Wednesday, January 16, 2008

Economic Disconnect's Bailout Plan

There was a wild coyote caught in downtown BOSTON yesterday. I saw the thing on the news and it looked very well fed. Either that thing was eating the enormous rats in the city, or pet owners that have lost a pet recently probably have their answer.

Wednesday Action - What Happened?
If you read Market Ticker's proposal that there was a 1 in 4 chance of a serious market drop today, then you may have been very interested in the market action. When I got up at 5am I fed the doggie as usual, got a coffee, sat down and turned on CNBC. The Asian markets were all down very hard. The Dow futures were pegged at negative 100. Gold was down $20 dollars. Things looked terrible indeed. By the time I got to work and had a minute near 8:30am things had eased up. The market opened and.....stocks took off! Amazing stuff. The JP Morgan report was the supposed catalyst for the upside momentum, but does anyone really believe JP's numbers? I think they wrote off as little as possible to take advantage of poor results by peers.

Somebody out there was buying futures this morning very hard to stop a big leg down. Any ideas out there as to whom? Stocks looked good all day until near close when the markets took a complete dive down. So much for a rally. Today smacked of manipulation and total fakeness. I wonder how much longer the charade can go on?

Economic Disconnect's Bailout Plan
Much of the criticism that this blog and others like it get sounds mostly like "you like to bash people and programs, but what is your solution to this mess? I guess it is a reasonable question. In my mind it is kind of a non- starter because if I was in charge none of this would have happened in the first place. With that in mind, I do indeed have a fix for the housing market, other than to stop any and all intervention and let market forces correct the bubble that is!

The Issue - Home prices are too high and must come down to somewhere near their historical rent ratio and personal income ratio. Far too many borrowers with limited ability to pay the mortgages they took out are being foreclosed upon. Inventory is too high and speculators hold too many properties. Banks, due to the wonders of fractional reserve banking, do not have sufficient capital to deal with losses due to the mess.

The Plan
Scenario One - If you are a "homeowner" whose home value has fallen below the purchase price you have 2 options:
  1. Accept a one time penalty of $10,000 which you must repay over 5 years. No tax break will be extended towards this payment. You can now walk away from the home without further consequence. Homes that fall into this category will have to be sold by the banks at substantial losses.
  2. Accept a new mortgage with the amount set by using historical rent/own ratios. This amount will vary wildly by region with former hot areas seeing 50% markdowns, and on average about 30%. The new mortgage will be a 30 year fixed rate and there will be no ability to refinance or extract equity for a period of 10 years.

How to pay for it - The massive losses from either option above will cause serious problems for the banks. Obviously the US government will have to step in and backstop the banks. To cope with the loss of capital here is how it will be paid for:

  1. Homeowners accepting the new mortgage will forfeit any and all price appreciation gains that might occur upon selling for the next 15 years, payable to the Treasury.
  2. Mortgage interest deductions are revoked.
  3. The banks will limit top executive pay to $200,000 a year without any stock option plans or bonuses. Top executives will exercise any shares that hold value and pay 50% of the proceeds to the Treasury.
  4. The banks will pay a corporate tax flat rate of 20% to the Treasury until the losses are paid back in full.

Going Forward - Homes will always have buyers, people need to move and live. Here is what will keep things sane for a while;

  1. Only 15% down borrowers with full documentation can be approved for home loans.
  2. Individuals cannot own more than 2 homes to bar speculators.
  3. Buyers must meet the 30% of gross income threshold for a mortgage.

That is about the best I can think of. It really sticks it to the banks, as it should be. It also takes away the premise of capitalism as it relates to real estate. I hate the plan, but it makes the most sense to me. In no way am I for this plan, again I think things should be left alone without ANY manipulation and we will see how things pan out.

The point of this exercise is to show just how silly and insane things have become over the past 5 years. All the bad loans, home flippers, multi home speculators, willing banks, and no oversight all contributed to the mess. Only a radical plan like the one above can even begin to undo the damage. Sad isn't it?

Have a good night.


Anonymous said...

...and the moon is made of green cheese. Dream on. Please don't get me wrong, you suggest excellent proposals, but it ain't, no way, gunna happen. A dead duck President, and candidates, who will not take office until 2009, guarantees nothing but BS.

And that is why this mess is so dismal. The only solution, as you say, is a market solution, which is going to tank the economy. It's going to be a blood bath. We are looking into the abyss.

It's official. We have entered into a bear market. I heard from no less than ten commentators, today, between CNBC and Fox Business, speculating on "The Bottom". We are now in the slope of hope phase.

In the mean time, the gold market climbs a wall of worry. Has gold reached a top, will it correct, will it crash, will it go to $1000? Answer to any and all conjecture, yes, no, maybe.

watchtower said...

You keep forgetting that we might get a $1000 from "W", we're saved!(sarcasm off)

Chris Puplava over at Financial Sense has an interesting perspective on the Yen carry trade. Might be worth the trouble to go look.

Anonymous said...

"Individuals cannot own more than 2 homes to bar speculators."

You had better put a grandfather clause on that one sonny, I own three although mine are paid for.

Henry To says buy, he cover his short on the DOW and went long, also recommends financials and japan small caps. FWIW


Anonymous said...

In the mean time, the gold market climbs a wall of worry. Has gold reached a top, will it correct, will it crash, will it go to $1000? Answer to any and all conjecture, yes, no, maybe.

I think commodities in general are about ready to get there ass handed to them. I am selling a couple hundred oz of silver and buying cow-calf pairs for my farm, Cattle and hogs have been creamed by the high grain prices and look to be a good buy in the next month or so.


Anonymous said...

this thing is over..the end...the 2009 election guarantees it...hold on to you skivvies...ha

watchtower said...

This was an interesting day.