With 50 experiments going on at once, the federal government should have an excellent source of case data to see what works and what doesn’t. Why, then, does the federal government much more closely resemble the California model then the Texas model?

We know there are distinct differences between the federal and state governments. The feds are to secure the borders and oversee national defense. The feds haven’t secured the borders. Just ask Arizona, which is home to the city with the second highest volume of kidnappings in the world: Phoenix. How does that happen in America? Arizona had to pass state legislation to enforce federal immigration laws already on the book, which apparently is highly controversial. The feds are working to appeal the law before it’s scheduled to take effect July 29th. Said Justice Department lawyers:

“In our constitutional system, the power to regulate immigration is exclusively vested in the federal government. The immigration framework set forth by Congress and administered by federal agencies reflects a careful and considered balance of national law enforcement, foreign relations, and humanitarian concerns — concerns that belong to the nation as a whole, not a single state.”

Except that they haven’t enforced the national laws and Arizona is paying for it. At this point, I’m just bracing for Washington to declare open commerce of drug wars across the border as an “economic stimulus” for the southwest. When it comes to drug wars and kidnappings, this aggression will not stand, dude.

Other differences between the federal and state governments is that the feds have taken it upon themselves to institute and run national social insurance programs like Medicare, Social Security, and FDIC. They control the US dollar, monetary policy, and thus interest rates (the Federal Reserve isn’t technically a government entity, but for all intents and purposes, it is…other then having elected officials and that whole transparency thing). But in essence, the feds are still a government instituting laws on a sovereign land. For some head-scratching reason they aspire toward the California model which is festering in bankruptcy, rooted in high taxes, regulation, and entitlements.

All I’m saying is why not be more like the Lone Star State? So far, Texas has managed to skirt through the financial collapse and recession rather swimmingly. The Texas unemployment rate has been at or below the national rate for 42 consecutive months. In June, unemployment clocked in at 8.2%, compared to California’s rate of 12.3%, and a national rate of 9.5%.

Chief Executive magazine’s 2010 survey of the best places to conduct business called California “the Venezuela of North America”, ranking it last. Guess who came in at number one? Texas.

I think we can all agree that Texas’ performance relative to demographically similar California probably has something to do with friendly tax policy. Texas has no personal state income tax, no personal capital gains tax, and no corporate income tax. California on the other hand, is, well, Venezuela. For the last twenty years, California’s oppressive tax burdens have consistently ranked among the top 10 highest in the country.

Source: newgeography.com

Texans are smart. They understand that inflation parties eventually end and instituted sound lending practices. They didn’t trust Fannie, Freddie, and the Federal Reserve to set long-run interest rates and assume everything would be peachy. Texas proved to have an understanding of bubbles, over-heated markets, risk, herd behavior, contagion, moral hazard, the global financial system, sustainability, fundamentals, and common sense.

Now let’s take a look at unions. In my opinion, unions are generally a negative because they inflate labor costs and make the United States far less competitive. It’s one thing to institute a minimum wage and child labor laws (which in a modern, free, and democratic society like ours, doesn’t make sense in many ways), but it’s entirely another thing to impose the benefit packages, above-market salaries, and legacy costs on companies that unions so often do. The percent of Texas’ labor force represented by unions is only 6.2%. Contrast that to California which has 18.3%.

When it comes to government revenue (receipts and fees), the practice of taxing income can create great fluctuations. In California’s case, they experienced a 20% upswing in annual revenues through fiscal 2000, which quickly turned into a 17% drop in 2002. This volatility makes it much more difficult to balance a budget. This time frame was during the slight contraction of the economy following the dot.com bust and post-9/11. Now that we’re in the worst economic period since the Great Depression, what type of revenue swings will be in store for The Golden State? Texas, on the other hand, get’s the lion’s share of its revenues through taxing sales. This inevitably distorts the economy less and allows for more flexibility. As far as a model for the federal government, this would support a Fair Tax-type movement on a national scale. Other benefits to scrapping the 67,000 page tax code would be getting rid of the many special favors and handouts it creates. This breeds the lobbyist and toxic culture in DC. If we moved to a Fair Tax, not only would each and everyone of us get back hours and days of our lives doing taxes every year (or the accountant’s lives), there would be no more lobbying community in Washington. Thinking about the creative energy lost every year in this country due to becoming compliant with our tax code is astonishing.

Lastly, the Texas economy is very diverse. The government plays a role in this diversity. For one, the University of Texas at Austin is the fifth largest college in the country with enrollment of 51,032. This is a public institution which generates plenty of jobs. Texas benefits from flourishing professional fields such as accountancy, law, security services, and the oil and natural gas industry. The latter has to do with natural resources, but the presence of just about any other industry you can point to has to largely be contributed to Texas’ business-friendly practices. Businesses go to less taxed, less regulated places. The flocking of such businesses creates diversity, which in a recession, cannot be under-appreciated.

The government of Texas has striven to be a responsible steward of the economy. But they let the people manage it. As a result, Texans have a great economy and a balanced budget. They did not sink themselves through pensions and entitlements to the tune of California.

There’s really no question that in a state death match, California does not want to mess with Texas. The federal government should be implementing similar policies as the Texas experiment. That was one of the major advantages to federalism as our Founders saw it.

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By Cesar Zambrano at ForexFraud.com

During the middle part of this decade the United State housing market was the talk of the town. Real estate was the asset for many investors to buy. Homes were appreciating at such a high rate that buying and selling homes within a few months created wealth for many. No one really understood at the time why so many could afford multiple homes. The homes were appreciating every day so loans were extended to most everyone who wanted to buy real estate as an investment. The assumption was that if the borrower stopped payment, the asset was going to be worth enough to cover the loan. Many of these loans were taken by those who really didn’t have a lot of money to afford multiple homes. The banks gave them a low interest rate for the first year, which made the investment home affordable.  When the rates reset a year later and the borrower still could not find buyers, his new higher interest rate become too much to pay. With no one willing to buy the home, real estate investors simply stopped paying mortgages. Some of these investors had three or four homes that they intended on flipping for profit. Investors knew they could not keep them forever, but obviously thought that the demand for housing would never subside. As the foreclosures started to go through the courts later in the decade, we began to uncover why so many were able to get loans that they couldn’t afford.

It all started with the mortgage brokers giving out loans to those who had no intention or didn’t have the funds to pay the loan off. These brokers were sometimes even convicted criminals. In states like Florida it was later discovered that an alarmingly high rate of the licensed mortgage brokers had prior felony convictions. Florida typically won’t allow prior felons to obtain business licenses without a thorough screening. During these years they simply gave licenses to anyone who applied. Any mortgage broker out there, convicted felon or not, was paid on commission from originating a loan. The more loans they gave out the more money went into their pockets. Banks at the time would not keep the loan with them, but instead sell the loan off into the secondary market. The mortgage market is quite large; however most mortgages are bought by government agencies, which were created to buy the loans from banks, so that the bank could create more loans to qualified homeowners. This whole concept of investors buying loans from banks was based upon the belief that banks had made the loans to well qualified borrowers with a steady job and money in the bank.

If the borrower had a solid job then he could make the monthly payments. If there was money in his bank account it gave the lender the ability to go after their funds if the borrower had to sell the house at a loss. Sadly enough, most of the banks never even checked if they had sufficient funds or a job. The fraud that occurred here was most likely the borrowers fault for falsifying information on their loan application. Lying about monthly income and assets on the application was the issue. But for mortgage brokers not to ask for proof of their income and assets was equally appalling.  The bank simply did not care whether or not they had the ability to repay a loan it created, the loan was sold the next day into the secondary market. Both the bank originating the loan and the mortgage broker profited so what was the reason not to continue this process? There was none, and over the course of a few years millions of loans were created without the banks ever asking the borrower for any of the required documents to prove their income. They later became known as NINJA loans, meaning: No Income, No Job/Assets.

The impact that these loans is having is quite sever. Since banks and investors got burned by so many bad loans, they are requiring tighter lending standards these days. You might have a decent job, but if your employment history is not long enough you might be turned down for a loan.  These tighter lending standards are helping drive down prices. The housing market that was once affordable to everyone because of easy money now has far less potential buyers that are able to access loans. This will create an inventory surplus. Simple economics will tell you that more supply will drive down prices. Buyers will be pickier and selling your home will be difficult because of all the competition. Depending on the region that you are selling in, the increased competition is in the form of bank properties that were foreclosed upon due to mortgage fraud. Foreclosed homes tend to sell at prices below other homes in the area. This is because they bank don’t want to own the property, so they lower the price below any other comparable home in the community to get it sold first. If there is more than one foreclosure in the community the banks are essentially competing against each other for buyers. This creates a scenario where both banks competing for buyers bring down the property values of the surrounding homes.

Not being able to obtain a loan will ultimately create some increased demand for rental properties. Everyone needs a place to live, if you cannot buy then renting is the only other option. Rents are reasonably low right now; so many potential home buyers consider this the better decision even if they can get a loan.  Recently investors have been buying up these foreclosed homes and renting them out. They are buying these homes at such low prices their return on their investment is far greater than what you would get from buying government and corporate bonds or from currency trading.  Any investor can compare the interest they would receive from holding currency versus the return they would receive from income producing property by contacting a currency broker and looking at their daily rates. Real estate also has tax benefits that wealthy investors would like to take advantage of.  These real estate investors are defiantly helping take supply off the market, however there are still more properties coming on to the market daily.

The mortgage fraud is even leading to the disintegration of certain neighborhoods. There are some neighbor hoods that have been so affected by fraud that over half the homes in the area are owned by the banks. These vacant homes lead to crime. Many homeless people live in them, as well as prostitutes and drug dealers. The banks are so overwhelmed by the amount of homes that they own all around the country, taking care of all of them is simply not possible. The influx of crime onto a community then leads to the depreciation in value of surrounding properties. No buyer wants to live in a community of criminals and homeless squatters. This leads to very little or no demand for the asset, causing others to stop making payments because the value of their home is far less than the amount they owe on the loan. There is also no demand for the home; buyers just don’t want to buy a house in a community like these.

Cities such as Detroit have even thought of tearing down sections of the city and restoring it to farm land. The land is worth more as a vacant lot with grass, than a half standing dilapidated structure. The idea of tearing down structures that are used for illegal activity is necessary if the city wants to improve going forward. The city needs the land to be used where it can have the highest value, so they can collect as much tax revenue as they can.  The falling home values started by the mortgage fraud have made the county tax assessors lower property values considerably over the past few years. The lost revenue then affects the county citizens who lose city services like police, fire and schools. There are many sad stories about what mortgage fraud has done to the communities and the people that live in them. We can only hope that as we all move forward into the future the banks are more prudent in whom they loan money to.

A few days ago a friend of mine asked me what I would say in an open letter to a group of Independents if they asked me what I thought of the financial reform bill that is currently being considered in Washington. The following is my open letter response to those Independents:

Dear Friend,

Financial reform is needed very badly, but the financial reform bill that is being considered in Washington at the moment is not good. The current financial reform bill as proposed will not fix the financial systems of this country. Never, ever. To fix the financial systems of this country much more drastic changes need to be made than those that are being proposed.

Recently, I had an article published in Business Insider that explains how the Federal Reserve, Fannie Mae, and Freddie Mac mismanaged long-term interest rates for a period that goes all the way back to the early 1980s.

What the Federal Reserve did and what they allowed Fannie Mae and Freddie Mac to do over the past thirty years went against financial theory. What the Fed allowed was a setting of mortgage rates much, much higher than they should have been back in the early 1980s, which then led to a period where the people of the United States were able to live off newly created debt year after year as a result of the sanctioned refinancing, refinancing, and more refinancing of our American homes.

All the time that this was happening, Fannie Mae and Freddie Mac grew “fat” off of our debt. The more debt that Fannie and Freddie could create, the more money Fannie and Freddie made. Don’t fool yourself. Fannie Mae and Freddie Mac were Government Sponsored Enterprises (GSEs) and not true business enterprises. And as such, with the protective shield of the government implied behind them, the executives of those agencies managed to pay themselves grandly while building up the long-term debt of our country. In truth, Fannie Mae and Freddie Mac did not answer to the people of the United States; they answered to their stockholders. And it was solely because of that fact that we are living through the greatest recession since the Great Depression.

Yet, guess what? There is not a single thing in the current financial reform bill dealing with the issue of Fannie Mae, Freddie Mac, or even the Fed (at least in the proper way).

Now it is time to get blunt. The current Federal Reserve Chairman should resign his post, and so should the current Secretary of the Treasury. And along with that as a given, the Democrats and/or the Republicans need to replace both Chris Dodd and Barney Frank from their central positions as it relates to governmental finance. In fact, all the financial leadership positions in Congress need to be reconsidered.

Over the last thirty years the United States financial system failed the people of the United States of America and the world.

Historically speaking, if there is one thing we should never forget: it is that freedom, innovation, and business is what made the United States of America strong, and it will be freedom, innovation, and business in the United States that will continue to make the United States strong in the future.

Related to that philosophy, I was recently asked by another friend to comment on the recent G20 meetings. Now I would like to share with you my own “independent” reading of the world’s (G20) situation. Here is how I responded to my friend:

“Everyone at the G20 seems to want to get their debt spending down. I think that is a noble objective. I even think that our own Fed guys (Bernanke) and Treasury (Geithner) are working towards that same solution themselves. The trouble is: there is no reason for delay. The solution to the problem is already known. It is the establishment of a fixed, steady 4.0% long-term interest rate for the United States. If you did that, all the other currencies of the world would be able to set their debt currencies against that. And do you know what? A 4.0% long-term fixed rate in the United States is just about as low as you can go and still leave room to avoid both “inflationary” or “deflationary” spikes.

I’m beginning to think we have the wrong people going to the G20 meetings. Over time, and especially through this most recent crisis, I have come to realize how business represents the strength of the United States of America. The stronger our businesses are the stronger our country is. I have also come to understand that it’s in our form of freedom-loving government in the United States of America that business best prospers, which then led me to believe that businesses in the United States of America will always have an advantage over businesses coming from other governmental forms.

However, through my analysis, I have also come to realize that part of business as I define business (both in a macro and micro scale) is tied to finance (or economics) in some form or another. And having looked at it in that manner, I have also come to the conclusion that finance (economics) is in place to serve (rather than direct) business and thus the general welfare of the people.

Now considering contemporary times, based upon what the Fed did and allowed Fannie/Freddie to do, all I can say is this–finance did a very, very poor job of helping business and the people of the United States and the world these last thirty years. In fact, finance, by itself, nearly toppled all of the world’s economies and businesses in 2008, and I think we all know what that might have meant.

Change needs to take place! But the current financial reform bill does not change a thing. And for that reason, I believe the current Fed chairman and the current Secretary of the Treasury need to resign their positions. I also believe that both the Republican and Democratic parties need to quickly find new replacements for the likes of Barney Frank and Christopher Dodd.

The United States of America needs a “new world (globalnomic)” economist at the Fed. The United States of America needs a “new world (globalnomic)” economist at the Treasury. Our global community is advancing quickly, and it is important that the “greatest society of all the world’s great societies” grows at least as fast as those who count on us to lead.

Putting that in practical terms–the longer it takes us to make the necessary changes at the top so we can implement “real financial reform”, the longer all of those newly unemployed people we have in the United States are going to stay unemployed. And the longer it is going to take the world to work itself out of our current economic crisis.”

Note from SwiftEconomics.com founder, Ryan Swift:

If any of Jim’s proposals resonate with you, please contact me. Let’s work together to address the problems in our economic system. It is on us to create a sustainable and vibrant US economy. The powers at be have let us down. Based on their “solutions” to health care, mortgage debt/housing, public debt, and the financial system, I wouldn’t expect that to change.

Jim Boswell has an M.B.A. degree from The Wharton School (University of Pennsylvania), an M.P.A. from School of Public and Environmental Affairs (Indiana University), and a B.A. degree from Hanover College. His recently published book, Crush Depth Alert, Fourth Lloyd Productions, explains in detail with supporting exhibits, graphs, and tables the factors that led up to the recent financial crisis while offering solutions on how to move forward. This is a follow-up to an earlier BusinessInsider.com article (June 24, 2010) by Boswell called “How 25 Years of Mismanagement at Fannie and Freddie Caused The Financial Crisis”.

You can purchase Crush Depth Alert here.

The current financial crisis did not happen because investment companies were dealing in derivative products that no one understood (the simplistic general Democratic explanation), nor was it a result of an abnormal growth in homeownership rates in the United States (the simplistic general Republican explanation). The real reason for our current crisis is that our economic leaders allowed Fannie Mae and Freddie Mac to mismanage mortgage rates and thus mismanage a substantial portion of our “debt economy” for more than twenty-five years.

Here are the facts that back up this statement. Exhibit 1 shows a 12-month running average plot of Freddie Mac single family fixed rate mortgages against the 12-month running average of the CPI between 1972 and 2008 (nearly the full period of time mortgage-backed securities had been issued prior to the recent financial crisis).

Exhibit 1

Many readers might recall the periods of high inflation that resulted in the 1970s, which are clearly shown in the first quartile of the Exhibit. Many readers might also recall how Paul Volcker in his role of Fed Chairman raised the Federal Funds and Prime Rates significantly in the early 1980s, which curtailed inflationary rates from a 14% annual rate to a 4% annual rate in a short two-year period between the end of 1981 to the end of 1983. That significant drop in inflation can be seen about a third of the way from the y-axis in Exhibit 1.

What most readers (including most economists) do not know, however, is how long-term mortgage rates rose even higher than short-term rates during the early 1980s, and then how subsequently long-term rates have tracked with inflation over time. Both Exhibit 1 and Exhibit 2 can be used to see how they have tracked, and they have not tracked well. And that mistake of allowing mortgages rates to go to 18.0% in 1983, which was either ignored or conceded to by the Federal Reserve, allowed Fannie Mae and Freddie Mac to have unprecedented control of our economy for more than twenty-five years, which significantly led to our current economic crisis.

Exhibit 2

If there is anything we should learn from the past, it is that long-term rates should not be used to control inflation; unless of course, you believe current inflationary trends are expected to continue for the long-term also. Not only were long-term mortgage rates raised and mishandled in the early 1980s, it is also noteworthy that it took a lot longer than it should have to lower long-term rates. While it took less than two years to go from 14% to 4% inflation, it took more than ten-years to drop mortgages rates a similar ten percentage points from 18% to 8%.

For the last 27-years (almost the full time for a 30-year loan to mature), inflation as measured by the CPI has averaged 2.99%, yet only very recently have long-term rates begun to come into sync with long-term inflation. With mortgage-rates set so far above what they should have been set in 1983, Fannie Mae and Freddie Mac were allowed to establish a policy that slowly lowered mortgage rates year after year, in effect allowing us to enjoy one refinancing cycle after another so that their mortgage portfolios could grow and grow and grow.

Debt through refinancing meant nothing more than income to these Government Sponsored Enterprises. Not only did the GSEs have free reign on setting mortgage rate policy, they used that power to construct derivative (REMIC-type) products than enabled them to further outwit investors.

Hindsight you say? Considering technological productivity gains, the fall of the Berlin Wall, China-India-Brazil’s development, and globalization in general, how long should it have taken our esteemed economists to understand that inflationary trends could be somewhat tame over the long haul? If you look at Exhibit 1 again, you will see that we have been experiencing the benefits of these factors and low inflation ever since the late 1980s.

How did the GSEs get away with their strategy in light of oversight and investor supply and demand issues? There are two fundamental reasons why:

One, the Federal Reserve was asleep at the wheel. Even though we may revere our esteemed Reserve economists; the Federal Reserve never understood mortgage debt, nor did they ever question mortgage rate policy. Instead, the Fed simply received regular reports from Freddie Mac telling them what the current GSE mortgage rate policy was. The Fed either was ignorant or played ignorant while we added nearly $7.5 Trillion in “new mortgage debt” during the fifteen-year period between 1992 and 2007. Talk about Keynesian economics! Any Reserve Chairman of the Great Depression era would have been envious of what Alan Greenspan was allowed to get away with while collecting accolades—and that does not include the stimulus that was being added during his reign from our Government’s deficit spending and growth in our “national debt”.

Two, demand for Mortgage-Backed Securities, was always there. MBSs have always served as one of the best “risk free” hedges against inflation. An 18% MBS when compared against a 3% long-term inflationary perspective is an extremely attractive product, as is a 14% MBS, as is a 10% MBS. Need I go on? Anyway, what could be safer than investing in American housing? The stock market carries risk, does it not, or have we forgotten what happened in 2000-2001?

So for twenty-five years we Americans took advantage of mortgage rate mistakes made by the GSEs going back as far as the early 1980s to live off our houses and build up our debt to unreasonable levels, while the executives at the GSEs gloated over their growing MBS portfolios and their “well-deserved” bonuses. The money-making machines that the GSEs owned were the envy of Wall Street bankers, so they, too, joined into the game. After all, housing prices would never fall—another gross misconception made by our elite financial leaders.

The good news is this. We will recover from all of our blundering in housing finance, and some day real estate will again offer a means to slowly build equity. The bad news is that housing is not the only major financial problem that needs to be solved in the United States. We still have other big financial issues equally important facing us ahead, including fixing our “health care cost” systems (private, Medicare, Medicaid) and our social security systems. Solutions exist, as long as we understand and face up to our problems head-on. The question remains, however—is that something we are willing to do?

Jim Boswell (MBA, MPA, BA) directed the analytical risk monitoring activities of Ginnie Mae’s $500 billion portfolio of mortgage-backed securities for 12 years (1988-2000), including the period of the S&L crisis. His recent book, Crush Depth Alert, published by Fourth Lloyd Productions, explains in detail with supporting exhibits, graphs, and tables the factors that led up to the financial crisis while offering solutions on how to move forward.

You can purchase Crush Depth Alert here.

This article was first published on BusinessInsider.com.

During the 15-year period between 1992 and 2007 American homeowners increased the total amount of their housing debt from $2.8 trillion to $10.2 trillion, almost a three-fold increase of $7.4 trillion! This increase in housing debt was greater than the increase of the better known National Debt, which went from $4.1 trillion to $9 trillion during the same time period.

The following chart shows a 12-month running average plot of Freddie Mac single family fixed rate mortgages against the 12-month running average of the CPI between 1972 and 2008 (nearly the full period of time mortgage-backed securities had been issued prior to the recent financial crisis).

During the first quartile (1972-1981) shown above, the monthly average difference between the 30-year fixed rate mortgage and the CPI was 1.25%; during the second quartile (1982-1991) the average difference was 7.54%; between the third quartile (1992-2001) the average difference was 5.11%; and for the last quartile (2002-2008) the average monthly difference has been 3.54%.

Who was responsible for setting and controlling mortgage rates during this entire period? Of course, you would think that the Federal Reserve might have had something to say about it. But no, the Federal Reserve conceded its authority to the politically savvy and self-serving executives heading the Government Sponsored Enterprises called Fannie Mae and Freddie Mac, who through their oligopoly-like power and underwriting systems established mortgage rate policy for the United States instead!

Interest rate theory assumes that the Nominal Interest Rate is equal to the Real Interest Rate plus Expected Inflation. Using 18 years of data between short-term U.S. Treasury bills and actual inflation, Eugene Fama somewhat confirmed this theory by showing that the average Real Interest Rate return on supposedly “risk-free” Treasury notes was 0.2% above inflation for the period between 1953 and 1971.

Although the time period for Fama’s analysis may seem ancient history; his findings are still relevant. Essentially, “risk-free” interest rate theory says that interest rates for notes or bonds that are guaranteed by the US Treasury (thus supposedly risk-free) need only be set high enough to cover the general cost of inflation in the U.S. with an additional fudge factor for the potential error in one’s estimate of future inflation, which when based upon averages is assumed to be somewhat nominal itself.

And that leads us to a very important question. What is a mortgaged-backed security that carries with it the full faith and credit guarantee of the United States of America behind it, if it is not a “risk-free” U.S. note — implied or otherwise?

The table to the left provides a 60-year history of inflation in the United States as represented by the Consumer Price Index. Note than in all but two of the 10-year periods in the top part of the Exhibit (including most of the period of Fama’s study) that inflation averaged near or below 3% in the United States. Note also from the bottom part of the Exhibit that for the last 27 years (from 1983-2010) inflation as represented by the CPI has averaged 2.99%.

Based upon the previous exhibits and “risk-free rate” theory, it is long past time that we establish a Federal policy to refinance and guarantee “existing” U.S. homeowner debt for “risk-free borrowers” to 4%! Considering that half the world’s population lives on less than $2.50 a day (World Bank statistics), there are ample opportunities to further globalization and contain “long-term” inflation within the United States at or below 3.0% for a long time moving forward.

Who are these risk-free U.S. borrowers? They are the same people (or heroes) that helped us divert what could have become a Second Great Depression into a manageable recession instead. They own at least 80% of the current $10.9 trillion in mortgage debt and are the people who continued to make their regular monthly principal and interest payments all through the recent crisis despite the fact that their own financial condition was constantly deteriorating. It is time to reward them.

One last refinancing cycle to 4% for 80% of our mortgage debt would: (1) add $100 billion in annual stimulation to our economy without government spending and without taxes; (2) increase homeowner equity to the tune of $1.6 trillion; and (3) actually lead to a reduction of U.S. Mortgage Debt and U.S. National Debt!

Who would buy this debt at 4%? The same people that currently own that debt, which includes the Federal Government, pension funds, foreign concerns, insurance companies, and any other institution that wants to hedge their bets and feel safe about having their money keep up with inflation.

Who should run the program? After abolishing the GSEs and creating a much smaller and financially conservative federal entity that includes the remains of the GSEs, and the Ginnie Mae, FHA, and the VA mortgage programs, the Federal Government should run the program.

Can the government be trusted to run such a program? Yes, and a lot better than the GSEs, who were nothing but “private entities” cloaked in public sector cloth. The only fundamental requirements would be to put a responsible financial leader (and not some political hack) in charge of the new entity and provide him or her with a new state of the art underwriting system with conservative controls.

There are two things we should learn out of this most recent financial crisis. One, the U.S. economy is too important to leave a very important and influencing sector of our economy in the control of Fannie Mae and Freddie Mac (or the leaders of our big banks). Two, it is better to control inflationary spikes with short term rates than long term rates.

Jim Boswell (MBA, MPA, BA) directed the analytical risk monitoring activities of Ginnie Mae’s $500 billion portfolio of mortgage-backed securities for 12 years (1988-2000), including the period of the S&L crisis. His recent book, Crush Depth Alert, published by Fourth Lloyd Productions, explains in detail with supporting exhibits, graphs, and tables the factors that led up to the financial crisis while offering solutions on how to move forward.

You can purchase Crush Depth Alert here.

This article was first published on TheStreet.com.

For a less humorous version of the above, see here.

“The Dow Jones Industrial Average plunged almost 1,000 points before trimming its drop and ended down 347.80 points, or 3.2 percent, at 10,520.32. About $700 billion of U.S. stock- market value was wiped out in less than 10 minutes, according to data compiled by Bloomberg.”

Now the SEC and CFTC are looking at allegations of “unusual trading” to explain what happend – although it’s a good bet that Greece’s exploding debt problem played a part.

The SEC may also want to investigate the Plunge Protection Team, or the President’s Working Group on Financial Markets (although they most certainly won’t). The group was established after the stock market crash in 1987 to make legislative and private sector recommendations. The Plunge Protection Team, a term first used by The Washington Post in 1997, is a “conspiracy theory” that the Working Group on Financial Markets uses government funds to buy stocks in the event of a crash to avoid an all out panic.

The idea, according to Jonathan Moreland, is to “intervene to put a floor under stocks whenever they are at risk of penetrating important levels of technical support, such as when the 50-day moving average slips under the 200-day moving average.” I think it’s safe to say that today’s 1000 point drop counts.

But that’s all a conspiracy theory, right? Well maybe, I can’t say for certain. But the Working Group on Financial Markets did release a statement in October of 2008 regarding the financial crisis that stated the following:

“Conditions in U.S. and global financial markets remain extremely strained.  The President’s Working Group on Financial Markets (PWG) is working with market participants and regulators globally to address the current challenges and restore confidence and stability to financial markets around the world.”

What exactly do they mean by that? The document mainly discusses the role of other government institutions and is fairly vague overall, so it’s hard to know. Regardless, it’s needless to say that our government can be just a tad bit secretive from time to time. So if the Plunge Protection Team does exist, it would mean the late recovery today is no sign that we’re out of the woods. And even if it doesn’t exist, well, losing almost 350 points isn’t anything to pop open the champagne about.

“When you’ve been in government for 21 years, as I have been, the issue of retrospect and what you should have done is a really futile activity. I was right 70% of the time. But I was wrong 30% of the time, and there were an awful lot of mistakes in 21 years.”

I wonder if he came up with his 30% mistake rate using the same formula to calculate the ideal federal funds rate from 2001-2006. I guess if there’s anything to learn from Mr. Greenspan, it is to always error on the low side.

Influx of Foreign Capital via Mortgage Bundles

One nice thing I will say about Greenspan’s explanations of the housing collapse is his point on the influx of foreign capital. Once Wall St. figured out they could securitize sub-prime mortgages and sell them abroad, we had two more influencing factors to the housing bubble: 1) a cavalcade of new buyers for US housing debt, propping up home values for a little longer and 2) an influx of foreign capital from the sales of these financial instruments which could be used to extend more credit or increase debt accumulation through derivatives. Mortgage-backed securities have been fairly well covered, particularly the moral hazard of transferring risky loans to other investors. But foreign capital flooding into the financial system really has not. Greenspan claims it was this phenomenon that was most responsible for the bubble, not his low federal funds rate. Seems rather convenient for him, but it is also a fair point as one of the many causes for the housing and financial collapse.

General Motors Takes A $3.4 Billion Loss in Q4 2009

The little company that could, as long as they receive a little help from the taxpayer pool, apparently still can’t. If their “Reinvention” commercial post-bailout wasn’t inspiring enough, I give you a $3.4 billion Q4 loss. GM lagged far behind competitors Toyota and Ford, who both posted profits during the period; one which featured improved auto sales. Now is certainly the time to strike for GM. I think it’s safe to say Toyota has hit an all-time public relations low with their faulty brakes. So take Q4 on the chin GM-owning taxpayers, and hope CEO Fritz Henderson has something up his sleeve. Really it doesn’t matter, because any returns made by the federal government using taxpayer funds will never be returned to the taxpayer, only used for more spending; or at best, to pay down federal debt from past spending. Remember that “returns” when it comes to owning shares in a company are usually distributed through dividends, equity-share payments, and/or net profit made from the final sale of the shares. Be sure to let me know if any of these reach your mailbox.

So we’ve had a jobless recovery because our economy grew 2.2% last quarter. Unfortunately, as Anthony Randazzo points out in Reason Magazine, most of that “growth” is based on temporary government programs:

“Consider that 37 percent of the third-quarter GDP growth was due to motor vehicle purchases, which were stimulated almost entirely by the Cash for Clunkers program… Another 20 percent of third-quarter GDP growth came from new residential investments, propped up largely by the First-Time Homebuyer Credit… Overall, government support accounts for roughly 77 percent of economic growth in the third quarter of 2009, according to my analysis of Commerce Department statistics. This means that non-Washington GDP growth was closer to 0.34 percent from July to September 2009, instead of 2.2 percent.” (2)

He concludes, “This is not real growth. It’s the national equivalent of a credit-card buying spree, with the bills—in the form of debt service and unfunded liabilities—to be paid off later. It is a faux recovery.”

Still, 0.34 percent growth, and continuously shrinking job losses does, potentially, show signs the recession will be over soon. The key word is ‘potentially.’ Regrettably, the fundamentals of our economy are still way out of whack. Stimulating home purchases just prolongs the needed correction in the vastly overinflated housing market and stimulating car purchases is just a way to increase consumer spending when Americans desperately need to rebuild their savings.

These programs also add to our immense national debt. The deficit for 2009 alone was $1.4 trillion, which was put on top of the $12.6 trillion in national debt. Some have estimated unfunded liabilities at over $100 trillion. (3) Sooner or later, we are going to have to pay back these debts. Or even worse, foreigners may stop lending to us, or even start liquidating our debt, which would cause a run on our currency. Furthermore, the Federal Reserve has more than doubled the monetary base which could have massive inflationary consequences if lending and velocity of circulation ever pick up. (4) And if the Fed tries to stop inflation by increasing interest rates, it would surely throw the economy back into a recession.

As bad as all that sounds, it ignores the dire situation we are facing in a very familiar setting: the housing market. Contrary to popular wisdom, the ‘toxic assets’ have not been cleaned out. It is very likely we are heading for a second mortgage meltdown.

A fantastic website called DoctorHousingBubble.com, has compiled a vast array of data on housing trends and the future looks bleak. Most of this data is for California, but much of it illustrates a larger trend in the country. The following chart shows when California mortgages are timed to reset from a low ‘teaser’ rate to an actual adjustable rate. See if you notice anything disturbing:

Source: DoctorHousingBubble.com

California is moving straight into some very dangerous territory. While most of the subprime loans have reset, most option ARMs have yet to reset. Option ARMs are even more dubious than the infamous interest-only loans, which allowed homeowners to pay none of the principle and simply rely on appreciation (i.e. inflation) to gain equity. Option ARMs allow homeowners to pay even less than the full amount of interest due each month (called negative amortization), which then just pads the unpaid interest onto the principle of the loan. And these teaser rates are about to disappear en masse.

Given the recent fall in housing prices, it is no surprise that the vast majority of Option ARMs are attached to houses that are severely underwater (the owner owes more than the home is worth). 73 percent of Option ARMs are severely underwater as compared to 50 percent of subprime and 25 percent of prime loans. (5)

Given all that, it should be no surprise that the percentage of Option ARMs becoming delinquent is skyrocketing. The following graph shows the percentage of Option ARMs in California that are delinquent:

Source: DoctorHousingBubble.com

Fortunately, only four states have major exposure to Option ARMs; California, Arizona, Florida and Nevada. (6) Unfortunately, what happens in these states can reverberate throughout the country. And even more unfortunately, as far as properties being underwater, it’s not as if California is the only state facing this problem. Not by a long shot:

Source: DoctorHousingBubble.com

There’s another problem in the housing market looming beneath the surface. Banks are not clearing out bad debt nearly as fast as it is coming across their desks. Loss mitigators are overloaded with case files and can barely keep up with them. Stephanie Armour of USA Today concludes, “Banks dealing with a surge in refinancing, mortgage modifications and defaults are overwhelmed with demand, so it can take longer to initiate a foreclosure sale.” (6)

Furthermore, banks have at least a short-term incentive to not recognize losses. If a loan is not performing, the loan is still recognized as an asset on the bank’s balance sheet. However, if the property is brought to foreclosure, that asset disappears. And banks typically lose the majority of their investment in the foreclosure process. Thereby, taking a property to foreclosure may be the right financial decision for a bank, but it makes their income statements look worse, which in turn makes their stock look worse.

What we see is a massive glut of ‘shadow inventory.’ These are properties in the process of being foreclosed on or sold by short sale (when the bank agrees to discount a mortgage so a property can sell). The following graph shows that not only are delinquencies continuing to increase, but there has been a massive increase in shadow inventory:

Source: http://Mortgage.FreedomBlogging.com

As you can see, while the foreclosure-in-process rate mirrors the 90+ day delinquency rate, the REO rate does not. REO (real estate owned) are properties that were foreclosed on but did not sell at auction. These are properties the bank owns and must sell to recoup as much of their original investment as possible (usually a relatively small fraction). In essence, it means there is a large glut of soon-to-be-foreclosed properties, which haven’t flooded their way into the market yet. According to the Amherst Securities Group, another 7 million properties are set to be foreclosed (as compared to 1.27 million in 2005).(8) Furthermore, based on data from the Lender Processing Servicers database, 7.5 million loans are delinquent and another 1 million are REO’s. The number of delinquencies has risen by 25% from January of 2010 as compared to January of 2009, while 31 percent of delinquent loans have been delinquent for over six months without a foreclosure process being initiated and 22.8% over 12 months. (9)

Sooner or later, these properties will have to go to market. At that point, the additional glut of housing on the market will create an oversupply of homes. This, in turn, will further reduce housing prices and cause even more homes to go underwater, meaning fewer homeowners will be able to refinance or sell a home without doing a short sale.

Some would argue this requires government action to stimulate the housing market. I would say that is like treating a heroin addict with heroin. Housing was artificially inflated and it’s going to come down, whether we like it or not. Furthermore, attempts at re-inflating bubbles usually end up inflating other bubbles. For example, the attempt to re-inflate the stock market after the dot-com bust brought much more inflation into housing than it did into the stock market.

Policy prescriptions are a moot point here, however. The big point is it appears we are heading straight into a second mortgage meltdown. Of course, that’s assuming the first one ever ended.
___________________________________________________________
(1) George Stephanopoulos, “Summers: Job Growth by Spring,” ABC News, December 12, 2009, http://blogs.abcnews.com/george/2009/12/summers-job-growth-by-spring.html
(2) Anthony Randazzo, “The Myth of the Recovery,” Reason Magazine, March 10, 2010, http://reason.com/archives/2010/03/10/the-myth-of-the-recovery
(3) For the deficit, see Brian Faler and Julianna Goldman, “CBO Projects 2009 Deficit Will Reach $1.85 Trillion,” Bloomberg, March 20, 2009, http://www.bloomberg.com/apps/news?pid=20601103&sid=aA8lChe4zUQU, for debt, see “U.S. National Debt Clock,” Last update March 22, 2010, http://www.brillig.com/debt_clock/, for unfunded liabilities, see Pamela Villarreal, “Social Security and Medicare Projects,” National Center for Policy Analysis, June 11, 2009, http://www.ncpa.org/pdfs/ba662.pdf
(4) George Melloan, “We’re All Keynesians Again,” Wall Street Journal, January 13, 2009, http://online.wsj.com/article/SB123180502788675359.html
(5) “California Sending out Approximately 475,000 Notice of Defaults for 2009 yet Overall Foreclosures Declining, Shadow Inventory, Q3 Defaults, Toxic Loans, The State of the National Housing Market, DoctorHousingBubble.com, October 21, 2009, http://www.doctorhousingbubble.com/california-sending-out-approximately-475000-notice-of-defaults-for-2009-yet-overall-foreclosures-declining-shadow-inventory-q3-defaults-toxic-loans-the-state-of-the-national-housing-market/
(6) “Option ARMs Enter the Eye of the Hurricane: The $189 Billion Recast Problem Targeted Directly at the California Housing Market, Of $189 Billion in Securitized Option ARMS $109 Billion in California,” DoctorHousingBubble.com, October 30, 2009, http://www.doctorhousingbubble.com/option-arms-enter-the-eye-of-the-hurricane-the-189-billion-recast-problem-targeted-directly-at-the-california-housing-market-of-189-billion-in-securitized-option-arms-109-billion-in-california/
(7) Stephanie Armour, “Another wave of foreclosure looms, USA Today, 11/19/2009, http://www.usatoday.com/money/economy/housing/2009-11-19-shadow19_ST_N.htm
(8) Ibid
(9) “Lender Processing Services’ February 2010 Mortgage Monitor Report Shows Pace of Delinquencies Slowing, But Delinquency Rates At All-Time Highs,” Lender Processing Services, February 2010, http://www.lpsvcs.com/NewsRoom/Pages/20100315.aspx

At some point, the easy money policies of the Federal Reserve must be reigned in. Let's hope the timing is right.

The easy money policies have some Americans fearing a rise in inflation on the horizon. Combine stagnant growth with inflation, and the wonderful phenomenon known as stagflation is born, another fear percolating for some. To prevent either, Bernanke will have to be very careful with how he tightens financial conditions, reeling in the money supply. In pictures, the money supply looks something like this:

Click for larger image

The gray bars denote a recession, and you can see the vertical rise since 2008. Currency is a medium of exchange which represents a value for goods and services. If the amount of money increases in the economy, so, too, will demand for goods and services, in the long-run. When demand picks up, prices go up. Think about trying to pick up that zombie mask on eBay: the more bidders there are, the higher the price will be. Money is only as valuable as its ability to pay for goods and services. So, if prices increase, it takes more dollars to pay for the same goods and services. This is inflation.

We haven’t seen inflation on the whole during the financial rescue and government stimulus efforts, despite the Federal Reserve’s easy money policies. If you wanted to cherry pick certain assets, the argument could be made that $140/barrel oil, during a recession, coinciding with a dump of liquidity on the economy, could be related. Global oil transactions are denominated in US dollars. It is hard to imagine any other factor being solely responsible for such a historic, and counterintuitive, rise in petroleum during a recession.

But those who fear a rise in price levels say the game isn’t over yet. The amount of money in the economy is only one part of the equation; the rate of money circulating in the economy, the other. Credit is still tight, and economic growth modest. Once bank’s begin lending in normal volumes, and the economy picks up, the possibility of inflation rears its ugly head. Now, who knows when either of those two things will actually happen. The Fed doesn’t know either. Bernanke has been sticking to his guns on interest rate policy, promising low rates for “an extended period”. But he has finally unveiled a game plan for tighter money, albeit without a time frame.

The first phase of his plan will be to offer reverse repurchase agreements to third parties. In effect, the Fed will offer some of its mortgage debt and Treasurys to investors, with a promise to repurchase them at some point in the future. This offers an exchange of paper securities to the investor, and money back into the Fed coffers. I suppose the repurchase aspect of the arrangement offers some insurance to investors who want to purchase US debt and housing debt, two areas of investment I would not be eager to jump into.

The second phase of the Bernanke plan involves selling banks what essentially would be a certificate of deposit. The bank would give the Fed a chunk of its reserves, while the Fed would pay the bank interest. Banks would not be able to count their investment in the Fed as cash or reserves, slowing the process of fractional reserve banking.

If Bernanke pulls too much money out of the economy, too quickly, the economy will suffer. If he pulls too much money out, too late, the economy could hit a wave of inflation. Inflation is not good for business, particularly in a consumption economy. So he’s a central planner who is credited with saving the banks, and the economy from depression. Let’s hope he hits the mark on his plan for tighter money, and with surgical precision.