Secretary of the Treasury Hank Paulson’s speech this morning took any doubt about how far the government is going to go in this credit crisis and threw it out the window. Paulson proposed a complete bailout of the mortgage market by allowing the US government to absorb the bad mortgage debt out of the financial system. Leaving, you guessed it, you and me on the hook for all the bad loans that no one wants anymore.

We’ve been calling that for more than a year now - but who’s keeping score at this point.

Here’s a snip of Paulson’s speech on the mortgage bailout, read the whole thing if you can stomach it.

The federal government must implement a program to remove these illiquid assets that are weighing down our financial institutions and threatening our economy. This troubled asset relief program must be properly designed and sufficiently large to have maximum impact, while including features that protect the taxpayer to the maximum extent possible. The ultimate taxpayer protection will be the stability this troubled asset relief program provides to our financial system, even as it will involve a significant investment of taxpayer dollars. I am convinced that this bold approach will cost American families far less than the alternative - a continuing series of financial institution failures and frozen credit markets unable to fund economic expansion.

As we work with the Congress to pass this legislation over the next week, other immediate actions will provide relief.

First, to provide critical additional funding to our mortgage markets, the GSEs Fannie Mae and Freddie Mac will increase their purchases of mortgage-backed securities (MBS). These two enterprises must carry out their mission to support the mortgage market.

Second, to increase the availability of capital for new home loans, Treasury will expand the MBS purchase program we announced earlier this month. This will complement the capital provided by the GSEs and will help facilitate mortgage availability and affordability.

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Filed under: Bad news, Comfort Zone Investing, Headline news

Ted Allrich is the founder of The Online Investor and author of the just released book: Comfort Zone Investing: Build Wealth And Sleep Well At Night. In this weekly column, he’ll offer advice to investors who are just getting started.

What really happened to these venerable names of Wall Street? They were once so powerful, so unbelievably powerful. How could they fail? Simple: everyone got greedy.

Gordon Gecko wasn’t right. Greed isn’t good. It’s the one element of investing that will take you down, doesn’t matter who or what you are. When greed enters the room, rational decisions go out the window. Greed doesn’t color your vision. It blinds. And it blinded the management of these companies.

Basically these once pillars of Wall Street took on investments that were bad, very bad. Many of them came from their own investment banking departments where they put together deals that didn’t make economic sense but put plenty of fees in the pockets of department heads and bankers. Deals like mortgage-backed securities made up of loans that were made to individuals who couldn’t possibly pay them back. But when you pool all of them together, make them into a security, maybe, just maybe, some of them will work out. And besides, there was always some greater fool willing to buy them.

Problem was that all the stupid people already had enough stupid loans. There wasn’t enough stupid money to buy the last round of worthless paper. So the brokers were stuck with securities nobody wanted. And they were getting worth less every day because the stupid people were trying to sell their stupid securities back to the dealers who sold them originally. That drove the price down further.

The dealers made really low bids and thought they could steal the securities. And they did. They bought lots and lots of them. But they couldn’t sell them. All the stupid money was getting smart real fast. Big losses tend to do that.

The brokers sat in a sea of paper, with more angry clients calling every day, yelling just one thing: “Get us out.” The brokers finally couldn’t make any more bids for more securities, not even low ball bids. They had no capital to support what they already owned which was going down in value every day, much less add more securities. There capital was being wiped out by the hour by securities they had originated, pooled and sold. They came home to roost. Call it karmic justice, if you like.

The essence of the problem is the greed that drove all these deals. Wall Street people are mostly very intelligent. But they work in an environment that demands more of everything. Your worth is determined by how many fees and commissions you generate. Your swagger comes from the deals you do, the car your drive, the homes you own. That’s the culture. And to stay in the game, you have to constantly be coming up with new products and services that can be sold to institutions and the public, even if they aren’t the best products and services. After all, since Wall Street types are so smart and make so much money, the buyers must be less smart so it’s easy to sell to them if they put enough gibberish around the newest product. Problem was, there were too many bad securities. No matter how they tried to put lipstick on the pig, it was still a pig. But the buyers already had enough pigs. Their pens were full.

So it’s not just greed. There’s some arrogance in there as well. To top it all off, there’s also leverage. Brokerage firms are allowed to borrow heavily against securities, to leverage up their balance sheets. For every one dollar of capital they can have anywhere between $2 to $25 of securities, depending on the category. The firms can hold a security, borrow against it to buy more securities, then take the new securities and borrow more to buy more securities. The leverage goes on and on until it reaches a limit, governed by the SEC and NASD. Maybe those limits were a little too high. Just a guess.

Now the bomb has detonated, and everyone is waiting for the dust to settle. The two major independent brokerage houses, Goldman, Sachs and Morgan, Stanley, have always been known as prudent risk takers. They still have as much greed. It’s just that they’ve kept it under control. Now they’ll be able to pick and choose from even more deals, demand more fees, and make more money. That’s how it works. To the survivors belong the spoils.

Wall Street will be back. There’s always money to back smart people, ones who can manage capital. If you have a brokerage account at Lehman, it will most likely be sold to another firm or you’ll be able to get your securities and money out thanks to SIPC and private insurance. It may take awhile because Lehman management will be busy with other things for some time, but you’ll be able to get your investments back. Things will resolve. Mostly because Wall Street serves a function: it moves capital from those who have it to those who need it to build businesses. As long as no one gets too greedy in the process, it works very well.

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Filed under: Merrill Lynch (MER), Goldman Sachs Group (GS), Morgan Stanley (MS), Lehman Br Holdings (LEH)

Financial stocks, which have been bloodied over the past few weeks, rallied today on the plan announced by Treasury Secretary Henry Paulson for the government to acquire troubled bank assets. The recently announced ban on short-selling helped the shares as well.

Goldman Sachs Group Inc. (NYSE: GS), down 40 percent for the year, rose $20 to $128 in mid-morning trading. That’s about an 18 percent rise and comes a day after the stock hit a 52-week low. Remember, Goldman recently reported a 70 percent decline in third quarter profits which given the billions of write-offs taken by its competitors is almost miraculous. Maybe Paulson decided the government needed to suck away the bad investments from their balance sheets when he saw pressure building on his old firm.

Today’s 25 percent raise in Morgan Stanley (NYSE: MS) may alleviate some of the pressure on the investment bank to find a merger partner to avoid the same fate as Lehman Brothers Holdings Inc. and Merrill Lynch & Co. (NYSE: MER). Shares in the New York-based company rose $5.28 to $27.83. Morgan Stanley reportedly is mulling a tie-up with Wachovia Corp. (NYSE: WB).

Even Washington Mutual Inc. (NYSE: WM), another company that might get a multi-billion buyout, got a boost, soaring 81 cents to $3.80. That’s an increase of more than 27 percent. Of course, the 52-week high is $39.25, so any celebration is muted.

The joy from shareholders about the Paulson buyouts is palpable. Taxpayers are more sanguine. The one thing I remember from Economics 101 — where my professor used to always use marijuana joints in his lectures about supply and demand — is that every transaction needs a buyer and seller. What makes the government think it will be any more successful in unloading the toxic paper than the private sector? I just don’t see who is going to buy the stuff until there is a major turnaround in the housing market which may not happen for years. Even then, turning a profit will be a challenge.

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The selling pressure on Fannie Mae and Freddie Mac has been heavy this week after a Barron’s article published on the weekend made the case that both government sponsored entities would require a full fledged bailout.  This was made clear even prior to the Housing and Economic Recovery Act of 2008 being signed into law.  […]
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The selling pressure on Fannie Mae and Freddie Mac has been heavy this week after a Barron’s article published on the weekend made the case that both government sponsored entities would require a full fledged bailout.  This was made clear even prior to the Housing and Economic Recovery Act of 2008 being signed into law.  The challenge now becomes if they do go out and sell more stock that current shares will be diluted to a point where the shares become worthless.  Both Fannie Mae and Freddie Mac are testing multi-decade lows.

Sometimes people forget what these two companies stand for.  Part of their mission is of creating liquidity on the secondary mortgage market.  Yet with a struggling housing market these large institutions have to contend with a faltering portfolio that is seeing more and more losses.  Now it is very likely that current shareholders would be wiped out in the event of a bailout.  The question becomes why would foreign investors purchase bonds or preferred shares in the company if the likelihood of failure is around the corner.  Certainly they will be made whole but not at premium rates.  The well is drying up quickly.

There are a few emerging trends in the housing market.  It is rather clear that housing still remains in a precarious situation.  We are nearing the end of the summer selling season and the boost that was expected unfortunately did not materialize.  Record inventory is still on the market and questionable mortgages such as pay option ARMs still loom on the balance sheets of many lenders.  One of the trends that is emerging is people engaging in housing swaps.  That is, people exchanging homes normally without a broker or agent.  In many cases, it is a barter trade.  Another trend is towards frugality.  Now some would argue that this isn’t a trend more than the economic situation forcing the hand of many to face the grim reality.  Yet there should be little doubt that prudence is making a comeback.  Also, we will examine the hidden housing numbers embedded in the Southern California housing market.  Are we really approaching some sort of market bottom?

Housing Swaps

I happened to stumble upon housing swaps on Craigslist.  For those two of you who haven’t heard of Craigslist, this is one of the most visited sites on the internet with some 20,000,000 visits per month in the United States alone.  You can consider this a dynamic classified section where you can find pets, look for employment, trade cars, get rid of unwanted furniture, and now swap your home with someone else.  Now I’ve used housing swaps when traveling for a temporary living arrangement.  For example, you need a place to stay and you find someone in your desired location who is looking to travel as well, and you come to an agreed upon trade.  Now this I used during college and was amazed at how many people are out there and the ability of technology to shrink the world.

That isn’t the new trend.  But what I am noticing is postings from people looking to permanently swap their place with others.  That is something that is new.  There were the unique postings in the past but now everyday you can find a person looking to trade their home with your home.  Here is an example:

The person above is looking to exchange their Chicago home with a home out here in Burbank either temporarily or permanently.  Now why would someone do a housing swap as opposed to selling their home?  There are actually many good reasons.  First, you may be an area with depressed sales and can’t sell your home.  For many corporate careers, if you are in a junior position you may need to go where the company sends you.  This may translate into you relocating but if you own your home and cannot sell, then you are stuck.  What if you absolutely love your career?  Then most would do anything they can to find a way to move to their new location.

Another reason people would do a housing swap instead of selling is they may be in a negative equity position.  Say you bought a home for $350,000 and the home is now “worth” $250,000.  A large number of people do not (or don’t want to) come to the table with $100,000 simply to sell their home.  There is a large portion of the population that can manage the housing payment but is simply stuck in this position of limbo.  They would like to sell their home but cannot.  There only other option is to ruthlessly default and some are going down this path as well.

Finally, this may workout for people who are on the margins.  If you have say a 4 or 5 percent equity position in your home, it may cost you $10,000 or $30,000 simply to sell your place.  Why not contact someone and save yourself that amount?  You can hire a real estate attorney for a few hours, get the paperwork drawn up and finish the deal.  This may work for cases like the person that needs to relocate and doesn’t really care if they get a profit on their home.  They are simply looking to sell the home.

It’ll be interesting to see if more and more of these cases pop up on Craigslist.

Frugality

There is a definitive emerging trend in frugality.  There is a fountain of wealth with Google.  You can use Google Maps and have access to technology that only a few years ago was accessible by the highest level government officials.  You also have the luxury of searching for information from a variety of sources.  One of the features I enjoy from Google is their Google Trends search feature.  In this, you can see the amount of search queries for any phrase or word.  Since Google dominates the search world, this is an excellent view of what people are searching for at any given time.  Take a look at this search phrase:

As you can see from the above chart, not many people are searching for “real estate investing” anymore which shouldn’t come as a surprise.  Ironically, in times where people should be more financially educated they tend to steer away from this.  They ramp up their investments at the worst time, near a peak, and face rapid problems.  Is it any wonder that California has now seen a drop of 38 percent in one-year for a median priced home?

This trend can also be seen perfectly by comparing two stocks for the year.  That of Family Dollar Stores and Best Buy:

For the year Family Dollar Stores are up 24 percent while Best Buy is down 15 percent.  So what does this mean?  What it means is that people are focusing on things they “need” and avoiding things they “want.”  It is interesting to note that consumer and producer inflation is running at decade highs.  Now why is this?  Clearly housing prices collapsing and credit tightening is wealth destruction so you would think that we would be seeing possibly deflation.  The problem however is items that people need such as food, fuel, and healthcare are not growing exponentially.  These remain fixed while the U.S. Dollar declines and purchases less and less of these items.  In addition, many Wal-Mart goods are produced in China which is facing its own inflation.  The workforce is slowly getting more educated and is demanding slightly higher wages which find their way into the price of the goods that people consume.

With budgets getting tight “want” stores like Best Buy are facing the brunt of the economic contraction.  We saw this with Mervyn’s filing for Chapter 11 bankruptcy in July.  Another clear example is looking at a low cost food source such as McDonald’s and comparing it to P.F. Chang’s China Bistro:

Over the past year McDonald’s is up 29 percent while P.F. Chang’s is down 27 percent.  Frugality is becoming a way of life because money is tight and this is being reflected in the spending behavior of Americans.

Census Selling

Much to the chagrin of many the housing market won’t see a bottom at least in California until 2011.  There is some positive aspects to this including more affordable housing for many.  It will also lighten the debt load for households in the future.  It may also give people the incentive to purchase homes in areas they plan on staying in and investing their time in creating a better community.

Foreclosures are still at historical highs.  Given the recent housing report for Southern California and the modest jump in sales, I think it is important to look at the actual sales and how they played out in various regions.  Let us first get a population count for the 6 major counties:

Population Count For County:

Los Angeles:               9,948,081

Orange:                       3,002,048

Riverside:                    2,026,803

San Bernardino:          1,999,332

Ventura:                      799,720

San Diego:                  2,941,454

Total Southern California:   20,717,438

So that gives us the entire population count for Southern California.  The total population of California is 36,457,549 so Southern California makes up 56 percent of this amount.  Now let us look at last months sales data:

Now I made the case in a previous article that the minor bump in sales was in large part by the fire sale of homes in the Inland Empire.  Let us now break down the numbers to get an actual proportion:

Riverside + San Bernardino Total July Sales =  6,637 / (20,329 total SoCal Sold)

So these two counties made up 32.6 percent of all sales for Southern California.  Now we should look at what percent these counties make up for the Southern California population:

Riverside + San Bernardino Population = 4,026,135 / (SoCal total 20,717,438)

Total population percentage for these two counties is 19.4 percent.  So essentially these two counties are selling at twice the percent of their population representation.  I was listening on the radio to someone explain the median price drop and cautioning that sales are getting skewed because “expensive” homes aren’t selling and only foreclosures and lower priced homes are selling.  This in fact is true.  The only thing I would caution these folks about is that distress sales are now the bulk of the market even though miraculously in some of the data, foreclosures don’t pop up in multiple listing services.

These new trends are simply a way people are coping with the economic conditions.  It is very unlikely we will be seeing a second half recovery especially for housing.

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Emerging Economic Trends: Housing Swaps, Frugality, and Selling Homes in Lower Priced Areas.

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Related Posts:
■Real Homes of Genius: Two For One in Compton. Southern California Housing Bubble Hangover.
■Real Homes of Genius: Today we Salute you Paramount. 768 Square Feet for $324,900. Buy, Withdraw, Sell, Foreclose. The Cycle of Life.
■World Premier! Real Homes of Genius Video.
■Real Homes of Genius: Today we Salute you Compton. $90,000 in Los Angeles County?
■How Many People Overpaid for Their Home in Los Angeles County? Trying to get a Raw Number of Households Underwater.

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Filed under: Before the bell, Products and services, Consumer experience, Competitive strategy, Google (GOOG), Microsoft (MSFT), Time Warner (TWX), Technology

For a long time now, when it comes to search engines, Google Inc. (NASDAQ: GOOG) has been the king of the hill, and a new survey shows that Google extended its lead once again during August, taking valuable traffic away from its main competitors Yahoo (NASDAQ: YHOO) and Microsoft (NASDAQ: MSFT).

According to comScore, Google increased its dominance during August by attracting 63% of all search engine traffic, up from 61.9% during the month of July. comScore’s data was based on 11.7 billion searches in the month, and shows that Yahoo and Microsoft are still unable to tap into the valuable search engine traffic that Google maintains.

Yahoo scored a very distant second place, with 19.6% of all search engine traffic. This was a drop of 0.9% from its July figures. Third place goes to Microsoft, who scored 8.3% of search engine traffic during the month, down 0.6% from the previous month.

Continue reading Google (GOOG) extends lead in search engine market

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In light of the continuing degredation of the US credit market and the recent collapse of Lehman Brothers and AIG (not to mention the Merrill Lynch sale) Morgan Stanley is considering whether it will need to merge with a deposit-taking bank to remain afloat.  Many analysts fear that the AIG government bailout is a sure sign that credit is nearly impossible to obtain.  Even the most stable companies like Goldman may not be able to remain independent and weather the credit storm.

While there are no official merger talks yet between Morgan and any parties the company has hinted at the possibility of a merger if the stock continues to get hammered by the market.

From the AP:

“But senior people at Morgan concede that further zig-zags in the company’s stock price could and possibly will force the company to change course and seek a merger partner, probably a well capitalized bank,” CNBC reported on its Website.

Morgan Stanley shares closed down 10.8 percent at $28.70 on Tuesday, having fallen 46 percent so far this year.

“The U.S. government’s rescue of AIG helped the markets to avoid the worst case scenario, but the fact that only the government was willing to help indicated the gravity of U.S. credit problems,” said Choi Seong-lak, an analyst at SK Securities in Seoul.

“Reports that Morgan Stanley is considering a merger with a commercial bank confirmed such fears, and market participants are now wondering if even Goldman Sachs (GS.N) is safe. Sentiment is extremely fragile.

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Filed under: Before the bell, Major movement, Deals, Good news, Bad news, Market matters, Money and Finance Today, Economic data, Politics, Headline news, Federal Reserve, Recession

Equity markets in the United States and across the world rose Thursday and this morning as the Federal Reserve and the other major central banks injected billions of dollars into the global financial system in an unprecedented move to stabilize the financial markets. The stock market soared as word spread that the government was also preparing a more long-term solution to the credit crisis. There are also restrictions on short sales and guarantees of money market funds.

The good news with the recent intervention by the Federal Reserve and the other central banks is that this is a tremendous amount of financial and monetary power being applied. Usually, true disasters like the Great Depression or 1973-74 Bear Market occur when the central banks fail to recognize the problem early or a mistake is made. The Fed clearly recognizes the problem, and Chairman Ben Bernanke, because of his obsession with Fed mistakes during the 1930’s, is unlikely to repeat these errors.

There is also global coordination among central banks to resolve this. History has shown in the 1930’s and 1970’s that it is not wise to “Fight the Fed.” Even if large stocks, such as the S&P 500, continue to lag Treasury Bills in terms of total return, small cap stocks can rally in this loose monetary environment. This occurred in both the mid 1930’s and the late 1970’s. This has been documented in my book, Follow the Fed to Investment Success. It also occurred in the early 1990’s when we last experienced a credit crisis similar to this.

Continue reading Government intervention and the credit crisis: The good news and the bad news

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