 Today, I want to talk about something that is very much in the news and has been in the news for a long long time and There doesn't seem to be any end in sight To what I'm talking about and that is the foreclosure for crisis the housing crisis You know this foreclosure crisis has crawled on for four years now In fact the latest case Schiller housing index fell 3.4% during October from a year ago Despite the fact that every year all the pundits say This is the bottom in housing In fact in June of 2009 CNBC's Jim Kramer, and I know you get all of your news from Jim Kramer He told his mad money viewers that the residential real estate had finally found a floor The next year the CEO of toll brothers Douglas yearly He said in late 2010 the recovery is here to stay Yet case Schiller continues to fall and fall and fall, and you know if that wasn't bad enough I don't know if you read this but in the last few weeks the National Association of Realtors Finally fast up they finally fast up because they said they've been overstating sales for the previous Previous three years in terms of their counting up of sales Yeah, three million sales that they said happened never happened So when you adjust that out if you think some things have been bad Well actual sales were 14 percent worse than what they had actually said and in fact In 2010 it was 14.6 percent less than what they would say But that didn't stop Jamie Diamond from JP Morgan Chase the other day. He sat down with NBC's Maria Bartiromo and He also said that again the housing market has bottomed Really? Well the fact is nobody knows how bad the housing market is and They don't know how bad the housing market is going to be and just think about this core logic Who does work in this area? Projects that the shadow inventory and shadow inventory being Foreclosures waiting to happen but not yet on the market is 1.6 million homes throughout the United States 1.6 sounds like a big number But think about this Recently there was a deposition where an attorney Who was deposed a bankruptcy attorney who was deposed? Said under oath and the attorneys I know When they're under oath in an opposition Tell the truth now. I don't know You might have your opinions on whether lawyers tell the truth any other time but When they're under oath they tend to tell the truth what he said was that Fannie Mae representatives told him that There were six hundred thousand Fannie Mae Homes mortgages in shadow inventory 600,000 just with Fannie Mae Not in the United States just in the state of Florida 600,000 shadow inventory Fannie Mae only not Freddie Mac Not JP Morgan not B of A But just in the state of Florida Fannie Mae, so I don't think core logics Estimation of the mortgage overhand is in any way shape or form Close to being reality Fact is housing prices have fallen from 2007 2009 33% below their 2006 peak Now we haven't seen declines on this scale since the Great Depression And what that means in dollars and cents is in the aggregate seven trillion dollars of household equity Home equity the difference between the value of your home and what you owe on your home The difference between that in the aggregate has fallen Seven trillion dollars. That's more than half more than half of the aggregate home equity that exists Existed in early 2006. It's all been gone wiped out Now the Federal Reserve is doing a lot of work on this lately I don't know if you've noticed but they just came out with a white paper last week and They say that there's 12 million homes Underwater 12 million homes where the debt on the home is higher than the value of the of the underlying collateral and the aggregate negative equity is 700 billion dollars of these mortgages 8.6 million of them are current We continue to have people who are there's probably people in this audience that continue to pay and pay and pay Despite the fact that they have negative equity of roughly 425 billion dollars in the aggregate, but they continue to pay But even the Federal Reserve knows Given this situation, there's continual problems in the housing market Bill Dudley president. He's actually my favorite federal reserve Talking head because he says such stupid things, but This one I think he may have right the Federal Reserve bill Dudley from the Federal Reserve wrote that Continued house price declines could lead to even more defaults more foreclosures and distress sales undermining wealth confidence and Spending breaking this vicious cycle is one of the most pressing issues facing policymakers Of course, I would contend and will contend during this talk that policymakers should just butt out, but The at least is aware of the potential for further Fall and home housing prices and the effect that that's going to That that's going to have now Ben Bernanke figures. He's done all he can do He's he said the Federal Reserve has made enormous efforts to try to help this economy recover and stabilize through the control of interest rates or monetary policy he said These policies have driven Interest rates to record lows record lows. Yeah zero is is pretty low Monetary policy can do a lot. He says but monetary policy is not a panacea So on the housing crisis Bernanke Said strong government program to help the industry recover would aid the feds own Efforts to boost the housing Boost housing by driving mortgage rates lower He said then and the Fed white paper that I mentioned earlier mentions three problems in housing credit-worthy borrowers cannot find mortgages Number two the foreclosure process is costly and inefficient and number three the persistent excess supply of homes on the market Those people at the Fed know exactly what's going on. They've identified. There's excess supply of homes. It's amazing Now the gang at the Fed writes that there's there's really if if there's no policy to action to address these problems Then they say and I quote the Adjustment process will take longer and incur more deadweight losses causing home prices love sending home prices lower and thereby Prolonging the downward pressure on the wealth of current homeowners and the resultant drag on the economy at large Now of course a con Austrian economists know That it's actually policy action that has prolonged This crisis already and more government intervention is only going to make matters worse for instance I can think of nothing worse than to have Fannie and Freddie Be the largest land Landlords in the United States. Can you imagine that they own the majority of rental property? But that's what they're talking about doing that. They're talking about there's a policy initiative out there that Fannie Mae and And Freddie Mac become take ownership of these properties and rent them out just to get them out of the supply chain Also, I think it's terrible policy to get government more involved With the home modification market It's clearly hasn't worked to this point and it won't work going forward now. This has been a big not a Big issue on the campaign trail but it has been mentioned at least one or two debates and every one of the Republican candidates have been asked about what they would do with about the housing crisis and In fact new gingers said he would rewrite the rules to make it profitable for banks To renegotiate loan principal amounts. That's newt gingrich's big idea Good old newt he wants to make sure that his banking buddies can Write off principle and come out smelling like a rose After all gingrich earned 1.6 to 1.8 billion dollar or million dollars Working for mortgage bar giant Freddie Mac his critics claim he was lobbying But you know newt says that he maintained he maintains that he only offered strategic Advice as a historian Now we have some historians in the audience. I think Tom De Lorenzo is a historian Have have you ever made 1.6 million dollars working for Fannie or Freddie? Have they called you? Would you they have called you and And Thankfully Tom De Lorenzo turned them down ladies and gentlemen give him a big hand Well reporters said that newt disagrees with his Republican colleagues about the free market that the free market will find a way To let the banks and the homeowners work things out. Well You know that remains to do that remains to be seen now President Obama of course has gotten in this fray and his big idea if you remember He said he came in and was able to adjust Fannie Mae and Freddie Mac rules to allow people to refinance loans Even when they were 125% Loan to value so that means if you were 25% underwater on your mortgage President Obama made it easier for you to go ahead and refinance. He said that this Policy would save homeowners Thousands and thousands of dollars and this is his way of solving the housing crisis Princeton professor Alan Blinder. He's of course. He's one of these go-to economic wise men he he penned an op-ed in the Wall Street Journal and his idea was to force lenders to reduce principal amounts and Of course, that's going to cost money and he believes that the banks and you guys should share the cost in that Taxpayers and banks only with the proviso that if The home does eventually go up in value that the government be able to Get an equity kicker if the prices go back up now Blinder also thinks it's a Federal Reserve and the Treasury should provide cheap financing to developers To go ahead and buy up properties with the intention of renting them out again It's similar to that Fannie and Freddie being in the rental business Martin Feldstein of Harvard He always need a Harvard man to weigh in on this he put in his two cents worth for the New York Times and He points out that that homes have dropped 40% and the result he said less consumer spending That's what he's worried about But he claims that the government can stop the fall of prices by just slicing off the amount of mortgage Anyone has that is in excess of a hundred and ten percent of loan to value So if you're ten percent underwater or if you're more than ten percent underwater then Feldstein would just come in and And do away with anything Above that and he said that would fix things. He says the policy would cost $350 billion or less and it would modify 11 million dollars or 11 million loans that are under water in America Now of course who's gonna who's gonna pick up this cost? Well the banks and the government are going to split again the government is you and you and you and you He's going to pick up the cost here he said in the case of Mortgages held by Fannie Mae and Freddie Mac and this is a direct quote the government would just be paying itself Presumably wrote that with a straight face when he did this so and and of course if if you had a Mortgage that was underwater by over ten ten percent and you allowed the government to Expunge that debt that exceeded that the borrowers would then accept full recourse For the rest of their mortgage now what that means is I don't know what kind of what this law is in Texas But in many states Mortgages are essentially non recourse So if you're foreclosed upon and the home brings less than what you owe at a foreclosure sale there is a what's called a deficiency and in non Recourse states then the lender cannot come after the homeowner for that deficiency and but in this case in the Feldstein plan that would that would be reworked to the and Borrowers would have to accept full recourse for doing them Feldstein said I cannot agree with those who say we should just let housing prices continue to fail till they stop by themselves Also, although some forest fires are allowed to burn out naturally. No one lets fires continue To burn when they threaten residential neighborhoods But the fact is that recovering 33% of a fallen housing prices. It's just gonna from the 2006 peak is going to take years and years and years and years It's not gonna it's not gonna snap back anytime soon. This is gonna take forever So I mean despite the obvious policymakers and wonks. They think this trimming of Mortgage principle down to just 10% underwater or allowing people to refinance when they're 25% underwater or more Well, somehow halt the sliding home values and somehow spur consumer spending The belief is is that if you know if you're just kind of sorta underwater Then you're just gonna keep faithfully paying Fannie and Freddie and B of a and JP Morgan Chase Until the rest of time Never mind that it's going to take years and years and years in fact You'll probably pass away before you ever have any equity in your home So all of these ideas to save the housing market and supposedly to increase Consumer spending are doing just the opposite these people keep Keep people chained to the homes that they're still in they can't move to where better jobs are Factors is a great example of this that was brought out. I believe it was in a USA Today article that There's a heavy equipment operator in North Las Vegas, Nevada, and he bought his home at the peak and in 2006 Denny's There is very little need for heavy equipment operators in North Las Vegas anymore They're needed in Oklahoma. He has the opportunity to go to Oklahoma and get a job, but he is $200,000 Underwater on his home, so he can't leave and he feels compelled morally to keep paying But he's unemployed and he's he's running out of running out of money and running out of time Now the Blinder and the Feldstein proposals would take about a hundred and ninety thousand off his mortgage But the problem is it's not going to get him a new job So you can reduce you can reduce principal amounts, but They're not going to be enough and they're not going to put them back to work The idea is that the too big to fail banks will come and the idea that these too big to fail banks are Going to hold up their hand and say sure we'll cover we'll cover half the cost of this is is crazy Because that's going to come exactly out of their bottom line They don't have enough capital to cover that and if they did do that they would immediately go To Washington DC with a tin cup in their hand and say we need another tarp bailout So it'd be tarp to tarp three and so on just to accomplish that and by the way, how much bureaucracy would be needed to manage a program of somehow Cutting everyone's mortgage amount down to a hundred and ten percent loan to value Imagine the appraisal duels that will go on anybody who's Purchased a house or tried to refi a house know what kind of boondoggles involved with getting appraisals and and One prasel versus another appraisal. I mean it'd be a nightmare. It would never it would take so long Nothing would ever happen all of these plans are really nothing to aid underwater home owners the only thing it does is aid Fannie Mae Freddie Mac and the rest of the two big to fail banks Now there's thousands of stories that people trying to do the right thing People going to their banks. They're current on their payments They walk in and want to renegotiate because they say listen. We're a hundred thousand dollars under underwater on our home or a hundred and fifty thousand dollars in our $200,000 and they go into their banks and what are the banks do? They refuse to negotiate with them. Why because these people are current Now say you're current we know we're not going to talk to you about this Why don't you go ahead and skip a couple three payments and then come back and we'll start talking to you about this And then they go through this whole grind of trying to do the government Read renegotiation process But all the time that the banks are not negotiating with these homeowners They are holding these mortgages on their books at a hundred cents on the dollar When there's no way the mortgage is worth that Because if you have a two hundred thousand dollar mortgage secured by a house that's worth a hundred thousand dollars That mortgage is not worth on a bank's books $200,000, but that's what the banks want to pretend and by pretending to do that. They're still in business Now Mitt Romney laid out his prescription For the America's housing crisis when he is campaigning in Nevada a couple of months ago And he said the policy makers shouldn't try and stop the foreclosure process He said let it run its course and hit bottom In the state Nevada which has the highest foreclosure rate in the country. He took a lot of flak for this In fact the governor of the state Brian Sandoval had some very harsh words for for Romney But a few few months later or a few weeks later the GOP had a CNBC debate and Romney again declared that as president he would do nothing to ease the housing crisis Markets work he says Well, mr. Romney is right Markets do work But any business dominated by entities only in business By the good graces of the government is not the free market It cannot be considered the free market the reason the housing market is not cleared is that the government Stands in the way by propping up the large mortgage holders No reasonable person sees Fanny sees Freddie Which were seized by the government September of 2008 as the product of spontaneous order to stay in business the two firms together have needed a hundred and sixty nine billion dollars to stay in business that's 169 billion dollars in taxpayer money to keep them in business and there is no end in sight every quarter Fanny and Freddie the friend of Newt Gingrich Go to the taxpayer say I've we've lost X billion dollars, and we need X billion more. That's the only reason they're in business Also at the same time there's been changes to Fasby's Fair accounting standards board rules Their numbers 157 115 124 this essentially allows banks to Value certain assets on their books at whatever they want to Now if you can allow banks to Value these mortgages that are underwater At whatever they want to you are essentially keeping them in business essentially by government fiat They are in business because the government has just merely changed the rules for their benefit and they are essentially wards of the state And that's the problem bailouts attempt to erase the effect of losses or economic failure Profit and loss go together. It's like up and down left and right Good and bad we do away with losses. We wind up diluting the meaning of profit After all why strive for profits if Uncle Sam is just going to prop you up They allow us to destroy the profit motive and the incentive to work with customers And that's what it's done in the case of the mortgage market The real help for homeowners will only arrive with Fannie and Freddie and the rest will be allowed to fail The equivalent of a Chapter 7 bankruptcy proceeding liquidation would put the underwater loans out forbid in the marketplace Now I don't know this for a fact But I'm guessing that when mr. Romney says let the market hit bottom He does not have in mind Fannie Freddie and B of a being allowed to fail I mean, I'm guessing that Mitt doesn't have that in mind, but that's what needs to happen He believes that it's a free market for you and I It's a free market for the people who sign on the dotted line on their mortgage Pay X amount per month. You have 30 years to pay The note doesn't say anything about the value of the collateral You just keep paying till the very end but 12 million households right now have a mortgage on Something that isn't an asset anymore. It will never be an asset It will continue to be a liability probably as long as they live and There's no difference in that Then being a renter and if the rent of a similar Structure is half that or a third that then the only thing it makes sense to do is to walk away Now you might say whoa, wait a minute wait a minute Doug we We believe in contracts people must honor them for the market to work But the market hasn't been allowed to work on the other side of the equation since the housing crisis began In fact Bloomberg had to go to court to obtain documents To shed how much light or shed light on how much dough the Federal Reserve really provided the banks during 2000 2008 meltdown the banks and the Fed fought this so hard that it had to go all the way to the Supreme Court and Finally the Supreme Court said no you have to hand over you had to hand over these documents 29,000 pages and it revealed that banks worldwide made 13 billion dollars on the difference between They're what they paid for their emergency funding and what they earned with that funding When you total up When you add up the guarantees and the lending limits that the Fed provided The bailout wasn't $100 billion that everybody complains about in Tartmoney the total was 7.77 trillion dollars As of March 2009 in rescuing the financial system more than half the value of everything that was produced in the United States that year Now here's just one example. Not only did B of a receive 45 Billion dollars in Tartmoney, which most everybody knows about what everybody doesn't know about is at the peak Bank of America Borrowed another 91.4 billion dollars from the Fed To stay alive now. They buy borrowed this from a very kind of alphabet soup of programs There was dozens of them just a few of them were AMLF PDC TSLF STOMO TAF you get the idea just goes on and on this like these guys strung acronyms together just for the the heck of it to Create these loan programs, but they borrowed 91 on top of the 45 billion in Tartmoney They got 91.4 billion in loans Secretly from the Fed that we didn't find out about until just the other day and it wasn't like a daylight overdraft Just because it B of a was a little shorted dough You know for a day or two Bank of America was in debt to the Federal Reserve for 518 days During the dark days of March 2009 government bailout funds amounted to over 400% of Bank of America's market cap There is no question the Bank of America was bankrupt and probably still is and That's not how the free market works But they want the free market to work for the person who's paying on their mortgage But they don't want the free market to work on The entity that owns the mortgage Now let's say Bank of America, which by the way absorbed country-wide So that was included in there Let's imagine if they were allowed to go bankrupt as they should in a free market in the free market that Mitt Romney wants to talk about What would happen what would these mortgages sell for if they were part of the banks If they were under the control of a bankruptcy trustee and put on the free market Would they sell for a hundred and ten percent of the home's value would they sell for a hundred and twenty five percent of The home's value like the Feldstein and the Obama plans No, when you're not looking for a mortgage you better have it twenty percent down You're looking for an eighty percent loan to value mortgage and in fact if you look at what distressed Sellers are receiving for assets and loans that they sell on the market It is likely that these mortgages would go for twenty five or 35 cents on the dollar And what buyers of those notes would do the first thing they would do is trying to make keep these people in their homes Trying to make these loans Conforming and performing that's the first thing they would do in fact. There's examples of this in the marketplace Lewis Rinnari who is a legend in the mortgage business worked at Solomon Brothers for those of you who Ever read Michael Lewis's great book liars poker He has a new fund called saline residential mortgage opportunity fund Was featured on the front page of the Wall Street Journal buys up distressed debt Not to not to better society but to make a profit and they made the example of a couple in st. George, Utah That had been delinquent on their loan they owed 421,000 on their mortgage Saline came to them immediately restructured the loan reduced the principal the 243,000 and reduced their payment from 3,500 a month down to 1500 a month all of a sudden they had a performing loan on their hand and Both parties benefit 90% of the loans that saline does modifications for involve reducing principal less than 2% of the modifications that the government does involve reducing principal and While many upside down Borrowers can't find anyone to talk to when they're trying to negotiate with their with their lender when saline Buys a note the first thing they do is reach out to the borrower very quickly In fact, they will send them a FedEx package with a gift card in it that can only be activated once the borrower makes Contact with saline's debt Specialist it's hard to imagine that Fannie or Freddie might do something like that Now this is much different than what Mr. Gingrich has in mind where he's thinking that current mortgage holders can somehow write down loans and make a profit at it That's not who should make a profit the current mortgage holders should be allowed to go broke Firms that lose money should be allowed to fail Otherwise precious capital continues to be wasted by these firms The firms that shouldn't make money on this are the opportunists are Opportunistic firms like saline capital They must profit and they must benefit By buying these loans out of foreclosure by making these loans performing and conforming and going ahead and second selling them into the secondary market They profit and The homeowner benefits You know Ludwig von Mises explained that one government intervention Leads to endless successions of interventions to deal with the effects of the first and subsequent interventions Ultimately, it comes down to two choices. He said Either capitalism or socialism there exists no middle way Likewise, there is no middle way in solving the housing crisis For capitalism to work its magic for underwater homeowners to be set free Mortgage holders must be allowed to fail Thank you You