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Published on Leave a comment on More on the Florida Financing Fiasco

Some e-mail feedback on the last post reveals that David Evans and co-authors at Bloomberg Markets Magazine have been on the case for months. This is very good investigative reporting of the subprime meltdown in financial markets and the case of Florida in particular. Put these on your required reading list:

I warn you--if you go into anaphylactic shock at the sight of the words "declined to comment," have your Epi-Pen ready. Our justice system should make a point of getting involved to clean up this mess.

Published on Leave a comment on A Surprising Place for a Run

I have from time to time had the pleasure of commenting on the reporting of Mary Williams Walsh of The New York Times, where she covers pensions, state and local governments, and some other topics. Over the holiday, I read her excellent article, written jointly with Kirk Semple, on the burden that poor investments by the state of Florida have had on local communities. The opening paragraphs:

PORT ST. LUCIE, Fla. — On Nov. 28, Marcia L. Dedert, finance director of this rapidly growing city, called the administrators of Florida’s state-run investment pool to ask whether it was still safe to park her city’s money there. She was hearing talk of urgent withdrawals by others worried about the pool’s investments in debt related to subprime mortgages.

After the pool’s manager told her the money would be all right, Ms. Dedert recalled, she deposited $135 million in bond proceeds. But less than 24 hours later, the administrators froze the pool and blocked withdrawals to halt a full-blown run.

Now the city cannot touch the money. And rest of the $371 million it has in the pool is also off-limits unless the city pays a 2 percent penalty.

Port St. Lucie is among hundreds of local governments in Florida that were drawn to the pool by its air of reliability and the promise of higher returns than banks offered. They now find themselves grappling with the consequences of having their money frozen.

Some have had to borrow money to meet day-to-day obligations. Others have had to shift money around for the time being or consider postponing long-planned projects.

For Port St. Lucie, the timing of the freeze could not have been worse. The city is trying to recreate itself as a center of the biotech industry and had just issued $155 million worth of bonds to lay roads, water pipes and sewer lines in a planned “jobs corridor,” where it hopes to house the companies it is courting from out of state.

I question why localities actually need this service from the state. Given investment amounts in the hundreds of millions, there are any number of banks and financial service companies with whom they could contract directly. People with accounts as small as 0.1% of Port St. Lucie's account get treated very well by financial service companies. Why tie up your money with a state fund that thinks it's doing you a favor instead of going to the professionals who would actively compete for your business?

Published on Leave a comment on Money Talks

Apparently, some folks in Ireland are dismayed by how much money hedge funds have made with short positions in their nation's stock market:

A HIGHLY secretive coterie of London and New York-based hedge funds has made hundreds of millions in profits from driving down Irish share prices.

Last week, Anglo Irish Bank boss, David Drumm, criticised hedge funds which were shorting Anglo shares, adding that it had been hugely damaging to the bank, which has shed almost half its value since June.

For the first time, the Sunday Independent can reveal the identities of the principal hedge funds targeting the Irish market.

We should take a moment to be clear about what's happening here and how grownups settle these sorts of disputes. The hedge funds made profits not because they drove down Irish share prices. They made profits because they sold Irish shares, ... and then the prices of those shares went down. The hedge funds cannot make the shares go down and stay down simply by betting that they will--other traders need to agree with them.

If Mr. Drumm has a different opinion about the appropriate price of his bank's stock, then he should be thanking the hedge funds for offering him a cheap opportunity to buy it back.

Published on Leave a comment on Citigroup, Yeah, Right

It's been quiet of late on the pension front, as the parade of stupid ideas for how to further erode workers' retirement security seemed to be over. Interrupting the silence are the events in this recent article by Jonathan Peterson of the Los Angeles Times with the inviting title, "Pensions May Be Outsourced." It begins as follows:

WASHINGTON -- Would you feel comfortable if your company sold off your pension plan to a big bank?

This month, Citigroup Inc. got the green light from the Federal Reserve for an unusual deal to take over the $400-million retirement plan of a British newspaper company.

In exchange for getting its hands on all that cash, Citigroup will run the pension plan -- investing the money, paying the benefits and taking on the liability previously borne by Thomson Regional Newspapers. And it's eyeing similar moves stateside.

Let's not mince words here. There is no upside for the workers and retirees. Federal regulators should put a stop to this immediately. If Citigroup (yes, this one) can convince the plan sponsor that it can provide financial management services in the most efficient manner, then the plan sponsor should be allowed to employ Citigroup for its investment management. However, the plan sponsor must still be the entity that guarantees the pension payments to the plan participants. The plan participants should always have recourse to the plan sponsor. That should not be outsourced.

Read the whole article. If you are like me, you will roll your eyes, possibly to the point of permanent damage, when you get to this part:

Ari Jacobs, head of the Retirement Benefits Advisory Group at Citigroup in New York, said American employers seemed "very interested in opportunities to reduce or eliminate the risks associated with their pension plans." He added: "We in the U.S. are looking at a similar model" as the British deal."

A lot of these companies -- including some that are our clients -- are asking, 'What are our alternatives now that we've frozen the pension plan?'" said Scott Macey, senior vice president and director of government affairs for Aon Consulting.

Until now, the alternatives have been to pay off workers with cash or to buy annuities from insurance companies, which then continue to pay the benefits.

But now, financial companies such as Citigroup say they could do the job more cheaply than insurance companies -- and with greater expertise at managing risk. Insurance companies, for example, face costly state-by-state regulation that pushes up the price of annuities.

"As a financial institution, we believe we're better at managing financial risk than anybody else," Citigroup's Jacobs said. "That's our core business."

(Yes, that Jacobs fellow seems to be talking about the risk management virtues of this Citigroup.) If the plan is frozen, then the plan sponsor can simply prefund the present value of expected payouts with purchases of government bonds and eliminate interest rate risk by duration matching the bonds to the expected payouts. That's all that needs to be done if what is being done is purely in the interests of the plan participants, and any number of financial services or insurance companies could be contracted to do it.

The reason plan sponsors perceive there to be risk is that they feel like they should be using the pension fund to invest in stocks, so that they can claim the risk premium in the present value calculations of their obligations and prefund them with less money today. That sleight of hand is what generates almost all of the problems in pension regulation.

And where there are investors looking to get something for nothing, there will be investment firms willing to give them nothing for something. Normally, I'd say they are a perfect match for each other, except that in this instance, they are playing with the pensions of workers and retirees.

Published on Leave a comment on The Wisconsin Naming Partnership

This is a brilliant idea:

Alumni Give $85 Million to Name Wisconsin School of Business
The Wisconsin School of Business at the University of Wisconsin-Madison has received an unprecedented gift totaling $85 million from a small group of alumni who have formed the “Wisconsin Naming Partnership” to support the school’s mission.

This innovative partnership provides a naming gift that will preserve the Wisconsin name for at least 20 years. During that time, the school will not be named for a single donor or entity. This unprecedented naming partnership will uphold tradition and greatly enhance the value of the school to students, the campus and the state.

The Wisconsin naming gift is the first of its kind received by a U.S. business school. Conventional business school naming gifts adopt the name of a single donor in perpetuity. By preserving the Wisconsin name for 20 years, this gift leaves open the option of future naming gifts.

UW-Madison Chancellor John D. Wiley calls the gift “a creative act of philanthropy and a major milestone for our university.”

Why would a school want to keep open the opportunity to name itself? The answer seems to be that the price tags for naming business schools are going up faster than just about anything, including the returns to university-managed endowments. Perhaps this is because naming schools is the province of the ultra-rich, who get where they are because they can build wealth faster than conventionally managed funds. So if the school sells the name today and invests the money, it gives up the opportunity to sell the name for a higher current value later on. Wisconsin's solution is to rent the name for 20 years. It allows the school to use a large gift today, without foreclosing the possibility of a much larger naming gift in the future. To really determine how much value it adds, we would have to make assumptions about what the giving behavior of the members of the partnership would have been over that period in the absence of this gift (with or without a conventional naming gift).

The Milwaukee Journal Sentinel reports on it here, including a list of other large gifts to business schools in past years.

Published on Leave a comment on What Is Falling?

The dollar, that's for sure. Even with the Loonie. A new low against the Euro. Paul Krugman asks if this is the Wile E. Coyote moment. I have a general view about what happens to the economies of large countries.

In almost all cases, the sky is not falling. Prices adjust so that it hangs lower and grayer.

Expect the dollar to decline until the U.S. current account imbalances shrink substantially. Expect some of this decline to happen as major exporting countries become less willing to organize themselves around holding dollars in exchange for their goods. Expect these countries to diversify their new investments and some of their existing ones, but not to dump their dollar holdings. No other country's short-term economic interests are served by devaluing its own asset holdings, and no exporting country's long-term economic interests are served by inviting a nationalistic, political response from the U.S.

Published on Leave a comment on Own-to-Rent on the Marketplace Morning Report

Economics correspondent Chris Farrell got the main points of the Own-to-Rent proposal across yesterday on Marketplace Morning Repot and added a bit of his own spice. From the transcript:

You know, the idea is out there. See there's a real problem with bailouts and let's just use the word bailout loosely all right? You don't want to reward speculators and you don't want to reward lenders. You really want them to suffer, you want that pain. They deserve to go to the seventh circle of hell anyway right? Now, but you do want to protect the homeowner that was misled. The benefit of this idea is that it's the most targeted idea I've seen that helps out that person, doesn't throw them out on the street, doesn't force them to go through foreclosure, and at the same time forces the lenders and the speculators to take a financial hit.

And I would add--the proposal does not force the taxpayer, whether directly through a government bailout or indirectly through greater involvement of Fannie Mae or Freddie Mac, to take a financial hit. This is what most makes it appealing to me, of all the different proposed interventions I have seen.

Published on Leave a comment on Save the Homeowners, Not the Hedge Funds

From today's Providence Journal, Dean Baker grants my request to co-sign his proposal to help struggling homeowners rather than bailing out hedge funds. Here's our co-authored op-ed:

THE MORTGAGE-MARKET meltdown has gotten big enough that even Congress is taking notice. Members of Congress, especially those running for president, are now racing to propose bills that promise relief to the millions of homeowners who can’t pay their mortgages.

They are right to act. In the run-up to this crisis, there was precious little counsel to families at the margin of homeownership that it could be better economically to not take on the commitment of ownership. There was aggressive marketing of deceptively worded mortgages that were virtually certain to reset to payments that these families could not afford. And the government has for years been abetting this process, pointing to ever-increasing rates of homeownership as a policy success and pushing for the low short-term interest rates that fostered the bubble in prices and the increase in leverage that precipitated the crisis.

In light of this history, it is important that policy be focused on assisting financially strapped homeowners, not lenders that issued deceptive mortgages or investors who foolishly speculated in mortgage-backed debt.

Some of the proposals currently on the table, for example, getting Fannie Mae and Freddie Mac more involved in the subprime- and jumbo-mortgage market, will do more to help the speculators than the homeowners. After all, if private investors are not prepared to hold this debt, why should these government-backed agencies jump in and buy risky mortgages at above-market prices?

There is a simple way to allow troubled homeowners to stay in their homes without also bailing out the mortgage issuers and speculators.

Congress can pass legislation granting current homeowners the right to stay in their homes as long as they like, simply by paying the fair-market rent. In other words, no one gets tossed out on the street, as long as they can pay the rental value of their house. The fair rent would be determined by an independent appraiser — exactly the same way that a lender is supposed to determine the size of a mortgage that can be issued on a home.

Under this plan, homeowners would turn over their property to the mortgage holder. This would generally not be a loss since borrowers currently face crises precisely because they owe more than the value of their house. If the value of the home exceeded their debt, then they wouldn’t have to sign up for the program.

As a renter with secure tenure, the former homeowner would have incentive to do necessary maintenance and keep the home from falling into disrepair. This would prevent the blight that is already hitting neighborhoods where foreclosures have become commonplace.

The mortgage holder would get possession of the house, but they would be stuck having the former homeowner as a tenant. Otherwise the mortgage holder is free to hold or sell the property as they choose. Being stuck with a renter may reduce the resale value of the house, but intelligent investors knew there was risk when they got into the business.

To limit the size of the program and to ensure that it only benefits those who are really in need, there can be a cap placed on the value of homes that qualify. For example, Congress could stipulate that only homes with a market value below the median price for an area are eligible for this plan.

This security-of-housing proposal meets the needs of the homeowners who were victimized by deceptive lending practices and pro-homeownership ideologues. It gives them the right to stay in their home as long as they want. It accomplishes this task in a way that provides minimal opportunities for fraud and should require very little by way of new government bureaucracy.

It also manages to benefit homeowners in crisis without also rescuing the financial institutions that were speculating in mortgages gone bad. This will give the presidential candidates, and other members of Congress, a clear choice between helping distressed homeowners or bailing out financial institutions that should have known better.

Published on Leave a comment on More on Own to Rent

Jim Pethokoukis picks up on Dean Baker's proposal in the current U.S. News & World Report. He quotes a phone conversation we had as follows:

Andrew Samwick, former chief economist for Bush's Council of Economic Advisers, admits his first instinct is that the government should do nothing. Yet he admits feeling more than a "pang of sympathy" for people who were misled when taking out subprime mortgages. So if the government does take action, he would prefer a plan like Baker's that "leaves as small a footprint as possible" over one that creates billion-dollar bailout funds or sweeping changes to Fannie Mae and Freddie Mac. Even Andrew Mellon might have approved.

This answers some of the thoughtful comments on the last post. In particular, if the government is going to intervene in some way, I want it done in such as way that it assists borrowers, not lenders. Baker's proposal in fact helps borrowers at the expense of lenders and does not create or expand the government (or government-sponsored) bureaucracy by much. My views of what happened in the floating rate mortgage market are very much influenced by advertising come-ons like this one that I blogged about last year. So I was persuaded fairly easily that some government-mediated remedy might be appropriate.

In the comments on the last post, ed asks a very good question:

Why should we give advantages to foolish buyers not enjoyed by prudent renters?

... or prudent buyers who locked in a higher (but still low) fixed-rate mortgages, ... or prudent buyers who chose a home that they would be able to afford when the ARM reset? These questions will arise any time that the government intervenes on distributional grounds. If these are your concerns, then you will join me in looking for the government intervention on the smallest possible footprint. This is not a policy that I think of as permanent, and it is certainly one that should only be invoked when there is evidence of systemic fraud or abuse.

The comments also point out that the problems of implementation and equity with Baker's proposal rise with the length of the guaranteed tenancy. That's a key parameter to be decided through the public policy process if the proposal moves forward.