I might have spoken to quickly on some items in my last post, “Fannie and Freddie Shareholders Benefit more than Homeowners.” I assumed that mortgage insurance would be required in President Obama’s Fannie Mae (FMN) Freddie Mac (FRE) 105% LTV refinancing scheme. FHFA Director Lockhart’s letter to the Mortgage Insurance Companies of America dated February 20 set me straight on that PMI will not be an absolute requirement for LTV over 80%. Lockhart wrote: “In layman's terms, the refinance initiative is akin to a loan modification for charter purposes as it affects loans for which an Enterprise already holds the credit risk.” Given Lockhart’s modification versus refinance theme, I don’t know if the GSEs would actual collect new loan initiation fees either.
The Dow Jones Newswires explains: “The government charters for Fannie and Freddie expressly prohibit them from guaranteeing or buying mortgages with loan-to-value ratios above 80% unless the borrower has mortgage insurance or the loan originator retains 10% of the default risk.”
While Lockhart considers the word refinance only a technicality and plans to circumvent the GSE charters, he does ask the PMI providers to indulge him in transferring any existing mortgage insurance from the original loans to the new loans at the same dollar amount. The credit enhancers are of course free to raise their insurance to a high dollar amount and provide PMI where it was not required in the original loans. The cooperation of PMI appears to be voluntary: “For that, the Enterprises and the homeowners need the assistance of the mortgage insurer. Thus it would be beneficial to the success of this initiative for mortgage insurers to work with both companies [Fannie and Freddie] as they move towards implementation.”
Lockhart’s logic is twisted. If the new loans lose PMI and no new origination fees are collected, the GSE risk does increase, even if their insured loan principal balances do not. Either the loans are refinanced or their not. Please help me understand the legal basis for Lockhart’s hybrid. Refinancing pays off the old loans and frees the borrower from the modification restrictions of mortgage investors. Conversely, loan modifications subject Fannie and Freddie to mortgage investor insurance claims.
Lockhart wants to refinance his way out of MBS insurance claims and modify his way out of the GSE charter obligations. This is the start of a bad precedent and interferes with the return of the GSEs to sound footing. If the PMIs don’t cooperate, and there is no reason why they should, the new mortgages become per social giveaways. What’s next, 100% mortgages for all?
No wonder Bloomberg is reporting “Fannie Mae Rescue Hindered as Asians Seek Guarantee.” The "Treasury’s Elusive Guarantee of Fannie/Freddie Debt and MBS" continues to be a recurring theme with foreign investors. The evasion of the GSE charters is just another reason why.
Disclosures: Author is long FNM and FRE.
FHFA Director Lockhart’s Twisted Fannie Freddie Logic
Fannie and Freddie Shareholders Benefit more than Homeowners
The White House unveiled the “Homeowner Affordability and Stability Plan”, or what I call the Fannie Mae (FNM) Freddie Mac (FRE) status quo plan, this morning. Lucky for me enough details were revealed this morning that I did not have to listen to our overexposed, overly staged President Obama lecturing me. My initial analysis is that this part of the Administration’s mortgage plan should benefit, or at least not inflict additional pain to current GSE shareholders.
Full details won’t be available until March 4, but let’s see what we know so far: The Treasury will now be able to purchase up to $200B in preferred stock each from Fannie and Freddie. This insures that the forces for fully killing GSE shareholders lost out to deficit funding reality. Also, there was no mention of curtailing Fannie and Freddie fee increases to as much as 3.5% on April 1. Together these show that the Administration wants to return the GSEs into viable independent entities.
President Obama has shown great strength in holding back the Congressional onslaught from the real estate and home builder lobbies to rein in Fannie and Freddie fees. This program is limited to refinancing loans either held in GSE portfolios or securitized by Fannie and Freddie. Again, there is no help to real estate brokers and home builders. The President is clearly not interested in generating home sale transactions.
The program is voluntary for lenders and borrowers still have to go through normal underwriting. The loan limit is 105% of the current appraised value, including any fees financed. So if you back out fees the realistic loan limit is closer to 100% of appraised value for the 105% LTV. Only primary mortgages for owner-occupied properties qualify; second lien holders would have to voluntarily subordinate. Help will be limited to borrowers whose payments exceed 31% of their monthly gross income.
What we don’t know: Whether the interest charged will be a market rate or a subsidized rate was not revealed. We also don’t know if PMI will still be required for LTV ratios above 80%. My guess is it will be market rates and PMI because strong GSEs are vital to the economy.
A quick examination shows that not many weak borrowers will qualify for this program or gain bank approval. Certainly second lien holders wouldn’t agree to subordinate unless borrowers were put in a better position to pay them. So what is the purpose of this program? I believe the underlying purpose is to free up strong homeowners to spend more at the mall or buy a new car with the savings on lower monthly mortgage payments. This could be stimulus number two.
President Obama has presented us with a very creative form of cash-out refinancing, without the stigma. The stimulus is further enhanced with the 5-year $1,000 per year monthly principal reductions just for paying on time. Trouble is most qualifying borrowers might not get enough of a payment reduction to justify the costs of refinancing. The real benefit would be to those refinancing from variable rate loans. But the extra security of their new 15 or 30-year fixed loan might come at the expense of a high rather than lower monthly payment.
The dynamics are interesting. Borrowers can’t be so strong that their payments are less than 31% or their gross income, but must be strong enough to pass underwriting and most likely not be carrying and a home equity loan. True of most government programs, a very thin needle must be thread.
The effects on Fannie and Freddie should be neutral to positive for shareholders. The GSEs will collect new fees with each refinancing. Borrowers will be better underwritten, reducing default risk. The downside is the possible reduction in portfolio interest income. Now is the time for the Treasury to lower the dividends on its GSE preferreds. The new motto should be “Let’s build a stronger Fannie-Freddie together.”
The details on the program for non-GSE mortgages were even sketchier. “Cram downs” were endorsed for loans not exceeding the GSE limits. Banks would not be required to write down principal. But participants must lower payments to 38% of gross income through a combination of rate reductions and term extensions. After which the government would buy down the interest rate to 31% of a qualifying borrower’s gross income. This appears to be modification, rather than a refinancing program. The FDIC will be selling insurance to banks modifying loans. Little details on who qualifies were provided.
Disclosure: Author is long FNM and FRE.
Starbucks – Instant Brand Degradation
Most major near-luxury goods retailers, from Abercrombie and Fitch (ANF) to Coach (COH), tried to avoid the type of discounting that would cheapen their brands. But, they all eventually capitulated in one form or another. Some designers have created lower cost accessories to supplement their lineups. Macy’s (M) and Kohl’s (KSS) at the lower end have populated their stores with so many 50% off junk racks that they are competing with Wal-Mart (WMT) for ambience.
Starbucks (SBUX) is now taking the opposite approach. They are taking one of the lowest brow products and raising its prestige. Their baby is the $1 cup of instant coffee. That’s just what I need to go along with my Tang to stir a little aspiration into my breakfast. Thinking back to my childhood days in the 1960’s, I’m wondering if the astronauts can take Starbucks instant coffee into space. Starbucks founder and CEO Howard Schultz said on CNBC today that it could be prepared hot or cold.
The Starbucks experience is about as relevant today as the Gap (GPS) preppy look of the 1980’s. Schultz is struggling for a value proposition when aspirational branding is losing out to the austerity image people are now trying to project, regardless of their actual wealth. Since when is $1 for one cup of instant coffee a value?
Schultz has to create an exciting new Starbucks atmosphere and a value beverage menu with more energy. Most of the coffee drinks have so little espresso that they taste like water. The brewed coffee sits in containers for up to two hours. That’s right, the containers have little high tech egg timers attached to them and the baristas won’t brew fresh if the time hasn’t expired. Ask before you order.
Schultz told CNBC that panels could not taste the difference between the instant and freshly brewed coffee. I don’t know what that tells us about the freshly brewed. If the instant is so good, maybe it should replace the not so freshly brewed coffee in the stores.
Most specialty retailers have trouble reinventing themselves after they peak and their fads have passed. Abercrombie could follow the Gap or even Gloria Vanderbilt jeans into irrelevance, as they think the clubby formula is invulnerable. So too, I believe the Schulz thinks that his affordable luxury formula is not lost.
Note: The actual price is 24 servings for $19.
No disclosures.
Capitalist Michael Moore
The New York Times Deal Book “Michael Moore Wants Wall Street Scuttlebutt” reports that Michael is looking for a few good financial Marines to step forward and give him the inside scoop to exploit in his next movie. After the crisis, Mr. Moore takes no prisoners and provides no solutions. He sells victimization with a smile, and uses targeted guilt to promote commercial success.
Michael rarely provides any new information and often the information that he does provide is out of date by the time his movies hit the theaters. He will make the whistle blowers into temporary heroes, but they should be aware that their limelight will fade quickly. Michael is only interested in his own commercial success, not help for any of the movie victims.
Michael Moore has clearly transitioned from altruistic to commercial success with a vengeance. I thought that he might have inspired healthcare reform as he rode the talk show circuit to promote Sicko, but now he’s on to his next project. The financial crisis is in vogue, so universal healthcare is old news. Michael is becoming an expert at exploiting the populist wave, a true capitalist surfing from crest to crest without a single spill.
The trouble for Michael is he is overplaying to the Hollywood sequel, without adding enough special effects to keep it interesting. If James Bond simply harassed the KGB with a microphone and a camera, the series would have ended after Roger Moore. So I don’t think a few financial defectors will save our fleeting documentarian from becoming irrelevant.
Michael needs to lose some of that commercial fat gained with success and reinvent himself. Now Mr. Hollywood is without his rough aestheticism, too much high priced tinsel town direction and technology. Michael has become too smooth and his productions too polished for his own good. He is no longer the underdog. He should look at M. Night Shayamalan for inspiration.
Michael is also far more vulnerable to internet bootlegging than movies in which dramatic scenery and spectacular effects require the big screen to fully appreciate.
Dow Chemical Company on the Miami River
The South Florida Business Journal reports “Wind condo buyers want out, blame financial crisis.” The investors are seeking rescission (our old health insurance term) of their sales contracts because: “In the intervening time since the date the contracts were entered into, nothing short of a global financial crisis has taken hold, which even the most renowned of economists were unable to predict.” Doesn’t this sound just like the dispute between Dow Chemical (DOW) and Rohm and Haas (ROH)?
The complaint filed February 5 by Blanca and Julio Hernandez, Claudia Gomez and Miryam Gregory in Miami-Dade County Circuit Court against developer Neo Epoch 1 Ltd. alleges that the inability to obtain a mortgage gave rise to a “mutual mistake and impossibility of performance.” Attorney Jared Beck says this is ground for rescission under Florida law.
The 42-story, 498-unit Wind is located in a marginal area on the Miami River at the edge of the financial district. The completed building is the first part of a multi-building complex started during the boom. Wachovia started foreclosure proceedings on the developer for the second building in the complex. The claimants are seeking return of their deposits.
Geithner Cannot Break with the Past
Treasury Secretary Geithner resoundingly endorsed President Obama’s message that government cannot spend enough trillions of dollars, even though he has no detailed plans. Today Geithner gave us a broad outline of the Administration’s theories, but told us nothing about the risk to interest rates from the government’s growing tsunami of borrowing. Only that the risk of not spending enough is disastrous.
Let’s start counting the trillions: No price was given to stress testing the banks’ balance sheets with the Treasury providing bridge capital to cleanse and strengthen them. The mechanics were not disclosed, but the banks’ obligations include leveraging the government’s capital into loans and finding replacement private capital as soon as practical. This program was not priced.
The second program is a public-private investment fund to buy legacy toxic assets. Geithner is still “exploring the structure” of this program. Government funding will start at $500B and grow to $1T. Third is an expansion of the Federal Reserve’s program to support the securitization market for consumer debt to $1T. The only consolation Geithner gave us is that the Treasury, Fed and FDIC will work in concert.
Geithner conceded that falling housing prices were beneficial in creating demand, but the destruction of wealth and hardship in refinancing costly mortgages has reached a crisis. As former President Reagan would say, “There you go again,” another crisis. Instead of cheering the banks for more diligent lending, Geithner criticized them for being too tough. Geithner gave us a vague promise of lower mortgage rates, but no details on how the Administration would accomplish that. Correspondingly, Geithner gave no details on the future of Fannie Mae (FNM) and Freddie Mac (FRE). Geithner just told us to wait a few more weeks for mortgage and foreclosure mitigation details.
Now let’s see if this is “Change we can believe in.” The stock market certainly did not think so. We did get a lot of fluff about disclosure on a website financialstability.gov and what sounded like a guarantee that government injected bank capital would be leveraged into loans. But as JP Morgan (JPM) CEO Jamie Dimon told us many times, money is fungible and the government’s capital cannot be distinguished from any other bank capital. The rumors of a "bad bank" and Bank of America (BAC) and Citigroup (C) style legacy assets backstops or guarantees were both absent from today’s speech.
Not only don’t I see any detail, I don’t even see any change in theory. To a large extent, it was securitizations (CDO) and the insurance of securitizations (CDS) that was to a large degree responsible for the financial meltdown. Geithner should be leading us down the path of banks going back to traditional portfolio lending, underwriting and retaining loans. His comments that most consumer lending is securitized, therefore we must restore that market shows the Obama Administration wants to restore the old status quo. And Federal Reserve Chairman Bernanke is all too happy to cooperate.
It is clear that we will remain in a fog for several more weeks while the Administration tries to figure out what to do. They are trying to use the nearly $1T stimulus to buy time during their confusion. At the same time President Obama and crew feel it is necessary to spout inflammatory populist rhetoric against those that profited at the expense of the people. While saying banks should not benefit from the government’s help, at least Geithner also states that the people were partially to blame.
At least one part of Geithner’s rhetoric bears closer attention. That is how does the government attract private capital while implementing programs that destroy shareholder value? While it is admirable that the government wants to leverage its capital, it first has to take steps to unwind the punitive warrants in TARP 1 and make its preferred stock investments convertible at the banks’ option. The government also has to rethink its punitive investments in American International Group (AIG), Fannie and Freddie.
President Obama reminded us last night that we have to be bold. Being bold implies breaking free from populist rhetoric and taking unpopular pragmatic approaches. That’s real change, but unfortunately all I see is laziness.
Disclosures: Author is long AIG, BAC, C, FNM and FRE.
Stimulating the Prudent Person
The health insurance industry has a concept in medical underwriting called the prudent person. If a prudent person would have sought medical attention (in the underwriter’s judgment) that could have revealed a preexisting condition basis for rejection, the policy is rescinded. In essence, it is undone. The premium is returned and the policy holder must reimburse the insurer for all covered medical costs. Does the Obama Administration pass the prudent person test with its now $900B stimulus plan?
President Obama is acting like the messiah or second coming ready to hand us the new ten commandments of economics, and cannot understand why we are not coming together under his lead. First he tried reconciliation through expanding the plan to include every piece of pork and tax break that both parties wanted. Then when he was unable to convince the grass roots American people on the plan’s merits, he resorted to dictating to both the legislators and the people that he knew best. Sensing President Obama’s frustration as a sign of weakness, the Republicans started to revolt.
Beyond the jockeying for political advantage, the grass roots see an imprudent political process. Switching back and forth between dictating and trying to instill fear of economic disaster, is not winning over the American people. President Obama and his staging crew have learned nothing from Presidents Reagan and Clinton’s mixture of humble optimism. Even President Bush, of whom I was no fan, gave a sense of humble sincerity. President Obama, whom I voted for hoping for healthcare reform, makes me feel that I am being talked down to. Successful presidents are not great stage shows, monarchs or dictators. Successful presidents are great communicators; so far President Obama is not.
Let’s get back the prudent theme: Germany found out the hard way that sovereign debt of G7 or G8 nations cannot be issued without limit. They recently had a failed auction, whereby they did not receive enough bids to sell the entire issue. Even with interest rates on treasuries and mortgages starting to head up, the Obama Administration believes they can lower mortgage rates and sell an addition $2T in government debt this year. That does not give much credit to the rules of thermodynamics, or the law of supply and demand for you economists. The health insurers would rescind the Obama Administration’s economic policy if next week’s massive $67B treasury auction does not go well. Trouble is the American people cannot get their premiums (taxes) back.
The health insurers would have told the President that rising interest rates was a clear indication that he should have returned to the doctors of fiscal and monetary policies for checkup. That would have revealed that the country had a preexisting condition of borrowing up to the limits of its capacity and an economic insurance policy would not be issued. Unfortunately, the Administration’s chief economic architect Larry Summers does not have to pass medical or economic underwriting. The health insurers would surely reject him on both accounts.
On the serious side: The Treasury needs to test the appetite for the volume of debt they would need to sell this year to support both their stimulus and banking plans. Congress cannot judge the impact on the debt markets of one plan without the other. It appears that the Administration has given up delaying the banking plan until the stimulus has passed.
I believe that next week’s treasury auction will indicate whether the Federal Reserve is still in control of interest rates or whether our debtor nation is at the mercy of our creditors. A rise in treasury rates implies that the United States has reached its borrowing limit at the current rates and the flight to safety does not always mean to the dollar. Keep in mind that our lenders in China, the rest of Asia, Europe and even the oil rich Middle East are also in trouble. Their capacity and desire to buy treasuries has been diminished.
I think that next week will confirm that interest rates are past the bottom and starting back up. The Fed has lost control. But the Administration can control the rate of interest rate increase (the second derivative) by the size of fiscal stimulus. The bigger the better is certainly not prudent.
I see a scenario of deflation in real estate and durable goods, inflation in food and other consumer consumables, and a slowly accelerating rise in interest rates. Some commodities would fall or stabilize to conform to lower durable prices. We are heading for a 5% 10-year treasury and 30-year fixed conforming mortgage interest rates in the 6.5% to 8% range by year end or earlier. Even former Treasury Secretary Paulson called the 4.5% mortgage a pipe dream.
Private Health Insurers Losing their Medicare Advantage
Bloomberg’s “Medicare ‘Rip-Off’ Hits Elderly as Obama Maps Changes” reports that Humana (HUM), Health Net and UnitedHealth (UNH) are all changing their strategies for offering Medicare Advantage plans to eligible seniors. Princeton political economy professor Uwe Reinhardt told Bloomberg: “The insurers’ dream was that maybe 80 percent of the elderly would enroll in Medicare Advantage and then traditional Medicare would just die, and these private health plans could do what they want.” Now President Obama wants to extract 15% in excessive fees that the Advantage plans cost over traditional Medicare.
Seniors get $96 per month deducted from their Social Security to pay for Basic Medicare. At the start of the Advantage program, private insurers were rebating part or the entire Basic premium to lure senior membership. Now the rebates have ended and premiums with annual increases are common. In addition to the $100B the government pays private insurers for Medicare Advantage, the seniors contribute $5B in premiums.
Reinhardt concludes that the absence of premiums was “unsustainable”, a “come-on” to get things started. Advantage plans now enroll about 23% of Medicare participants, but seniors are beginning to rebel against the higher premiums. Most Advantage plans have raised their premiums to as high as $50 per month, but UnitedHealth has taken a different path. Instead of raising premiums, UnitedHealth dropped its plans for the chronically ill and increased the remaining policies’ out-of-pocket costs. UnitedHealth hopes to gain the membership that the others lose.
It takes careful shopping for seniors to get value from the Advantage plans, which is no different from anyone shopping for health insurance. But being the government is paying the majority of the bill, it also must get value for its money. It seems as though the added benefits in the Advantage plans are coming at the government’s expense. When the government starts refusing to pay extra for outsourcing Medicare, it is unlikely the Medicare participants will. This spells trouble for the health insurance companies, who are rapidly losing private membership. Without Medicare private health insurance companies are dead.
Frustration and disappointment describes my reading of Bloomberg’s “Daschle Exit, Successor Search, Delays Health Agenda”. I feel that Treasury Secretary Geithner’s control of the IRS makes his tax indiscretion far more onerous than former Senator Daschle’s. President Obama needed both men for their respective abilities to push his economic and healthcare agendas. But apparently healthcare reform is being sacrificed for the heroic economic spending package.
While the Administration conceded that only on one “innocent” tax delinquency would pass the nomination process in the Senate, proponents of the healthcare status quo have time to take a breather. What our new President seems never to sacrifice is camera time. He dominates every cabinet secretary’s policy announcement.
Today President Obama let Geithner spout gibberish to warm up the reporters while he kept the details of executive compensation restraint for his own speech. The President’s fear of letting members of his cabinet develop their own credibility is developing a history: Secretary of State Clinton was not able to independently announce the envoys for the Middle East and Afghanistan, and Geithner is not able to independently negotiate the stimulus with Congress. Geithner looked incredibly weak in President Obama’s presence.
President Obama is smothering his Administration, and perhaps he might have even feared Daschle’s ability to accomplish healthcare reform. Turning back to Medicare Advantage, reigning in on the profiting of these plans at the government and seniors expense is an issue credited already to President Obama. The President won’t need Daschle to overshadow him in its accomplishment.
I recently sold UnitedHealth at a small profit. I bought it when President Obama looked inevitable and thought that UnitedHealth was destined to be one of the largest administrators under some form of universal healthcare. Health insurance reform appears to be delayed and President Obama will not pay excessive fees to outsource healthcare administration in any case. Administrative cost reduction is a pillar in his plan to finance the expansion of coverage. Now there is no case to be made for investing in private health insurers.
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