Acorn, Fannie Mae and the Housing Bubble: Who is Responsible?

In a recent WSJ piece, Edward Pinto links the housing bubble to liberal advocacy groups like Acorn.  The argument goes something like this: government polices aimed at increasing home ownership forced entities like Freddie Mac to lower lending standards and acquire large amounts of risky mortgages.

“The flood of CRA and affordable-housing loans with loosened underwriting standards, combined with declining mortgage interest rates—to 5% in 2003 from 10% in early 1991—resulted in a massive increase in borrowing capacity and fueled a house price bubble of unprecedented magnitude over the period 1997-2006.”

Groups like Acorn lobbied for “innovative and flexible” lending practices and helped “ignite” the housing bubble. Acorn is a large political advocacy group that pushes issues for low-income earners.  Pinto links Acorn’s efforts to increase homeownership to the recent housing bubble and financial crisis.

Does he have a case? First we should recognize his bias.  Mr. Pinto was chief credit officer at Fannie Mae from 1987-1989. Not surprising then that he would defend his former professional affiliation.  However, a massive increase in loans made without due diligence over the past 15 years is an undeniable cause for collapse.  As Pinto points out, loans made with less than 5 percent down increased from 9 percent in 1991, to 29 percent in 2007.  Default rates also increased.  Government-sponsored enterprises’ high-risk loans faced a 10.3 percent default rate.

Bankers and regulators should have known better.  Barney Frank, Chairman of the Financial Services Committee, argued to switch the focus from home ownership to rental properties.  This would have isolated the mortgage industry from reckless lending practices.  He made his argument back in 2002.

Lack of due diligence is the real crime here.  Why did the nation’s largest mortgage lenders ignore a fundamental principle of finance?   The answer to that question will help us avoid another meltdown.  You cannot blame a poverty-advocacy group for a banker’s lack of competence.  Yes, policies aimed at increasing homeownership failed.  But that is only part of the puzzle.  Financial innovation, de-regulation, derivatives, Glass-Steagall, China and Fed policy where other factors.

Though I agree with Pinto’s analysis, blaming community groups for advocating loose lending standards is a bit harsh.  Bankers need to take some responsibility.

Tom Powell

 

Real Estate Wrap-Up and the RIA

Residential Real Estate  

There are dozens of reasons why the residential real estate market bubbled and exploded, causing the ensuing credit crisis and economic strife. The popularity of loans requiring no documentation, the easy access to sub-prime loans and the Federal Reserve’s decision to keep interest rates low all intertwined to fuel the housing crisis. The housing bubble was also inflated by Wall Street’s ability to package and sell mortgages in large pools. Now, after struggling to repair the housing market for more than a year, we are seeing improvements that are unveiling extraordinary investment opportunities in residential real estate.

It appears we have hit the bottom of the housing market trough. Housing prices found some stabilization, although the prices are still close to the lowest they have been all decade. But, the collapse took years to build and expecting a complete turnaround in 2009 is unrealistic. The real promise in housing is in the future. Getting your money into the market now is optimal because of low prices and reasonable mortgage rates. Plus, there will continue to be tax relief with the recent Obama-endorsed home-buyers’ tax credit extension—which is planned to be available for repeat buyers who have lived in their prior residence for at least five years.

The United States should see a gradual increase in home sales throughout 2010, but the residential market will most likely not witness a return to “normalcy” until 2011. According to Steve Bergsman, author of “After the Fall, Opportunities and Strategies for Real Estate Investing in the Coming Decade,” “When a bubble market bursts, left behind is a lot of carnage and it takes about three years for the markets just to get a handle on the mess.”[1]

The three-year anniversary of the housing collapse is fast approaching and a number of high-profile reports have been published this month that suggest the residential housing market is already improving. The Case-Shiller index, which tracks variations in the values of houses in 20 U.S. metropolitan areas, showed an increase of 2.9 percent in the second quarter of 2009. In the first quarter it was down 7.9 percent. Two reports released by the Commerce Department last week suggest that while the overall economy continues on a wobbly path toward recovery, the housing industry is experiencing a number of positive signs. For example, “The supply of new homes was at 7.5 months in September, down from 9.5 months in May.”

While residential inventory appears to be slimming, foreclosure rates continue to mount in multiple areas across the country. With a significant number of Option ARMs set to reset over the next several months, many cities will continue to experience record-setting foreclosure levels.  

However, foreclosures are increasing in different cities than those affected in the last quarters of 2008.  Rates appear to be easing in the cities that were hit hardest by the housing collapse and rising in major metro areas in other states. This suggests that the cities previously overrun with foreclosures have found ways to combat the problem and are gradually making progress.

A continuing stream of foreclosures may keep the residential inventory plump, and prices could remain stable over the next couple quarters. But, as inventory shrinks, so too will the abundance of quality investment opportunities. With the residential real estate market now hovering around the bottom, now is the right time to invest.

Commercial Real Estate: No Reason to Panic

While it appears that we have already witnessed the worst of the residential real-estate collapse, we are preparing for the brunt of the crash in commercial real estate. The commercial real-estate industry has taken the place of residential real estate as the breeding ground for widespread fear. Daily reports suggest the commercial real estate storm will be more severe than the one that struck residential housing. Instead of causing another shipwreck, our economy’s commercial woes may prove to be more of an anchor that puts an imposing drag on our recovery.

The combination of job losses, store closings, rising vacancies and drastic cost-cutting measures puts commercial real estate in a serious bind. However, knowing their mortgages will soon come due or reset, owners and managers of office buildings, shopping centers, hotels and apartment complexes have had ample time to prepare for upcoming obstacles.

 Owners of commercial real estate are not backed into a corner. Banks prefer options that keep mortgage payments flowing. Therefore, banks are willing to work with borrowers to find solutions, even though bundled commercial mortgages will add to the difficulty of negotiations. Securing loan payments is not entirely the responsibility of banks or those who hold investments in pools of bundled loans. The owners of commercial buildings originally took on the responsibility and many of them are actively working to find solutions to keep their properties operating. Many property owners will continue to make their payments either because they have adapted their strategies to fit the difficult times, or because they have explored creative ways to bring in extra income. Of course, some number of defaults will be inevitable. Some of those property owners who are unable to acquire loan restructuring or extensions will view a loan default as their best option.

As with the residential real estate debacle, the government is sure to intervene in an attempt to keep our economy from falling into another dark hole. For example, the already-in-place Term Asset-Backed Securities Loan Facility (TALF) supports the issuance of asset-backed securities in order to help small businesses meet their credit needs. The TALF is one of a handful of sluggish government efforts that was created to help provide a crutch for the commercial real-estate industry.

Commercial real estate will continue to tug on recovery efforts, but it is not likely to cause the amount of damage we witnessed during the residential collapse. The time to invest is not when everyone shows interest in an asset. A staple to wise investing has always been buying low and selling high. The commercial real estate market has produced sound investments in the past and will once again flourish. Getting into the market in times of success is more costly, the opportunities are scarcer and the rewards are not as fruitful. The best time to invest is when the masses are fearful, and the masses are easily spooked by commercial real estate right now.

The Benefits of Hiring Professionals

As is the case when taking on any money-making venture, the waters are difficult to navigate alone. We all want to make investments that are conducive to both our current financial situation and our future goals. Investing with a Registered Investment Advisor (RIA) helps eliminate the series of headaches that come with making sound investment decisions.

Hiring a RIA has a number of benefits. For instance, a RIA can take on the following responsibilities:

• Provide objective investment and financial advice
• Set achievable financial and personal goals
• Take into account all of the factors that influence your current financial situation (your assets, liabilities, income, insurance, taxes, etc.) and provide a comprehensive analysis of where improvements can be made. Also, this helps to guide your investment plans and retirement goals
• Provide consistent investment consultation based on your fluctuating savings, investment selections and asset allocation

Before hiring a RIA, you should also be able to answer the following questions:

• What services do you need? Can your potential RIA deliver these services or are there any limitations on what they can deliver?
• What experience does the RIA have in dealing with investors in your situation?
• Has the RIA ever been disciplined by a government regulator for unethical behavior?
• What services are you paying for and how much do those services cost?
• How does the RIA plan on getting paid and are you comfortable with this payment method?
• RIAs are required to register with either the SEC or their state securities agency, depending on their size. It is imperative to ask for proof of their registration

There are a number of professionals who can provide guidance for your investment strategies. Hiring a RIA can help to take the frustration out of the investment process and help you avoid many of the common roadblocks. The true value of a RIA is their ability to thoroughly understand your overall financial goals and provide professional investment advice that is consistent with those goals.

 All My Best,

Thomas J. Powell

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[1] Bergsman, Steve. After the Fall: Opportunities and Strategies for Real Estate Investing in the Coming Decade. Wiley, 2009.

Stimulus, Growth and Recovery: The Debate Continues

There is growing intelligent dissent to the administration’s stimulus policy.  Critics argue that recent growth is the result of market principles.  Edward P. Lazear wrote Monday in the WSJ, that he forecasted a return to growth without stimulus spending.  He goes on to argue, along with others, that  housing programs have had questionable results.  Lazear said that Uncle Sam is fibbing about job growth as well, reporting job retention as if it where job creation.  John Irons of the Economic Policy Institute agrees.  The administration has an incentive to report positive unemployment numbers- the most popular, but also misunderstood indicator.

Unemployment is only part of the overall picture.  Other improving indicators reported this week tell us that the economy is turning around-but for whom? It depends on how you define growth.  A technical definition says that growth is positive GDP.  That means little to most people.  Real growth, theoretically, is an improvement in living standards for the entire country.  That’s why Main Street understands the unemployment rate.  Accordingly, the media use it as the sole judge for growth.  The problem is, as Lazear mentioned,  job growth is the final component of recovery- behind financial stability and GDP growth.  Unemployment lags years behind an actual recovery.   If unemployment is a lagging indicator, Lazear cannot empirically link failed stimulus policy to persistent unemployment.  He says that the administration is ignoring job losses while inflating job creation numbers.  Isn’t he doing the same thing by ignoring market stabilization and GDP growth? 

BEA Released GDP Data This Week 

According to the BEA, GDP is up for a number of reasons.  Look closely at the report.  Exports rose 14 percent over last quarter and consumer spending rose 3.4 percent.  Market Watch reported that positive numbers where in part due to stimulus spending, but as I argued in the past, these gains are only temporary.  The purpose of the stimulus is to stabilize the economy so that private markets can function again.  There is no wider conspiracy.  The government will roll back stimulus as soon as it sees the return of private investment.  There is evidence of this already: government spending actually slowed by 3.5 percent.

Not all the news was good.  Personal income fell and prices rose.  Hopefully this is a temporary trend based on slight price increases and high unemployment.  However, as long as export growth remains positive, I see no need to fear 70s style stagflation.  

Savings and Long-Term Growth

According to the old Solow Model, a country’s savings rate is positively related to long-term growth.  Today, personal savings is around five percent, that’s up from around one percent just four years ago.  This bodes well for long-term growth in the US.  And now is a great time to invest.  As private investment (including people’s savings) replaces public spending in the next few years, markets will rebound.  Private investment will power an upswing in the business cycle, spark growth and reduce unemployment. The sooner the government rolls back stimulus, the better.  In the mean time, citizens can take advantage of great opportunities in real estate and other deflated markets.  This transfer of savings from a stock to a flow will jump-start the economy in way no stimulus could.  It would take tens of trillions of dollars in government spending to match the power of private investors.

Thomas J. Powell

Death of Tax Credit Signals Return to Market Functionality

The new homebuyer tax credit expires at the end of next month.  Officials are considering extending the credit into next year to avoid destabilizing the housing markets.  The news today suggests that recent gains in residential real estate may be temporary.  I think they should pull the plug on the subsidy and let the market function without intervention.

According to Goldman, what good has come from the credit is only temporary.  They expect a five to ten percent decrease in prices when the credit expires.  The administration also admits a possible decline in prices.  The decision of whether to extend the credit depends on how much government intervention has aided recent stability.

Most people buying new homes would be buying now anyway.  The tax credit amounts to a transfer payment, with no real value added to the market.  At this point, the credit is either inflating prices or putting off an inevitable adjustment. Better to take the five percent hit now and let the market function as intended.  

The Washington Post argues that the credit has artificially inflated prices and hurt commercial real-estate markets by transferring cash to homebuyers.  It also argues, and I agree, that the credit exposes commercial real-estate to unfair competition.  When the credit expires, both markets will be equally attractive.  Low prices and low interest rates are enough to attract buyers in competitive markets.  We don’t need the artificial stimulus.

Thomas J. Powell

Reno’s ELP Capital Seeks OK for Investment Vehicles

BY JOHN SEELMEYER

ELP Capital Inc. of Reno seeks regulatory

approval for two investment funds that will

target well-heeled sophisticated individual

investors.

Thomas Powell, the chief executive officer

of ELP Capital Inc., says the funds mark an

effort to jump-start the northern Nevada economy

by channeling local investment dollars

into local projects.

The company last week filed a notice with

the U.S. Securities and Exchange Commission

that it believes the two funds are exempt from

securities regulations because they will be sold

to a limited number of investors or to buyers

who meet the SEC’s standards for accredited

investors. (Those standards include net worth

and annual income for individual investors.)

The ELP Strategic Asset Fund LLC has

raised $450,000 so far, the company said in an

SEC filing. There’s no maximum size on the

fund, and minimum investments are set at

$250,000.

A second fund, ELP Opportunity Fund 1—

GBLL LLC, is planned to raised $2.3 million.

So far, $100,000 has been raised.Minimum

investment in the fund is $50,000.

ELP Capital, incorporated in 2004, has

managed debt and equity financing of real

estate. The company traces its beginnings to

IntoHomes LLC, a residential mortgage lender

launched by Powell in 1999.

Along with Powell, its board includes Jesse

Haw, president of Hawco Properties of Spanish

Springs, and Bob Barone, chairman of Ancora

West Trust Co. in Reno.

Powell, who’s also an author of books and

articles, has argued recently that private

investors can play a major role in getting the

construction and development markets moving

again if they’ll fund stalled quality projects.

“This recession … left a stockpile of quality

real-estate projects to collect dust.Without

proper funding, the projects remain undeveloped,

unproductive and severely underemployed.

Placing our private capital into quality

projects will bolster the number of available

jobs in our communities and get people

behind a meaningful cause,” he wrote in an

essay this month.

ELP Capital expects to charge an annual

management fee of 1 percent of the funds’

assets, and it also may collect a performance

fee.

Along with the two investment funds, ELP

Capital last week filed SEC paperwork for

exempt offerings of securities in two real estate

funds.

One of the filings covers ELP Mortgage

Fund III — The Ridges LLC. The company

said $2.1 million of the $2.5 million fund has

been sold to accredited investors.

The second filing covered ELP Acquisition

Fund—Citi Centre LLC, which has raised

about $3.28 million of a $4.5 million offering.

Proceed with Caution

 It is now evident that this recession has uncovered a number of substantial flaws in our country’s financial industry. The now-exposed wounds became so complex that it took a meltdown of this size to identify them and it will take a long, sluggish recovery for them to heal. The majority of the flaws in our financial system hit individual investors the hardest. Faced with frauds, unclear loan agreements, mislabeled ratings and much more; individual investors have felt the pain and are now changing their behaviors in order to wisely navigate through this new investment jungle.

 In this new, heavily-battered playing field, I have seen one group of investors disguised as two vastly different types of investors. They appear to have swapped each other spots on the risk spectrum, but the groups are really one in the same. The first type is the group that fears more losses so much that they are persuaded to stay out of the game. The second is the group of investors that has been chasing risky investments in an attempt to quickly recoup the wealth they lost in the crash. Once this type of investor wins back their losses, they pull out and leave the game; joining the first type of investor on the sidelines. These groups share a trait that makes them more similar than different: They both fear the current market.

Emotion and speculation fueled many investors before the bust and will certainly again fuel the masses during the next boom. The tendency to chase easy money is in our hardwiring and it is a difficult force to resist. Now, as is the case immediately following any recession, investors are cautious. But, this caution should do more than lead to rampant mattress stuffing. Investors should now be more willing to seek the knowledge that will allow them to make more informed decisions. The bust knocked the wind out of the majority of individual investors. Many were forced into being cautious but all can use this new caution to their benefit.

Rather than abandon investing, now is the time to be fine tuning your investment strategy by getting back to the fundamentals. Rebalance your portfolio in a way that makes sense. Hold stocks in companies with good business models. Learn to make informed decisions. Demand transparency. Get in the habit of practicing prudent due diligence or search for an expert who you trust will. Instead of letting the fear of uncertainty keep you on the sidelines, analyze your risks, lower your uncertainty and reestablish your place on the field.

Unleashing Small Business Horsepower

Small businesses have historically been the force that pulls our country out of tough economic times. Their ability to work more efficiently allows them to find innovative ways that spur job creation. But, without being able to find available capital, small businesses are restrained. A full recovery will not take hold until small businesses have access to adequate capital. The mega businesses have been propped up by the government, but small businesses heavily rely on the private-capital investments that are currently lacking.   

Investing in small businesses has many advantages. From a business stance, while larger corporations have strayed from their original initiatives, small businesses usually have focused business plans that detail their near-future commitments. Yet, small businesses still tend to be more flexible, which is a huge advantage considering the amount of ideas that small businesses produce. Without flexibility and the willingness to take educated risks, their ideas would have no Petri dish in which to grow. Another advantage is that small businesses usually carry less debt than large corporations; which use debt as a primary ingredient in their financial engineering. Less debt equals fewer obligations, and this can translate into quicker returns for investors.

No matter how simple or complex a small-business investment appears, it is important to always keep in mind a few basics. First, invest in small businesses that have solid business models that you believe in. Just because a company has filed with the state to sell its securities does not mean that the investment will be a success. Businesses succeed because of vision and follow-through. Remember that “publicly-traded” does not necessarily mean “better.” Second, do not let an employee of a company convince you that an investment is not risky, that is a lie. Companies will often have securities salespeople who work on a commission. This does not mean they are automatically corrupt, it just means do not let their promises replace your due diligence. Plus, investments ALWAYS carry some level of risk. Which brings me to my last point: Always carry through with proper risk analysis. There are registered investment advisors, lawyers and other financial professionals that can help take the headache out of the process. Do not pinch pennies early on in the investment process only to be burned later by a flaw that a professional could have identified and corrected.

These are terrific times for investing in small businesses. There are countless opportunities to invest your capital in quality projects that will produce high returns. With credit not rushing like it did before the bust, business owners are actively searching for ways to acquire capital. Our recovery will continue to look and feel like a false hope until small businesses have the means to expand, create jobs and put people back to work.

Hanging on by a Home-Buyer Tax Credit

The $8,000 first-time homebuyer tax credit, included in the economic stimulus plan passed in February, is set to expire next month. The credit is widely touted as having given the stagnant housing industry its first sales jolt after a lengthy lull following the housing market’s implosion. Now, with legislation in recess, officials will be forced to scramble if they wish to extend the tax credit.

With a fast-approaching deadline of November 30^th, many in the real-estate and construction industries have their fingers crossed that an extension will be filed and keep buyers approaching the market. Last month, some groups, such as the National Association of Home Builders, even launched newspaper advertising campaigns pleading for the extension of the credit. Several members of Congress have either drafted bills or showed support for bills in favor of extending and expanding the home-buyer tax credit. U.S. Senator John Isakson (R-Ga.) introduced a bill that would extend the program through 2010 and increase the amount to $15,000. Also, Isakson’s version would be available to all homebuyers, regardless of current ownership status or income level (the current tax credit is limited to first timers who make under $75,000 annually).

Nearly everyone agrees that the residential housing industry has been using the first-time homebuyer tax credit as a crutch; and therefore has managed to stay on its feet. However, not everyone agrees the tax credit should be extended. While many experts worry how the housing industry will fair when the tax credit expires, they also agree that a true housing-market recovery will be delayed until natural economic forces replace government support. Outside of the tax credit, the government currently provides support to home buyers in multiple ways. While attempting to thaw the credit freeze, the Fed has kept the interest rate at or around zero. This encourages lending, which includes home mortgages. Also, the current tax code already shows great support for home ownership by providing incentives such as deducting the interest on your mortgage.

A number of senators have been criticized that they support an extension because it would favor their states heavily. While this may be true for those states that have been badly bruised by the housing implosion, an extension is likely to benefit real-estate markets across the country. The general consensus is that extending the tax credit would continue to encourage buyers to explore the market. But, passing an extension depends on Congress giving attention to the matter before the November 30^th deadline—for there is no shortage of higher-profile issues waiting to be addressed in September and October.  

 

All My Best,

Thomas J. Powell 

 

 

 

             

The Great Recession is not over

While Wall Street celebrates the apparent passing of systemic financial failure, there is a different reality on America’s streets. The Great Recession is not over. Millions of jobs have been lost, and most people’s incomes have fallen. So has America’s ability to consume and pay down debt. Because consumption is the most important component of GDP in America, without shoppers filling stores, production, income and job growth will remain weak.
A side effect of reduced incomes is falling prices. When consumers feel financially pinched, they become more frugal. Wariness to spend forces businesses to lower prices in an effort to entice shoppers. Rents, too, will continue to fall as massive home and commercial real estate supply compete for available renters.
For years, the answer to every income short fall was credit. Want some new $250 jeans – Charge it! Don’t have cash for the big ticket item? – Put it on an adjustable rate payment plan. Trillions of dollars were pulled out of homes as prices soared, with the money spent on improvements, trips, and a multitude of consumer goods. Now, this debt is coming due, and incomes are falling!
In short, the great boom of the last twenty years was a story of debt expansion. As long as credit kept growing, more money could be spent. Easy money created a multi decade spending boom, which created an illusion of affluence. But, the credit party is over. The only way out is to spend less and pay off debt. Unfortunately both society and our political process are in denial. History has shown that every debt bubble ends the same way – prices fall until existing incomes can support them. All of the debt spending in Washington only delays the inevitable deflationary pain, and that new debt weakens us as an international economic power.
To finish the story, lower income will, along with tight credit, push down a buyer’s ability to support high rents. Lower rents make real estate less enticing as an investment until the property prices fall far enough to align with the new lower rent levels. Here in Nevada, this saga continues.
On the bright side, many are rediscovering the simple things in life. Family and friends are more important than weekends in Las Vegas! Perhaps this reality check will bring us back to what made this country the greatest in the world, namely, hard work and entrepreneurship.
Matt Marcewicz
Robert Barone, Ph.D.
Robert Barone and Matt Marcewicz are Investment Advisor Representatives of Ancora West Advisors LLC an SEC Registered Investment Advisor. They are also a Registered Representatives of Ancora Securities, Inc. (Member FINRA/SIPC). Mr. Barone is a Principal of Ancora West Advisors and a Registered Principal of Ancora Securities.

Robert’s Blog

Cambridge AMDP Newsletter

Check out my recent entry in the AMDP Alumni Newsletter.
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Best Wishes,

Thomas J. Powell

Main Street Versus Wall Street

While Wall Street is celebrating an end to the recession, folks on Main Street know better. Jobs are still disappearing. It is widely acknowledged that America’s small businesses are the engine of job creation. So, the recession won’t end until small business expands. For this to happen, access to credit for working capital is essential.
We should all be disturbed, then, that our government has used trillions of our taxpayer dollars to save Wall Street while ignoring the financial institutions on Main Street who actually lend to small businesses (the community financial institutions). The number of troubled institutions on the FDIC’s list is now 416, mostly community institutions. With their insurance fund nearly depleted, it is a certainty that the FDIC will soon be using its Treasury line of credit. As long as they are now using our taxpayer money, shouldn’t these community institutions get the same treatment that the large Wall Street firms received (i.e., access to funds to shore up their capital bases until the recession ends)? Most of the troubled institutions are in the states hardest hit by the real estate bubble, i.e., AZ, CA, FL, and NV. Their assets are troubled, not because they made speculative bets on funny new financial instruments (like Wall Street did), but because their economies have tanked.
According to the Federal Reserve Bank of St. Louis, since TARP and other funds were given to the behemoths, business loans have declined every single month (Oct. ’08 through July ‘09). So much for the requirement that these folks increase loans to businesses. It appears that the TARP funds were either pocketed as unconscionable bonuses or went into shoring up the capital bases of these institutions that now prowl the countryside looking for takeover targets and requiring taxpayer participation in losses (the normal FDIC practice) when takeover occurs.
I have seen several in depth studies that indicate that today’s financial structure does not have the capacity to refinance the debt already out there that will be coming due in the next five years. Fortune 500 companies don’t have to worry because the now saved Wall Street banks will fund them. But, unless America’s community institutions get equal access to TARP, America’s small businesses won’t get the liquidity or credit they need to expand. So much for job creation!
The political party that now controls both Congress and the Presidency say they represent the “little guy”. So far, they have only aided the rich and greedy on Wall Street.

Guest Blogger,

Robert Barone, Ph.D.
Robert Barone is a Principal and an Investment Advisor Representative of Ancora West Advisors LLC an SEC Registered Investment Advisor. He is also a Registered Representative and a Registered Principal of Ancora Securities, Inc. (Member FINRA/SIPC).

Robert’s Blog

Too Big To Learn

With a bad habit of ignoring profound systemic problems, Federal Treasury officials are now securing a system that encourages the same careless risk-taking that originally got us into this mess. With this week marking the one-year anniversary since Lehman Brothers imploded, it is only appropriate to discuss the faulty system that protects and rewards failing financial institutions.
The talking heads in charge of the world’s financial practices are on path to deliver more of the pain and suffering we have been experiencing over the past 20 plus months. The Lehman Brothers’ collapse last year showed us how brutal a large bank failure can be. Now, because of the mess caused by Lehman’s demise, it is unlikely that our government would again allow an institution of similar size to fail. This essentially gives big banks a free pass to misbehave. If you owned a business that was referred to as “too big to fail,” and you knew the government would do all they could to keep your doors open, would you not be inclined to take risks? It is like giving a six year old the keys to a candy factory and a set of cavity-resistant teeth. All risk is stripped away, so why not have some fun?
By receiving government funds, big banks are allowed to carelessly take on high degrees of risk, knowing that there is a safety net underneath them. This recession has been gut-wrenching. It has badly battered our economy and exposed wounds that will not heal in our lifetimes. No one wants to experience a downturn of this size again. But, if officials continue to foster an environment that rewards carelessness by major financial institutions, we will inevitably get more rounds of the same. While we should be demanding big banks to practice prudent due diligence, we are instead enabling them to write off any level of accountability. This recession should have been a major wake-up call for all businesses, but those institutions deemed “too big to fail” have also been allowed to be “too big to learn.”

Top Five of the Bad, Bottom Five of the Good

Ravaged by the bursting of the real estate bubble, Nevada is among the states with the deepest wounds. Historically, our state has been in the top or bottom five of the most-unappealing statistically-compiled lists put out by major media. Unfavorable, sure, but we all choose to live here for one good reason or another. For instance, our tax structure keeps Nevada among the most business-friendly states in the country. For this reason, we have highly-competitive local markets and capitalism thrives here. Our state officials are somewhat handcuffed because of our demand to keep government out of our businesses as much as possible. By adopting and supporting this system, Nevadans have agreed to take on more personal responsibility when it comes to providing our own financial security—and we are now being put to the test.
Across our country, state officials are scrambling for ideas that will simultaneously better their state’s situation and put them in the position of being quality leaders. In Nevada, our elected officials have considered bringing in a pricey third-party consultant to advise them on how to progress the state. This means not only are the individuals we put in office to make vital decisions not carrying out their duty, but now we will also foot the bill for a new position. We elected these authorities to represent us; not lead us, by way of expensive consultation, in an undesirable direction. With that said, when we elect them we do not, in turn, remove ourselves from the equation. We are not reduced to waiting on our state leaders to be proactive.
These are extremely trying times for our country. The recovery is going to be led by us via our private capital and our private enterprise. The government does not have a weapon in its repertoire that comes close to matching the power of our collective private resources. Across the U.S., and particularly in our state, there is an abundant supply of quality projects that have been postponed due to insufficient capital. Because success requires both money and knowledge, every successful idea struggles with acquiring adequate funding at least once throughout the process. Every successful venture has to be properly backed and the majority of the backing comes from private capital. At the end of the day we, the people, are the engine that runs our country.
Nevada is riddled with quality projects that could be going forward with proper capital and qualified management. We now have to be proactive in matching the two. Being among the top five states in the country in foreclosures, troubled institutions and bank closures does not mean we cannot also be among the top five states to emerge from this recession.

Survival of the Government-Backed Banks

Even the banks that did not become entangled in the shaky investment strategies of Wall Street during the boom still indirectly had their knees taken out from beneath them throughout this meltdown. According to CNBC.com, 92 banks have failed in the U.S. through the first nine months of 2009; including three here in Nevada. As a comparison, in all of 2008 only 25 banks closed.
In any meltdown, the government’s focus is on the big banks that have the potential to buckle our country’s financial system if they go under. But, that focus leads to a distinct advantage for big banks over their competition. Having government support allows the bigger banks the power to go out and collect the majority of the available capital, while smaller banks are forced to scavenge. This crisis has presented terrible obstacles for banks to raise the capital lifeblood needed to remain in business. Without liquid capital, smaller banks are consumed by their debts. With losses on commercial real-estate loans rising, the smaller banks that feed credit into our communities are drowning.
When governments support the behemoth banks and allow the smaller banks to sink, they essentially help eliminate the competition needed to improve our financial system. Without intervention, smaller banks are generally able to pose a competitive threat to the large firms because they are more apt to find ways to be faster, smarter and more strategic. It has always been a staple in American capitalism to save a place in our economy for smaller businesses because they push against the bigger corporations and keep them honest.
Competition in the banking industry leads to a financial system that operates more efficiently. By helping to eliminate competition, our government is essentially allowing the largest banks to monopolize the industry. By supporting the large and abandoning the small, our government is positioning us to face a much weaker economic recovery than if the innovative smaller firms were allowed to compete fairly. We are essentially heading in the same direction as Europe, which has long had its bank assets heavily concentrated in massive firms. The tactic may make it easier for governments to regulate financial systems, but it also eliminates the capitalistic nature that has made our banking industry the strongest in the world.

NEXT WEEK: Banks as Intermediaries

All my best,

Thomas J Powell