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By Daniel R. Amerman, CFA
As a result of apparent systemic
incompetence coupled with fraud, it appears there is a chance that most real
estate foreclosures may come to a screeching halt on a nationwide basis in the
United States. What is missing from the headlines is the real impact on you and
I, and how we will be the ones bearing the pain. To understand the implications
of this extraordinary situation, we must first pierce a triple charade.
The first charade is the joke which the
banking industry - and their regulators - in the United States has been making
of contracts and the law. The second charade is the idea that the banks will
bear the consequences for their gross negligence and lies, when in fact it is
the US government and Federal Reserve that will be bearing the full costs (which
is to say, you and I). The third charade
is the idea that taxes will pay for these extraordinary expenses, when the only
credible source of sufficient funds is ultimately the destruction of the value
of the US dollar.
The economic bottom line (as is so often the case in the these troubling times) is that a massive redistribution of wealth is underway, and most of the US population has no idea what is going on. Which means that the older savers and investors who will be paying most of the real costs for this fiasco, will never understand what happened – they'll just pay a devastating price as the purchasing power of their life savings plunges. Fully understand what is happening, on the other hand, and you can not only protect yourself, but position yourself so that wealth is redistributed to you rather than away from you.
Most people have little or no idea how
the mortgage market actually works in 2010. There is this outdated idea that
banks make mortgage lending decisions, and stand to lose if they make bad
decisions with the investment of their money. But effectively speaking, the
banks don't actually make the decisions about who gets loans, nor do they
guarantee the loans, nor do they buy the loans.
The government does all of that, as explained in my article "Futile
Attempts To Reflate The Housing Bubble & The Deadly Cost", linked
below:
http://danielamerman.com/articles/Reflatep.htm
Large scale US government intervention
in the mortgage markets is nothing new, as I wrote in my book, Mortgage Securities (Probus, 1993). The US government has played a crucial role
in mortgage credit since the formation of the Federal National Mortgage
Association (Fannie Mae) in 1938, followed by the formation of Ginnie Mae and Freddie
Mac. However, in the wake of the
subprime mortgage crisis, the US government has gone from being a major player
- the dominant player - to being almost the only game in town, on an unprecedented
number of levels.
Few private lenders want to take
genuine mortgage credit risks in today's housing market. So the norm for
mortgage bankers is to originate "conforming" loans in as many cases
as possible, with the standards for those loans being set by FHA, Fannie Mae
and/or Freddie Mac, all of which are currently 100% owned by the US government.
Because compliance with government
standards is required for a loan to be "conforming", the federal
government effectively makes the credit decisions for the overwhelming majority
of mortgage originations in the US. It
is government-controlled mortgage underwriting criteria which determine who is
allowed mortgages, and how much they can borrow.
What gives the federal government the
ability to set the criteria is that it takes all the credit risk for conforming
mortgages, and guarantees the payment of principal and interest to
investors. As soon as they are closed,
conforming mortgages are nearly always quickly turned into Fannie Mae,
Freddie Mac or Ginnie Mae mortgage securities, which are guaranteed in full by
the US Government.
By 2009 and early 2010, however, that
extraordinary degree of government intervention was not enough. The US government wanted something else that
was without precedent in US financial history:
it wanted mortgage rates to be lower than the rates the free market
would bear. So the Federal Reserve effectively (on a net basis) bought almost
all mortgage originations for over a year, once the mortgages had been securitized
and turned into government guaranteed mortgage securities.
So the US government decides who
qualifies for mortgages, the US government guarantees the mortgages, and the US
government buys the mortgages (using money created directly out of thin air as
covered in my article "Creating A Trillion From Thin Air").
http://danielamerman.com/articles/Trillions.htm
What that means is that when something
goes wrong, and money can't be collected from homeowners who are no longer
making payments, then it is the citizens of the US who are already essentially
taking 100% of the risk. We're the ones
guaranteeing the mortgages, and with recent mortgage originations, we're most
likely the mortgage security owners as well.
When seen from this light then, we can
understand that far from providing the money and taking the credit risk, the
role of the banking institutions in the mortgage market in the United States is
to follow government instructions on the origination and servicing of
mortgages, which the US government buys for itself, and guarantees to itself.
Unfortunately, the collective banking industry has shown itself to be incapable
of handling even these tasks.
With genuine capitalism, in a genuine
free market, those employees responsible for the current fiasco - as well as
their supervisors and top bank executives - would all pay through losing their
jobs, and the shareholders would pay with the loss of their investments. Which
would then provide keen motivation for the next round of banking executives and
shareholders to make sure they get it right the next time.
If you want to understand a good part
of the reason why this crisis exists, it is because that situation of genuine
capitalism and free markets does not exist, and obviously has not existed for
some time. It was the incompetence and
negligence of the nation's major banks that created the mortgage crisis in the
first place, with even the most basic due diligence not being performed or acted
upon, in the quest for ever larger bonuses for the executives involved.
However, most of those executives
remain with their jobs intact, and the banks have not closed their doors.
Instead the United States government in a minor role, and the Federal Reserve playing
the major role, have made essentially unlimited funds available to bail the
bankers out of their mistakes, while still keeping their jobs. In light of this well understood situation,
we can get a sense as to how the banks could be behaving so poorly in their
basically clerical duties with regard to the mortgage market at this time. No
matter how many mistakes they make, no matter how poorly they perform, the
banks will be preserved and protected as institutions because it is held to be
a national priority to do so. With the rest of the nation's citizens picking up
the tab for this.
Perhaps the biggest and most dangerous
charade is the idea that because the US government is guaranteeing the
mortgages, and is the owner of so many of the mortgages, that the taxpayer will
be taking the hit in the form of higher taxes for the likely huge financial
losses that will be associated with this mortgage malfeasance, in one form or
another.
But the problem with that assumption,
as is the case in so many other areas, is that the US government long ago
passed the point where it became reasonable to believe that taxpayers could pay
for all the promises. We're already running official deficits well in excess of
$1 trillion per year, not accounting for the additional direct monetary
creation in even larger amounts by the Federal Reserve. We have no means of
paying for the baby boomer retirement promises, nor for the extraordinary
international debts we are currently bearing, nor for the ongoing stimulus
packages that continue to come out in a series of one after another.
These obligations already add up to over $1 million per non-retired and above
poverty line household, as covered in my article "Bailout Lies
Threaten Your Savings" ( http://danielamerman.com/Video/BBL1B.htm ). The
only credible means of paying for all of these vast obligations is the same
means that nations have used again and again over the course of history:
The government devalues the currency
through inflation.
Inflation effectively repays much of the
debts, and in the process wipes out the value of government bonds for
unfortunate bond investors. Even more
profoundly, inflation destroys the value of the life savings for the nation's
citizens. Indeed, for savers, there is not a more expensive means of repaying
debts than a high rate of inflation, even if it seems like the magical cure to
government officials in power at that time.
When we look at this fast developing crisis
with extraordinarily expensive implications for millions of problem mortgages across
the United States, we need to clearly understand that it is not the banks that will
be bearing the cost, nor will it be the taxpayers who are primarily bearing the
cost, but rather it will be the savers and investors within the United States
as well as foreign investors that hold US dollars or securities. Ultimately the
only source that is large enough to pay for this crisis, when added to all of
the other crises already in existence, is an accelerated and more complete
destruction of the value of the US dollar.
Let's consider three houses that have
gone into foreclosure, due to each of their homeowners no longer having jobs. Each
of the mortgages is for $350,000, and the homes are located in California,
Nevada and Florida. In each case, the bank servicing the mortgage has committed
fraud in their standard foreclosure process, as an effective matter of bank policy.
With the bank having said (in essence) "we don't have to follow these
legal technicalities or the letter of the law in general, because well, we're a
bank, and that's not our industry-standard."
For the sake of illustration, we will
also assume that each one of these foreclosure flaws is effectively
"fatal", and the mortgage lender never does get the house. So there
is a 100% loss on investment.
The mortgage in California was
"conforming", and had been purchased by the Federal Reserve, after
having been converted into a Fannie Mae mortgage-backed security. Fannie Mae
guaranteed the mortgage – so Fannie Mae (which is 100% owned by the US
government) takes a straight up $350,000 loss, and pays the Federal Reserve. In other words, the citizens of the US just
took a $350,000 loss. Which the US
government can't pay for, so the Federal Reserve creates the money out of thin
air, to provide funds to buy the treasury bonds, that give the US government
the money to pay the Federal Reserve the $350,000.
(Fannie and Freddie are making noises
about going after the banks in these cases, but even if that actually happens
we just move to one of the two other categories below.)
The mortgage in Nevada was
"non-conforming", with no federal guarantees, and had been thrown into
a huge pool with thousands of other mortgages, with a dozen different types of
securities then carved out and sold to investors around the world. When this extraordinarily complex financial
instrument runs into an unsympathetic and literal minded local judge, it turns
out that it is legally unclear who the owner of the mortgage is. So there is no foreclosure, the homeowner
keeps his or her house, and the $350,000 that actually funded the purchase of
"their" house is a 100% loss to investors.
The next step is a bit unclear and
depends on the specifics of the securities offering, but let's assume that the
banks involved are legally found to have misrepresented the mortgage securities
at the time that they were sold, and required to cover investor losses. So the
major banks in the United States have a massive liability which they cannot
handle, and would bankrupt them if they had to pay it themselves.
The banks need not worry, as the
federal government has already determined that will not be allowed to happen. Instead, the massive losses merely trigger
another round of bailouts, and the US government steps forward to cover the
$350,000 individual mortgage loss (and hundreds of thousands or millions more
like it). Except for that troublesome
technicality of the US government not having the $350,000. So again, the
Federal Reserve directly creates the $350,000 out of the void, uses the new
dollars to buy treasury bonds, which gives the federal government the $350,000,
and the federal government gives the $350,000 to the banks which give it to the
investors to cover the losses from the banks' mistakes.
The mortgage in Florida is very similar
to the mortgage in Nevada, except that the bank is not one of the anointed
ones. Perhaps the bank had only been committing small-scale fraud on a local
basis, rather than massive national fraud, or perhaps the bank executives have
been failing to make their expected congressional campaign contributions. The
bank is required to make up investor losses that resulted from the bank's
negligence, but can't do so, and it is taken over by the government. With the
FDIC covering the losses and paying off the depositors. Governmental accounting aside, the FDIC is
just as broke as the rest of the federal government, and doesn't have the
$350,000. So the Federal Reserve brings forth $350,000 out of the nothingness,
buys $350,000 worth of treasury bonds, the US government takes the new cash and
gives it to the FDIC, which uses the money to pay off bank depositor claims. (There is also the interesting question of
whether the government would stiff the mortgage security investors and not make
good the losses, thereby sending major shockwaves into other corners of the
financial world, including already stressed pension funds.)
Do you see a pattern here?
A bank that projects financial
expertise to the world turns out to be unable to handle clerical and
administrative functions, or maintain clear ownership of assets.
These bank errors result in numerous
homeowners across the United States "winning the lottery" and being
given the homes they live in, without having to repay the mortgages that paid
for their homes.
This leads to massive investor losses.
Those losses are covered by the federal government in one form or another, whether
it be mortgage security guarantees, further rounds of bailouts, or federal
deposit insurance payouts.
The federal government does not have
the money to pay for those losses, so they are paid for by direct new monetary
creation by the Federal Reserve. This
may look like "free money", and is being treated as such by the
federal government and Federal Reserve these days, but there is no such thing
as free money. Every time the Federal Reserve creates another $350,000, or
another billion, or another trillion, it brings forward in time - and increases
the severity - of the inflationary explosion that is coming.
Which risks the annihilation of the
life savings of all savers in the United States, as well as overseas investors
holding US dollars and dollar-denominated securities.
Week after week, the financial media
have been filled with stories of the trouble the banks have gotten themselves
into. These headlines tend to create the impression that those banks are in a
lot of trouble. Indeed, they are.
But the banks can't pay for their way
out of the trouble that they are in. So the US government will do so, with the
only question being the specifics of the form of the payout. Except the US
government can't pay for these losses either, as it's already effectively
bankrupt, and running huge deficits that can be expected to only grow larger in
the future.
So the colossal losses are
"paid" by the Federal Reserve creating new money on a fantastic
scale. The Federal Reserve, however, possesses
neither real economic resources nor taxing authority. Ultimately, all it can do is dilute the money
supply.
Which dilutes the value of money. Which
brings us back to your savings.
When piercing through the multiple
levels of deception, every time you read about another huge problem with Foreclosuregate,
understand that it is not the bank that is in deep trouble so much as it is the
value of your savings, and your standard of living in future years.
Perhaps the most natural reaction to this
article is one of outrage, followed by flight. This is a very understandable
reaction. The banks, the US government, and the Federal Reserve have all been
behaving in an outrageous fashion that works to the benefit of insiders, while
cheating almost the entire rest of the population. The simple solution when the
outrage reaches a sufficient point, is to pull all you can out of paper
investments and symbolic currencies, put them into gold, and hunker down to
survive the still developing crisis.
Unfortunately, we live in a complex and
deeply unfair world, that makes mincemeat of emotional reactions and simple
solutions. As shown in step-by-step, simple – but irrefutable – detail in the
article "Hidden Gold Taxes: The
Secret Weapon of Bankrupt Governments" linked below, a simple solution of
just buying gold leaves you handing a good chunk of your starting net worth - or perhaps even most of your starting net
worth - over to the government by the time all is said and done. The way the
government under existing laws
effectively confiscates the wealth of gold investors in a highly inflationary
environment is little understood by most gold investors, but should form the
central point for their planning.
http://danielamerman.com/articles/GoldTaxes1.htm
Let me suggest an alternative approach,which is to study, learn and reposition. Almost all financial and economic
articles that you see today are really about the upcoming re-distribution of
wealth, whether those words are used in the article or not. Learn not just how
wealth will redistribute, but how unfair government tax policies (that can be
relied upon to grow still more unfair) will cripple most simple methods of
attempting to survive inflation.
| Click Here To Learn About A Free Mini Course That Will Teach You How To Turn Inflation Into Wealth. |
Then, yes – buying gold (and perhaps alot of it) can be one key component of a portfolio approach, as discussed in my
Gold Out-Of-The-Box DVD set. Use
multiple components in a dynamic process over the stages of the crisis, with each
component doing what it does best, and position yourself so that wealth will be
redistributed to you in a manner that reverses the effects of government tax
policy. So that instead of paying real taxes on illusionary income, you're
paying illusory taxes on real income. And the more outrageous the government
actions – the more your after-inflation and after-tax net worth grows.
Do you know how to Turn Inflation Into Wealth? To position yourself so that inflation will
redistribute real wealth to you, and the higher the rate of inflation – the
more your after-inflation net worth grows?
Do you know how to achieve these gains on a long-term and tax-advantaged
basis? Do you know how to potentially
triple your after-tax and after-inflation returns through Reversing The
Inflation Tax? So that instead
of paying real taxes on illusionary income, you are paying illusionary taxes on
real increases in net worth? These are
among the many topics covered in the free “Turning Inflation Into
Wealth” Mini-Course. Starting simple,
this course delivers a series of 10-15 minute readings, with each
reading building on the knowledge and information contained in previous
readings. More information on the course
is available at DanielAmerman.com or InflationIntoWealth.com .
Contact Information:
Daniel R. Amerman, CFA
Website: http://danielamerman.com/
E-mail: mail@the-great-retirement-experiment.com
This article contains the ideas and
opinions of the author. It is a conceptual exploration of financial
and general economic principles. As with any financial
discussion of the future, there cannot be any absolute certainty. What
this article does not contain is specific investment, legal, tax or any other
form of professional advice. If specific advice is
needed, it should be sought from an appropriate professional. Any
liability, responsibility or warranty for the results of the application of
principles contained in the article, website, readings, videos, DVDs, books and
related materials, either directly or indirectly, are expressly disclaimed
by the author.
Copyright 2010 by Daniel Amerman