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Richard Green:

Is housing the best way for low-income people to build wealth?, by Richard Green:
I was thrilled to be invited to the Future of Housing Finance conference held at
the Treasury Department and co-sponsored by HUD this week. It was particularly
nice to be seated next to Self-Help's Martin Eakes, whom I have admired for some
time. Like Elizabeth Warren, Eakes long ago had insights into sub-prime lending
that I wish more of us had taken seriously.

At the conference, Martin worried about a conversation that emphasized the
need for robust underwriting standards for the mortgage market going forward.
The three most important standards are loan-to-value ratio, payment-to-income
ratio, and credit history. As Martin pointed out, African-Americans have less
wealth available for down-payment than others (even after controlling for
income), and have lower FICO scores than others, and therefore will be denied
access to credit at a greater rate than others if underwriting standards are
tough and uniform. Because much of the reason that African-Americans lack wealth
is because they have been systematically stripped of wealth for many
generations, policies that reduce access to credit disproportionately for
African-Americans violate fairness.

The events of the past six or seven years show that loose underwriting does
nobody any favors, either. Foreclosures are terrible things for the families who
experience them and for the communities that have large numbers of them. The
whole point of underwriting is to prevent default and foreclosure, and the
unpleasant fact is that downpayment and FICO are predictors of likelihood of
default.

In the era where almost all mortgages were self-amortizing, housing allowed
families to build wealth because mortgages were a form of forced saving. Those
who got a 20 year mortgage in 1960 owned their house free and clear in 1980;
households gained wealth not because housing was such a great investment, but
because they built equity, month after month. Housing was a particularly
attractive way for those of modest means to save, because they could live in the
very piggy bank they were building. In principle, however, these households
could have rented and taken the difference between a mortgage payment and a
rental payment and put it in another investment (a small business or the stock
market). But we know that in the absence of

nudges, people tend to save less.

Perhaps, then, the government could come at the savings issue more directly
by giving low-income people a nudge toward saving. Suppose it developed a 401(k)
type plan that matched the savings of those with below-median incomes at 2 to 1.
This would encourage savings that then could be used for a down payment or a
host of other investments (say a Vanguard index fund). This would cost taxpayers
money, but perhaps less than mortgage programs built on thin underwriting
standards. At the same time, getting people into the habit of savings could
produce other social benefits as well. I am not sure such a plan is practical,
but I think we do need to think about how we can help people who have been
denied wealth for generations how to start accumulating assets without relying
entirely on the housing finance system to do it.

We also need to ensure that when people with limited experience in such markets do participate in financial markets by buying houses, investing their savings, etc., they aren't steered toward products that are highly profitable for the originator, but not the best fit for the borrower/investor. It's my understanding that such behavior -- steering people into the wrong products -- explain part of the problems observed in subprime markets. Perhaps we need a consumer finance protection agency? And someone to lead it who understands these issues? However, it's not enough to simply provide advice about financial products. That will help, but some of this was fraud that needs to be prosecuted -- it won't stop otherwise.

As investors search for yield anywhere and everywhere, bonds are trading in uncharted territory. Please consider Obama Wins Low Yield as Markets Shrink Aiding Deficit

Bond investors seeking top-rated securities face fewer alternatives to Treasuries, allowing President Barack Obama to sell unprecedented sums of debt at ever lower rates to finance a $1.47 trillion deficit.

Shrinking credit markets help explain why some Treasury yields are at record lows even after the amount of marketable government debt outstanding increased by 21 percent from a year earlier to $8.18 trillion. Last week, the U.S. government auctioned $34 billion of three-year notes at a yield of 0.844 percent, the lowest ever for that maturity.

Spending by companies and consumers has slowed as the economy has shown signs of weakening. Companies in the Standard & Poor’s 500 Index have stockpiled a record $2.3 trillion of cash and equivalents. Company borrowing slid 29 percent in the first half of the year to $528 billion amid a dearth of business investment, Bloomberg data shows.

Piles of Cash Equates to Piles of Debt

Companies are piling up cash alright. However, the flip side of that cash is debt.

Moreover, analysts mistake that cash for willingness to expand. The reality is corporations do not want to get trapped like they did in 2008, unable to borrow.

For more on corporate cash levels, please see Are Corporations Sitting on Piles of Cash?

Individuals are also hoarding cash. The U.S. savings rate reached 6.4 percent in June, up from 1.7 percent in August 2007, the start of the financial crisis.

Are Individuals Hoarding Cash?

Individuals are not really "hoarding cash" either. Instead they are paying down debt. Most do not realize that by definition, paying down debt constitutes "saving".

For most wage earners, the savings rate is after-tax salary minus personal consumption expenditures (PCE). For a more precise definition, please see What's Behind The Soaring Savings Rate?

“There’s been a collapse in both consumer and business credit demand,” said James Kochan, the chief fixed-income strategist at Menomonee Falls, Wisconsin-based Wells Fargo Fund Management, which oversees $179 billion. “To see both categories so weak for such an extended period of time, you’d probably have to go back to the Depression.”

Food Stamps and Unemployment Insurance Mask Depression

I believe we are in a depression now. The key difference is food stamps and unemployment checks have replaced bread lines.

We also have hundreds of thousands of people living in their homes without making payments on their mortgage or home equity lines. The slow foreclosure process encourages more to do the same.

“The diminishing supply” of alternatives to Treasuries “is giving Washington an opportunity to continue with its fiscal irresponsibilities,” said Mark MacQueen, partner and portfolio manager at Austin, Texas-based Sage Advisory Services, which oversees $8.5 billion. “The only way to tell Washington and America ‘no more’ is a weak dollar, which eventually leads to higher interest rates.”

“We are slowly playing a fool’s game as rates go further down to unsustainably low levels,” said Dan Shackelford, a money manager who helps oversee $15 billion in fixed-income assets at T. Rowe Price Group Inc. in Baltimore.

Thoughts on the Fool's Game

If you are managing $15 billion thinking it is a "fool's game", then in my opinion you ought not be doing it. It seems to me there is a lack of fiduciary responsibility if one is investing client money in a "fool's game".

What the hell - Anything for a fee!

I do think corporate bonds, especially most junk is playing for the greater fool. In regards to treasuries, there is going to be an exit problem for sure, but that could be years away. In Japan, yields stayed low for a decade. Why can't it happen here?

Yields certainly might stay low for an extended period. Whether or not they do remains to be seen. I happen to like long-term treasuries right now, but certainly not as much as when the 10-year was at 3.75% and bears were foolishly shorting treasuries like mad.

The government isn’t the only one getting a good deal. Armonk, New York-based International Business Machines Corp., the world’s biggest computer services provider, sold $1.5 billion of three-year notes on Aug. 2 with a coupon of 1 percent, the lowest of the more than 3,400 securities in the Barclays Capital U.S. Corporate Index of investment-grade company debt.

Portland, Oregon, sold about $408 million in sewer-system revenue debt on Aug. 11, with utility bond yields at the lowest level on record. Yields on 10-year, AA rated tax-exempts backed by utility revenue stood at 3.02 percent on Aug. 10, according to Bloomberg Fair Market Value data. That’s the lowest since the index was created in November 1993.

“We are in unchartered territory,” said [William Larkin, a fixed-income money manager in Salem, Massachusetts at Cabot Money Management]. “We are pushing and pulling levers that we don’t understand the full implications.”

Uncharted Territory

This is indeed uncharted territory thanks to the Fed pushing and pulling levers in a manner it does not understand. William Black, a former bank regulator, is one person who does understand. Black says U.S. Using "Rally Stupid Strategy" to Hide Bank Losses - Will Produce Japanese Style Lost Decade.

I agree with his assessment.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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