Foreclosure Robo-Blob Grows

Like a blob in a low-budget horror film that grows larger and larger until it smothers everything, the foreclosure robo mess is ballooning. We now learn that there are robo signing problems with notices of foreclosure in at least some states having nonjudicial foreclosure procedures. (See http://www.cnbc.com/id/41250862). In nonjudicial foreclosure states, where a creditor doesn't need to go to court to foreclose, the trustee bank handling the foreclosure has to give notice to the homeowner of the impending foreclosure, and file the notice in a public office. One of the tiresome requirements of the law is that the person signing the notice should ascertain that there is a valid legal reason for foreclosure. However, it may be that employees of trustees or their agents were robo-signing notices of foreclosure--i.e., affixing their John Hancocks without first bestirring themselves to review the facts of the case and ensure that a valid basis for foreclosure existed.

Nag, nag, nag, nag, nag. The law is such a pain in the . . . assssssk a lawyer what the effect of a defective notice might be and you'd probably be told that it means questions come up whether the bank can obtain clear title from the foreclosure. The bank may be unable to resell the property. Bad debts would remain on its books. The real estate market would linger in its current morass, with the Sword of Robo-Damocles dangling over foreclosed properties the banks have resold or try to resell.

The robo-mess revealed last fall, with robo-signers gone wild in judicial foreclosures, mucked up the foreclosure process in close to two dozen states. The kicker about the latest revelations is that if robo-signing permeated the nonjudicial foreclosure states, then the robo-mess will have reached every state. We've previously suggested the foreclosure crisis needs a national solution. (See http://blogger.uncleleosden.com/2010/10/foreclosure-crisis-time-to-put-mortgage.html.) This would be all the more so, now that robo-signers seem to lurk the length and breadth of the nation.

When you think about it, the robo problem is the problem in the real estate markets. We got to where we are today with mortgage lenders robo-lending to every Tom, Dick and Harry who had a signature and a pulse, without regard to income, employment, assets, past credit history, or anything else that might be relevant to a borrower's ability to repay. Then, the big banks on Wall Street bought up vast quantities of hinky mortgages that the robo-lenders churned out and robo-stuffed them into asset pools underlying mortgage-backed securities and derivatives, making financial sausages containing a lot of things you really wouldn't want if you knew about them. (Investors are now trying to regurgitate the bad mortgages by making underwriters buy them back.) Then, when things fell apart, the big banks tried robo-signing their way through the foreclosure process, disregarding the dreary requirements of the law that might interfere with the bottom line. Somehow, all this robo-banking has to stop. If it doesn't, only a matter of time separates us from the next financial robo-wreck.

The Fed and Foreign Policy

The Fed's easy money policies have spurred inflation and rising real estate prices in China. China's informal link of the yuan to the dollar in effect imports U.S. monetary policy into China. Even though the slack in the U.S. economy from the Great Recession has held prices down here, the red hot Chinese economy reacted to excess liquidity by pushing up prices there.

The Chinese have a deep fear of inflation, having experienced far worse in their four millenia of existence as a civilization than anything Americans have seen. They're imposing monetary constraints, and even resorting to price controls. The Fed is meeting this Tuesday and Wednesday, and is expected to continue running its money printing press at full throttle. With its inflationary implications for the yuan, the Fed's current stance provides China a reason to de-link the yuan from the dollar. Once the yuan is de-linked, China can regain control of its own monetary policies.

The dissatisfaction of Chinese consumers with inflation has much more influence on Beijing's thinking than all the haranguing of the U.S. and European governments. Thus, the yuan is edging up in value, and is becoming more freely tradeable in international currency markets. Its continued rise against the dollar can be expected, albeit at a carefully managed rate. Among other things, a rising yuan makes it easier for China to buy oil and other commodities traded in dollars. Greater Chinese demand would push up the dollar-denominated price of those commodities.

This will be a mixed bag for America. As the yuan rises, U.S. exports to China may increase, creating jobs here. But a falling dollar also means a loss of buying power. America imports a lot from China, and as the yuan rises, those imports become more expensive. Cheaper substitutes may be available in some instances--Southeast and South Asia offer lower cost alternatives for manufacturing clothes. But the manufacture of high tech components that go into computers, cell phones, PDAs, tablet computers and what not can't easily be shifted to new suppliers. And rising oil and other commodities prices have obvious implications for American consumers. A rising yuan, bottom line, means falling wealth levels in America.

It may be that the Fed intends to engineer a drop in the dollar's value. That would be one way it can discharge its statutory mandate to foster full employment. America's wealth levels during the past decade were puffed up by the profligate borrowing that funded the nation's consumption. Debt-fueled "prosperity" can't go on indefinitely, and America's wealth was at risk for a fall.

As the dollar drops against the yuan, the Chinese government will take losses on its vast portfolio of dollar-denominated investments. It would likely be willing to take these losses in order to hold inflation in check and keep its citizens from becoming overly restive.

Many Americans would consider jobs for some of the unemployed at the expense of less buying power for all to be a fair trade. High unemployment has many social costs, ranging from increased government spending to discouraging consumption to familial distress and breakdowns. Fair or not, however, as the yuan rises, American living standards could be squeezed.

Uncle Leo's Den Steps Down

Uncle Leo's Den, the website formerly connected to this blog, is no longer operating due to technical difficulties beyond my rudimentary computer programming skills. I hope to offer its content in some other form in the future. This blog lives. Please keep reading. It's the unanimous view of all--political left, right and middle, business and financial communities, investors, consumers, wealthy, poor, middle class and off-the-grid dropouts--that the country and the world are going to hell. That means there's plenty to write about.

Good Thing Goldman's Earnings are Down

It's a good thing Goldman Sachs just reported that its 4th quarter 2010 earnings are down 52%. Not for its officers, employees, or shareholders, but for the economy and the nation. Too much capital has flowed into financial services. Too much of America's talent and energy has gone into financial engineering. If creating and trading cleverly concocted financial side bets becomes less lucrative, maybe some of the nation's best and brightest will devote their careers to something that has lasting value.

It's really not surprising that Goldman's earnings are down. The financial crisis of the past three years caused the derivatives market to contract sharply. Too of these contracts that were too clever by half proved to be pigs in pokes, and investors grew twice shy. Derivatives, enveloped in opacity, commanded high margins. Without this lucrative business, and in an uncertain economy where clients didn't want to take big risks, Goldman's financial performance was bound to lag.

One wonders if Goldman's personnel are taking the news a bit too hard. Almost surely they had an inkling of what was coming before it was announced. GS's stumble in the rather public Facebook private placement may smack of an investment bank trying too hard to buttress its reputation for prowess on the eve of a decidedly downcast earnings announcement. Sometimes, it's better to go with the flow. Capitalism is cyclical. Exceptions aren't made for even the best investment banks. And that's good, because America can't retain its standing as a world power through financial intermediation. China has become the second most powerful nation in the world with a financial system that is rudimentary compared to ours. America needs to return to its economic roots and concentrate on producing things of value.

A Key to Facebook's Valuation

Recent press reports indicate that Facebook may go public in a year or so. Its recently reported private placement deal with Goldman Sachs supposedly put a $50 billion valuation on Facebook. Many think this is an optimistic number. Conventional measures of value are hard to apply to Facebook because it doesn't publicly disclose its finances. Uncertainties about its business model add to the problem. One wild card is the continued evolution of online privacy policies.

In many respects, online privacy is an oxymoron. Every day brings news of yet more security breakdowns and thefts of personal information. There doesn't seem to be a website that can't be hacked into, one way or another.

But online crime isn't the most important factor affecting online privacy. The commercialization of the Internet is far more significant. Businesses that want to sell your personal information will do much more to reduce online privacy than pimply kids eating junk food in front of computer screens.

Banks are starting to place targeted ads in your online statements. If your bank account shows, say, several recent debit card charges for fast food breakfasts, you may be offered a discount on your next Egg McMuffin. Some bank customers may like the idea of getting a discount while they review their account activity. Others will be creeped out by the idea that the most confidential financial information they have is being mined for the further profitability of purveyors of salt, sugar and fat. Many customers would be outraged at the possibility that insurance companies might pay to know about their slovenly eating habits and charge them higher life, health or disability insurance premiums. Actual insurance company access to your bank account hasn't been reported in the news, but don't think insurers--and the websites that are collecting your personal information--aren't pondering the possibility.

Banks have a lot of ways to make money, yet they are trying to profit from selling your personal information. Think of the pressures on Facebook, which has far fewer potential revenue streams than a bank. The most valuable thing Facebook has is the personal information it gathers about its members. If it can't find a way to monetize that data, its future could be difficult.

The FTC is proposing guidelines about online privacy. Members of Congress are getting interested in the issue and may offer legislation. One way or another, the law in this area will evolve and soon. When it does, Facebook's stock market value could rise or fall, depending on what rules are imposed. Indeed, since the monetization of personal information is likely to be Facebook's biggest potential revenue stream, online privacy laws could be crucial to determining the company's valuation.

Unintended Consequences of Monetary Policy

Today's news reported that China's foreign exchange reserves have risen to $2.85 trillion (yes, trillion, not billion), an increase of 20% over the past year. This is almost triple the next highest amount of foreign reserves held by a central bank (Japan, at $1.04 trillion). At the same time, China's trade balance narrowed over the past year. In other words, China's increased holdings of foreign reserves don't come from a net increase in exports.

Many commentators blame China's low exchange rate for the yuan, which it depresses in order to protect its exporters. But if net exports aren't increasing, something else is going on. A prime suspect is the carry trade, in which speculators borrow dollars made cheap by the Fed's easy money policies and convert them into yuan in order to profit from China's rising interest rates. The dichotomy in interest rates between China (high) and America (low) gives capital the incentive to flee the U.S. for higher returns in China. The fact that China has recently loosened trading restrictions in the yuan, allowing it to be traded in Hong Kong and now the U.S., only makes such capital flight easier. The Chinese central bank will levitate rates further in order to combat accelerating inflation in China, so the disparity with America will only increase.

China's high interest rate/low yuan exchange rate strategy exacerbates economic imbalance. The high rates will predictably draw in foreign capital, and the low exchange rate for the yuan will only aggravate the phenomenon by making it cheap in forex terms to buy high interest rate yuan obligations. But the Federal Reserve's easy money policy heightens incentives for speculators to invest the dollars it's printing in China rather than America. Such a capital outflow would help explain why inflation has been so low in the U.S., notwithstanding the Fed's 'round the clock money printing operation. Capital outflow detracts from whatever stimulus effect the Fed's quantitative easing program might have. Although unintended, QE is boosting China's forex reserves. The Chinese want to eat their cake and have it, too. So does the Fed, hoping that printing money will spur growth without inflation. But it isn't spurring much growth, and is producing inflation in China. That does nobody much good.

Monetary policy is heightening the imbalance between China and America. The Fed doesn't intend this, and the Chinese surely recognize the dangers as well. But China can't turn on a dime away from an export driven economy, and the Fed clearly will persist in QE come hell or high water. So we shouldn't expect things to change much in the foreseeable future.

Euro Zone on a Slippery Slope

After taking a break for the holidays, the Euro zone's debt crisis is back in full swing. Portugal is now under pressure to take a bailout. As previously choreographed for Greece and Ireland, the Portuguese government is strenuously resisting the idea, proclaiming that it has more than met its goal this year for deficit reduction. If things go according to script, the bond markets will smack Portugal around, and European leaders will pressure Lisbon to bite the bullet before other dominoes--think Spain and Belgium--being to teeter.

This time, China and Japan have joined the fun. Both nations committed to buy bonds to help shaky Euro bloc nations, Spanish debt in the case of China and special bailout bonds jointly issued by the Euro bloc nations in the case of Japan. This isn't altruism. Both Asian nations are export-driven, and already hold significant amounts of Euro-denominated investments. They have plenty to gain if the Euro zone stabilizes and much to lose if it doesn't.

Europeans may welcome the Asian infusion. But it changes the landscape. The more China and Japan help Europe, the more they would want the EU to remain intact. Germany and other wealthy EU members may find themselves increasingly constrained to support their profligate neighbors, even as their citizens become more restive over the costs. The political dialogue in Europe could deteriorate, particularly if EU leaders appear to pay heed to China and Japan while their citizens pay more taxes.

The Euro zone is on a slippery slope. That China and Japan would openly acknowledge their support for Euro zone debt highlights Europe's inability to finance itself. The more Europe needs outside help, the fewer options the Euro zone will have. Unity will be its only rational option. The need to pay back Revolutionary War debt was one of the major reasons why the 13 rebellious British colonies in North America remained united after attaining independence--ultimately, the United States assumed responsibility for this debt as part of the price of ratification of the Constitution. Europe will have to move toward greater political union in order to establish greater fiscal control and restraint.

But people aren't always rational. In the preceding century, Europe was the principal battleground for two world wars that killed tens of millions. Why? Historians still debate that question, but there's no rational explanation. Although the Euro's problems won't lead to war (the Europeans learned from WWII not to be trigger happy), precipitous secessions by wealthier Euro bloc members can't be excluded. Electorates have a limited tolerance for bailouts, as the American mid-term elections last year illustrate.

There's no to know for certain how things in Europe will end up. But the continent cannot maintain the status quo. It's on a slippery slope, and time will tell which way it slips.

It's Not Just a Foreclosure Problem, It's an Accounting Problem

A recent decision by the Supreme Judicial Court of Massachusetts (U.S. Bank, NA v. Ibanez, Jan. 7, 2011) to block certain foreclosures has deeper implications than has generally been reported. The court ruled that two banks, trustees holding pools of securitized mortgages that tried to foreclose on two of the mortgages, hadn't submitted the documentation required to establish valid ownership of the mortgages. Thus, the banks couldn't prove they legally held the mortgages in question, and consequently couldn't foreclose. Nor could they obtain title to the mortgaged homes when they purported to buy them at the auction, so they couldn't resell them. Although the court didn't expressly say so, the homes would appear to be still owned by the original mortgage borrowers.

The court's decision implies that, for perhaps numerous securitized mortgages in Massachusetts, foreclosure may be difficult or near impossible. Such a legal conclusion, if applied nationwide, would gum up the recovery of the real estate markets. Even though halting foreclosures will hold homes off the market (because foreclosing banks can't resell what they don't legally own), prospective buyers will be cautious with the prices they pay for the remaining houses on the market. The foreclosure problems will eventually be resolved and foreclosed homes would then be dumped onto the market. This would push prices downward. Anyone who paid an optimistic price today could end up underwater in a year or two. The real estate markets will not stabilize until the foreclosure problems are dealt with. Delaying them, which will be the result of the Massachusetts decision and similar decisions by the lower courts of other states, will only postpone the day of reckoning. And the delay will add to the costs to the banks for having been so careless about documentation requirements.

What makes things worse is that there's more than a foreclosure problem here. If mortgages haven't been legally transferred to trustee banks, the principal process for financing home purchases--securitization--would have broken down. Mortgages being securitized are supposed to be pooled together and held by trustees for the benefit of investors. The big banks that underwrote the mortgage-backed securities would have breached their contracts to the investors by failing to deliver mortgages to the securitization pool. Investors could demand their money back. And refuse to accept losses the banks claim were sustained on defaulting mortgages, on the ground that those mortgages were never validly transferred to the securitization pool and the investors have no liability for losses from mortgages not held by the pool.

Moreover, depending on how the courts interpret the law, the banks might be liable for fraud, especially if bank officers were aware of the documentation deficiencies but sold mortgage-backed investments anyway. That could result in more liabilities, to investors and in SEC enforcement actions. In the worst case scenario, criminal charges could be filed. Since trillions of dollars of mortgages have supposedly been securitized, but now perhaps weren't, the potential liabilities could be very large.

Another problem would come up with mortgages that banks bought, either directly or as part of a securitization offering. If those mortgages have the same documentation problems the Supreme Judicial Court found deficient, the banks wouldn't really own the mortgages (or securitized interests in them), but would have reported phantom assets on their balance sheets. Again, depending on how widespread the documentation problems are, the quantity of improperly reported assets could be tens of billions, or even hundreds of billions.

Banks are now closing their books for 2010, and will be filing their financial statements at the end of March. The impact of the mortgage documentation problems will grow as a result of the Massachusetts ruling. The banks will have to account for these problems, and make a variety of disclosures. The banks' auditors will likely advocate caution; the New York Attorney General's recent case against Ernst & Young over Lehman Brothers' accounting for quarter end repo transactions will surely loom large in their minds. If the banks understate their problems, they (and their auditors) could buy more fraud suits from other classes of investors or government agencies. Stay tuned. This crisis could make our times even more interesting.

Maybe Facebook Just Wants to Keep Mum

The SEC is reportedly interested in Goldman Sach's recent deal with Facebook to invest around $500 million and maybe up to $2 billion, some of which will be raised from well-to-do investors. A lot of speculation has popped up in the financial press about what Facebook is doing and why the SEC might be nosing around. Commentators harrumph about the burdens of complying with the federal securities laws and insinuate that the SEC's interest may amount to regulatory overreach that interferes with financial innovation. They imply that Facebook and GS may be fashioning a brave new financing structure for companies that don't want to be forced into the SEC's 1960s vintage regulatory model, and that the SEC is poking around to protect its turf.

The truth may be a lot simpler. Facebook hasn't publicly defined a clear business model. There is good reason to suspect it doesn't have one. It doesn't sell anything to users, and derives much of its revenue from banner advertising. Banner ads aren't generally viewed as the wave of the future for websites. So Facebook is most likely a work in progress.

Its biggest rival is Google, and Facebook doesn't participate in Google's targeted advertising programs. If Google could place targeted ads on Facebook, it might be able to collect enough information to develop its own, improved social network (and Google has the cash--maybe $30 billion plus--to do it). Facebook might, in effect, provide Google with the means to undermine Facebook.

Facebook could try to develop its own targeted advertising program (after an early failure in 2007). But that would take a lot of work, and would put it in direct competition with Google and Google's $30 billion cash hoard. Facebook may be an aircraft carrier to Google's battleship, but an aircraft carrier doesn't want to get within range of a battleship's big guns. So Facebook is probably still figuring out what its principal revenue streams will be.

The SEC's disclosure regulations would require Facebook, if it went public, to reveal a lot about its business activities and risks. First and foremost, Facebook would have to report detailed financial information; and the impression one gets is that Facebook isn't a gusher of net profits yet. If its business model is still a work in progress, it won't have the most glowing picture to paint. That would translate into a less than meteoric rise in its stock price.

A company doesn't go public until it's got a good story to tell about itself. That's how insiders get juicy valuations for their shares. Facebook has little incentive to try to develop a new financial paradigm to go "public" in a private manner, because it wouldn't maximize share price right now. There's a news report on Money.cnn.com saying that Facebook will use the money it's raising from Goldman to buy back employee stock and keep the number of investors below the 500 shareholder level where Facebook would have to start filing the reports required of a public company. http://finance.fortune.cnn.com/2011/01/05/facebook-raising-goldman-money-so-it-wont-go-public/ Assuming that's true, the whole point of the GS deal is to avoid going public. That would seem to make sense, from a business standpoint. The SEC will find whatever it finds in its inquiry, and the possibility that GS and Facebook might have tripped over a regulatory requirement somewhere cannot be discounted. But the whole thing may be, not a sneak IPO, but a bid to stay private until Facebook's founders can hear the cash register ringing really loudly.

A Tale of Two Recoveries

Near unanimity reigns on Wall Street that the economy will keep expanding and the stock market will rise further this year. Corporate profits are growing as worker productivity improves. Commodities prices are levitating. Retail sales have moderately increased. Even junk bond yields are relatively benign. Stock market investors, even if still shell shocked from two years ago, are doing better. In the tonier parts of Standard Metropolitan Statistical Areas, things are looking up.

Evidence of recovery is harder to find elsewhere. Food banks remain heavily patronized. Unemployment levels cling tenaciously near the 10% level. The long term unemployed are becoming entrenched in joblessness. Wages are stagnant. Many unemployed who find jobs have to accept lower incomes. Real estate prices are dropping again, after a brief and shallow upswing. Mortgage rates have risen off record lows, dampening refinancings and home purchases.

There has never been a lasting economic recovery without a restoration of full employment and a strong housing market. Neither seems to be in the offing, not for years. America is dividing into two camps. There are the relatively few well-off, who own most of the assets and are the least likely to be laid off. They have more resources to ride out the bad times and greater opportunities to profit from a rebound. Then, there is everyone else, for whom the Great Recession continues.

Today's politics only exacerbate the divide. Many moderate and middle income taxpayers, frustrated by the disparate impact of the recovery, became Tea Partiers and voted Republican. But the resurgent Republicans made sure that the wealthy were protected in the tax deal they cut with President Obama this past fall. The same tax deal also gave everyone a 2% cut in Social Security taxes, while the more progressive $400 Making Work Pay tax credit wasn't renewed. The first legislative maneuver by the new Republican majority in the House is to schedule a vote to repeal last year's health insurance reform law. This symbolic digital salute will do nothing to improve the economy or help the unemployed.

Deficit reduction is on every politician's list of resolutions for this year. But you know how it goes with New Year's resolutions. There's more water to be found in the Sahara than spending cuts in Washington. Last fall's tax deal, the first major product of the new bipartisanship, widened the deficit. The only way to truly reduce the deficit is to cut Social Security and Medicare spending, and/or raise taxes. Recent polls show that a large majority of Americans, from Millenials to the World War II generation, oppose cuts in either program. Yet there is no way today's Republican-controlled House would sign off on tax increases (even though a recent poll shows most Americans favor increasing taxes on the well-to-do in order to balance the budget). So the new bipartisanship will produce, at best, nominal deficit reductions in highly visible ways (a la the two-year pay freeze for federal employees, which hardly affects the deficit but sounds good in press releases). Given that today's recovery is largely due to deficit spending and the slackest monetary policy ever adopted by the Fed, there is little incentive in Washington to control deficits. No politician wants to be the grinch that stole the recovery.

But for most Americans (i.e., the majority trapped in stagnation), there hasn't been much of a recovery to steal. Current projections are for high unemployment and depressed real estate prices to linger for years after 2012. America may be morphing into a society where a small group of elites enjoy prosperity while everyone else just gets by (or not). That's not a good development for a nation dedicated to the pursuit of happiness. America was founded by immigrants aspiring for better lives. If hope dies, the essence of the nation is lost. The damage from the Great Recession will be great, indeed, if the nation loses its heart.