The Katrina Depression

Main Street, America - November24, 2008



Today the Government sunk an additional $20 billion into Citibank and guaranteed them against losses of another $300 billion on their mortgage portfolio. They're swapping treasury bonds for bad mortgages.

We stood by in stunned disbelief three years ago as we watched our Government fumble and mismanage the Katrina disaster and its aftermath. There was plenty of warning. We knew the storm was coming three days in advance. We watched the disaster unfold on TV. Apparently our government officials were too busy to watch TV and seemed unaware of the catastrophe for nearly a week.

I told my neighbor that it looked like a $50 billion problem in the making as we watched Katrina move slowly north that weekend. A year earlier, I told him that adjustable rate mortgages would cause big problems for homeowners sometime in the future.

The last depression, in my opinion, was caused largely by speculative and unsound lending practices. You could put down $1,000 and borrow another $9,000 from a local bank to buy common stock on margin. The resulting wave of bank failures after Black Monday depressed economic activity and increased unemployment for a decade.

This time lending practices became even more bizarre. Mortgages were bundled into strips by the originators and sold as securities. Insurance was purchased in the form of credit default swaps. The issuers of this insurance did not have assets to cover the losses. Despite this, the rating agencies ranked these bundles of mortgages as investment grade securities. These were called CDOs or Collateralized Debt Obligations.

We all know about the subprime mortgages. Those were issued to folks with bad credit ratings. What the hell! The commercial banks and mortgage companies got fat fees for originating the mortgages and passed most of the risk on the Fanny Mae, Freddy Mac or investors. The Investment Banks racked up huge profits securitizing the mortgages and passing them along to foolish investors.

Then there were the ARMs or Adjustable Rate Mortgages. These came with a low initial monthly payment. Several years later the payments reset, sometimes to more than twice the original payment.

There were also “No Doc” mortgage loans where the borrower was not required to provide and documentation about income. The bankers amusingly called these “liar loans”.

Even more insane were the “pay option” mortgages. Here you pay a low teaser rate of interest only until your mortgage balance hits perhaps 125% of the original loan and then your payments reset to maybe triple the original monthly payment.

The speculative bubble in housing prices caused by insane monetary policy and Republican deregulation of our banking system sprang a leak and started to deflate two years ago.

We are a long way from the bottom of this economic death spiral. Houses still cost three times as much to buy and maintain as they do to rent. Even with millions of homeowners “underwater” (which is why I call this is the Katrina Depression) on their mortgages, home values will continue to decline for probably another five years until 2013. As a result, even strong borrowers will simply walk away from their mortgage obligations in droves, piling up an increasing supply of ever less valuable housing for sale.

The mortgage modification programs being implemented by banks right now will not be effective. They simply reduce interest rates and payments, sometimes adding the reduction to the mortgage balance. This keeps the homeowner trapped in an unsellable home until eventually and inevitably they walk away, leaving the bank with a bigger problem down the road.

If you own an investment home or a second home, a bankruptcy judge can modify the terms of your mortgage in bankruptcy. The judge’s options include reducing the interest rate AND reducing the principal balance of the mortgage. Due to a 1978 modification of US bankruptcy laws, this option is not available if you actually occupy your home and need it for shelter.

A further wrinkle is that most mortgages are simply serviced and not owned by banks. When a bank services a loan, it has no incentive to modify the mortgage terms. On the other hand, the bankers get paid “cost-plus” to foreclose on the home and nobody is auditing the cost or the plus.

For years, we have been living with an economic engine supercharged and overheated by cheap and freely available consumer credit. I feel a little sorry for the Chinese and the Russians. They were largely unaffected by the Great Depression. Now that we have sold them on the benefits of the capitalist economic system, we introduce them to the Katrina Depression. Surprise!

Our economic hopes rest squarely on the shoulders of Obama. I think he is “The One”...Maybe I'll rent The Matrix again today and wake up from this bad dream.

-Bob the Blogger (aka Phred Firecloud)

Getting Rid of Columbus Day

On a Yet to be Named Continent....1142 AD

I went to the bank this morning to take care of the debit card fraud only to learn that it was Columbus Day and the banks were closed. What a worthless holiday. Like it doesn’t matter that 80 million people got here first over the Siberian land bridge, eating hairy mammoths and battling saber tooth tigers. We just go ahead and celebrate good ole Chris who arrived somewhere in the Caribbean and enslaved the natives.

I decide to do something about it. First a trip to Wall Street to cash in 5 billion in credit default swaps. I’m glad I saw the credit crunch coming and bet heavily against AAA rated collateralized debt obligations made up of baskets of toxic sub prime mortgages. I wondered for awhile if AIG would cough up my winnings. With the cash bundles of cash I can buy the suppressed energy technology owned by Big Oil.

Adding the wormhole drive to the RV is no big deal. The cold fusion power plant slips in neatly in place of the big Ford V-10 and provides the power of a mini-sun. The really tricky part was generating a black hole the right size and then programming the laptop to send us to the right time and place.

Wrapping the whole thing around the RV made a lot of sense because we can use the RV generator to make turkey soup in the crock pot when we travel to the past and also because we need to keep the laptop powered up for the return trip. The navigational math is a little complicated, but I've been doing sudoku for the last few months to sharpen my wits.

We arrive on the beach of "San Salvador" on the morning of October 12, 1492 and set up our offensive positions. Mrs. Phred is checked out with the black market RPGs that are stuffed in the RV storage compartments. Mrs. Phred suggests adding orzos, celery, onions and carrots to the turkey soup while we wait. We grab a few coconuts, splash naked in the surf for an hour and eat the chicken sandwiches we packed for the time jaunt. We catch a few big spiny lobsters for the RV freezer. Eventually we hear voices cursing in primitive Spanish.

The crew was cursing because Chris had promised a fat lifetime pension in gold to the first man to see land. Chris claimed to have seen lights several nights before and put the promised reward in his own pocket. Considering the recent behavior of bankers, perhaps the "Columbus Day" bank holiday is understandable. His ethics were a model.

We let Chris and his boys pull their shitty little boats into range and then hole them at the waterline. The RPGs blow big holes in the hulls and we watch the crews swim to shore with no weapons. We figure they’ll have a good time learning to live with the natives this time around.

We hit the return button for the morning of October 12, 2009 and drive back to the bank. The building style has changed to Mediterranean and the bank’s name is now Banco Popular. A sign in Spanish says that the bank is closed to celebrate Vasco da Gama day. Da Gama now gets credit for discovering the new world. He landed near what was New York City on October 12, 1498.…the whole continent is a diseased and corrupt Spanish colony. It's called Gamaland, of course. The city that was New York is now the cesspool "Neuva Madrid".

Da Gama sailed the ocean great
In fourteen hundred and ninety-eight

This is not what we had in mind when we scuttled the Pinta, the Nina and the Santa Maria. We’re going back again. We’ll go back further this time. I’m determined to teach what were the Iroquois Nations of what was to have been New York State about advanced metallurgy, steam engines, central banking, medicine, agriculture, credit cards, ice cream, sliced bread, nuclear energy, Teflon, steel ships, velcro, gunpowder, Pink Floyd music, aquatic mines and radio.

The Iroquois also refer to themselves as the Haudenosaunee, which means "People of the Longhouse." Oral tradition indicates that the six-tribe nation was formed prior to 1142 AD. This estimate is based on a tribal stories about a solar eclipse. It's a shame that we'll miss The Great Peacemaker, Ayonwentah, but we need to get an earlier start to crush and subjugate Europe. It should take maybe 60 years. Sorry about that, Beowulf...Sorry Shakespeare...Sorry Mr. Hitler...Sorry Douglas Adams.

I'm making several trips back with a complete curriculum of home-schooling textbooks and advanced engineering and scientific textbooks. I've got firearms to show them from the simplest antiques to the best modern weapons I can buy on the black market. The Iroquois had a Nation going that rivaled Athens. I think they'll see the point of the AK-47 and night vision goggles and be motivated to study hard, especially when they read future history.

I'll show them Chief Joseph's surrender speech after his brilliant 1400 mile fighting retreat...I am tired of fighting. Our chiefs are killed. Looking Glass is dead. Toohoolhoolzote is dead. The old men are all dead. It is the young men who say, "Yes" or "No." He who led the young men [Olikut] is dead. It is cold, and we have no blankets. The little children are freezing to death. My people, some of them, have run away to the hills, and have no blankets, no food. No one knows where they are -- perhaps freezing to death. I want to have time to look for my children, and see how many of them I can find. Maybe I shall find them among the dead. Hear me, my chiefs! I am tired. My heart is sick and sad. From where the sun now stands I will fight no more forever.

We're taking benign philosophy books like Santayana (no Germans, no Kafka) and geologic maps that show where the richest deposits of strategic materials are located. It may take us a lifetime, but we’ll just see who discovers which "new world" and if it is to be the Last of the Mohegans or the Last of the viciously inappropriate bank holidays.

Dark Rum and Wall Street Bail-0uts

San Juan, Puerto Rico

First off, I would like to wish my Little Brother in Wendover a happy birthday and a future life of happiness, equanimity and love....I don't have his telephone number with me. Happy Birthday, David!

I'm drinking more than my fair share of dark rum. I go down to the local liquor store and treat myself to a bottle of dark Bacardi select...I eyeball the Bacardi 151... but that way lies madness...

Flashback to 1964...I have a roommate, Ted, who is a blond good-looking fraternity guy from Palm Beach...He tells me about "pig parties". That is where you compete to find the least attractive possible date and then delight in their embarrassment when they realize that they have all been invited to a party for ugly women. He actually seems a little guilty relating this to me...maybe there was hope for him?

My deviant non-empathetic roommate produces a bottle of Bacardi 151. I end up with a traffic ticket for driving my Harley-Davidson Sportster at 110 MPH in a 30 MPH zone at 2 AM in front of the Tallahassee police station. Only a year earlier Jim Morrison, my former almost roommate, was charged for stealing an umbrella from a police car. The judge gives me a break after seeing my military ID, but he chews me out good...but at least I didn't get caught stealing a stupid umbrella...

Outside the hotel room tonight, they are blasting away with Puerto Rican tunes...one of the songs is about "muchos saxophones"....I sit in an Audit Committee meeting with 12 staff and volunteers...it's embarrassing to be the only non-bilingual person in the room...they all speak English for my benefit...If I come back, I will be fluent in Spanish...

My pay grade is GS0...I'm a volunteer.

So what about that credit freeze? One problem is colateralized debt obligations (CDOs). These are bundles of securitized sub-prime mortgages. They were rated AAA by the rating organization when issued primarily because of "insurance" against defaults...more about that later.

The banks are using models to value these CDO assets which reflect home price declines in metropolitan areas. For example. the San Francisco Metropolitan Area (SFMA) has just experienced a 24% house price decline. The problem with that is that housing prices in some San Francisco areas are down 70% and in other area only 5%. The banks should be using zip code data to value mortgages and CDOs. This would result in valuing CDOs at near market value. For example, many banks are carrying CDOs worth 15% on the dollar at 75% or more.

I don't think $700 Billion is going to do much to correct the "exuberant excesses" of the last seven years. It's a ten trillion dollar issue...but wait...what about credit default swaps?...and what happened to the Investment Banks?

A Credit Default Swap is like an insurance policy against CDO defaults. Warren Buffet called these instruments of financial mass destruction five years ago. The Investment Banks collected big fees on these policies for years but never set aside payment reserves or anticipated any defaults on mortgages. So when the housing market went south two years ago, eventually "hedge fund" managers panicked and withdrew assets from the investment banks leading to the collapse of Bear Sterns, Merrill Lynch, AIG Insurance, Lehman Brothers and others...what's a "hedge fund"? Please...Don't even ask.

While "subprime" mortgages, borrower fraud, speculative greed and low interest rates created a huge housing and mortgage bubble, a bigger problem now looms...negative amortiztion or "pay option" mortgages. These have brought down Washington Mutual and Wachovia, two of the biggest US Commercial banks. How's this for a deal...sign an 8% mortgage but pay only 2% until your mortgsge balance reaches 125% of the original loan...then you get a letter that your payments have doubled or tripled. You owe maybe twice as much as your home is worth after a 30% decline in value...to walk or not to walk...that is the question...

Meanwhile, inter-bank lending has virtually dried up because banks realize that mortgage assets of other banks are significantly overvalued or impossible to evaluate based on current valuation models. Depositors are making panicked (but somewhat justified) withdrawals from banks where they hsve more on deposit than the $100,000 FDIC insurance limit. The $44 billion in the FDIC fund won't go all that far in the current climate.

I've evaluated the finances of my own credit union. Here is some scary stuff on their provision for bad debts:
2005 $12,000,000
2006 $12,000,000
2007 $60,000,000
2008 $150,000,000

So what about suspension of the "mark to market" method of accounting for mortgage assets that just got signed into law as part of the bailout package? Now banks don't have to writedown assets to what they fetch in similar sales...how helpful..