoisted picket signs reading: “Bank of America: You Got Bailed Out. We Got Sold Out.” After a few days, Bank of America caved in, a provided $1.35 million to Republic in what is essentially a gift of the workers their severance and vacation pay.
None of this is bad, it’s just different. All large scale changes produce unintended consequences. This is an iron law. The changes currently being imposed on the financial system are enormous and necessary. Without massive government intervention, it’s terrifying but true that the system would have collapsed. A new system is evolving, whose first faint glimmers we are just beginning to discern.