Oh, Felix...

The normally clear-sighted Felix Salmon dropped his glasses in the sink this morning, and put on the rose-colored ones instead. Averse to the burdens of home ownership, he just discovered the magic of rent-to-buy:

Often, it’s a simple lease with an embedded option to buy the property at a set price on a set date — an attempt to give the buyer a bit of time to scare up a downpayment, and to give the seller an income stream. Typically the option is purchased for cash (1% of the purchase price seems to be standard) at the same time that the lease is signed; generally if the option is exercised, the price of the option is deducted from the purchase price.

Alternatively, rent-to-buy schemes can increase the rental price and apply rent payments to the purchase price: here the price of the option is likely to be embedded in higher rent payments rather than being an explicit up-front payment.

Oh Felix, Felix. This "transferee" (I chose my words with care here) has the obligation to keep or walk away. This is non-recourse debt. Just like all first-mortgage residential in California (and most other mortgage debt here as well, but skip the details). That's what nonrecourse means: keep or walk away.

And he isn't done yet:

Then there’s a scheme I’ve heard of in Germany. Essentially it takes banks and mortgages out of the picture altogether, and sets up a long-term contract between the buyer and the seller. The buyer pays rent monthly, the house is essentially placed in escrow, and the buyer ends up owning the house after a set number of years paying rent. I like this scheme because it involves buying a house without any debt — and the buyer can even move house and sublease the property, so long as she continues to make rent payments to the seller. ...

Buying a house slowly, over time, is a great way of building equity without taking on debt — and it’s also a great way of making sure that you’re spending what you think it’s worth to live in a house, rather than speculating dangerously on future property prices. It’s also a great way of giving renters the same kind of emotional equity in their home — and the ability to make changes and improvements — that are generally the domain only of homeowners. Right now, when a lot of motivated sellers are looking to any possible way to move their properties, might be a very good time for these ideas to gain traction.

Felix, Felix baby: the buyer makes monthly payments. If he makes enough payments, he gets the house. If he can take or walk away, it is nonrecourse debt. If he has to take--no matter what the house is worth--this is debt. You can call it Mickey Mouse or Mr. Magoo; if it walks and quacks like debt, it's debt. Oh, Felix, Felix...

Afterthought: there is, inter alia, a huge industry devoted to deluding the acquirer of consumer goods on just this issue. Most of the customers are the most unsophisticaed and gullible, the ones most likely to be deluded by smoke and mirrors. Not usually the finance columnists for major news organizations.

Department of Wha--? Redux

A couple of days ago I complained that Felix Salmon had rocks in his head on the matter of debtors buying back their own homes at distressed prices from mortgagees. From the trenches, my friend Mary weighs in to tell me that I'm the rocky one:

I disagree with your take on Thornburg Borrowers' Unit ("TBU"), and here's why. ... [W]ouldn't that have the effect of causing sophisticated [borrowers] to go into default on their loans with the purpose of purchasing them at a steep discount?

My understanding is that after the real estate bubble began to collapse, but before the home mortgage lending market collapsed, borrowers with underwater homes were buying new homes at 60% or so of the price of the existing home, while they still had good credit, then walking away from underwater home. Now that home mortgage lending begins to revive, we may see more of that. So TBU doesn't want to make that easier. Borrowers] could buy the note at a discount and end up owning the residence at 40 - 60% of prior debt without the hassle of moving, etc.

Comment: Ooh, cool. I hadn't heard it, but I'll bet she is right that some borrowers succeeded in buying the new home while their credit was still good, and then dumping the old overpriced one back on the lender. I wonder how many. Still, I go bollywackers when I hear a banker (of all people) saying that somebody "should" do something that is not in the contract. But people dump out-of-the-money options all the time. Banks have been telling us for years (without, I grant, a shred of evidence) that (California) purchase-money home loans are made more expensive by the presence of the (statute-mandated) anti-deficiency rule; if I take them at their word, I must assume they have already priced some such risk. I can't believe for a moment that the bank wouldn't take advantage of this kind of opportunity if offered. Why should they be surprised if their cusotmers behave as they do?

Anyway, I never meant to argue that Thornburg was "misbehaving" by not offering the option--only that I thought they were acting against their own interest. Still, I learn something from Mary every time I have the good sense to keep my ears open--so, thanks again.

Department of Wha--? Salmon on Mortgage Buybacks

Felix Salmon has an uncharacteristically boneheaded piece up about mortgage buybacks. Apparently Thornburg Borrowers' Unit (who?) is auctioning off some of its scum mortgages--with a proviso that current borrowers can't bid.

Or more precisely, on two levels--Thornburg for establishing the proviso, Salmon for endorsing it. I haven't any idea what Thornburg's reasoning could be, but Salmon says it is a moral hazard problem: the borrowers who "are generally the most valuable of Thornburg's borrowers -- they're overwhelmingly likely to be the ones whose loans are worth par." I can't imagine where he gets that idea: the real framework is that for any individual mortgage, the borrower is the person most likely to pay the highest price. This has, in other words, nothing to do with the value of the mortgage relative to par; only to the value of the mortgagee's bid relative to other bids.

Bankruptcy trustees know this; since the mist of time, they have been selling the debtor's old ratty junk car back to the debtor because he is the one willing to pay most--and he pays most because he has the informational advantage, knowing exactly how beat up it really is, exactly how much change has dropped behind the set cushions, and so forth. There may also be a "non-economic" (can there be any such thing?) "sentimental attachment" factor, but this, too, only works to the advantage of the lender. Meshulam Riklis gained a kind of bankruptcy notoriety when he bought "his own" McCrory's Department store back from Chapter 11 in 1997. Creditors howled but couldn't offer a better bid (the deal later went sour--apparently Riklis paid too much).

Salmon further let his spleen cloud his judgment by saying it would cost taxpayers money in that a buy-back would be tax free--money "which would normally be taxed as income." This is oversimple, to put it charitably. In fact almost any direct write-down would almost certainly come under the (admittedly complicatd) Crane/Tufts "debt forgiveness" rules designed to put some or all debt forgiveness "income" beyond the reach of the tax collector.

The only unusual wrinkle in this deal is that Thornburg is apparently trying to sell these mortgages in "packages" (don't call them "S*c*r*t*z*t**ns"). Maybe Thornburg believes (like Salmon?) that they have a problem if the good ones get cherry-picked away. But even if this were true, the result wouldn't follow. The recent epidemic of "toxic" securitizations came about not because the assets were worth too little, but because the buyers paid too much. Anything is a bargain at the right price. If Thornburg doesn't want to deal with the debtors, that's their business (sic!), but it looks to me like they are leaving money on the table.

Fn.: The borrowers' own blog is fascinating.

Allen Who?

Given my taste for financial fraud, I admit I am coming a bit late to the story of Allen Stanford who seems to be the very model of watch-the-shell and watch-the-pea multijurisdictional banking (and perhaps a middleweight Bernie Madoff to boot). Maybe because it kind of snuck up sideways:

For anybody who's coming new to this story, it began with an article entitled "Duck Tales", which can be downloaded here, in Veneconomia magazine in Venezuela. The article essentially accused Stanford of being a fraud; it was picked up by Venezuelan blog Venepiramides on February 6, and had made it to Portfolio.com by the morning of Feburary 10. The following day, February 11, there was a big article at both BusinessWeek; by February 12, the rest of the mainstream media had cottoned on, if cautiously.

As it happens, I don't read Business Week but I should know that it is always a mistake to leave Felix Salmon unread. I suspect he is giving himself a bit of a pat on the back here and I say God bless, he deserves it (and so, of course, does God).

Is There a Confict Here?

The reviews are coming in:

Has Barack Obama’s presidency already failed? In normal times, this would be a ludicrous question. But these are not normal times. They are times of great danger. ... What is needed? The answer is: focus and ferocity. If Mr Obama does not fix this crisis, all he hopes from his presidency will be lost.

That's the not-easily frightened Martin Wolf in the Financial Times (link). Compare:

Barack Obama for Treasury Secretary!

... Barack Obama stepped up to show ... how questions about nationalization should be answered: [he made] as clear and well-argued a case for not nationalizing as you could hope to get. ...

That is the not-easily conned Felix Salmon (link). And yes, I am being cute here. The ellipses white out the parts in which Salmon agrees with just about everybody: Geithner laid an egg, and if he doesn't find someway to talk (cluck?) his way out of the problem, he can join the line of unemployed bankers. Salmon seems to differ from the common herd in believing the game is not entirely lost yet. Of course that has to be right. While the chicken littles like are clucking in our own way, this is one news cycle and this game can change at whiplash speed.

Funny thing about Geithner: I had thought he was Larry Summers' errand boy and front man. Seems like I got that one wrong: all reports are that he is an aggressive player in his own right. Dunno, maybe he is good at the inside/operations/dealmaking thing. But he certainly did not have a good day.

Salmon on Blodget on How Not to Fix the Times

I must say I enjoyed Felix Salmon's ungentle fisking of Henry Blodget re how to save the New York Times even though I am not persuaded by--nor can I follow--every bit of it. But hey, this is still a blog entry, and they don't have to make 100 percent sense now do they? I certainly endorse the idea that you can't treat the newsroom as a theatre for Taylorite efficiency studies. It takes me back to my time in the city room: at some point, some thimble-head sent in a time-and-motion guy whose job was to ask three minutes what the reporters were doing right now: evidently they thought the solution to the problem was to get us to type faster. But a larger issue that they missed, and that Blodget missed, is that a newspaper city room profits from a certain amount of ludic horseplay: it keeps people motivated and alert, and it serves as a great forum for the transmission of ideas (I assume that something like the same philosophy is at work in the loosey goosey management style said to reign at Google). Indeed, if there is a problem with city rooms right now it may be that the new technology has cut down on just the sort of interaction that made the old-fashioned city room thrive.

Still, I think Felix dances around the core economic problem: newspaper readers never paid for content, they paid for paper and ink and delivery; advertisers paid for content. And until somebody figures out how to bring them back into the game (or finds a substitute) the downward spiral will continue.

A final poiint: Felix likes his physical newspaper at the breakfast table, and on the train. News: the New York Times and the Financial Times were offering promotional freebies just this morning-at Kindle, for download. The FT, by he way, is priced actually higher on Kindle than the lowest available street price: evidently they are figuring that somebody (globetrotters?) will be wooed by the allure of instant-anywhere.

[For people who get their fingers greasy at the table, Kindle also offers an "automatic page turner option." I leave it to the reader to decide whether this a design feature or a ludicrous misadventure--haven't used it myself, and doubt that I will.]

Update: Thedeal.com has a nice wrapup on the general blogosphere debate.

Bring Back the Bean-Counters

Felix Salmon has a good piece up about economists wrong-footed by the data, and by the general decline in the utility of "economic numbers" like, e.g., the Gross Domestic Product. He offers a good menu of possible reasons:

the fragmentation of the economy, with a large rise in the number of small companies and self-employed individuals; the globalization of the economy, with its attendant blurring of the idea of what counts as "domestic production"; the fact that first-rank economists simply don't become statisticians any more; and a general fiscal neglect of the statisticians that the government does have.

All true, and here's another: there are just too damn many of them. We've learned how to measure everything (at least badly) and so it is almost always possible to pull out a plausible counter-datum to defang any particular data point. Makes me pine for the day when the bean counters really counted.

The Dustman Strikes Again

In Our Mutual Friend, Dickens chronicled the life of “the Golden Dustman,” and his monumental heap of garbage. Now this:

Japanese Garbage Datapoints of the Day

The value of indium in Japan's garbage dumps: $833 million
The value of lead in Japan's garbage dumps: $15 billion
The value of silver in Japan's garbage dumps: $30 billion
The value of gold in Japan's garbage dumps: $178 billion
The value of copper in Japan's garbage dumps: $283 billion

The 6,800 tons of gold in Japan's "urban mines" compares to 765 tons in Japan's official reserves; it's more even than the official reserves of Germany and the IMF combined.

HT: Felix Salmon, Portfolio.com: Market Movers, and beyond.

More on the Mortgage Meltdown

For anyone trying to make sense out of credit markets, there’s an interesting cage match under way between Gretchen Morgenson at the NY Times and blogger/journo Felix Salmon over everybody’s current favorite bogeyman, the subprime market.

Morgenson’s Sunday Times piece (not her first on the topic), compared the current state of subprimes to the Dot.Com madness of 2000:

Now, as then, Wall Street firms and entrepreneurs made fortunes issuing questionable securities, in this case pools of home loans taken out by risky borrowers. Now, as then, bullish stock and credit analysts for some of those same Wall Street firms, which profited in the underwriting and rating of those investments, lulled investors with upbeat pronouncements even as loan defaults ballooned. Now, as then, regulators stood by as the mania churned, fed by lax standards and anything-goes lending. …

The regulators are trying to figure out how to work around it, but the Hill is going to be in for one big surprise,” said Josh Rosner, a managing director at Graham-Fisher & Company, an independent investment research firm in New York, and an expert on mortgage securities. “This is far more dramatic than what led to Sarbanes-Oxley,” he added, referring to the legislation that followed the WorldCom and Enron scandals, “both in conflicts and in terms of absolute economic impact.”

Rubbish, says Salmon. Executive summary, per Salmon, of Morgenson’s work: :[W[e can ignore it, on the grounds that Morgenson adduces no evidence whatsoever that any crisis is looming at all.”

I don’t have any business pretending to expertise here, but Salmon’s own response doesn’t seem to provide the assurance he thinks he does. In particular, he has an unsettling way off seeming to sidestep the issue. Morgenson says that “Wall Street firms and entrepreneurs made fortunes issuing questionable securities … Regulators stood by as the mania churned…” Salmon responds by showing that mortgage-backed securities issuance peaked back in 2003. But this seems unresponsive; current levels still seem high in terms of history, and it may be that the industry is already struggling to dig itself out of a hole.

Similarly, Morgenson says the problem is obscured by the fact that the industry isn’t marking its loans to market. Salmon responds by saying they can’t mark to market because the market is too thin—which is hardly reassuring. But then he turns round and says that when this debt does trade, it turns out that it hasn’t fallen in price much at all. Say, what? Maybe he was right the first time—that the very rarity of the trades gives away the truth that you can’t sustain those prices.

It will be fun to watch this play out, but for the moment, I tend to lean towards Morgenson, for two reasons:

1) She’s got a pretty good record of being right and simultaneously not caring much about what anyone else things; and

2) I’m a congenital pessimist.

Hat tip to Economist’s View, with some cool comments, including one from Felix.