We think the euphoria over the Treasury plan, which we’ll touch on below, is a bit of an over-reaction as there are some unanswered questions along with what damage the latest bonus fiasco will have on private-sector willingness to team up with the government. Of course, participants will also have to execute, which is quite a big uncertainty in my mind.
The home sales data was very welcome; expectations were for another decline, yet sales rose substantially. This data definitely helped to fuel the gains, but even in this regard we are not out of the woods yet as the level of existing home sales remains below where they were in December.
Yesterday’s huge move has pushed the broad market 21% above the multi-year low hit on March 9. This is a similar move to the 21% advance in late-November/early-December, bouncing from that November 20 low.
We’re seeing some improvement regarding the short-term – massive liquidity injections via the Fed, nearly a trillion dollars in fiscal stimulus and plans to remove troubled assets along with a possible modification to mark-to-market accounting should result in some nice intermediate-term results. Still, we have long-term policy issues that are not being addressed. But hey, we’ll take what we can get for now; this rally may have some legs – the shorts without conviction are definitely scared right now. S&P 500 842 will be the next target and we could be moving to 900, although unlikely in straight shot.
Market Activity for March 23, 2009
The New New Treasury Plan
I was under the impression Mr.Geithner was going to make public comments on this plan; instead it appears the administration made a smart move and refrained from any more public addresses by the Treasury Secretary. They released the plan on the Treasury’s website.
The plan states the Public-Private Investment Program (PPIP) will use the Treasury, FDIC and Federal Reserve to provide financing for private investors to buy illiquid loans and securities held at banks. They will also expand the TALF (the Fed program originally tasked to specifically kick-start consumer loans) in a way that permits it to fund purchase of legacy securities. (the administration has dropped the term “toxic assets” and replaced that with a more euphemistic “legacy assets.”) The stated intention is to remove $500 billion to $1 trillion of legacy loans and securities from the balance sheets of banks and other financial institutions.
The FDIC will provide non-recourse financing of up to a maximum of six times the capital, or equity, provided – although the price on this financing is not defined; surely it will be dirt cheap. I’m confused over this part as there has been talk FDIC doesn’t exactly have a massive amount of excess funds – which means the Treasury will print up some more of those greenbacks to finance most of these transactions. The upside and downside is spit evenly between the government and the private investors, except in the case of a total loss whereby the FDIC will be on the hook since the loans are non-recourse in nature.
Here’s how the Treasury Department explains it, directly from their website:
Sample Investment Under the Legacy Loans Program
Step 1: If a bank has a pool of residential mortgages with $100 face value that it is seeking to divest, the bank would approach the FDIC. Step 2: The FDIC would determine, according to the above process, that they would be willing to leverage the pool at a 6-to-1 debt-to-equity ratio. Step 3: The pool would then be auctioned by the FDIC, with several private sector bidders submitting bids. The highest bid from the private sector – in this example, $84 – would be the winner and would form a Public-Private Investment Fund to purchase the pool of mortgages.Step 4: Of this $84 purchase price, the FDIC would provide guarantees for $72 of financing, leaving $12 of equity. Step 5: The Treasury would then provide 50% of the equity funding required on a side-by-side basis with the investor. In this example, Treasury would invest approximately $6, with the private investor contributing $6. Step 6: The private investor would then manage the servicing of the asset pool and the timing of its disposition on an ongoing basis – using asset managers approved and subject to oversight by the FDIC.
Ignoring the fact that the government finances a huge majority of this funding, the problem of a market clearing price remains. You’ve got to get the banks to sell these assets at a level either private investors are willing to bid or FDIC is willing to get the process started.
Banks understand many of these assets are worth much more than they are currently being valued. The private sector likely realizes this as well, but they will look to bid lower for these securities (even with these very attractive financing terms – whatever this happens to be) as many uncertainties remain – chief among them, will the government change the rules in the middle of the game? The main point missing here is whether or not there will be a reserve place on the auction. That is, the banks won’t just say they want to sell a loan, or asset, if there is complete uncertainty over where the bids will come in. There must be some reserve at which if bids are below this level, the bank takes the loan back.
Later in the day, Geithner expressed confidence that many private firms and investors will be eager to participate – maybe so; after all, the government will be putting up 93% of the funding ($78 bucks in their $84 example; a more appropriate name for this program would be the Very Public-Minimally Private Investment Program (VPMPIP). If so, then why didn’t he name a few participants? It seems to me investors will be leery to take government funds (and participate) based on the populist wave that Congress seems all too willing to foment. What happens if firms do participate and they make 30% returns a year from now, yet national unemployment stands at 10% by then – just a hypothetical. What do you think Congress’ reaction will be? Answer: serious legislative risk!
Attempting to quell this concern that they themselves have stirred up, National Economic Council Director Lawrence Summers stated investors in the PPIP won’t be subject to compensation limits – as the WSJ stated yesterday, that’s also what TARP recipients were told.
Existing Home Sales
The National Association of Realtors reported existing home sales unexpectedly rose in February as record foreclosures and a sub-5.00% 30-year fixed mortgage rate brought bargain hunters into the market.
Purchases of previously owned homes climbed 5.1% last month to an annual rate of 4.72 million from 4.49 million in January. While the level of activity remains very depressed, the increase is helpful nonetheless.
Multi-family units propelled the overall figure higher as this segment (condos, townhouses apartments) jumped 11.4% last month. Single-family units rose 4.4%.
We should see an uptrend present itself as foreclosures push prices lower (the median price of an existing home is now down 15% over the past year – most of this due to large declines in the West region) and the Federal Reserve will aggressively print money to buy mortgage-backed securities. As a result of this plan, the 30-year fixed rate should move toward the 4.50% range in the very short run – there is a risk the Fed’s program will not be as effective in bringing the rate to this level, it all depends on how the market reacts to its printing-press mentality.
Below is a chart of single-family sales (excluding multi-family). I like to present this figure as the data has a longer history (multi-family unit calculations did not begin until 1999, hence the overall number only goes back a decade).
We’re basically back to 1997 levels, as the chart shows. This should give one the feeling that much progress has been made in erasing excesses.
In fact, factoring in population growth and home affordability, which has hit an all-time high, you’ve got to believe the housing market has more than regressed to the mean. Problem is we have the labor market issue to deal with right now, which will delay a full-blown rebound.
The supply of single-family existing homes has ticked down, but we have much area to cover still. We’ll need to get down to 5.0-6.0 months’ worth of supply before we get too excited.
In term of calling a bottom for housing, it’s just too early. Existing sales remain below that seen in December and the weak employment picture will surely continue to weigh on the housing figures. Nevertheless, one should assume mortgage rates will fall meaningfully in the very short term and housing will get a boost as a result – yet the question of sustainability remains.
I have additional comments on the Treasury PPIP plan for those still interested.
Geithner gets an A for creativity but an F for logic. This is not an eighth grade creativity contest but a country and an economy that has plenty of challenges right now – millions of jobs and long-run growth prospects are on the line.
Look, the entire Treasury plan is based on the assumption that these toxic, er legacy, assets that are currently priced at distressed levels have a much higher intrinsic value – this is the explicit statement via the architecture of this plan. (Readers of this letter understand this is a view shared by us as well.)
So, since this is acknowledged, why go down this road of highfalutin, some may say grandiose, strategies instead of simply attacking the problem directly by de-linking the relationship between mark-to-market accounting and regulatory capital? Let the banks hold these assets in their “hold to maturity” accounts, call it a day and address the next problem.
Some may remember that I was in favor if the original TARP plan (devised back in September) as it seemed clear regulators would not change mark-to-market, but that was before the government was so terribly involved. Now, we roll out trillion-dollar programs as if this is not a substantial figure. Based on the degree to which the government is now involved, I fear additional plans.
As a country we really need to focus on the perils of increased government involvement and our citizenry would be well served to read Hayek’s Road to Serfdom. It would do our economy, and our future level of freedom, a lot of good. There comes a time when enough is enough.
Have a great day!
Brent Vondera, Senior Analyst
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