The Fed’s cut to “zero to 0.25%” cost of money and non-response in the mortgage markets combined to produce consternation among a refinance-hungry public.

Excepting a frantic hour at no-fee 4.75% on Wednesday morning, mortgage rates remain as they have been for ten days, roughly 5.00% with an inescapable origination fee. And that deal is available only for the best FICOs and loan-to-values.

These rates are not going lower any time soon, not on a sustained basis, not without extraordinary intervention by the Obamanauts. Miracles are rare.

The average client simply does not believe the paragraphs above. If we were not lifers in the mortgage trade, we wouldn’t believe them, either.

In the last month, irresponsible media reports, wishful expectation by housing industry survivors, and trial balloons by non-market theorists have made FOUR-AND-A-HALF a national imaginary fact.

Why are rates stuck? The main roadblock is the $10 trillion in outstanding first mortgages, rates scattered from mid-sixes to 5.25%. Toss out the ones that can’t refi (Jumbos, underwater vs. appraisal, clogged by piggy-back 2nd, stated-income or no-doc underwriting...), and the ARMs that no longer need to hurry -- $6 trillion, anyway. The first trillion, above 6.00%, everybody who bought from ’04 to ’08, is in the money right now, eligible to refi with quick recapture of costs. That volume is equivalent to the total production capacity of the mortgage industry in 2008, severely diminished since the September financial cardiac arrest.

But, refis are just rollovers, not new money...? The current owner of a 6.00% mortgage-backed security may have little interest in 5.00% or 4.50%. The last people who bought those, in ’03, lost money every day since. Worse, the financial system is still “deleveraging”, trying to sell IOUs, not buy.

But, if money doesn’t cost anything...? The Fed is acting in an emergency. It will not last forever. When it ends, rates will rise, explosively from time to time. The zero-cost money is overnight money, and it’s a bad idea to finance a 30-year loan with overnight money. Long-term Treasury rates are also approaching zero, the spread versus mortgages unbelievable. The Treasury market is the most liquid in the world; when the economy bottoms, today’s Treasury investors-for-safety will be able to dump at little loss. Even top-quality MBS are not very liquid... buyers at this level and below will get killed in the turn, and cannot hedge that risk in a Treasury market priced for GDII.

Why is “Four’ so hard? The one and only time that US mortgages reached 4.00%: at the GI-Bill rollout of VA loans on July 25, 1944. Went to 4.50% on May 5, 1953, and 4.75% on April 4, 1958, to 5.25% fifteen months later. That’s it, the cumulative history of four-something, all in a very different world. Also, those rates were set so low that the seller to a veteran had to pay two to four points for the veteran’s loan.

Why doesn’t the government buy, or just make 4% loans? See $10 trillion, above. The total US national debt traded on markets is only $6.5 trillion. One of the awful aspects of our predicament: having borrowed our way into trouble, there are limits to borrowing our way out.

But my brother-in-law said he got...!!!! Bernie Madoff’s clients got into trouble believing one-upmanship fables told by their neighbors. The fibs told in a locker room full of teenage boys about their sex escapades don’t hold a candle to your friends’ tales of their mortgage conquests.

Call me when we hit bottom, will you? Or at 4.00%, whichever. The law of refis: do any deal that works, recapturing costs in a year or so. Can’t know the future. Lock your rate, then don’t watch TV for three weeks. Or talk with your brother-in-law.

But you said rates could crawl lower...? Yup. It took a year for rates to move from 6.25% to the 45-year low 5.25% in June 2003, working off masses of refis at each intermediate stage.

Lasted one month.
 

Visions of Sugar Plums…
December 14th, 2008

On Wednesday morning, mortgages rates collapsed close to 5.00% -- just under for fee-heavy deals, just above for fee-light, all a tad higher today.

Four notes on mortgage pricing. These super-low rates are limited to 740+ FICOs and 80% or less loan-to-value. Fannie and Freddie, despite 90 days in Federal hands, still maintain punitive FICO pricing. 695 FICOs have to pay a fee just to get 5.50%.

Second, the normal fee-versus-rate progression has been distorted for two weeks. Usually it’s a bad idea to pay fees to get a lower rate (payback out at six years); however, a confused and fearful investment world, far removed from retailers’ pricing interests and the “secondary market,” wants to buy loans only at a discount. The result from time to time favors paying a fee even to refi.

Third: prior large-scale rate drops have quickly reversed under pressure from waves of refi rate locks. This time that wave is a ripple. Demand is huge -- desperate -- but availability has been crushed by fallen values, the total absence of “stated” and “no-doc” underwriting, piggyback-2nd lenders who will not subordinate to 1st-mortgage refis, too-tough pricing for investors, no market for fixed Jumbos, and the FICO hits above.

Fourth: despite diminished volume, it is enough to prevent another rapid rate drop.

Global financial markets have paused today to attend a public policy ballet performed by The Sugar Plum Idiots.

Chrysler and GM have no plan for reinvention, and a bankruptcy-equivalent event is inevitable. The UAW’s three-decade hostage racket has concluded upon the demise of the hostages. The Democrats, desperate to save jobs that cannot be saved, want to punt themselves into their own Coffin Corner of procrastination and subsequent blame. Senate Republicans with filibuster power for another 40 days, 20 days longer than GM’s cash, have intercepted the Democrats’ punt. These Senators are certain that taking credit for cratering Detroit will be a great start on a reconstituted party, offering supply-side blindfolds and cigarettes to the nation.

Even better, while these Senators pose, they know the White House will not allow an uncontrolled bankruptcy in a free-fall economy. So, the same Dubya who would not allow TARP money to be used as a bridge for Detroit has now been forced to do so by his own party, rescuing Democrats.

Just when the descendants of Herbert Hoover could hope that his infamy would be replaced by the malpractice of another President... damn.

Briefly, a little TARP clarification, and a kind word for bankers. (Honest.)

Partly pandering, the rest in ignorance, half of that willful, Congress is angry about TARP. We were misled, we didn’t want to do it, we don’t know where the money went, it didn’t work, and we would rather have wasted the money ourselves.

This snit is remarkable deceit even for Congress. The Western banking system was broke, capital exhausted, eighteen months ago. By last July, markets closed to new capital-raising, toxic losses not recognized but in plain sight, the capital shortage was near $1trillion. After September’s seizure, Henry Paulson and Dubya, late, in free-market mental shackles, fumbling for a moment with toxic extraction, unaccountably came to the correct solution: provide capital! (As the Europeans already had.)

Of $350 billion TARP released so far, only $250 billion has been used as capital, and we know exactly where it is. The only error: it was only one-quarter the need last July. Tardiness and inadequacy have led to deep recession and more losses ahead -- cyclical, as opposed to prior “structural” toxics -- we’re going to need twice as much capital as we did in July. There are many ways to do the job, even without borrowing; Norway figured out how to recapitalize with non-tradable securities. Just paper the hole.

Banks cannot lend without capital. Today bankers are staring into a bottomless hole of future losses, most aware that their credit clamp will cause more losses. Perhaps the Norwegian ambassador is available. Beats watching the Sugar Plums.
 

In one of the few benefits of increasing age, the older you get, the more times you’ve blown off your eyebrows in the lab, and the less shocked you are when things that “can’t happen”... happen.

The markets today, a bunch of kids under 50, are jaw-dropped. So whacked up-side the head they can’t even find the big river in Egypt. They’ve spent their whole working lives back-testing risk models, back to the Civil War (between Athens and Sparta), absolutely certain of what can and cannot happen, leveraged to the eyeballs based on those boundaries. Addled, life-long conceptual frameworks shattered, these kids are frozen, and with them the supply of credit of all kinds. Right beside are commentators, academics, and policy makers clutching familiar pillows, eyes squeezed shut.

Harvard’s miracle investment returns on its endowment... they’ve lost 22% in 90 days, much of what’s left too illiquid to sell. Couldn’t happen -- not to smart guys. The rest of us... Lose 10% on a portfolio of AAA corporate bonds and munis? With no defaults, just market panic? Impossible. Roll over junk bond debt at 20%? Never happen. Fed goes to 1%, T-bills to 0.01%, and all other rates rise?. No way.

You want me to trade, buy, lever, borrow, lend... in THIS?

Please pause to take heart: there are many policy solutions available. It’s not clear which ones or combinations are best, but they will be found. We have only two temporary problems: the last 46 days of this inept administration; and without leadership, a fragmented and equally inept Congress. The economic news this week was so bad that we may get some action shortly on both fronts.

Herewith the list of things that will not work.

1. The 4.50% Mortgage Fairy. Hopeful clients understood quickly that they had been fooled, either by the housing industry trying pressure-by-leak, or by yet another Treasury pratfall. We may get to 4.50% sometime next year, but several trillion dollars worth of refinances lie between then and now. Progressive decline, as ’01-’03, is most probable, even with the Fed buying. Could the Treasury “buy down” rates for buyers? Sure: in today’s market, four points, $40 billion per $1 trillion in loans, but six years to get the full benefit of cash cost versus payment reduction. Silly -- and the reason most people don’t pay points to get a lower rate. Neither should the Treasury.

2. The Foreclosure Fairy. The blown housing bubble was central to economic decline last year and the first half of this. However, as home prices slip in non-bubble zones, and prime mortgages go into default, it is painfully clear that housing trouble is now effect, not cause. Every sensible foreclosure mitigation effort should be pursued, but will have little effect on an economy losing a half-million jobs in a month.

3. Unspeakable Boobs. The no-bailout crowd, joined by Eek!-Inflation! wrong-siders. Senator Richard Selby, (R.AL), puzzled but firm 1930’s re-enactor. CNBC’s Rick Santelli and Larry Kudlow, the last ride of the Mister-Marketeers. Then, Frankn’Doddstein.

4. Additional routine efforts by central banks, cutting rates and hosing cash. Global CB cuts are approaching zero percent, but are neither reducing the cost of credit nor increasing availability. This situation, full-on since September, is called a “liquidity trap,” in which cash floods into the banking system but nothing comes out.

5. “Stimulus” by Federal spending tends to be too late, and tends to fail for two other reasons. Until consumers gain some faith in the future, they will save the windfall, as they did rebate checks. Second, without credit to sustain commerce and jobs Federal stimulus is like transfusing a patient with an open artery.

6. The “quantitative easing” by the Fed that began last week -- outright purchase of debt securities with invented money -- will help to drive down rates, and fund the economy to some degree, but it is no substitute for a functioning banking system.

Therefore, (how hard is this?), get the infernal banking system going again. Every other nation on earth is doing so, and we’ll get to it... maybe inside 46 days.
 

Yesterday the Fed announced that it would begin to buy mortgage and other private debt securities -- easily the most dramatic and unprecedented action in the Fed’s 95-year history.

Mortgages immediately fell a half-percent to 5.50%. An immense volume of loan-rate locks has pushed rates back up a bit today, but the decline is highly likely to resume. For the first time in the last 18-months’ credit-market nightmare the authorities have moved in front of the crisis, jumping past broken banks to fund the nation.

The Fed buys and sells short-term T-bills every day, managing monetary policy and short-term rates. However, the only prior Fed direct purchase intervention to push down long-term rates was during and shortly after WWII, and that operation was limited strictly to Treasurys. This time the Fed will buy a wide spectrum of consumer credit, driving down rates, and will eventually re-open private markets in volume.

The Fed’s actual purchases will not begin until next week, but it said it would continue to buy “over several quarters.” The Fed did not indicate any target for how far it intends to push down mortgage rates.

Why now? Two things. Last week marked the ultimate fracture in the credit markets: Treasury yields to the floor, rates for all other IOUs to the sky. No credit, no bottom for the economy. Previous efforts to cut the cost of credit (loaning cash to banks, TARP injection of capital) had not yet worked, and could not be expected to work in time. Second: the next ten days will bring awful news of economic decline in November, and the first washout of Thanksgiving shopping in modern times.

Will it work? Oh, my, yes. In 1983, the Fed entered the market in a surprise purchase of T-bills. An itty-bitty thing. A roomful of calm-to-bored pros leaped in the air, screeching, “The Fed is IN!!!” And so that roar went up yesterday. All-powerful. The Fed hasn’t spent a dime, but is already swinging a psychological hammer. The markets had priced for Great Depression II. “If the Fed is in, then we aren’t going to have GDII... If the Fed is in, what am I doing out?”

When will it work on the economy? When it does. Recessions cannot bottom without plentiful and cheap credit. Credit-sensitive industries lead the way, houses and autos; both will take a while even with credit restored. Unemployment will not crest until the recession is over. Hence, the Fed will be in for “several quarters.”

Where will the Fed get the money? If you or we print money, we go to jail. When staring at a Depression, the Fed is supposed to print money. It has infinite capacity to do so, and in this case is buying very high quality IOUs that will rise in quality as the economy heals, can be sold then, or held to maturity. The main risk is off in the future: next time we’re in a little trouble, the troubled will ask the Fed to buy again. Answer: only once every 95 years.

At your dinner table tomorrow someone will say: Hang the Fed for this! Let the market work! Inflation is certain to follow! The dollar will crash! The Fed is a giant conspiracy! Gold gold gold! Hand this individual a turkey bone and hope he chokes. No Heimlich until he admits the Depression was not cool.

How to play refinancing? Any deal that recaptures closing costs in a year or so after tax effects, do it! As always... closing costs are not deductible, interest saved is; hence savings are overstated. Calculate interest savings, not changes in payment distorted by amortization. Avoid points and origination (deductible only over the whole life of the loan!). If you have an ARM... move now.

Whose idea was this? Many of us thought it was inevitable a year ago. The idea is in Perfesser Bernanke’s book. We’re a zero on a scale of conspiracy theorists, but we have to believe that when Obama’s new team reviewed options with the exhausted group still in charge, somebody said, “What in hell are you waiting for?” If it was Hapless Hank Paulson’s work by himself... or not... hand that man some pie. It is Thanksgiving.
 

One week ago today, Henry Pauslon announced that Federal efforts had “stabilized the banking system.” On Wednesday a new panic rolled through markets, running to Treasurys. T-bills 90 days and shorter fell to 0.01%, and the 10-year T-note from 3.61% to 3.01%. Few ran to mortgages: rates fell briefly below 6.00%, and are back there today. All ran from non-Federal credits, dumping munis and corporates.

In prior recessions, the fearful dumped stocks but bought IOUs of most kinds; the resulting cut in the cost of credit helped the economy to bottom. This Treasury separation from all other IOUs began in September, had not been seen since 1930, and marks terminal shortage of credit to the private sector.

The S&P500 closed yesterday at 748; on December 5, 1996, the day Alan Greenspan delivered his “irrational exuberance” speech, the close was 745. The old SOB knew what he was talking about after all. Too bad he forgot later on.

Why this new panic? Pending bankruptcies of GM and Chrysler. Understanding that Citibank will not survive as-is. The Fed forecast for GDP decline into mid-2009. New unemployment clams to 542,000 last week (the record was 700,000 at the tag end of the ‘79-’82 post-war worst, and we’ll beat that in some miserable week next year).

All bad, but no surprise. This new panic, putting us right back where we were in the September shutdown, was the direct result of the Paulson/Dubya decision last week to mothball Administration rescue efforts. The announcement refused a new battle with Congress for access to the second half of the $700 billion TARP funding, and all in the markets knew they were back on their own.

Our economy -- really the global economy, now -- has been “in the grip of an adverse feedback loop” (Janet Yellen, fine Prez of SF Fed). Credit defaults have cut credit availability, which has cut GDP, which has caused more credit defaults, which have cut credit, which will cut GDP.... The Treasury market separation described above is the signal that the spiral cannot stop by itself.

Only government can get in front of it and stop it. The application of infinite government resources must convince all economic players that their panic is self-defeating. Then it will stop, and risk-taking will resume. Just 30 days’ TARP effort had big effect, and then Paulson and Dubya shoved all downhill again.

The resources of government are still available. We promise that the Fed was not a party to the Paulson/Dubya decision, and will not take a day or an hour off between now and inauguration. There will be a big fight between the money hosers (aggregate stimulus, checks in the mail, infrastructure spending, foreclosures...), Democrats controllable only by a new President; and the capital-injectors, who know that the only spiral-stopper is adequate credit -- and who will prevail.


In soft times, both leadership and the led give priority to the trivial, ignore the substantial, and defer the critical. When times have been too easy for too long, a terrible word comes into play: decadence. When times turn tough, that internal rot for a time prevents self-salvation. Only for a time.

Then the spectacle of decadence and the anger it brings to us, and at our own participation -- that starts the turn. The three auto CEOs, private jets but no plans; Paulson and Bush; bankers taking public capital but making no loans and canceling old ones, credit cards, lines of credit, car loans, student loans... decadence personified.

Today on NPR Chris Dodd (D.,CT), Senate Banking Chair and in ordinary times ego-bloated and obnoxious, revealed good judgment, serious intent, and merciless fury. If we were a bank CEO or board member, we would today take off our toga, put down our grapes and goblet, and scramble on chubby legs to make loans.

As is said of another high authority, the wheels of Congress grind slow, but they grind exceeding fine.

The credit market thaw paused this week: Libor fell just a little, mortgages touched 6.00% and rebounded, short-term Treasury rates are still near zero, and corporate and consumer credit is as scarce and expensive as ever.

Massive, global intervention by central banks and national treasuries has been underway for only a month. Just seems longer when you’re having fun. Economic activity is slowing faster than businesses can make down-sizing decisions: only in the last week have unemployment claims risen above the 90-day average (by 25,000 to 516,000). October retail sales dropped 2.8%, the largest decline since the series began in 1992, and the NFIB said small-business sales conditions were the worst since 1980.

In 1933, just after his inauguration, Franklin Roosevelt delivered his first “fireside chat” on the radio. He began, “Tonight I would like to speak to you in simple terms about banking....” Afterwards, Will Rogers said that the terms were so simple that even bankers could understand.

Henry Paulson’s chats are televised. He looks like a man who has just stumbled in and out of a fireplace, puzzled but energetically slapping at embers, and in bold voice and many words trying to convince his audience that he is in charge and all is well.

He is doing a better job than it seems, and it is not his fault that this administration has no voice of leadership. His Wednesday speech abandoning TARP’s extraction of troubled assets shocked many people, but should not have: We are reassured by the WSJ report today that Paulson shifted to capital injection planning before final Congressional passage on October 3. The extraction idea might have worked 15 months ago, but is too late now. More good news: Treasury/Fed teams are working to reopen the non-bank “structured securities” market, essential to modern credit-creation. Yes, those markets ran wild and got us into this mess, but we cannot recover until they re-open.

The disturbing elements in the speech: asked when the Treasury would request from Congress the next $350 billion of TARP (all but $60 billion of the first half is now deployed), Mr. Paulson said, “We have no timeline on that.” Second, he flatly refused to instruct banks to make loans. Paulson did not address the bad news from Fannie and Freddie: in the two months since takeover, their borrowing costs have risen, and they have failed to increase mortgage purchases -- net, zero -- or to relax fees and terms.

We are caught in a transfer-of-power moment worthy of Tom Clancy, and uncertain policy and action are the result. In wartime Congress defers to the Executive Branch; but during a speed-of-light economic emergency, who is in charge? A request now for the rest of the TARP money would instantly ignite a frustrated and fantasizing Congress. The financial authorities are fighting a daily shape-shifting emergency requiring ad hoc responses. Congress naturally slows any policy or action, demands control, and fights internally for power. Only a strong President can bring order.

Congress and way too many other people think that housing markets are key to economic bottom and recovery. That was partly true until September, now completely backwards: the only way to stop prices from falling and to abate foreclosures is to get the economy going, and quickly. All current proposals to mitigate foreclosures will fail; and far worse, the time spent haggling over DOA proposals will starve effective economic action. Same goes, unfortunately, for the auto makers: bankruptcy and downsizing (not closure) are the inevitable result of 30 years’ mismanagement. After that, Federal assistance would be appropriate and useful.

There is only one way out of this or any other recession: restore CREDIT. All modern recessions resulted from the tight credit imposed by an inflation-fighting Fed, and recovery followed release of grip by the Fed. This time the financial system itself has failed, thus far defying the most dramatic monetary ease in the 95-year history of the Fed; we need the rest of the TARP money and a lot more from Congress. Now.

We don’t know how we’ll make it to Inauguration Day, and fear that we’ll have to.

The credit markets this week continued to thaw. All-important Libor fell another percent to 2.38% for 90-day money; and one-year is down to 2.84% -- ARMs resetting next month will settle just a hair above 5.00%. 30-year mortgage rates with no fees made it to 6.00%, but for the umpteenth time this year stopped at that barrier.

Central banks and treasuries around the world this week increased already-massive intervention: the Bank of England cut 1.5% in one whack yesterday, joined by the ECB’s .5% cut in the Eurozone. The Fed’s overnight rate is 1.00%, but actual domestic interbank trading has been 0.23%. They will succeed in stabilizing the patient.

The economic data are awful. You knew that -- no point in reciting. However, the pattern unfolding is important.

The last two recessions, ’01-’02 and ’91-’92, were miniature affairs discovered after conclusion, typical of all post-WWII recessions except the two big ones, ’73-‘74 and ’79-’82. Those were the first central bank fights against oil-spiked inflation; this fight began in 2006, and by summer caused a general economic slowdown. However, the breakdown in September was caused by a credit panic, not the Fed.

We have been here before. Not in 1930, and not in Japan, but in the spring of 1980. In October of 1979, inflation over 12%, Paul Volcker stood on the brakes and the economy quickly slowed. In late winter, benighted Jimmy Carter wanted to help with the inflation battle and decided that “credit controls” were just the thing: get Americans to stop borrowing, and inflation would die.

Even brutal Volcker took a dim view. The Fed had already jacked its rate to 17%, so it watered the controls to insignificance. However, following the President’s March 15 patriotic appeal to the nation to stop borrowing, that’s what we did. Credit panic.

The economy collapsed. GNP growth free-fell 9.9% (annualized) in the 2nd quarter of 1980, the deepest single-quarter decline in modern times. Then, chaos: the Fed had to ease in a still-inflationary economy, wasting the first year of the inflation fight, and then in September re-tightened, causing four more negative quarters scattered through ’81 and ’82, and unemployment crested at the very end, 10.8%.

Lessons. This is not a “still-inflationary” economy, and there will be no “re-tightening” -- not until the economy is in recovery. The credit panic underway will make this 4th quarter the worst negative since ’79-‘82, but concerted central-bank action is as likely to pull us out now as then. Slow in 2009, but not into the pit.

The central banks and treasuries are going to need some help. From the banks: loans! France this week threatened to fire senior managers unless they began to lend and at rates reflecting lower cost of money. The UK is hard at the same thing, banks to make loans an explicit quid pro quo of government capital injection. Bankers here better get with it, or Mr. Obama will turn loose Barney Frank. A fate worse than firing.

More help. Investors must resume risk-taking; and there’s nothing for that like the liquid courage of near-zero cost-of-cash.

And help from you. Do not accept passively the cancellation of a line of credit or a cap on a credit card. Inform someone senior in the miscreant bank that their contemptible and unpatriotic behavior will cost them reputation. Then march straight to a nearby small bank or credit union that will be delighted to hear from you.

Then educate yourself. Every financial crackpot in the nation is loose, scaring and confusing everybody from your neighbors to policy makers. Secrets of the Temple is a superb, readable history of the Volcker era, and of the Fed itself. The first half of imposing but enthralling Freedom From Fear is the best current account of the onset of the Depression, and the desperate and futile effort to find the fixes that are understood and available today. For the technically adept, nothing beats Bernanke’s own essays in The Great Depression. All in paperback -- and to see the breadth of opinion among escapees from the economic funny farm, scan the reviews of these books at Amazon.

Mortgage rates bottomed at 6.00% early in the week, down .75% in four days, and are back to 6.25% now (lowest fees). Five-something loans will have to wait for stabilization in global credit, or effective Federal intervention.

The depth of the recession ahead will depend on the job market, and the newest data shows surprising resilience: new claims for unemployment insurance are still inside the 60-day range, just under a half-million weekly. Since the onset of credit collapse on September 15, the real economy has resembled the adversary of the great swordsman, his blade so sharp that his opponent, neck cut through, did not realize the damage until he bent over. Comrades, until the authorities resolve this panic, stand straight.

There is a chance, and a good one despite layoffs and bankruptcies ahead, that the worst of the economic damage will be confined to our wealth, not the engines of production as in the ‘30s. Wealth we can rebuild; whole economies are harder. The “wealth effect” will run in reverse, diminishing consumption and investment in expansion. However, correctives abound: topping the list, it will be a pleasure to have so many Baby Boomers deferring retirement, working beside me into our 70s.

Another corrective: as asset prices fall, they find buyers. We’re amazed at the 5.5% increase in sales of existing homes in September. These were contracts written in August, and the market shocks since will hurt the months ahead, but the absorption of foreclosures is extraordinary. All markets describe multiple offers at entry-level prices.

If you’re caught in a once-in-a-century event..., might as well enjoy the details.

In the two weeks since the UK’s Gordon Brown led the way to bank recapitalization, the world-total has grown to about $2 trillion. $70byn UK, $55byn Norway, $700byn here, $70byn Switzerland... China, Russia, Malaysia, Singapore, Middle East.... More coming as necessary. We did some more of our own today to take heat off the FDIC fund, PNC acquiring the wreck of National City with $7byn in TARP money.

All-important inter-bank Libor has fallen from near 5% (versus Fed cost-of-money at 1.5%!) to 3.25%, but stopped there. The panicked run to short Treasurys abated, one-month yield rising from .05% last week to .37%, but today back to .22%; 30-year bonds today briefly fell below 4.00%, the lowest since first sold in 1977. One part of the Fed-Treasury effort to bust up panic: if the herd wants Treasurys, drown it in paper; by the end of next week the Treasury will have raised an incredible $600 billion in 20 days.

Speaking of cash... way back there in August, the world‘s great problem was inflation, which the Fed had been fighting with very tight monetary policy, money growth near zero since oil prices exploded in 2007. Since mid-September, the monetary base (St. Louis Fed) has increased by 50%, and the Fed will hose out as much money as long as necessary. If confronted by an “Ah-HAH! INFLATION!!!” fruitcake, and feel brave, say back: “We’re fighting deflation. You might pray that reflation works.” Those who ridiculed the deflation-antidote theories of “Helicopter Ben” Bernanke should take a moment to give thanks that he’s in the chair.

Financial markets are resisting treatment, even recapitalization, because the Great Run of ’08 has morphed into the Mother of All Margin Calls, and forced selling of everything. Oil diving from $150 to $80 was good consumer news, but $65 and falling is a catastrophe for producing economies and their leveraged investors. Lest you take pleasure in their pain, they used to have a lot of money to invest in American mortgages and stocks. The same applies to the euro, from $1.60 in freefall now passing $1.26, UK sterling from $2.00 going by $1.58, and commodities broadly down by half.

To visualize this margin-call cascade, think of a game of standing dominoes in a big room, exact borders vague. The dominoes are invisible, the length of lines and points of cross-connection unknown, dominoes coming into view only as they fall. The invisible game must play itself out. However, the authorities are already standing up the fallen and will inevitably win in the end -- as will we all, less wealthy but wide awake.

Four weeks ago yesterday marked the turning point in the Great Run of ’08: after the Lehman disaster the White House and Congress vowed to intervene as necessary.

Last Monday afternoon marked the fact of effective intervention, the authorities for the first time moving ahead of the crisis. The Treasury summoned the CEOs of the nine largest bank-survivors, and broke the capital-shortage by involuntary injection -- an event and scene without American precedent.

During these four wasted weeks, frozen credit markets did serious harm to an already recessionary economy. September industrial production collapsed by 2.8%, the largest decline since 1974, and retail sales slid 1.2%, double the forecast.

However, a weak labor market has resisted free-fall: last week 16,000 fewer people filed new claims for unemployment insurance. Foreign economies are sinking faster than ours, reinforcing global-price decline: September CPI was unchanged, and will soon go negative. The commodity collapse is already reversing pressure on consumers at the gas pump, will soon at the grocery, and by winter by prices for lots of things.


Many books will be written about the events leading to Monday’s meeting at Treasury. For the first time in a long time, at least back to the ‘70s, the Federal government asserted control over commercial banks. The Gucci cowboys of finance and their right-side buddies have since cried all sorts of foul out of arrogant habit, but from the day in 1933 that the first bank accepted an FDIC-eagle decal in its window, and deposit insurance, American banks were and are a form of public utility.

The Treasury did not tell the Nine why they were summoned, just “Be here at 3:00.” They were seated in alphabetical order, none more equal than the others. Across from them were Perfesser Bernanke, Secretary Pauslon, and FDIC’s Bair, who read the riot act to the Nine: the economy is failing, the credit markets flat-lined, and extraordinary action is necessary. The authorities slid across the table nine term sheets showing the amount of Federal capital each institution would intake, filled out in advance and without consultation, for signature. Now. Not for negotiation. For signature. Now.

Only one CEO argued (the WSJ and NYTimes accounts agree): Wells Fargo’s Kovacevich insisted that his bank didn’t need any capital, and was concerned for his $183-million retirement package. He will not enjoy the parts of future books about his conduct, and he signed with the rest, anyway.

That $125 billion in capital will likely come back to taxpayers in time, and another $125 billion will go to smaller banks (also to return) -- more beyond that as necessary. This capital injection should have been planned, politicked, and ready to go way back last spring, when the risks of arriving at this moment were so clear. If so, we would still be in recession, but not so hard to jump-start credit. All accounts of the wasted September concur: TARP, the Rube Goldberg extraction of bad assets, was Paulson’s work, at last giving way to the capital replenishment long-recommended by the Fed.

Many commentators have us sentenced to a long recession. We doubt it: our hope/hunch holds that the September stumble precipitated a sharper but shorter affair. The rescue came just in time, the risk of black hole intercepted. When Perfesser Bernanke says that he and his people “will not stand down” until we are on safe ground, believe him, and believe that he knows what to do. Progress will come in stages: first stabilization and pull-back from panic. Then the beginnings of adequate credit offered. Then the slow resumption of risk-taking by borrowers.

Opportunity for policy error will remain, but will move to the political sphere. Congress will demand a new, several-hundred-billion “stimulus” package. Tell them, “No!” They will also try to throw money at defaulting households -- no to that, too. The best way to help housing: an adequate supply of mortgage credit. The authorities will grope a while longer on that one, but the easy fix is in underwriting: last year credit swung from silly-easy to zilch, and re-centering would be a huge help.

Mortgage rates are stuck just above 6.00%, but at least not blowing up or shut down along with the rest of the credit world. We and our peers are operating normally.

Passage of the rescue bill has pushed up long-term Treasury rates, markets anticipating large sales of new Treasury bonds to raise bailout cash. The stock market has stopped nauseating freefalls twice this week at S&P 1100, rallying well now. These moves also reflect hopes for coordinated global central bank rate cuts over the weekend, and a Euro-zone version of our rescue package.

New economic data are awful, GDP obviously contracting in September. Auto sales fell below one million last month, 26% below last year. The always-reliable purchasing managers’ “ISM” manufacturing index plunged from an expected 50 reading to 43.5 (50 is a breakeven economy, 44 is recession). New claims for unemployment insurance are running a sustained half-million each week, double the rate in a healthy economy. Today’s crusher: payrolls fell 159,000 in September, half-again worse than forecast.

Before political and financial follies, the highest possible honor to Sheila Bair, FDIC head, for grace under pressure. She has gotten us out of WaMu and Wachovia with no hit to the insurance fund: no fuss, no mess, on time. Those of you worried about your bank accounts, stashing greenbacks -- cool it. We think our banks are fine, now.

This week we have been in the worst moments of the largest “run” in history, nothing remotely comparable, in part because of these damned electrons. Civilians and experts alike have been terribly confused, trying to understand what is happening.

Two things have complicated comprehension: until the last two-weeks’ disaster, this was the slowest-moving run in history, starting 14 months ago. A “walk” on banks, no matter how massive, does not focus the mind of Main Street voters. Second, this run has been at wholesale, bank-on-bank, money-market fund on commercial paper, funds on munis... but no lines of depositors, no deposits lost.

That missing panic on Main Street is the largest reason the House flinched on Monday, and “nay” voters still do not understand the fantastic and lasting harm they did. Rejection instantly caused the stock-market loss of $1.2 trillion, and spread the run all over the world. There is only one way to stop a run, and that’s with an unlimited mass of cash: drive up with a big truck-full, and start throwing bales of it at old ladies in the run. Flinch, and even this re-do loses force. The global element: the US is the only domestic-driven economy on the planet; the rest of the world earns its rice and strudel by selling stuff to us. If our Congress appears locked in cranio-sacral inversion, then the whole world is lost, and so it traded all week long.

More politics. The whole House faces re-election in 30 days, many new Democrats from conservative districts, many Republicans fighting a Democratic wave. The President is unable to fly top cover, to “go to the people” in a compelling speech. He is also the lamest duck of all time, and the House has no fear of him. One Congressman said of Lyndon Johnson, “If he wanted your vote, and you resisted, you had the strong impression that electricity to your district would be cut off and never turned on again.” In 30 days we will have a President-Elect deserving fearful respect, order restored.

The bill has passed, but execution of the absurdly complex plan will take a month or more. A lot of people are coalescing around a simple and fast “Reverse Sutton.” Willie Sutton focused his legendary work on removing cash from banks; instead of all this horsing around with re-underwriting toxic securities one at a time, buying at auction and re-selling, just give banks the capital they need. Do it in exchange for ownership, long-term workout, and by accounting fiction, not by selling new Treasurys.

Even then, we’ll have to jump-start the system, get bankers back to making loans. So, let’s invite the big dogs, BofA’s Lewis, Citi’s Pandit, Morgan-Chase’s Dimon down to Guantanamo for the weekend: “Gentlemen, meet the bucket and the board....”

Mortgage rates are unchanged, about 6.125%, just one aspect of completely frozen credit markets, hostage to a political moment without parallel.

The real economy is tipping over: New claims for unemployment insurance last week jumped to 493,000 from the 450,000 range. Orders for durable goods in August plunged 4.5%, double the forecast decline, and sales of New homes free-fell 11%.

When financial events move into politics, this column is relentlessly anti-partisan -- not “non-“, but anti. Nothing below is intended to favor either party or candidate.

Any large-scale Federal financial rescue was certain to face political chaos. However, within hours of rollout last Thursday this rescue collided with two linked and disastrous forces which may yet defeat immediate rescue.

When Secretary Paulson and Perfesser Bernanke went to the political authorities last week, the Perfesser’s Tales From The Crypt risks to the economy produced immediate bi-partisan support for a rescue. Then and since, as all Fed Chairpersons should, the Perfesser has left legislative details to the Treasury Secretary. In disaster number one, not clear until hearings on Tuesday, Paulson was not prepared.

Most grown-ups know that it’s a mistake to ask a group to vote on an important proposal without prior discussion. You wouldn’t spring something big on your PTA, your HOA, or your book club, and demand an immediate approval. You wouldn’t ask a Cub Scout troop to vote on a field trip without some testing of the water.

Hank Paulson would. Hank has had 13 months to prepare a contingency plan in case market solutions to this crisis failed, and quietly to explore alternatives with Congress. Instead, he dumped on Congress a three-page sketch of a highly technical and questionable proposal. Tuesday’s hearings in the first minutes revealed bi-partisan, confused, angry, and incredulous Senators, and a completely clueless Paulson.

This man, Paulson, this extraordinary fool, has not only failed to advise us in the Senate, to develop his plans with us, to find out what we can sell to a wounded nation, he is not prepared to defend his idea! We watched part of the testimony beside an experienced trial lawyer, who after fifteen minutes burst out laughing. We asked what was so funny; he said, “You can always tell when a witness has lost it -- they just babble.” Reports today are unanimous that one of last night’s negotiating sessions blew up when Paulson again bungled a description of his plan’s benefits and execution.

Over last weekend another force erupted all over the country: native, grass-roots rage at a bailout that would leave all the big institutions in place -- officers, directors, stockholders, all -- and offer to taxpayers the absurd promise of payback from hundreds of billions of trash that the institutions couldn’t unload on anyone else.

You tell us your precious markets will melt down without this? Why do we care? Your stock market can go to zero on Monday, and then you can come down here with us to find out how it feels not to be able pay the bills. More than half of Americans have no stake in these markets, no savings at all; and there is a political price to be paid for extreme inequality of income.

This bailout, incomprehensible to civilians and many experts and Senators, should have taken ownership in the institutions involved. Proper vetting to Congress months ago would have gotten that done. Instead, the same ancient American forces that ignited the Palin phenomenon, Jefferson-Jackson-Bryan-LaFollette Populism, have mobilized an anti-bank, anti-smarty-pants, street-level riot not seen in modern times.

Completing the scene: Mr. Bush’s nasty little speech on Wednesday, assigning blame and taking no responsibility; Mr. McCain’s grandstand play on economic issues he’s said for decades he’s not any good at; and Mr. Obama’s silent tip-toeing along.

Not pretty, but only-in-America: this flawed plan will probably pass by Sunday night, might work (50-50), might work in time (25-75), and we can always go to direct capital injection and ownership if Paulson’s Pratfall does just that.

We wrote last week that we heard “hoofbeats of cavalry on the way.” For a while this week it looked as though John Wayne had arrived to shoot the settlers and give firewater to the Apaches.

Mark this day: the worst of this crisis has passed. However, not yet the halfway point in time: we are thirteen months into this wreck, and you’ll sure as hell feel credit-market distress thirteen months from now. The greatest risk has passed.

Until yesterday the nation labored under the illusion that this crisis was a financial matter -- banks and markets thrashing around, remote from Main Street, something that would either solve itself or be calmed by usual means. In reality, of course, the financial matter was not remote and had been hopelessly lost by August, 2007.

Now this crisis is officially public property, in the political sphere, put there by final disaster on Wednesday, formally acknowledged today by the Fed, the Treasury, the President, both houses of Congress, both parties, and both Presidential candidates.

Before post-mortem, medals, and booby prizes, a brief timeout for the real world. The economy is sinking and will continue to do so, partly because it must to pass the inflation pig (no lipstick) still moving through the national python. New claims for unemployment insurance are continuously rising beyond forecast, 455,000 weekly now, and housing is not close to bottom, new-builds last month falling to a 17-year low.

Mortgage rates have risen to about 6.125%, a wrecked credit system unable create leverage to support higher prices for $5 trillion in mortgage-backed securities and lower rates. However, a somewhat less distracted Treasury Secretary will go to work on that problem shortly. So he said today (again). He and everybody else know that mortgage credit must be unlocked for housing to bottom.

The authorities, including White House and Congress, have obviously been working on today’s fix for months. Fed examiners have been inside securities firms since June for the first time ever, “lifting the kimono” to discover the Street’s secret losses. Thus we have an initial funding amount; not enough, but most to be recovered one day.

The authorities could not go public with planning until the market damage was so severe that a majority of both parties in Congress was willing to go along. The most difficult part of the journey ahead: helping the American people to understand, and to stay together despite contrary charlatans by the thousand.

Top honor: to Perfesser Bernanke. Quiet, no grandstand, the technician with the life-study knowledge of 1930 and the determination to prevent 1932.

An Honorable Discharge, no medal, to Hank Paulson. You hire an investment banker to look around corners for you. Relentlessly surprised, annoyed at the waste of his valuable time, Hank has only recently discovered that there are corners.

Medal of Honor: Tim Geithner, NY Fed Prez. If we are very, very lucky, this extraordinary man will stay in public service for a while longer.

The Boobs... oh, my. Start with the CEOs and boards of the failed firms. Name them, publicly humiliate them, and then shun them. Forbid them ever again to participate in a public company. That’s authentic “moral hazard.”

The Liquidationists. Find the hottest corner in Hades for those who thought (and still think) that mass bankruptcy and liquidation will bring proper punishment, future caution, and recovery. The Lehman butchery led directly to the AIG bloodbath and total system meltdown. Andrew Mellon, Herbert Hoover’s Treasury Secretary in 1931: “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate... and recovery will follow in a few months.”

Another high honor goes to the irrepressible American spirit under pressure. On Tuesday, news crackled over Lehman’s in-house squawk box that Barclay’s Bank would buy half the wreckage, and perhaps 10,000 people, many of whom lost their life-savings, would still have jobs. Then the box played “God Save The Queen” to cheers.

Mortgage rates have not been able to hold the early-week low at 5.875%, but are no worse than 6.00% for the lowest-fee deals.

The Fannie-Freddie takeover instantly knocked retail mortgage rates down .375%, but that’s been it. The sky-high spread versus the 10-year T-note has compressed from 270bps to mere cloud-height, 235bps -- but that’s still 70bps too high. We have argued all year that the spread was not a credit matter, instead an artifact of an insolvent banking system unable to leverage positions. We win, and wish we hadn’t.

Economic data are sliding all over the world. US retail sales in August were the worst of the year, minus .7% ex-autos. Newly surveyed consumer confidence rose here, probably on cheaper gas, but anxiety and confusion among civilians runs deep.

To describe where we are today, begin with a review of the last year: in August 2007, the large end of the banking system suddenly froze. 60% of total US banking assets reside in the top 10 institutions, and the freeze came from sudden awareness that too many of those assets were bad, and the bad ones were spread across all large firms, banks and securities dealers alike.

From August to early spring, oil spiked from $90 to $145 while the housing bubble blew -- one inflationary, the other deflationary -- and the Fed fought both threats: one by letting the credit freeze slow the economy, the other by slashing its interest rate and making massive loans to the banking system. In that August-March interval, most people thought markets would heal with the Fed’s help. Bottom would be found. The halfway point would be reached. Surely we were in a late inning. Then Bear Stearns blew, and the Fed again rescued the system, extraordinary action in its finest hour.

The political world was not ready. Post-Bear, Congress flayed Bernanke & Co. The average citizen and pol were more angry at perpetrators than in pain: bailouts, big and inventive ones, never fly through Congress until pain exceeds anger. That moment came in August, the Fannie/Freddie takeover marking the moment: except for a pair of jackasses (Dodd, D.CT; Bunning, R.KY), Congressional reaction has been “well done.”

The hell of the politics of bailout: you can’t get permission until it’s really ugly, and then it might be too late.

In public and private messages, the authorities now know that the banking system is beyond self-healing, and is in a downward and self-reinforcing spiral, and traditional measures are exhausted. Ordinary rate cuts and discount-window lending will not fix the fundamental problem: “captial” in the banking system is net worth, equity, and the large end of the system is just as under water as too many homeowners. Truly extraordinary measures are required.

We think we hear the hoofbeats of cavalry. The Fannie/Freddie takeover was routine except for the astounding, plain-English word that the Treasury will begin to buy MBS to drive down spreads. Housing must bottom, and it will require cheap credit.

We now know that Mr. Bush with striking courage at the end of a tough run has backed Hank Paulson, will not kick the can to January, and will act as necessary in the middle of an election. Well done, indeed.

Lehman Brothers will not exist on Monday. It may be bought whole or in pieces, but it will not receive Bear-style Federal assistance and may be liquidated (that’s our guess). It has had a year to sell itself, but the massive arrogance of its CEO and fiduciary failure of its board have brought its end.

Then, right quick, showtime for the cavalry: WaMu, AIG, and several other banks and firms threaten a failure cascade. That spiral must be stopped right now. And it must be done with as little Federal cash as possible: T-bills yields are falling on credit fear, but bonds are losing value on fear of a bailout avalanche of Treasury sales. There is no way to know quite how (direct injection of capital, accounting fiction, glom wrecks into a giant workout zombie...), but the authorities have the will, the skill, and support.

A big run to Treasurys has pulled mortgage rates down to 6.25%, but the spread to the 3.58% 10-year T-note remains immense.

Three forces have knocked all Treasury yields down a quarter-percent in four days. First, money scrambling to get out of commodities and the euro has to buy dollar-something, and the first preference of the foreign investor is Treasurys. Second, the oil-commodity reversal and onset of global recession will obviously break inflation -- different places, different timing, but inflation as fear number one has been replaced by asset deflation. Which leads to force three: plain, panicked flight to quality.

The economic data were tertiary to the market moves themselves, above, and to a pair of speeches. Today’s double-the-forecast loss of 142,000 jobs in August (including revisions), yesterday’s news of weekly unemployment claims a sustained 445,000, sub-breakeven purchasing managers’ surveys, another 15.5% clunk in car sales... more confirmation than news.

If, two months ago, you asked any stock-market cheerleader what the Dow would do if oil suddenly dropped to $106, natural gas to $7, the euro to $1.42, sterling to $1.76... you’d have gotten, “To infinity, and beyond!” Instead, in the best marker of our deepening predicament, stocks are testing their lows of the year and this cycle. Break Dow 11,000/S&P 1,220 and the run to Treasurys will stampede -- maybe, just maybe enough to pull mortgages into the fives.

The speeches. On Wednesday, Eric Rosengren, president of the Boston Fed (copy and great charts at www.bos.frb.org), delivered a market-moving beauty.

In any difficult economic moment misunderstanding is easy, compounded by desires to settle old scores. In the last year, an especially unfortunate group of regional Fed presidents and their boards have chosen to ignore the credit crunch afflicting big banks but not their country colleagues, and to overweight the inflation fight, no matter what the consequences. The rogue’s gallery: Fisher at Dallas, Plosser at Philadelphia, Lacker at Richmond, Hoenig at Kansas City, Bullard at St. Louis, Lockhart at Atlanta. At the August 5 Fed meeting, three regionals demanded a hike in the discount rate, trying to force a Fed funds rise, or a commitment to do so soon.

Country bankers are funded by retail deposits, not Libor-based wholesale. Country banks have none of the explosive “structured-finance” devices that have ruined the big guys; sure, some dance with the development-loan devil, but most country bankers think an exciting loan is 50% LTV on a fully-leased medical building. All country bankers want to get even with the New York Gucci brigade.

Mr. Rosengren, supported by Ms. Yellen at San Francisco, blew to smithereens the fantasy of the country stiffs. Others have made the points, but not from a Fed podium: the crunch has cancelled the Fed’s rate cuts; the crunch did not take full form until this summer; and the crunch is deteriorating in reinforcing spiral. Most striking, the speech has a dead-end: not the slightest suggestion of what might be done, indicating to me that the Fed is out of options.

On Thursday, Bill Gross’s flowery version of the same song (www.pimco.com) contributed a couple of hundred points to the Dow dive. Gross added one stanza: get the Treasury involved, or else.

He is right, of course, but how should the Treasury deploy? And the Congress and taxpayer? Mr. Paulson and Mr. Bush are silent, but bailout proposals will shortly be a free-fire zone, election or no, the Duck to Crawford intercepted by events.

Lefties will want stimulus, job and infrastructure cash-hosing. Righties will want moral hazard, market solutions, and beneficial suffering. Wrong and wrong. The skilled and alert professional fire brigade (Feldstein, Summers... dozens) is confused and scattered, unsure how to deploy full force. The longer this goes, the less room for error. We cannot tolerate another clean miss like the housing bill.

Mortgage rates improved again this week, slightly, to 6.375%, the 10-year T-note trading often just under 3.80%, a resistance level since spring. The improvement anticipates a weakening economy, but a further decline in rates will depend on the fact of weakness. A test comes quickly, in the first August data due next week.

This week’s data had more headline than authentic strength, but there was some: in the 2nd quarter, export sales rocketed 13.9%, the long-delayed benefit of a weaker dollar. Exchange-rate cycles and their effects tend to be very long-wave, several-year affairs: even though the dollar has begun a turn to sensible levels, and foreign economies are entering slowdowns that will reduce their appetite for our exports, our export sales will help our economy for quite a while.

Overall GDP popped 3.3% in the 2nd quarter, but under-measured inflation made the GDP leap rather like the guy in the falling elevator who hoped to save himself by jumping just before hitting bottom. “Nominal” GDP rose 4.6%, adjusted to “real”, non-inflated dollars by subtracting the 1.3% inflation “deflator.” The deflator, usually an excellent measure, is way too low right now: actual overall inflation ran close to 5% in the 2nd quarter, and real GDP thus was negative, as it was in the 1st quarter also.

July data showed the rebate-check fade: personal income dropped .7%, and spending rose a slim .2%. Weekly unemployment filings slid from a new peak early in August, from 450,000 to 425,000, but the overall trend is not good.

July sales of new and existing homes appeared stable but were not. New home sales are measured by contracts written, and fallout is staggering, at least one-third. The leading cause: buyers can’t sell the homes they have. Resales are holding roughly 4.9 million annual, down from the 7 million peak. However, at the peak, “involuntary” sales were negligible; today they are almost one-third of the total, compressing “voluntaries”, down perhaps 60% from peak.

Case-Shiller continues its hysterical mis-measurement, insisting that home prices fell 15.9% in the last year. The excellent www.ofheo.gov data has national prices down 4.8%, nothing that bad since the 1930s. The foreclosure and walkaway damage is obvious; the silent corrosion is in the millions of households unable to sell, or to refi off bad-idea ARMs, and in diminished household faith in the future.

A way to pass time in the 13-month run of the Crunch has been, “Do they get it?” “They” being the authorities, “it” being the insolvency of the financial system.

They do. Worth your time: www.federalreserve.gov, the minutes of the August 5th meeting. Unusually short, clear, and grim, two things stand out: they get the risk of credit-default spiral (shrinking credit, more defaults, less credit...), and that risk is greater than inflation. The FDIC sure as hell gets it, staring at a bank/collateral spiral.

New game: What will they do about it? Treasury’s Henry Paulson was a daily fixture on the tube in July, appearing impatient with too much attention paid to spilled milk. All through August, Hank has been the soul of patience, and completely invisible.

Nobody knows what the White House gets, but Paulson’s inactivity looks like somebody has told him to cool it. Maybe through McCain’s nomination, maybe through the election, maybe all the way to the Escape to Crawford.

Neither candidate has a word to say, which is understandable, as many money pros still don’t get the nature and magnitude of the problem. At nomination, which candidate would like to explain to the people these choices ahead: If we guarantee Fannie and Freddie, what parts -- stock, bonds, preferred, subordinated? Then, which banks do we save, and their parts? If we save rich financial guys, what of Ford, Chrysler, and GM, and their retirees? What of the impulse to save homeowners, no matter how foolish, no matter how terribly unfair to the prudent but unlucky?

Not one of the four nominees has financial-market experience or evident knowledge. Better not to talk. However, election-cycle paralysis may be overtaken by events.

The Fannie/Freddie Deathwatch
August 22, 2008

Mortgage rates bottomed again at 6.50%, as they have since May, maintaining a consistently wide spread to the 10-year T-note, likewise bottomed at 3.80%. It will take a substantial negative economic event or news to break below these rates.

Economic data were thin. The July index of leading indicators fell hard, the outsize .7% drop entirely due to rising claims for unemployment benefits and a big slide in building permits. July housing starts dumped another 11%, surprising the remarkable number of people still with faith in a housing bottom nearby -- rather like finding pigeons who want to bet ten bucks on an instant replay.

The last weeks of summer are poorly attended in the markets, movements meaning little. The world’s central bankers are now convened in Jackson Hole, reports indicating a consensus forming around hope and the hazards of action. The shooting will start again immediately after Labor Day with fresh data from August, especially payrolls.

The big news right now is the Fannie/Freddie deathwatch. First thing: borrowers should relax; the consequences of demise for you will be either good news or no news.

The pending takeover is in many ways a non-story, just confirmation that Fannie and Freddie were, indeed, too big to fail. Hopes will be dashed at the Fed and Congress that takeover will benefit our decapitalized financial system and the economy. Maybe, just maybe, the authorities will absorb that lesson, and begin useful action.

Secretary Henry Paulson demanded total takeover power in July, telling Congress that if he had such power he would not have to use it. Wrong again, Hank. Holders of $5 trillion in F&F paper immediately wanted to be Treasury-guaranteed, and any possible sources of new capital instantly vanished. Invest, to be wiped out in takeover?

Paulson’s new problems: whom else to wipe out in an F&F takeover. Common stockholders are already gone. Holders of bonds have to be made good, as the $1.4 trillion-worth is a key asset in institutions all over the world. Preferred stock? Same deal. The cutoff decision will be precedent for the bank failures to come: who, exactly is TBTF, and when one tanks, who gets paid?

The very good news: current Fannie and Freddie management and regulators, captains of malfeasance, will be excused. Historical error aside, these people have been busy in the last six months undermining their sole purpose. Every loan now suffers a .50% fee surcharge. Since winter, every borrower with a credit score under 720 has suffered a surcharge; unless cancelled , that bar will rise to 740 on November 1st. The list of loans ineligible for F&F assistance is now longer than the one of still-doables.

The no-news is disappointing, but real: takeover will not improve mortgage rates. Maybe a little, if the surcharges are removed. In the market’s eye for credit, there is little difference between the presumption of too-big-to-fail and the fact.

But, won’t F&F be able to buy loans again, and push rates down? For housing to bottom, we must have lower rates and better availability, right?

Right on the second point, wrong on the first. There are $5 trillion in GSE mortgage-backed securities out there, and F&F own only $1.4 trillion. The principal owners of the other $3.6 trillion are giant institutions in desperate trouble. If anybody began to bid aggressively for MBS, trying to drive price up and yield down, those owners would dump their massive holdings in the same market mechanism holding rates up where they are. Any slide to 6.50%, and they elbow new borrowers out of the way. Neither F&F nor the US Treasury could possibly borrow enough money to buy them out.

Maybe, just maybe, the authorities will get the following equation. Normal MBS holdings are maintained with leverage of capital. Capital mostly gone, every big outfit is trying to reduce leverage. So, rates have to be high to attract un-leveraged buyers: mutual funds and such. The only way to restore leveraged buyers is to restore capital by Federal injection and/or accounting mirrors. Until the authorities make that leap, the real economy will deteriorate in gradual credit starvation.

Mortgage rates are falling, almost 6.50% with the lowest fees. All other interest rates are headed down as well, on glide path parallel to the global economy: the 10-year T-note to 3.83% (traded 4.10% only a week ago), and the 2-year down to 2.37% acknowledges zero probability of a Fed rate hike from its current 2% overnight rate.

Domestic data are sliding at shallow slope, but the stuff from overseas is dramatic.

Here, claims for unemployment insurance have sustained the jump to the 450,000 range, a decisive deterioration from the 375,000 in the first half of the year. Consumer confidence has been lousy for a while, but is now lousier: the lowest values have been for the future, current conditions better, but sinking now. July retail sales were flat, but adjusted for 5.6% year-over-year CPI a substantial real decline.

The negative news has been inevitable, and is perverse good news. There is no way to win an inflation fight without destroying demand, and the very good news is the Fed and other central banks are winning. At a price.

Japan’s 2nd Quarter GDP fell 2.4%, and the Eurozone minus .2%. Going lower. Asian results are not in, but the global-trade engine has entered a sharp reversal, everyone’s exports declining. The most immediate impact is a run to the dollar: the euro is $1.47 today (down $.03 in a week), oil is $112 (was $116), and gold $791 (was $858, the March top $1033). That’s a deflationary pattern. To buy the dollar you have to buy dollar-somethings, Treasurys the favorite, and maybe, just maybe, soon... mortgages.

Sidebar. The Russian adventure in Georgia is a help to the dollar, but is not a big deal. The Russians do not want NATO to proceed any further eastward (and it should not), and Georgia’s aggressive president crossed a bright tripwire that the US had warned him not to. Russia already controls Europe’s energy supply, and there is little additional advantage in whacking Georgia. The uniquely clumsy and brutal effort by the Russian kleptocracy hurts them far more than helps: the world is reminded that the US does dumb things with good intentions; the Russians poison your tea on purpose.

Fannie’s Mudd and Freddie’s Syron continue to whitewash their false fronts (Russians would appreciate their Potemkin villages), raising fees, tightening credit, freezing loan purchases, looking after their stockholders instead of the nation, unimpeded by their comic-book regulator, Lockhart, and utterly oblivious to pending nationalization. A rising unemployment rate will in some cases bring justice.

There is a place for government in the mortgage market: uniform underwriting standards are a Good Thing, leading to uniform and liquid mortgage-backed securities; and guarantee-for-fee is a good public/private business. Recreating a mortgage buyer-of-last-resort for emergencies like this one can wait.

The model for a proper mortgage agency already exists, but it’s not the Effing twins. Fannie owns $723 billion in loans and has corresponding borrowing (the problem!), and guarantees another $2.1 trillion; Freddie, respectively, $710 billion and $1.4 trillion. Fannie employs 6,400 people, Freddie “nearly 5,000” (FAQ on Freddie’s website: Is Freddie a risk to the taxpayer? “No.”).

Consider the Government National Mortgage Association, Ginnie Mae, born in 1968, carrying the full faith and credit of the US Treasury, guarantor of MBS holding FHA and VA loans. Outstanding Ginnie MBS are just short of a half-trillion dollars, growing $27 billion per month now, triple last year’s rate as the FHA is one of the last games in town. Ginnie owns no loans and does not borrow. It lost a little money in the ‘80s, the only time, the result of an FHA experiment with lunatic loan types (planned negative amortization above purchase price, the legendary 245 GPM, “Gyp ‘em!”) and some simultaneous regional housing meltdowns.

Ginnie employs 62 people. It has asked Congress for money to hire 14 more, but the ever-watchful, never-wasteful, green-eyeshade guardians of the budget have allowed seven. Parts of this credit crisis are tough to solve. This? Good grief.

Mortgage rates are a hair lower, under 6.75% now, but spreads to Treasurys have widened despite overt Treasury backing of Fannie and Freddie.

There is a three-track story unfolding today: the US economy, the ex-US global economy, and the Crunch. To maintain clarity, and composure, keep ‘em separate!

The domestic economy is weakening. New claims for unemployment insurance spiked last week to 448,000, and all hands expected some pullback; instead, 455,000 this week, the worst in six years. The collapse in auto sales to the 12-million-annual range (from 15.5 forecast) has been a recent, June-July event; however, modern “just-in-time” delivery of components means instantaneous negative feedback all the way back through the supply chain to labor and raw materials. Credit-default measures and bond prices indicate imminent bankruptcy by all of the used-to-be Big Three.

Housing shows no bottom, and without one soon, and tentative recovery, credit losses will be unbearable. The best marker of US condition: the Fed’s post-meeting statement abandoned its June observation that “downside risks have diminished;” and despite its new recitation of inflation risks made clear no intention to raise its rate.

The global scene is changing very rapidly, all for the good here and bad elsewhere.

In this past year, a tribe of economic astrologers have claimed that a weak dollar was the cause of high oil and all other US woes, and if only the Fed would tighten all would be well. This alternate universe collapsed in today’s trading.

The dollar was weak because our Fed properly eased into the Crunch (interest-rate differential is a prime driver, and ECB rates have been double our Fed’s), and because of our immense trade deficit. This week marks the beginning of dollar reversal, and reversal of a lot of other things.

The Euro-zone sag to recession means the ECB is done with rate hikes. It may take well into ’09 for 4.1% Euro inflation to break, and the ECB to ease, but that event is no longer a theory but visible on the horizon. German bond yields are in free-fall in anticipation. As the Euro-zone tanks along with us, so do markets for Asian exports, and weakness there is daily more plain, and will further undercut commodities.

The consequences of these shifts are profound in today’s markets. Oil has dropped to $116, natural gas to $8.39, and gold all the way to $858. The dollar is rising fast (certainly not because of some imaginary Fed defense): the euro barely holding $1.50, ditto sterling at $1.90 and yen at 110/$. Europe is inheriting our currency problem: the anti-inflationary benefit from lower energy prices will be delayed by falling euro value.


Then there’s the Crunch. Credit scarcity as measured by spreads to Treasurys now affects all borrowing. The notion that the Crunch is confined to mortgages and structured securities stands exposed as urban legend: top-quality municipal and corporate borrowers are suffering. Consumers show signs of last-ditch credit-card defense: consumer credit outstanding jumped $14 billion in June, borrowers unable to pay down month-end balances, nowhere else to turn for a loan.

The best model for the Crunch dates to January with Jan Hatzius (Goldman) and the Bank Credit Analyst with the same insight: capital shortage means insufficient credit by the following equation. System write-offs in the last year total about $500 billion, and only $350 billion in new capital has been raised. That $150-billion shortage, by the miracle of 12:1 bank leverage (and 25:1 broker-dealer and hedge-fund leverage) leads to a credit shortfall of at least $2 trillion. This shortage shows up as price-rationing: if you want to borrow, you have to pay a hefty spread over Treasurys or do without.

Losses yet unrecognized are at least double the ones taken, and market capital is almost unobtainable. Despite the excellent news on the dollar, energy, commodity, and inflation front, the Crunch is the dominant force, and worsening. That’s why the Dow is still lurching around in the 11,000s, instead of rocketing on that good news.

Mortgage rates are back down to 6.50% (low-fee), taken by sudden understanding that the economy probably passed its high point for the year in June.

A huge spike in unemployment claims (to 443,000 last week, 60,000 above recent range) may overstate weakness, and today’s announcement of 51,000 jobs lost in July may understate, but weakness is spreading beyond housing, construction, and manufacturing. The purchasing managers’ July survey came in dead flat, 50.0, but with the fewest new orders since October 2001, and tailing strength in exports.

2nd quarter GDP arrived plus 1.9%, propped by rebate checks and the best export sales ever (a weak dollar has its benefits). However, the Euro economy is now slowing faster than we are, and soon won’t be buying much (a strong euro has its penalties). The UK is in real trouble, retail sales to a 25-year low, mortgage approvals off 72%.

Western central banks fighting inflation (Asian ones are still flinching) have been helped by market-based credit tightening. However, beware of Frankenstein. Credit shortage is spreading to all sectors: corporate bond issuance, intact through spring, just had its worst month in five years, prime rates an immense 3% above Treasurys.

The new housing assistance bill, dismissed here briefly last week, deserves a more thorough hatchet-job.

Its centerpiece is a $300-billion FHA loan guarantee (not money) to refinance under-water home “owners.” Consider a Bubble-Zone victim who bought a $200,000 home five years ago, made a 5% down payment and got a 5-year interest-only ARM for $190,000. The home has fallen 25% in value to $150,000. She has made interest-only payments since, and her $190,000 loan is entering amortization reset.

Her rate is not bad, 5.50% even after adjustment. However, her payment will jump from $871 to a killing $1,167. To her rescue, the bill’s “Hope for Homeowners.” In the land of unfortunate acronyms, gotta call it HoHo.

HoHo provides for a write-down of the mortgage to 90% of current market value, to $135,000, plus a 3% refinance fee to the FHA, $139,000 total. HoHo further provides a 1.5% annual surcharge; added to 6.50% current market equals 8%, amortized for 30 years is $1,020 per month. Better by a little, possibly affordable, equity negligible, pride failing. Then there’s HoHo’s anti-equity kicker: when the place appreciates in value (how many years ahead?), and she either refinances off the 8% or sells, HoHo will take half of any appreciation. We bet HoHo won’t split costs.

While she considers HoHo humiliation, a new renter moves into the house next door, identical, rent $700. Millions of people just like her are now condemned as “Walkaways.” Professionals, fiddle with local examples; we think this one is mainstream.

A more pernicious provision in the bill is the First-Time Homebuyer Tax Credit, retroactive to April 9, 2008, $7,500 per household. This is a credit, not a deduction; if you owed $7,500 in ’08 taxes and had $7,500 withheld, you’ll get a refund of your whole withholding. The advice from this firm to all buyers except compulsive savers and the rich: don’t take the FHOBTAC credit.

There’s a fishhook in the FHOBTAC sirloin: you have to pay it back. $500 per year added to your taxes (good-bye, refund), and the whole remaining balance if you sell the palace. Own for three years, you’ll still owe $6,000. How many recipients of the credit will still have that cash when it’s time to pay at tax time? Scammers are already trying a payday-loan trap: assign your credit to us, and we’ll give you money for a down payment.

Meanwhile, mortgage credit starvation -- the real problem -- is doing its grim work. MGIC, the mortgage insurer, published its new regional risk guide: of 73 metro areas, two are strong, 31 soft or weak. Of the remaining 42 rated “stable,” 19 are weakening. It is one thing to allow Bubble Zones to correct, another to let a credit crunch do some inflation-fighting. But, allow the entire housing market to sink? Careful, fellas.

Proposed Fix Makes Trouble for Jumbo Loans
July 25, 2008

Mortgage rates are still stuck near 6.75%, the financial markets confused and locked-up until a blast of argument-resolving data arrives next Friday.

Oil down to $123 and natural gas to $9.25 helped stocks for a while, but they still fell apart on no-bottom housing news and a sinking job market. The economy is obviously weakening, but rates are held up by fear that inflation is the greater risk -- even the stock market’s Thursday elevator-shaft could not hold down long-term rates.

Let us take time for silly-season recognition of government worthies and their efforts to combat our problems. Stagflation? Credit-binge? Housing ex-bubble? Financial-system insolvency? Energy crisis?

We’re hard at work on it. Whatever.

Highest marks to the Fed. In retrospect, Perfesser Bernanke figured out the 1930 risks back in January. Rarely do courage, fast action, and effectiveness meet so well as in the Bear Stearns intervention.

Treasury Secretary Paulson has been late to the game. Distracted by his China-trade offensive, the record shows his great and misplaced faith that the financial system would recapitalize itself. However, he’s up to speed now: his ”Bazooka Backstop” of Fannie and Freddie was prepared before confidence broke in the GSEs. His progress to out-in-front shows elsewhere: Fed examination teams now operate inside the big securities dealers and the GSEs. We may be in trouble, but we’re not going to be surprised again by indolence among lesser regulators (SEC, OFHEO...).

Both the Fed and Treasury indicate knowledge that mortgage supply and system capital are inadequate, and are engaged in slightly panicky floating of new ideas (European-style mortgage “covered bonds,” legal maneuvers to source bank capital from private-equity firms...) which will not work well enough or soon enough. Short of something big, like a nouveau RTC, the authorities are running out of ideas, forced to band-aids, and playing for time and miracles. However, the absence of illusion is good.

In the background the Fed has been working on new regulations: the