Today’s release of the official statement from the Federal Reserve following their two day meeting was not supposed to contain many surprises as the FOMC target rate could not move lower and the majority of economists expected the statement text to be relatively unchanged.

Well, the Fed threw us a curveball and announced it would be committing over $1 trillion dollars to provide support to the mortgage lending and housing markets. It will be committing $300 billion to purchasing long-dated treasuries over the next 6 months and also would be purchasing an additional $750 billion of agency mortgage-backed securities.

The Fed is telling us that mortgage rates ARE NOT GOING HIGHER any time soon and are likely to head lower to perhaps 4%. David Greenlaw of Morgan Stanley makes the following point:

This could represent a powerful source of stimulus for the household sector of the economy. In 2008, the average mortgage rate on the outstanding stock of loans was about 6.50%. So, if the Fed brings 30-yr fixed rate mortgages down to 4.50% and all homeowners are able refi, the aggregate permanent cash flow savings would be on the order of $200 billion per year.

David Greenlaw, Morgan Stanley, WSJ Real Time Economics March 18, 2009

Effectively, lower mortgage rates represent another stimulus package for the economy, as homeowners who are able to refinance now have extra money in their pockets each month, and this is potentially a large number.

Ben Bernanke is doing what he knows best — Printing Money. He is a student of the Great Depression and has spent his entire academic career studying what went wrong and crafting the right approach to the situation. He was called “Helicopter Ben” after he theorized that the correct approach would be for the government to essentially print money and drop it out of a helicopter.

The Fed has been extremely vigilant in averting an all-out depression and will continue to do so, as Bernanke indicated in his recent 60 minutes interview. Through its numerous lending facilities and outright purchases of securities in the market, the Fed will continue to expand its balance sheet until the financial markets are functioning properly again.

Many people got burned today being short the treasury market as the 10 year yield plummeted almost 50 basis points on the news, and they probably are right when you hear them say ” there is a massive bubble in treasuries”. I think the key here is to understand that the Fed is going to do everything in its power to keep interest rates low until a sustained economic recovery is on the way.

Uncategorized bernanke, federal reserve, mortgage rates

In Tuesday’s Wall Street Journal opinion section, Richard Lefrak and A. Gary Schilling present a compelling argument that by offering permanent resident status to those foreigners who purchase a home (not for rent) we can properly stabilize our housing market. At first, the idea seems a bit radical, but it does address the inherent flaw in our housing market whereas the current plan from the Obama administration does not.

The problem facing our housing market can be explained by the simple principles of supply and demand. The total supply of homes in this country is much greater than the demand at the current price levels. In the midst of the housing boom, many people speculated in the market or were given loans they could not afford, creating “artificial demand”. Now as the economy slows, and more people find themselves out of work, demand continues to wane as homes that used to be affordable currently are not for many American families.

In order to rectify the problem and bring us back to an equilibrium condition between supply and demand, we can do only three things:

• Reduce Supply
• Lower Home Prices
• Increase Demand

In the first case, we would demolish existing properties for which there is no demand. This leads to dramatic wealth loss as banks and developers would suffer massive losses and would not be in any condition to contribute to the economy, but the housing crisis would be solved. It’s unlikely we will head down this route.

In the second case, we just let nature take its course and let prices fall to their equilibrium level. Again, there will be dramatic wealth loss for the majority of Americans as their wealth is directly tied to the value of their home. The Obama administration seems determined not to let the housing price bubble deflate entirely, just like the stock market bubble did not deflate entirely by 2002.

The Obama admistration has already taken steps to stabilize demand through its $275 housing bailout plan, but the plan is designed to keep people in their homes and does not address the large overhang of inventory of unsold homes in cities like Miami, Phoenix, and Las Vegas. Without sharply reducing this inventory, home prices will continue to fall.

In order to increase demand and reduce existing inventory, the authors of the WSJ article propose that we “offer permanent residence status to the many foreigners who are clamoring to get into the U.S. — if they buy houses of minimal values (not shacks)”. Under the plan they wouldn’t need to live in the unit, but couldn’t rent it. At first, participants would be given temporary residence status that would convert to permanent residence status, after a period of say 5 years if they still owned the houses.

The plan is likely to attract highly educated, wealthy foreigners who are clamoring to get into this country. The article mentions: “Each year, 85,000 H-1B visas are granted for foreigners with advanced skills and education, and last year, 163,000 petitions were filed in the first five days after applications were accepted. The Ewing Marion Kauffman Foundation estimates that as of Sept. 30, 2006, 500,040 residents of the U.S. and 59,915 individuals living abroad were waiting for employment-based visas”. These are exactly the types of individuals we need as we try to restart the economy as they will contribute to existing businesses or start their own.

There is already precedent for allowing foreigners to achieve permanent resident status in return for investing in this country. The EB-5 visa program provides a path to permanent residency for those who invest $1 million in a new enterprise in the US. Other countries also offer similar programs for those who invest in businesses, tourism, or other sources. I don’t see why this same concept cant be extended to benefit those who invest in our country’s housing market.

Our country is a melting pot of immigrants and I believe this program could be effective if implemented on a limited scale in conjunction with the steps already taken by the Obama administration. Additional incentives should be given to foreigners who purchase property in hard-hit, less glamorous cities like Detroit and Cleveland. Immigrant populations have proven that they can regentrify communities and improve the overall quality of life for its residents.

I hope this plan receives serious consideration from the Obama administration.

Full text of the WSJ article can be found here.

Uncategorized housing, obama

US Stock markets rallied Tuesday on the back of the release of an internal memo at Citigroup in which CEO Vikram Pandit is “upbeat” and argues that the current stock price of $1 does not reflect the company’s earning power and capital position. Further contributing to the rally were comments from Rep. Barney Frank (D., Mass.), Chairman House Services Committee, indicating that the often debated “uptick rule” may return in a month. Frank was quoted as saying “I am hopeful the uptick rule will be restored within a month”, according to CNBC.

Although these pieces of news are good reason for a rally, I think that the 6% rally that we’ve seen in the Dow & S&P 500 is a bit overdone. Its my suspicion that a good portion of the upswing that we’ve seen was driven by short covering in financial stocks which have been beaten down lately. Any sign of financials returning to profitability and/or rules hindering short sellers are good reasons to cover existing shorts.

Pandit’s memo is optimistic and details that Citigroup has been profitable over the first two months of the year. The market rallied on the back of this, which I think is overdone. Pandit’s statement comes as no surprise to me as banks have continued to make money throughout this crisis if we exclude the massive writedowns they have been taking on their “toxic assets”. The majority of these writedowns usually happen around quarter-end before a company releases earnings. Citigroup holds the largest amount of these “toxic assets” on their balance sheet when compared with other banks, so for me it’s going to be another month before we can pass judgment on if Citi is returning to profitability. For me its a crapshoot as the market for these “toxic assets” continues to deteroriate. Full text of the Pandit memo can be found here.

As for the return of the uptick rule, nothing is DEFINITE, but Barney Frank’s words are encouraging. I’m taking a wait and see attitude with this market and not getting too excited about the news.

Uncategorized citigroup, rally, stock market, toxic assets