Underwater

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In a 5/6/09 WSJ article, Ruth Simon and James Hagerty report on current housing values after the release of industry results for the first quarter of 2009.

Across the U.S. 19% of mortgage holders are “underwater” or “upside down” – they owe more than their house is worth in today’s market. This is more than a 50% increase in the number of underwater borrowers since the end of 2008. According to one company that tracks this data, “more than one in 10 borrowers … owed 110% or more of their home’s value at the the end of last year.” Las Vegas homeowners have been hit the worst. Zillow.com estimates that over 67% of mortgage holders there are upside down.

Why wouldn’t a bank holding a mortgage agree to write down some of the principal on the mortgage? Let’s say a homeowner with a job is struggling to stay current on a $300K mortage on a house that is now valued at $240K. If the bank forecloses, they will probably sell for closer to $200K and will have expenses for legal fees, maintenance, fix-up and taxes. Wouldn’t it make sense for the bank to at least write down half of the $60K principal difference if that would mean the bank could avoid foreclosure?

The answer is – wait, sit down first. The loss on a foreclosure is a long term loss on the bank’s loan portfolio that can be spread out over several years. A write down in principal on the mortgage is an immediate loss that affects the bank’s bottom line this year. John and Mary Homeowner may have lost their chance to avoid foreclosure because of an accounting rule.

B-School Grade: F

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In a 4/24/09 WSJ op-ed, Michael Jacobs, a business school professor who formerly worked at the Treasury, takes business schools, “B-schools”, to task.

Management compensation should emphasize the long term value of a company. Yet there is no systematic study of the design of management compensation systems at most business schools. A shareholder should be wary when he or she reads assurances from CEOs that their compensation is designed to align management compensation with the interests of the shareholders.

Few business schools cover the topic of board structure – what it does and how it should do it. Citigroup, one of the largest financial companies in the world, had few directors on their board with any experience in financial markets. GE has a large financial division, GE Capital, but has only one board member with experience in a financial instution.

B-Schools offer comprehensive teaching in securitizing assets and diversifying risk. Those skills were well exercised in developing the mortgage backed securities (MBS) and collaterized debt securities (CDS) that crippled the financial world in 2008. In B-Schools, there is little examination of the increase in risk as the providers of capital grow further away from the users of that capital.

Half of Americans have some investment in the stock market but the majority of that investment is through pension and mutual funds. At the financial institutions that handle these investments and own almost 70% of the shares of American corporations, the MBAs have had little training in shareholder rights and duties as owners. Because of this, there is little shareholder input into the governance of America’s corporations.

The author concludes with an assessment: “by not internalizing sound principles of governance and accountability, B-school graduates have matured into executives and investment bankers who have failed American workers and retirees who have witnessed their jobs and savings vanish.”

Bank Stress Tests

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After stressing all of us out, the 19 largest banks had to undergo a stress test of their own. On 5/7/09, the Federal Reserve (Fed) released the results of their several month stress tests on the 19 largest banks in the country. These tests project certain levels of unemployment, loan delinquency, falling asset values and determine whether banks have the capital cushion to withstand the losses.

The stress test used a 9.5% unemployment rate, which some felt was too low. Weekly unemployment figures released 5/8/09 showed an 8.9% rate and it is widely believed that the rate will go over 10%. The U6 unemployment rate, which includes people who have given up looking for a job and those who have taken part time employment because they couldn’t find full time work, is estimated by the Fed at 15.6%. This figure is a more accurate indicator of the true impact of unemployment on the work force and the economy.

In April the Fed released their preliminary stress test results to the affected banks. Some bank executives were furious, claiming that the Fed was being too severe. The final figures released this past Thursday were the negotiated figures.

The capital deficit of Citigroup was originally estimated at $35B. The revised figure was $5B. Heck of a negotiation there.

In a front page WSJ article 5/9/09, an analyst calculated that the capital shortage of the 19 banks would have been $143B if the Fed’s revised results had accounted for unrealized losses. Those revised results required that the banks add only $75B to the capital on their balance sheets to protect themselves against future losses over the next two years.

As long as unemployment doesn’t get too much worse and real estate prices don’t decline much more, the banks should be in adequate shape.

These financial stress tests has been like the treadmill test that a patient undergoes to test the health of their heart. Perhaps we should take an example from the banks and negotiate with our doctors over the condition of the treadmill test. “According to your treadmill test, doc, I gotta lay off steaks and get more exercise. But you tested me while running. Now, how often do I run? Rarely. Your test is unrealistic. What if we did the test with walking fast instead of running?” Good luck with that.

401K

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In a 5/6/09 WSJ “Fund Track” article, Jennifer Levitz reviewed proposed changes to 401K retirement plans, which are the primary savings for 60% of workers.

One proposal is a listing of 401K fees on investors’ statements. A second proposal is a more automatic access to retirement plan participation. Obama’s budget “calls for the future establishment of a program in which all workers would be automatically enrolled in employers’ retirement plans.” There would also be a mandate for those employers without retirement plans to “enroll their employees in a direct-deposit individual retirement account.” Employees will have the choice to opt out of these plans.

Some industry proposals would limit equity investments in target-date funds. These funds are supposed to change their investment mix to be more conservative as the current date approaches the target date, when an investor presumably needs income from the fund. These funds are used for retirement and for college savings. This bear market revealed that some funds with target dates of 2010 had 60% of the fund in stocks, an inappropriately aggessive mix that prompted large declines in value as the stock market sank.

Other industry proposals are greater tax incentives for workers and employers who participate in 401K plans, and the creation of government insured annuities that would provide a dependable source of income for retired workers.

Health of Health Care

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In a 4/23/09 WSJ article, Vanessa Fuhrmans reports on the health of the country’s health plans.

Wellpoint, the largest insurer, lost 2% of its subscribers since December. It ascribed the larger than expected 1/2 million subscriber loss both to layoffs and workers who are declining coverage under their employer’s plan. United Health Group, the second largest insurer, reported a subscriber loss of 900,000 in the first 3 months of 2009.

The Kaiser Family Foundation estimates that the U.S. Census Bureau figure of 45.7 million uninsured in 2007 has grown to about 50 million uninsured. In a nation of 300 million, that is a 1 in 6 ratio. Of the estimated 9M people who have lost coverage since December 2007, Kaiser calculates that 3.6M have enrolled in Medicaid and other public health programs.

A Kaiser Family Foundation study of Medicaid fees from 2003 – 2008 shows that Medicaid pays physicians only 72% of what Medicare pays. In 2008, the average Medicaid reimbursement for the most commonly billed procedure, a 15 minute office visit with an existing patient, was $38. If you have a stopped up toilet, it costs $75 – $100 for a plumber to run a snake through the toilet bowl.

As the boomer generation nears retirement, swelling the ranks of both Medicare and Medicaid patients, should we be encouraging young people to become plumbers instead of doctors?
The Association of American Medical Colleges reported that the average educational debt of indebted graduates of the class of 2007 was $139,517. The site link is a student doctor network with a message board that you can read, but not post or comment.

Energy Bill Rush

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In a 5/6/09 WSJ article, Stephen Power and Greg Hill report on the progress of the climate bill. Without specifying details, President Obama informed Democrats on the House Energy and Commerce Committee that he “wants a bill that eases costs imposed on consumers and businesses, creates a predicatable set of rules, and addresses concerns that some regions of the country could shoulder disproportionately heavy costs.”

Obama plans to auction off CO2 permits and use the proceeds to fund middle class tax cuts. Representatives from the Rust Belt and the coal states are pushing for free permits for some industries in their districts. Texas lawmakers want free permits for oil and gas refiners.

Democrats and Republicans are arguing with each other and among themselves over the provisions of this bill. Henry Waxman, the Chairman of the Committee, may bypass what will probably be a contentious subcommitte vote in order to meet the President’s request that the bill get to him by Memorial Day.

Part of the bill will be a “cash for clunkers” provision, offering up to a $4500 rebate for people who buy cars that get at least 10 mpg more than the older car they are driving now. Car dealerships, particularly GM dealerships, could use a big stimulus.

A 1/27/09 US News article reported that “General Motors has 6,375 dealerships in the United States. Its closest rival, Ford, boasts less than 3,800. Toyota, the world’s largest automaker, claims less than 2,000.”

In a 4/27/09 article, Bob Golfen at SpeedTV reports that “General Motors will close half its dealerships nationwide by 2014 and cease Pontiac production next year, according to an “undated viability plan” offered Monday by GM to the U.S. Treasury Department. “

If you are planning on using that rebate to get a new GM car this summer, call first to make sure the dealership is still in business.

Bird Cage Bedding

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USA Today, the most popular daily newspaper in the U.S., reported a 7.5% decline in paid circulation in the past 6 months. Only the Wall St. Journal (WSJ) has reported a subscriber increase, although it was a slight 0.6%. This put the WSJ at over 2M subscribers, just 30K less than USA today. The New York Post and the Atlanta Journal-Constitution both fell about 20%.

“The [New York] Post, like many newspapers, has increased newstand prices as publishers come under increasing pressure to ratchet up revenue as their ad sales drop.” This process, a cyclic self-destructive market mechanism, is contributing to the steep decline in the number of newspapers. Until the newspaper industry can construct a viable model for profitability, newspapers will continue to close.

Does the world need newspapers? No. Does the world need more opinion articles? No. Does the world need professional reporters? Yes. They are our watchdogs, our synthesizers of current events. They sit through interminable state and federal hearings and give us, the readers, the short version. They read pages of budget projections and state and federal agency rulings and give us the “Cliff Notes” version. They ferret out scandals brewing in government and industry and raise red flags. How will those reporters get paid if there are no newspapers?

Small Business Lending

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In a 5/5/09 WSJ article, Raymund Flandez focuses on the market for small business loans.

In February, 35% of new SBA loans of the most popular type were sold on the secondary market, up from 24% the previous month. Before the crisis in September 2008, 45% of these loans were sold on the secondary market.

At GovGex.com, where these loans are bundled and sold, bids for these loans have more than doubled since mid-March, when the Obama administration made a pledge to use $15B of taxpayer money to free up the secondary market in these loans. The government is guaranteeing as much as 90% of some loans. Before that pledge, the market for these loans had all but dried up, with volume totalling on $7.8M. Since then, volume has rocketed to over $67M.

Loan applications have more than tripled at Small Business Loan Exchange, an online marketplace which matches up borrowers with lenders.

Government Loan Solutions follows the SBA market closely and reports that the delinquency on the most popular SBA loan was 6.18%, the second highest rate in 10 years.

Peer To Peer Lending

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In a 4/28/09 WSJ article, Jane Kim reviews the market for peer to peer (P2P) lending. Several companies provide a platform to bring together those who need money and those who have some extra.

A borrower fills out an application, stating their financial information, the amount of money they need to borrow and why they want the money. The P2P company verifies the identity of the borrower and pulls a credit report but doesn’t verify employment. Most of the companies have some minimum FICO score, a commonly used credit grade, that all borrowers must meet. The company then posts the loan request and investors bid on it.

LendingClub.com, PertuityDirect.com and Prosper.com are three companies using this model. At an average interest rate of 13 – 17%, borrowers can often get a better rate than using a traditional credit card.

At LendingClub.com, the delinquency rate was 4 – 5%, about the same as for credit cards. For investors, this is a way to earn more interest on their money. As always, with higher return comes higher risk. The P2P company makes its money by taking a fee on the loans.

Lawyer Layoffs

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The legal practice has long been thought to be recession proof.

According to the Bureau of Labor Statistics “Lawyers held about 761,000 jobs in 2006. Approximately 27 percent of lawyers were self-employed, practicing either as partners in law firms or in solo practices.”

In a 4/14/09 AP article in the WSJ, “more than 3000 lawyers have been laid off in the first three months of 2009.” That figure is low, including only layoffs reported by the top law firms.

The Labor Department reported that, in 2008, the number of unemployed lawyers jumped to a 10 year high of 20,000. “Law students graduating with jobs this spring are being paid to delay their start date.”