And on Monday the Stock Market reacted very favorably to the news, with a huge rise in the Dow (500 points, settling up 289), with a strong positive impact to the banking industry.

But I’m still convinced that the solution divides the interests of those in the government now set to manage the affairs of these companies.  Everyone who looks at this right now is breathing a sigh of relief and investors are happy that their risk has been reduced… thus the positive day on Wall Street.  Many of us are certainly benefiting personally, if we have any investments that are growing today as a result of this.

But, will you and I continue to benefit in the long term?

Do we really believe that the Fed will release the control it has taken at some time in the future?

Not as long as we continue to fear failure as badly as we seem to now.

Not as long as those in power are able to feed off of this level of control.

Not as long as all of us are happy that we are seeing money line our own pockets.

And what price will we pay?

Time will tell.  I sincerely hope this plays out in a positive way in the long term.  But we should all watch carefully and hold those in power accountable.

The move includes replacement of the CEO of both organizations, and an infusion of about $200 billion.  In return, the Treasury gets $1 billion in preferred stock from each company without providing the cash for it up front (I’m assuming this will work like a stock option).

From the Wall Street Journal:

It is unclear how much the government’s intervention will ultimately cost taxpayers. In exchange for agreeing to provide as much capital as needed to the companies as they cope with heavy losses on mortgage defaults, the Treasury will acquire $1 billion of preferred shares in each company. It has obtained warrants that give it the right to a stake of 79.9% for a nominal sum. The Treasury’s preferred shares will be senior to those earlier issued, meaning the government will have the first right to receive dividends.

The new overseers will also eliminate dividends on billions of common and preferred stock, moves that are expected to drive down the price of those shares, which have already dropped precipitously this year. The issue of additional preferred shares will dilute common shares.

And now the government gets to cover the bad debt, which means you and I cover the bad debt, and presumably the dividends from the preferred stock will go into the treasury.

Although I recognize the fact that the potential of these companies failing would have a devastating affect on the US and world economies, the deal smells to me.

First of all, the exiting CEOs are both getting a fairly tidy compensation package.  I think that’s just bonkers.  They suffer no real loss over their failings, especially in the light of the Alt-A loans debacle.  These loans were treated somewhere between prime and sub-prime loans and, get this, didn’t require the same level of documentation as you and I have to provide for income and assets on our mortgages.  These guys should have been shown the bomb-bay door with no parachute.

I don’t trust the fact that a new source of revenue is being created so that Congress can use it to spend more money it doesn’t have, money that really belongs to us, that we’re going to pay up front to cover the bad debt incurred by the bad loans made at these companies.

I don’t want to kill our economy, but I also don’t like propping up investors who are always warned boldly that “investments involve risk”.

And lastly, I don’t like seeing our government get any bigger.  The role of government should not be to get itself into the world of business.  First we start competing with banks with the faux tax credit ($7,500 for new home buyers that is treated like a tax credit but is really an interest free loan).  Now we take control of the 2 biggest mortgage owners in the country.  Which means, the government now owns your house AND collects taxes from you on it.

This will be a major balancing act as long as this authority is in place.  Between the mortgages, property taxes (I can just see the fights between the Fed and counties), the taxpayers getting squeezed, the proper handling of the income from the preferred stocks, working out the long term strategy (which will be left for the next congress and president).  We’ve become too scared of the risk of financial failure to ever really allow the market to run its course.

The logical end of this seems to be government controlled banking and investing.  I’m sure that will kill our growth and cripple our relative power in the global economy.

As I’ve said in the past, I am not a professional economist.

This really may have been the only and best thing that the government could do.  I’d just like someone to show me why.

Money is now expected to be tighter as we roll into the fall and home buying will continue to be slow due to the fact rates will be higher and people will be disinclined to borrow and therefore buy.

Don’t mind the fact that having the media and the industry simply telling the public that it’s bad probably causes a lot more people to sit on their hands.

With home prices as low as they are now, it’s the best time to buy.  The cost of money is already low and continues to be offset by the lower home prices.  This should be the best time to buy a home if you don’t own one.

Plus you get that great $7,000 loan tax credit from the government!

I have limited concern for the two big home loan banks.  Maybe I’m being too callous, but investments have an element of risk, and everyone’s complaining that those who invest in the banks are losing money.  That’s the risk.  People lose money in investments, even the not-so-risky types, and it’s accepted as part of the process.  You win some, you lose some, and you hope that you win more than you lose.   Yes, my 401K is impacted by this, but in two years it will bounce back.

More importantly is ensuring that home buyers know they have an opportunity right now, and that the state of the market is in their favor.

If you want to and can, go buy a house!

Make sure you can afford it, thought.

(Links from The Wall Street Journal web site)

What a shame.

After speaking with a good friend of mine that is a CPA, the tax incentives, particularly the $7,500 tax credit (a topic which is burning up the search engines at this time), are going to make life harder for tax preparers, tax payers, and probably increase the cost of running the IRS.  As I’ve said before, There are going to be a lot of problems keeping track of this. 

Plus, this is just an unfair competition with banks.  The government can lend the money interest free with little in the way of rules and underwriting (and if a Bank tried to offer this program, they would get sued or have criminal charges pressed under Fair Lending laws).  Frankly, it would have been much more appropriate to manage this boondoggle as a special type of Mortgage-related product for banks to offer to ensure that appropriate controls are maintained. 

And how much fraud is this going to generate?  How about scams, like buying a house on December and selling it for the same amount in January… no mortgage, no bank, no lawyer, no real estate agent, all cash, and then sell it for the same amount in January.  Cool $7,500 and no repayment required.  I have family that live in a rental house who could pull this one off easily.  Who is going to pay for that? 

Thankfully, though I missed it until today, this feature is only available for first time principal residences purchased between April 9, 2008 and July 1, 2009.  But we’ve got the aftereffects until 2026.  And the IRS still needs to track it until at least 2029 (or 2033, not sure). 

Clearly, Bush is on the same wagon that most of Congress is: “it’s an election year, we need to give people money”.  I know, the economy is a mess and people are suffering.  Frankly, many people are suffering because they’ve built up expectations over the years from all of the existing handouts and inflated values in the housing and stock markets.  I won’t deviate from the topic here, but I will post something at a later time on the topic of Suffering.

Sorry, back to the Housing Bill, so it’s understood that there is a need to solve the current ecomomic dilemma.  It’s unfortunate that we think bailing out the Home Loan Banks is part of that.  No one is really maintaining accountability on the whole Market model that we always propose: “if you do well, you make a lot of money, if you do poorly, you lose a lot of money”.  This bailout definitely gives the riskier players an edge now since they get a safety net they don’t need or deserve.

And it all comes on the backs of American taxpayers.   As usual.

Senator Charles Grassley, who is the ranking member of the Finance Committee which is responsible for tax legislation, voted against the bill.  In June, he hosted a mortgage assistance event in Iowa to bring lenders and consumers together.  Here are his comments about his vote: 

“The problem with this massive bill is that it could do more harm than good.  It started out to help Americans who are losing their homes, but it ended up giving banks a $4 billion incentive to foreclose rather than work something out with homeowners who are in trouble due to downturn in the housing market.  The bill’s bailout of Fannie Mae and Freddie Mac doesn’t even begin to reform the excesses and the conflicts of interest that contributed substantially to the problems the mortgage giants face today.  And, more broadly, the bailout fosters moral hazard by diminishing any incentive for the housing sector to act more responsibly in the future.  Even the tax package, which I was involved with during Senate consideration of the measure, has been discredited by changes made by the House of Representatives that unraveled bipartisan tax reforms and did things like give favor to tenants who are artists or literary figures over low-income families.  I voted to proceed to this legislation because I very much wanted Congress to address the important housing issues facing the country today, but this bill has fallen prey to the special interests on Wall Street and K Street at an unjustifiable expense to taxpayers and homeowners on Main Street.”

Lastly, now that the Housing Bill is law, the language of the Fair Tax bill is going to have to be changed in order for it to be passed during the next 15 years.  Something to the effect of forgiving the remaining recapture amount.

Another blogger, John D. Thornton, has some interesting insights regarding the OFHEO.

I’ve been getting some hits on Saturday’s post that are searches like this “explain the $7500 tax credit on the new housing bill that was just passed“.   I’m glad to see there are people wanting to understand it better.  This could be achille’s heel of the bill.

There is additional information available (this is where I found the cost estimate) at WashingtonWatch.com.

The entire bill is over 600 pages long.  The table of contents is 7 pages.  And technically, this is a bill that began its life over a year ago.  Sponsored by none other than Nancy Pelosi.  And apparently Bush is planning to sign.

He should not.

Touted by most of the media is the section that provides up to a $7,500 tax credit is 1,800 words.  And the  media manage to mention it without explaining that the taxpayer that gets the credit is then taxed (called a “recapture”) an additional 6-2/3% of the amount of the original credit for the next 15 years.  Yeah, that’s a 0% loan, not a tax credit.  As far as I know, there is no precedent for repaying a legitimate tax credit, so this is unique and is probably going to take a LOT of people by surprise.  And not today, not even next year, but you watch in the Spring of 2010 when people actually have to start paying this thing back… an extra $500 in tax that they were not expecting.  Keep your eyes on the shells and tell me where the pea is.

And 5 or 10 years from now when Congress wants to make another sweeping change to the system, these recaptures are going to create more complexity.  And don’t even get me started on the impact of ever getting the Fair Tax passed now.

So, briefly, here’s what the bill does:

1. Establishes a new agency called the Federal Housing Finance Agency.  Yeah, that’s right, yet another agency.  The section is referred to as “Improvement of Safety and Soundness Supervision”.
2. Specifies loan limits, capitalization levels, reporting, availability of some data to the public domain, housing goals.
3. Enforcement requirements, actions, penalties, subpoena authority.
4. Committees, directors, etc. for the new agency.
5. Abolishment of the OFHEO (Office of Federal Housing Enterprise Oversight, a sub-agency of HUD), and transfer of everything it does and owns to the new FHFA.
6. Abolishment of the Federal Housing Finance Board and transfer of everything it does and owns to the new FHFA.
7. Some attempts to reduce paperwork (always appreciated).
8. What appears to be sweeping changes in voucher and tax incentive programs.
9. Extending the length of time some programs such as PHA project-based assistance.
10. Updates to Federal Home Loan Bank code.
11. Establishment of HOPE for Homeowners Program.
12. A bunch of rule changes to make it easier for homeowners to avoid foreclosure.  Interestingly, this section includes an “Emergency Declaration”, that appears to allow Congress to break it’s budgetary rules to get this bill passed.  Someone a lot smarter than me is going to have to explain where in this part of the bill there would be substantial costs.
13. Special conditions for manufactured homes.
14. Emergency assistance for foreclosed and abandoned homes.
15. Counseling services.
16. For those of us who hate all the papers we already have to sign to close a mortgage, this disclosure is now added: “You are not required to complete this agreement merely because you have received these disclosures or signed a loan application.’” Unbelievable.
17. Servicemembers and Veterans get some special considerations, for which I cannot possibly disapprove.  As far as I’m concerned, we owe these folks a free and clear home.
18. Adding $30,000,000 to the McKinney-Vento Homeless Assistance Act (financing programs for Homeless Assisstance).
19. Changes to REIT rules.

Trust me, that was brief.

I’m going to admit that the Revenue Provisions section at the end of the bill is somewhat confusing to me, especially the “Bonus Depreciation” section.

Oh yeah, and the bill also encourages “energy efficient mortgages”, that is, mortgages on homes with energy efficient features and/or improvements.

I’ve skipped a LOT of little details that seem to amount to tweaks (some small, some large) to the system, or to adjustments required to realign the agency responsibilities or other administrative issues.

And this is an interesting item, a section titled: Secure and Fair Enforcement for Mortgage Licensing Act of 2008. The first four word’s initials spell “SAFE”.  Nice.  It states:

In order to increase uniformity, reduce regulatory burden, enhance consumer protection, and reduce fraud, the States, through the Conference of State Bank Supervisors and the American Association of Residential Mortgage Regulators, are hereby encouraged to establish a Nationwide Mortgage Licensing System and Registry for the residential mortgage industry that accomplishes all of the following objectives:

1. Provides uniform license applications and reporting requirements for State-licensed loan originators.
2. Provides a comprehensive licensing and supervisory database.
3. Aggregates and improves the flow of information to and between regulators.
4. Provides increased accountability and tracking of loan originators.
5. Streamlines the licensing process and reduces the regulatory burden.
6. Enhances consumer protections and supports anti-fraud measures.
7. Provides consumers with easily accessible information, offered at no charge, utilizing electronic media, including the Internet, regarding the employment history of, and publicly adjudicated disciplinary and enforcement actions against, loan originators.
8. Establishes a means by which residential mortgage loan originators would, to the greatest extent possible, be required to act in the best interests of the consumer.
9. Facilitates responsible behavior in the subprime mortgage market place and provides comprehensive training and examination requirements related to subprime mortgage lending.
10. Facilitates the collection and disbursement of consumer complaints on behalf of State and Federal mortgage regulators.

So, the bill attempts to modernize some of the technology, some of the dollar values, and elevate the accountability of the Financing arm of HUD.  Plus hand out some money.

This is going to cost quite a bit.

Maybe some of it is needed.  I doubt Bush really understands all of the implications of the bill, but then, I know I don’t either.  It would be interesting to hear some feedback from someone that is well versed in the law.

Of all the content I see here, the $7,500 tax credit (text of this section here) is the most disturbing.

1. It will cost us money, both in interest expense to disperse it (since the pay back is interest free) and and the conditions that appear to allow for reduction of the repayment.  Such as if you sell the property and the gain is less than the amount still owed to the government, you only have to repay the amount of the gain.  Other exceptions to repayment include death and involuntary conversion.
2. It will promote the same kind of over-extentions by homebuyers that led to the mess we’re in to begin with.  Homebuyers will either convince themselves or be convinced by realtors or bankers that they can borrow up to $7,500 more than they really should because they’ll get it back on their tax return.  Without telling them about the $500 per year tax hit.
3. It will create substantial frustration in 2010 when people go to pay their 2009 taxes, the first year they would experience the “recapture”.  Because they won’t understand it, and it will increase their tax burder by $500.  That can be enough to create a huge backlash and economic impact that may force Congress to give out more money.  Just what we need.
4. The IRS is bound to mess up the forms and the rules.  Tax preparers may be ill-prepared to handle this.  Tax payers will be confused.  Chaos will grow and cause Congress to have to create yet another agency to oversee tax preparation for homeowners that used this tax credit.  (okay, maybe not, but I never thought I’d see this kind of credit before either).

I don’t want to see people suffer.  It’s hard to question all of this bill as there are probably some very appropriate adjustments to caps and other details to accomodate inflation and other changes in the market, technologies, etc since 1992.

But bad law is still bad law.  Fix the big problems, the $7,500 tax credit and the new agency, and I might be willing to work with this.  Helping the people that are hurting right now by no fault of their own is all well and good.  Helping the people that were pushing the envelope or simply gaming the system and lost, that’s just stupid.  And encouraging more first-time homebuyers to enter the market when they’re really not ready is just wrong.

My previous comments (in May), cover some of my thoughts here in more detail, but we just have to stop coddling people.  Please.

So today (Thursday), the House passed a bill to spend yet another $300 billion that we don’t have in order to firmly entrench the new entitlement: home ownership.

We won’t spend any time bemoaning the end of apartment dwelling as we know it. Nor the fact that the riskiness of investments are going to slowly erode (erasing the potential of high returns in its wake).

No, we’ll just camp out on the fact that this bill is taking money out of our pockets and being used not just to help those who have exhausted all recourse with their lenders (many of whom, by the way, are working vigorously to help homeowners who are at risk of foreclosure without the governments help, thank you very much), but to make borrowing and lending money for homes a no-risk, no-fault arrangement.

The bill creates a $7,500 tax credit for first time home buyers and billions to communities to buy and fix abandoned homes, and a special FHA guarantee to lenders who write down the principal on homes that have significantly dropped in value (for about half a millon homes).

The biggest problem in my mind is the tax credit. That’s going to make a real mess of things. It will make it much easier for borderline borrowers to be convinced to buy a bigger home than they can really afford. It will certainly make the whole mortgage experience seem so much easier for the first year.

But wait, what do mortgage lenders do when they know there’s more money available as part of a deal? They figure out how to add it to the deal itself. If this bill passes, I guarantee that lenders will find a way to turn that $7,500 into down payment money… it will end up thrown into the escrow account as soon as it’s available. An automatic $7,500 taken off the bottom line, lowering the mortgage payment. And realtors will use this money to convince people they can afford a lot more house than the really can.
Wait, why make it hard in the first place? Why not just give the first time home buyers $7,500? Wouldn’t that be easier, more effective, simpler? Cut through all the red tape? Oh, yeah, then it looks like te Bank was doing it instead of the Government. Or, as I’ve said recently, Congress just likes to use the tax system to manipulate behavior… in this case, stimulating home buying.

But what is not showing up very clearly in the news (I see it in a few places, but not all), is the fact that the tax credit is really just a loan from the Government. Yup, that’s right, the poor sucker thought he got a free $7,500 just for buying a house, and now he’s stuck paying the IRS an extra $500 every year for 15 years. Has that ever been done before?

And here’s what’ll happen. The first year they have to pay it back, they won’t even know they have to pay it back, and instead of owing perhaps $675, they’ll owe $1,175. And they might not have have it, so the IRS fines them for being over the $1000 “owing” limit, and more for being late. Then, the next year, they might have the money, but they’ll still not have adjusted their W4, so they’ll go over the “owing” limit again. Finally, they’ll get it right the next year, but they’ll have figured out what a scam the government has played on them. PLUS they will have paid for part of the money the first year since they’re taxpayers just like me, and we’re all going to be paying for this. Because when the Government lends money out at zero percent, they still have to pay the interest on the $7,500 they borrowed in the first place. That means we’re all paying that interest. And, by the way, this eats up a third or more of the money saved on the mortgage interest deduction (which most people don’t take anyway).

What is troubling here is that Congress appears to be making things better, but they’re actually going to make things worse (at least they’re consistent). They believe they are making it easier for people to “live the American Dream” (home ownership is evidently the American Dream). Instead, they will manipulate people into buying more house than they can afford (in a market where it’s easier to buy a lot of house anyhow) and put them into a potentially worse position than they needed to be. Remember, home ownership is more than the purchase price of the home. Property taxes, heating & cooling, upkeep, furnishing, cleaning… you get the idea. So this bill, intended to fix a mess caused more or less by people buying more house than they could really afford, will simply create the same exact problem it’s supposed to solve. Nice.

I’ll add, just for perspective, that my wife and I lived in apartments for the first 11 years of our marriage and we don’t regret that for a moment. I do think that home ownership is great, and I know it means a lot especially for families with children. While I don’t begrudge that opportunity for anyone, I reject the notion that home ownership is a promise we should make to all Americans. It is inconceivable to me that we make it an entitlement. This is a steep and very slippery slope… we should stay away from it. Thankfully, President Bush plans to veto the bill, but the White House has stated they are open to discussion since they like of the features of the bill. We’re going to need to keep an eye on this one.

Of course, if Congress could loosen up another $15,000 in cash for each and every home owner for the next 2 years, without the pay back clause, that might be more effective. (for any US Congressmen are reading this, please, that was sarcasm).

If Congress really wants to make things better with the housing market, the stock market, and the economy as a whole, let’s get the FairTax passed. That’s HR 25, S 1025.

Update:  The more I think about it, the worse this gets.  The US Government now wants to compete with banks and does so unfairly by offering not only an interest-free loan for 15 years, but without any of the rigor the banking industry is required to use: credit analysis and appropriate contracting.  What happens if the homeowner dies?  Does his estate still own the money to the Government?  And again, I think this will end up as a deceptive program that if put together by any bank to an average Joe borrower would get them shut down.