To understand what’s going on here, let’s lay the groundwork. The bulk of loans in the United States are underwritten (the process of deciding whether a borrower is financially qualified for a loan) according to Fannie Mae and Freddie Mac udnerwriting guidelines.  One of the factors used in determining whether applicants are creditworthy is the evaluation of their debt in relation to income. Simply stated, borrowers who have high debt in relation to their income are less creditworthy than those with lower debts or higher income.

In evaluating this relationship lenders rely on two variations of debt ratios.  One is referred to as the “top-end” ratio. It’s the ratio that an applicant’s housing expense bears to his or her gross monthly income. The “housing expense” includes all mortgage payments secured by the property together with the monthly amount of taxes and hazard insurance associated with the property. The definition of housing expense has recently been amended to also include association dues owed in connection with ownership of the property.  The housing expense is often referred to under the acronym “PITIA” (representing “principal”, “interest”, “taxes”, “insurance” and “association dues”).

The other debt ratio used by lenders in evaluating creditworthiness is the total debt-to-income ratio (or “DTI” ratio), often referred to by lenders as the “bottom-end” ratio. The “debt” utilized in calculating this ratio includes the housing expense (PITIA) plus all monthly payments made by the applicant on installment and revolving (credit card) debt. This may be a slight over-simplification of the definitions, but it will do for our purposes.

Prior to the preceding decade mortgage lenders used two sets of debt ratios to determine creditworthiness for all applicants. For transactions with loan-to-value ratios above 80% the applicant’s top-end ratio could not exceed 28% and the bottom-end ratio could not exceed 36%.  For transactions involving an LTV ratio of 80% or less the ratios had to fall between 33% and 38% respectively. I’ve never been provided with any good explanation of why these particular limits were used. As best I can ascertain they were pulled out of thin air.  They just seemed to make sense, so banks used them. Hardly scientific.

Well, somewhere around 20 years ago, the big-wigs at Fannie Mae and Freddie Mac decided to do something interesting. Why not take a look at the statistics they had in their possession about default on loans and try to correlate default with applicant characteristics such as credit history and debt ratios?  What they discovered was that utilizing only two sets of debt-to-income ratio limits for all borrowers was a pretty unreliable way of assessing whether a borrower was creditworthy.  Using the traditional 28/36 ratios was a little bit like throwing darts at a dart board wearing a blindfold.

The new empirical models that were developed evaluated dozens of factors relating to an applicant to determine whether they were creditworthy. With two decades of data at their disposal lenders have been able to fine tune the process.  The risk models used in the mortgage industry today rely most heavily on the applicant’s credit scores (based on empirical data gathered by a couple of guys named Mr. Fair and Mr. Isaac), the aforementioned debt-to-income ratios, and the ratio that the proposed loan amount bears to the value of the property securing the loan (the “loan-to-value” ratio).

Armed with this information regarding debt-to-income ratios you have only half the knowledge you need to evaulate the President’s plan. To fully understand the ramifications of the plan you’ll also need to know a little bit about the various players involved in the mortgage industry.

When a borrower obtains a mortgage loan it’s delivered at the retail level primarily by mortgage brokers, mortgage bankers, or traditional banks. These entities that accept loan applications and process them are collectively referred to as “originators”.

The originators then transfer these loans to other entities in the “secondary market”.  The vast majority of these mortgage loans are then pooled into groups with similar interest rates (called coupons). These pooled loans are then used to collaterize bonds that are sold to investors.  These bonds typically have yields higher than treasury notes and bonds. There’s a pretty good chance that if you have a 401K or retirement plan, that some of the assets in the plan are these types of bonds.  Some of these bonds are owned by individuals like you and me. The owners or holders of the bonds, acting through a trustee, will contract with “servicers” who are charged with the responsibility for accepting payments from the mortgagor, assuring that taxes and insurance are maintained on the property securing the mortgage loan, and other administrative functions. In theory, if not in practice, the servicers are fiducaries charged with the duty of protecting the interests of the owners of the bonds.

One of the duties of the servicer is to work with borrowers who are in default and to attempt to mitigate losses to the bond owners in the event of borrower default. A small percentage of these mortgage-backed bonds are owned by the servicers themselves, but the bulk of these bonds are actually owned by Fannie Mae, Freddie Mac and private investors who hold these bonds in their security portfolios.

Having established the underwriting rules and players in the game, let’s now evaluate the plan.

The “modification” section of the plan proposes to permit a homeowner whose top-end (housing) ratios exceeds 31% to obtain an interest rate reduction to the extent necessary to bring the top-end ratio to 31% or lower. In other words, the plan returns to the dark ages of underwriting to use a single debt ratio to determine whether a homeowner is at risk of default on their mortgage loan.  It ignores 25 years of impirical research. And in doing so, it will cost American taxpayers billions, if not trillions of dollars, to subsidize the mortgage loans of their neighbors who are not remotely at risk of default.

Consider the following example: John Oglethorpe owns a home worth about $500,000. He has an outstanding balance of about $380,000 on his existing mortgage, that has an interest rate of 6.25% and a payment (including tax and insurance escrows) of $3,296.20.  His gross monthly income is $7,800.  Thus, his top-end ratio is 42.26%. After paying his monthly housing expense this guy has about $3,700 each month left over to pay for transportation, food, insurance and other living expenses.  This guy could own a Mercedes Benz and Porsce and still have plenty of greenbacks left over to buy a few bologna sandwiches.  Frankly, the guy isn’t even remotely at risk of defaulting on his mortgage.

Yet under the plan Mr. Oglethorpe’s mortgage loan servicer is given an incentive to reduce Oglethorpe’s rate to 4.875% so that the monthly payment is reduced to $2,950.16 (thereby reducing the top-end ratio to 38%).   But the goverment, having determined in its immenent wisdom that a 38% top-end ratios is still too high, wants to lower Mr. Oglethorpe’s rate and payment even more, so it persuades the servicer to reduce the rate by an additional 2.375 percentage points to 2.5% and the payment to $2,413.81 (thereby reducing the top-end ratio to the targeted 31%). The government will subsidize this second rate reduction by paying half of the amount by which the payment is reduced for up to 5 years.

Let’s do the math. With the second reduction (from a 38% to 31% top-end ratio) the borrower’s payment was reduced by $536.35. So the government foots the bill for 50% of this amount for 60 months for a total subsidy of $16,090.05. As if the gratuitous reduction in rate and payment were not incentive enough, the government is going to pay the borrower $1,000 each year for 5 years for accepting this new lower rate and making his payment on time for that 5 year period.  That’s right we’re going to pay the borrower $5,000 for accepting a reduction in rate to 2.5% for five-years. Mr. Oglethorpe’s no dummy.  He immediately says, “Where do it sign?”

Of course, the borrower isn’t the only one receiving a windfall in this little modification effort. The servicer that arranges the modification prior to default will be paid $1,500 up front plus $3,000 more dollars during the next three years.

How much money will the borrower (who we already concluded was never at risk) will save during this 5 year period. He’ll reduce his monthly nut by $882.39 each month for 60 months for a cumulative monthly savings of $52,943.40. And if that weren’t enough, we’ll pay him an additional $5,000 for accepting the lower rate and paying his payment for the next 5 years.  Total benefit to the undeserving borrower? $57,943.40.

Who pays for these benefits? Well, it’s probably not the servicer since the bulk of the mortgage loans that will be modified under the plan are either owned by Fannie Mae, Freddie Mac, or private investors (such as your pension plan or 401K plan).  We’ll assume for the sake of argument that this particular loan is packaged into a pool of loans securing a mortgage backed bond that’s owned by your 401K plan.

Of the total $63,943.40 that’s benefits the borrower, loan servicer and note holder in this modification fiasco, $27,090.05 is paid by millions of taxpayers, their children and grandchildren for decades to come. The remainder of the windfall to the borrower ($26,853.35) is paid by your 401K plan in the form of lost cash flow over a five year period.  This reduced cash flow has the effect of lowering the yield on your investment from something over 4.5% to something less than 2% for a five year period. It’s an investment nightmare.  Thanks, Uncle Sam.

Now, I’m sure the modification program will be utilized to help lots of homeowners who truly are at risk of default and foreclosure. But there will likely be hundreds of thousands of others who, in reality, required no assitance, and will reap a windfall at the expense of American taxpayers and private investors whose investment terms were modified by the federal government and the servicers.

Oh, and by the way. Do you know who the four biggest servicers are in the United States?  That would be CitiFinancial, Bank of America, Chase Bank and Countrywide (who is now owned by Bank of America), who just happen to already be the primary beneficiaries of huge sums of taxpayer bailout money.

This plan is ill-conceived, and absent restrictions (that have not yet been released) that prevent this type of abuse, will cost Americans and private investors trillions of dollars over the duration of the program.

The top reason given for dissatisfaction with their profession was the red-tape involved with filing insurance paperwork and complying with government regulations.  I was a little puzzled. When was the last time you saw a doctor filling out the insurance forms?  Isn’t that always done by the accounting gal named Mildred?

A recent study by the National Health Service in the United Kingdom found that primary care physicians in the United States were the highest paid in the world.  Dr. Kildaire in the United States makes four times what his counterpart makes in Italy. Wearing scrubs in the U.S. pays twice as much as it does in France.  This is true even though the cost of  living in most U.S. cities is much less than in those European countries.  (The only city in the United State to make last year’s list of the top 50 most expensive cities in the world was New York, ranked 22nd.)

Physicians claim that their salaries represent only about 25% of the total cost of health care in the United States and that a 10% reduction in pay would only result in a 2.5% decrease in the cost of healthcare. That’s a a little bit like saying that because lung cancer only accounts for 7% of all deaths in the U.S., it’s a waste of time to discourage smoking.  This argument also fails to account for the fact that the much of the excessive cost  in other parts of the industry is paid to businesses, such as hospitals, owned in large part by physcians.

Both my parents are now deceased. But during their last years I was able to spend quite a bit of time in hospitals and clinics. I vividly remember my mother’s stay at Presbyterian Hospital in Dallas after a relatively minor procedure. After the operation she remained in the hospital with tubes stuck everywhere for several days despite no real need for supervised care. I remember thinking just how bad that enviroment was for recuperation.  I’ve since learned that many of the referring physicians own stakes in the hospitals where they perform surgeries and other tests and procedures.  They often have a stake in the business that does the lab work and the post-surgery rehab. This is especially true in these niche hospitals that perform speciality procedures such as orthopaedic and cardiac surgery.  I’ve heard all the arguments in favor of this arrangement, but in the final analysis, it’s conflict of interest. Would you want your defense attorney to profit from full occupancy in the county jail?

The bottom line is that physicians bear a share of the blame for rising health care costs and it’s time for those excesses, whether directly relating to physicians’ salaries or to manner in which they profit from other businesses responsible for those excesses, to be eliminated from the American health care industry.

My name is Ken, and that’s the way I see it.

A majority of foreclosed properties are inadequately maintained and in disrepair when they are taken into the possession of the property managers employed by the government or the mortgage servicer charged with liquidating these bank owned properties.

Even though the government, mortgage servicers, and banks have deep pockets, they all seems to adhere to the policy that repairing or otherwise spending money on these properties for the purpose of preparing them for sale is throwing good money after bad.

Successful real estate brokers understand that staging a residential property prior to listing it is the most important element of marketing a property. Statistics show that sellers that “stage” properties prior to listing them for sale achieve significantly higher prices for homes compared to those that are inadequately prepared.

Statistics show that an unfurnished property sells for more than 10% less than a property that is unfurnished during the listing period. In some neighborhoods the unfurnished property may sell for as much as 20% less than its furnished competitors.  By investing a few thousand dollars for repairs, paint, and rented furnishings, home owners, including the government and mortgage lenders that own repossessed homes, will achieve sales price increases that easily exceed the amount invested in repairs and staging.

During periods of reduced demand, lender and government owned properties comprise a significant percentage of the properties being sold and often are the only properties an appraiser can utilize in arriving at an opinion of value.  Because it is common practice to spend no money preparing a property for sale these properties are often sold below market value. This combination of factors has the undesirable effect of artificially driving down the values of these properties and has contributed significantly to the rapid decline in real estate property values seen throughout the United States. 

Any policy aimed at mitigating losses incurred by lenders and home owners alike as a result of foreclosures must include a serious reevaluation of current policies followed by the agencies, entities and individuals charged with the responsibility for liquidating foreclosed real estate. These property managers must be provided adequate budgets to repair all mechanical and structural deficiencies, make appropriate design and cosmetic changes, employ ”staging” professionals to furnish these vacant properties, and hire and compensate the real estate agents whomarket these properties based on their success and productivity.  Instituting a program that enables property managers to adequately prepare and position a foreclosed property to obtain the highest possible price will mitigate losses to institutional lenders and their shareholders and will curb the decline of property values by assuring that foreclosed properties compete in terms of quality and price with other properties listed in the same or adjoining neighborhoods.

My name is Ken, and that’s my take on it.

This conclusion is based on an analysis of the historical data for the median home sales price in the San Diego metroplitan area for each year from 1982 through 2008.

The blue line in the graph shows the actual median sales price each year during the period from 1997 through 2008.

The purple and green lines show what those prices would have been based on historical trends during the preceding twenty five years. (Click here to see the methodology used for establishing the purple and green trend lines.)

As the graph indicates, actual home prices have been markedly higher than the trends established from the previous two and half decades.  Although there may be other factors that could minimally affect these values, it is obvious from the graph that the increases in actual price during the period shown in the graph were following an unsustainable trend.

Some would argue that real estate agents, appraisers and lenders contributed to the bubble by failing to advise clients of the precarious nature of the market and the risk associated with buying homes at prices that so significantly exceeded the predicted values based on historical trend.

However, a foreclosure mitigation program that provides assistance to homeowners because of the declining vlaue of their homes could actually be providing those homeowners with a windfall.  Bear in mind that the vast majority of purchasers that bought homes at inflated values during the past six or seven years, more than likely had reaped the benefit of an inflated sales price on the sale of a previous home.

Consider the following example that utilizes actual data relating to home sales during the indicated period:

Mr. Oglethorpe bought a home for $185,210 in 1997.  Six years later (in 2003) he sells that home for $424,880. Utilizing our historical trend data the realistic value of that home should have been $258,294. In other words, the Mr. Oglethorpe reaped a windfall from the inflated prices of about $166,586 when he sold his prior home. He then bought another home across town closer to his new employer. He paid $424,880 for that new home (the same price at which he sold his existing home). That home is valued at more than $600,000 just three years later. But then the bubble bursts and in January of 2009 the property appraises for only $305,000.  Thus the current value is $119,880 less than the what he paid for it.  Poor Mr. Oglethorpe. He needs government assistance, right?

Taking a closer look we see that his net appreciation on both transaction was a positive $46,706. That means that in the 11 year period that he owned both properties his average annual increase in value was $4,246. When he purchased the original home he invested $18,510 (a downpayment of 10%).  Having turned his original $18,510 investment into a net gain of $46,706 over an eleven year period, he yielded a healthy Now,house). Thus, his net improvement in value of $4,670 per year actually represents an effective yield over the elven year period of 22.93% per year. Not a bad rate of return for a guy complaining that he’s taken a bath.

Of course, if Mr. Oglethorpe invested the proceeds from the original sale in the stock market rather than a CD or money market, his actual position may still look pretty grim.  But are we to also give Mr. Oglethorpe a handout because he made some bad stock purchases?

The bottom line is that Mr. Oglethorpe takes on a certain degree of responsibility and risk when he purchases an asset, whether it be real estate or stock. It’s convenient to blame the lender, the appraiser, the real estate agent, or the stock broker. But, in the final analysis, Mr. Oglethorpe must bear the bulk of the blame, either for taking the risk associated with the purchase or for choosing the professionals that advised him in those transactions.

My name’s Ken, and that’s my take on it.

My first concern about the first section of the plan is that the premise on which it is based is misstated. The plan concludes that “…under current rules, most families who owe more than 80% of the value of their homes have a difficult time refinancing.” This is a grossly inaccurate statement. The vast majority of homeowners who fall into the group affected by declining property values have mortgages underwritten according to Fannie Mae and Freddie Mac eligibility requirements. Fannie Mae and Freddie Mac guidelines allow homeowners to refinance up to 95% of the value of their primary residence. The fact that the plan misstates the symptom for the which the remedy is designed should create some degree of skepticism when evaluating the efficacy of the plan.

That said, the problem that declining values have created for a large segment of homeowners seeking to refinance to more acceptable terms is a significant problem. Due to the liberal loan-to-value limits that were utilized by mortgage lenders to establish transaction eligibility during the preceding decade, there are millions of homeowners who have mortgage loan balances that exceed the current value of their homes. In fact, there are a substantial number of homeowners who purchased or refinanced homes at loan-to-value ratios exceeding 95% that currently fail to meet Fannie Mae and Freddie Mac eligibility requirements for refinancing, even though the values of their homes have not significantly declined simply because their equity position was so small at the time they originated their existing loans.

The summary of the plan states that “Millions of homeowners have … through no fault of their own … seen the value of their homes drop low enough to make them unable to access these lower rates.” There are many who would take issue with the statement that homeowners who purchased homes for more than their current values are without fault.  Those areas of the country where home values have declined significantly in the past two years were areas where the values of these home had reached unsustainably high levels during the years preceding the decline. Buyers who purchased homes at prices significantly above a realistic price (based on objective historical trends) are not without fault. I’ve previously stated concerns that a plan permitting a principal reduction on a homeowner’s mortgage based on the perceived decline in the value of the collateral securing it could, in fact, lead to a windfall profit for many homeowners that appear to be affected by these lower property values. ( See, The Declining value fallacy: why principal reductions are not an appropriate response )

The concept of permitting homeowners to refinance without regard to the value of their existing home is not a new concept. Special programs, called “streamline” refinances, permitting borrowers with acceptable mortgage payment histories to refinance without regard to the value of their properties have existed on both FHA insured mortgages and mortgages held by Fannie Mae and Freddie Mac for more than two decades. The current version of the Fannie Mae/Freddie Mac programs do not permit borrowers to refinance if the value of their property is now less than it was at the time the loan was originated.  The FHA streamline refinance (only available where the existing loan was originated as an FHA loan) currently permits a refinance without the necessity of a new appraisal provided the loan amount does not exceed the existing loan amount.

 The President’s plan will reincarnate a modified version of the “streamline refinance” on loans currently owned or insured by Fannie Mae or Freddie Mac to permit refinancing provided that the amount of the new loan does not exceed the current value by more than 5%. (i.e. the loan-to-value ratio of the new loan cannot exceed 105%).

The plan, although a step in the right direction, falls short of the scope necessary to solve the current problem.  Since the government now owns about 80% of the two government sponsored entities (Fannie Mae and Freddie Mac) they should have instituted the same standards that FHA utilizes on their streamline refinances. Simply stated, the 105% LTV limit should be eliminated and borrowers should be permitted to refinance, provided that they are not in default, that the new loan amount does not exceed the original loan amount and that the transaction does not permit the borrower to receive any cash-out.  A slightly higher rate of interest or a higher fees could be charged on those loans that exceed the 105% limit that would compensate for the higher risk associated with the new loan.  Bear in mind that Fannie Mae and Freddie Mac would, in theory, be placed in a more favorable position since the the balance on the new loan would be no greater than the original loan amount and only slightly higher than the balance of the existing loan.  The lower rate and payment would decrease the likelihood of default by the borrower and in the unfortunate event of a subsequent foreclosure the delay would likely place the lender in a better position than if it had to foreclosed and resell the property securing the loan in today’s depressed market.

This type of plan would permit homeowners to refinance at lower rates, but would assess a minor penalty (in terms of higher pricing) to homeowners having to use this type of qualification mechanism. Homeowners who made smart financing decisions by keeping adequate equity positions and by choosing to purchase homes at values that were realistic would be able to refinance under standard guidelines that provide superior rate and pricing terms.

Whatever plan is instituted, it should not limit the ability to originate these “streamline” refinances to the servicers of the existing loans. Limiting the authority to originate these new mortgage loans to the institutions that currently service those loans will drive up the cost of financing for the consumer.  The fact is that the entities that service loans are inefficient originators. When they originate mortgages they do so at a substantial cost to the consumer. On a typical mortgage loan of about $300,000 the transaction costs paid by the consumer to obtain a new mortgage loan are up to $6,000 more through the big-volume servicers than on a loan at the same interest rate originated by and/or through more efficient mortgage bankers and mortgage brokers who do not service loans. As an incidental result of limiting these modifications or the origination of these streamline refinances to the existing servicers, undeserving banks who are already the beneficiaries of public bailout funds (specifically, CitiMortgage, Countrywide (now owned by Bank of America), Bank of America and Chase) would receive perks at the expense of the more efficient originators, once again rewarding the entities that bear a unproportionate share of the blame for the current crises.

My name is Ken, and that’s my take on it.

The world’s changed a lot since then.  Most of the widgets are made in China. The U.S. economy is now based on the “sale” (not so much the “production”) of iPODs, automobiles, gasoline, and real estate and on providing SERVICES … LOTS of services.  Whether it’s computer programming, nursing, or advertising and selling a Big Mac, this is what today’s economy is all about.  And it’s this major difference in today’s world, compared to Roosevelt’s and Keynes’s world, that makes LOTS OF SPENDING on “projects” a little less effective than it used to be for pulling a stagnant economy up off the ground and to its feet.
Matthew Yglesias, in his blog post, In Defense of Stimulus Waste, is right about one thing, “The efficacy of stimulus as stimulus just has to do with how quickly the funds cycle into private hands and then out into the wider economy … “  And this is where the 2009 stimulus package horribly falls short of its intended purpose.

Although $787 billion sounds ominous, it’s an expenditure that a country like the United States, with potential for high production and growth, can conceivably fund within a few years.  It’s not likely, as claimed by the Republicans, that our grandchildren will be paying for this bill for years to come.  Well, on second thought, it might be a true statement for John McCain since the guy’s grandchildren are already paying taxes.  But even if the President’s prediction of “SAVING” or creating 3.5 million jobs is accurate that means that each job created (or “saved”) is costing the American people (or their as yet unborn children and grandchildren) about $225,000 for each job created.  Considering that the average salary of the individual hired to these new positions will likely be in the range of $30,000 to $40,000 annually, it will take seven to eight years to recover enough “stimulus” to repay the American people for what they spent to create each job. I suggest that there is nothing efficient about this cost/benefit ratio.  Score a negative one point for the Donkeys.  All these spending projects are horribly non-productive as stimuli.

So what about the tax cuts?  Well, if we give the same $225,000 directly back to the American peeps (call it a tax credit, a grant, or gift, it’s still rock and roll to me) then that expenditure is available dollar for dollar for spending from the day it’s received.  We don’t have to wait for a train to be manufactured or for rails to be laid. We don’t have to wait for buildings to be erected or painted.  That gift back to the American people can be spent on iPODs and Big Macs the minute it’s received.  But … not all tax breaks are created equal. If you give a tax break to a guy that already has more than enough money to buy the “stuff” he needs (or wants), that guy will just put that money in a trust fund so that his great grandkids can go to Harvard or Princeton.  (God forbid, since it’s those Harvard and Princeton graduates that are the “brainpower” that concocted this ill-conceived “not-so-stimulus” package.)

The Matthew Yglesias rule that judges a stimulus “by how quickly the funds cycle into the private hands” fails on certain tax breaks because we have to wait until the recipient’s grandkids are in college to collect the investment.  This makes the $70 billion spent to eliminate the alternative minimum tax (something that primarily benefits rich dudes whose grandkids will go to Harvard or Princeton) something that is just as ineffective as the excessive spending projects proposed by the bleeding heart liberals.  So on the some of the tax breaks, score a negative one point for the Elephants.

Of course the stimulus package had a few good tax breaks … the kind that find themselves put back into the chain of commerce rather quickly.  The tax break that was most likely to do some immediate good was the $15,000 home buyer tax credit.  This was one that had a lot of immediate benefits. It gave a dollar for dollar benefit to everyone  that purchased a home in 2009 (not just first-time homebuyers). What a splendid idea.  This one not only put significant sums of money immediately (or at least within a few months) back into the hands of lots of peeps, it served the secondary purpose of inhibiting or reversing the downward spiral of real estate values (which most economists concur is at the root of pit current economic crises) by creating more demand in the housing market.

Of course, this provision, added in the Senate version of the bill, was axed in conference committee. God forbid they actually put something that sounds and smells like “stimulus” in the bill!  To add insult to injury, our lawmakers, then reduced the package’s $500 tax refund to $400.

The stimulus Bill is further devoid of any provision that will contribute to the one most important element of an economic recovery plan … “low mortgage rates”.
After all, it’s not as if we have no experience with recessions in the modern era.   We had one in the period from 1991 to 1993 and another in 2001 through 2003.  In each of these recessions economic stimulus was primarily fueled by low mortgage rates which led to a refinance boom during both recessions.

The nice thing about low mortgage rates is that they are “super-charged” recession fighters. Like the $15,000 home buyer credit (that was eliminated from the package) low mortgage rates accomplish multiple objectives in a stimulus plan.  First, they encourage refinancing. And refinancing puts $300 to $400 back into the pockets of a huge number of home owners.  Let’s do the math. If about 20 million homeowners (an estimate by the government of the number of homeowners that would benefit from refinancing to an interest rate below 5%) could put $400 each month into their pockets (from the interest savings on refinancing) for three years the savings would be $288 billion dollars.  It’s hard to say just how much money Congress or the Treasury Department would have to spend to artificially push rates down to 4.5% for a year, but I can assure you it would be less than $787 billion.

Secondly, lower mortgage rates stimulate home buying.  For the same reasons that the $15,000 tax credit would have been a good thing, this is also a good thing.  It stimulates home buying which in turn reverses the decline in property values through increased demand.

Finally, lower mortgage rates, and the accompanying refinancing it creates, accomplishes another positive in the recession battle… It forces the employment of hundreds of thousands of individuals by the financial services industry to meet the demand created by thousands of new refinance and purchase mortgage applications each day.   This almost immediate creation of new jobs acts as third powerful stimulus.

We can only hope that the economic bailout package will provide the necessary elements to encourage lower mortgage rates, because the stimulus package just passed is totally devoid of anything designed to encourage lower mortgage rates.

In the final analysis, Congress and the President scored poorly on the stimulus package. Blame goes to Democrats and Republicans alike. The stimulus bill is an ill-conceived, hastily formulated plan, devoid of any significantly effective recession fighting provisions.  The bulk of the spending provisions and a good many of the tax breaks fail to provide any immediate economic stimulus.  I just hope that by the time a second bill is up for consideration after the first one falls short of its objectives, those Harvard graduates have taken the time to read this post.

My name is Ken, and that’s my take on it.

Mr. Oglethorpe’s Dilemma

Let’s suppose there’s a man named John Oglethorpe.  Mr. Oglethorpe has a son, Jimmy, and a daughter Elaine.  His wife, Jane, is a homemaker. John Oglethorpe is an insurance agent.
Due to a drop-off in new policies last year, related to the recent drop in home sales, John’s income is down about 25% in 2007 and things are getting pretty tight.   He’s got limited available credit … only about $2,000 available on his three bank cards with balances currently totaling over $18,000.  He has next to nothing in the bank.

By changing the location of his office, he could save $300 each month in rent. But to do it he’ll have to spend about $1,500 up front to move the office.

Mr. Oglethorpe’s house needs a coat of paint (that will cost $500), the daughter wants to join the drill team (but she will need to buy a uniform costing $400), and the son, Jimmy, has been pleading for a new drum set (that would cost about $600).

Mr. Oglethorpe’s next door neighbor was employed as a manager at Circuit City and just got laid off.  He came to Mr. Oglethorpe last night and asked for a loan for $1,000 to help him meet expenses.

Mr. Oglethorpe asks you … ”what should I do?”

I think the response to this is really simple.

1.  Considering the fix he’s in, helping the neighbor would be a bit risky.  He should ask the neighbor to search out every other possibility and explain that with his income down and with next to no savings he simply isn’t in the position to lend money to the neighbor.

2. Although the requests of his daughter and son are not unreasonable, if he uses valuable funds to satisfy their requests he won’t have the funds necessary to move the office.

3. The peeling paint makes the house look a little shabby but painting could be delayed a year or two without causing any significant damage to the underlying wood.

4. If he pulls a cash-advance of $1,500 off the credit cards for the move it will cost him an extra $38 per month in interest, but it’s a certainty that he’ll reduce his outgoing expenditures by $3,600 in the next few years with the $300 per month reduction in office rent.  This is something that he has to do. It makes good sense.

5. In the final analysis, the smart move is to do the cash advance on his existing credit card and spend the $1,500 on the new office location to get the immediate and verifiable results ($3,600 per year in savings) and to delay the remainder of the expenditures until the family is in a better financial position.   He’s even keeping an extra $500 in available credit for any emergency.

I doubt if there are many of you who would argue the logic of this approach.

Using the logic that Congress is applying to the proposed stimulus package, here’s how they would handle the problem:

1. First, Mr. Oglethorpe would apply for another credit card to get an additional $1,500 in credit (even though the interest rate is 29% on the new credit account).

2. He’ll then do a cash advance on the new card to paint the house ($500), buy the drill-team uniform ($400), and the drum set ($600).  If Mr. Oglethorpe’s brother asks him why he spent the money so foolishly, he’ll just respond that it’s no more stupid than the Shotgun his brother bought himself on his last birthday.  He’ll also rationalize that paying the painter and buying the drum set will help the painter and the manufacturers and salesmen of the drumset make a few bucks.  This is good on the outside chance that they’ll need insurance sometime in the near future.

3. Next, he gets a cash advance of an additional $1,000 off the existing credit cards and lends the neighbor the requested $1,000 and tells him to pay it back when he can.  It’s good to stay in the neighbor’s good graces so he’ll renew his insurance policy NEXT year.

4. Then, he finds another office location that only requires him to spend $1,000 up front but that will still save him $100 each month.  He rationalizes all the other expenditures by bragging that this one will net him $200 the first year and another $1,200 each year thereafter.

5. Of course now he has no money in the bank and no available credit for future emergencies.
This plan is a bit crazy isn’t it? Do you see the similarities between Mr. Oglethorpe’s dilemma and the dilemma facing Congress? I ask you, “Why should we expect any less of Congress and the President than we would of Mr. Oglethorpe?”  Contrary to the President’s position, I take the position that sometimes doing less or doing nothing is better than doing lots of stupid things.  And this is why I oppose both the Senate and House versions of the stimulus bill.

My name is Ken, and that’s my take on it.