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At Arm's Length: 09.28.05

Without reform to the Alternative Minimum Tax, any discussion about making the 2001 tax cuts permanent would not only be misguided but sad to say, typically Bush.

The full article

Today's Commentary: 09.26.05
The High Cost of Renting Money

I remember when the thought of borrowing money was a way to build credit and eventually participate in the American dream. Those naive moments have given way to an economy that embraces borrowing as if it were a constitutional right. But if you listen closely, several top banking officials want that easy access to money replaced with a tighter, more realistic approach to lending.

We have taken borrowing to an extreme, using not only our credit cards but our homes as ready sources of cash. That cash has kept the economy going for the last several years as lenders turned contortionists put more house in the hands of fewer qualified applicants. The net result of these lending practices has been higher risk on both sides of the transaction.

Greenspan can see it. The Office of the Comptroller for the Currency sees it. Why then, can't the rest of us see this approaching economic storm?

Last week, for the eleventh predictable time, Alan Greenspan raised the short term overnight rate. We expected it as a foregone conclusion and seemed to absorb it as if - and I love this next term - the market had already priced it in. That barely noticeable move in the face of another hurricane bearing done on the Gulf Coast took guts. Not moxy or savvy, just fly-in-the-face of reasoning gumption.

Fortunately, Hurricane Rita was not as bad a catastrophy as it was predicted to be. The cost of the storm will still be there, but the damage that was generally assumed would occur did not which allowed most of the fuel consumers in this country, which happens to be every last one of us in some way, shape or form, to breathe a sigh of relief.

The increase in interest rates is not firmly attributed to the Fed chiefs unarticulated worry about housing. We, however, know better. It seems as if the housing market has slowed somewhat as reports of doubled and redoubled material costs have given new home buyers reason to pause and remodelers to reconsider. Katrina and Rita are simply backdrops to the approaching storm and Greenspan knows this better than most.

The steadily rising interest rate has the net effect of adding to the consumer's growing basket of worries. Fuel prices and the speculation of future costs for that commodity has forced Dick and Jane Consumer to evaluate those costs and recalculate their budgets to absorb it. Now they may be faced with a new problem.

If Dick and Jane suffer from one fault, it is the misguided belief that they will always be able to hold onto their home no matter what. That "no matter what" may be coming due and this has Julie Williams of the OCC more than just a little concerned.

Now for those of you do not know who Julie is, she is the chief counsel for the Treasury Department's Office of the Comptroller of the Currency and the first senior deputy comptroller. It's okay to admit that you didn't even know such a job existed.

Ms. Williams made a speech recently that included some of the regulatory agency's concern about the banking system and how the agency feels about their role in the system. As much as she would like to keep the "unnecessary regulatory burdens" out of the system, she suggested that her agency should shoulder the responsibility to "protect safety and soundness, foster the integrity of bank operations, safeguard the interest of consumers, and do not impose regulatory burdens that exceed what is necessary to achieve those goals, and thereby act as a drag on our banks' efficiency and competitiveness." Those lofty ideals however are going to be very difficult to achieve let alone do it without changing a banking system prone to giving the consumer what they want even if they can't afford it.

And herein lies the clouds on the horizon that Wall Street has been ignoring.

Beneath the surface, her testimony before the House Committee on Financial Services on Regulatory Relief and Support to Katrina Recovery Efforts sought to find a way to address the amount of loans outstanding and the chances that the bank will never, nor do the expect to, collect on the loan. In other words, far too many banks are collecting interest only without ever hoping to get the principal back.

Folks are renting money on the backs of their homes that our old buddy Alan Greenspan feels are overpriced. His strategy for fixing this problem is to keep raising interest rates. That should bring those prices down as the cost of borrowing increases. If homes become less expensive because demand falls due to lack of money to borrow, the events that follow will have al of the elements of the perfect economic storm. But there is still money to borrow, you might say. It just has become more expensive to use. And you would be right.

Even though Mr. Greenspan's rate hikes have not been proven to affect the housing markets - they are, after all short term in nature - it is his hope that lenders will take notice of the message those increases are sending. So far, banks and lenders have turned a deaf ear to his muted warnings.

Banks have a problem, as Ms. Williams points out, and it lies in their exposure to too many risky loans, many of which are often and lovingly referred to as creative. The health of the bank is at risk because of these lending practices should home prices fall. Their customers will be faced with reverse amortization or the sudden realization that their so-called investment is worth less than the loan amount. The result of such knowledge could cause folks to default on those loans, sell, or move into a rental. Unable to afford to repay the oversized mortgages, the consumer could pull back dramatically.

Renting money presumes that we are a mobile society of borrowers, able to hunt for the better deal and secure it with high priced assets. What happens when those days end?

It leaves the average investor only one option to fix two unsavory problems. Consumers who expect to ride out this storm should be considering a lock on their home loans, fixed to a specific time period. This will not only promote good financial health for the borrower but will, by default allow the banks to improve their infrastructure by making the assumption that they may actually get their money back - with interest. Shoring up the books would be a great way of avoiding a potential disaster in the banking business. The economy will take a hit but it will be a good deal softer than the one that these two bankers think are quietly predicting could happen should these lending practices continue.

BlueMoney Report

The Blue Money Report
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