From The Fed:

Information received since the Federal Open Market Committee met in April indicates that the economic recovery is continuing at a moderate pace, though somewhat more slowly than the Committee had expected.  Also, recent labor market indicators have been weaker than anticipated. The slower pace of the recovery reflects in part factors that are likely to be temporary, including the damping effect of higher food and energy prices on consumer purchasing power and spending as well as supply chain disruptions associated with the tragic events in Japan. Household spending and business investment in equipment and software continue to expand.  However, investment in nonresidential structures is still weak, and the housing sector continues to be depressed. Inflation has picked up in recent months, mainly reflecting higher prices for some commodities and imported goods, as well as the recent supply chain disruptions. However, longer-term inflation expectations have remained stable.

…

The Committee will complete its purchases of $600 billion of longer-term Treasury securities by the end of this month…

5 Things You Need to Know About The Fed and Real Estate

1. The Fed, always the optimist.

Information received since the Federal Open Market Committee met in April indicates that the economic recovery is continuing at a moderate pace, though somewhat more slowly than the Committee had expected.

This is nothing new. In fact, the pretty much always happens. Barry Ritholtz adds:

The sooner we recognize that the field of economics is a branch of Sociology and not Mathematics, the better off we will all be.

Federal Reserve Economic Forecast, January 2008

Why the heck are the “experts” so bad at seeing what seems so clear to the rest of us? Consider The Arrogance of Economics.

Where before economists were skeptical, they became blindly accepting, rationalizing the whole of bubbles and booms by the fact that smart and rational people were engineering the parts. Because the parts are logical, then the whole must be correct, regardless of how unsustainable it may seem.

Economists and policy-makers saw the housing and credit bubbles forming, saw the same things that the skeptics were blogging about, but chose to ignore them. It was economic religion instead of economic science. Bubbles formed by rational parts couldn’t be bubbles, so said their text books.

Arrogantly, they gave more weight to their self-formulated theories than the slap-you-in-the-face, obvious events that were unfolding on their watch. It wasn’t that the bubble bloggers were smarter than professional economists, but that they weren’t brainwashed by academic theory.

2. QE2 will end in June. Will there be a QE3?

QE2 consisted of The Fed buying $600 Billion of securities, effectively injecting new money into the financial system and lowering interest rates. The results: a stock market up 30% or so and mortgage rates at 4.5%. The problems: when the $600 goes away, the stock market will probably go back to where it was and mortgage rates will pop back to the mid-5 percent range. No more refi’s and, yes, none of this is good for home prices.

Our economy is not at all healthy. And while The Fed reiterates that it will end QE2 at the end of this month, it is hard to believe that there won’t be a QE3 waiting in the wings.

Tim Iacono shares this must-watch video of Jim Grant :

The Fed has two edicts – it’s meant to promote full employment and stable prices. This business about levitating stock prices is something new and I think it’s a quite dangerous thing. How are we to know that this 30 percent gain in the Russell and 20 percent gain in Dow since the Chairman spoke in August of last year … how are we to know these are real values. The prices are up, but are people who are buying these stocks on the back of the Fed, are they doing something that is wise and considered from an investment point of view? An if the market is too high because the Fed has put it there, what does the Fed do when the market comes down, which I think opens the gate for QE3.

Richard Koo adds:

I suspect that initially the Fed intended to discontinue QE2 as the economy gradually recovered, but was forced to reconsider after the gloomy jobs report released at the beginning of June. With the usual macroeconomic monetary measures proven to be ineffective, the Fed now needs to come up with new microeconomic policies for the post-QE2 era. Here it all depends on the kinds of ideas that emerge. In this area, it will not be surprising if the Fed begins providing assistance to smaller financial institutions, which it has been concerned about for some time.

3. Interest rates aren’t going up much any time soon.

However, longer-term inflation expectations have remained stable.

Inflationistas shout from the mountain-tops that all of the money-printing shenanigans of the last few years are going to lead to high inflation. People are buying gold and even homes as a hedge. Actually, most probably just use inflation as an excuse to buy a house they wanted anyway…

The problem is that inflation isn’t prices, it’s an expansion of the money supply, which includes debt. Prices are merely a symptom of money supply.

Simply put, as much debt is being destroyed, through foreclosure, bankruptcy, and write-downs, as new money is being created. We’re borderline deflation. The Fed knows this, but the word “deflation” wrongly-scares the heck out of people. Instead, we’ve heard a lot about “disinflation” lately.

The truth is that deflation isn’t necessarily a bad thing. In fact, for most Americans, it would be a great thing because their money would go further.

The point is this: at some point, we’re bound to end up in a high-inflation environment, but don’t make your real estate decisions out of inflation fears just yet.

4. TARP, HAMP, and foreclosure prevention: if we end up in the same place was it worth it?

Though the TARP money is mostly getting paid back, not much of it was ever went to achieve it’s intended goal: lending to businesses and consumers. And HAMP…well…the 700,000 permanent mods aren’t bad, but they are well short of the 3-4 million original goal.

What worries me more is that, of those 700,000 permanent mods, how many homeowners will walk away anyway if the value of their home keeps falling? Or end up as short sales? It’s far too early to suggest that HAMP “saved” 700,000 homes. For many, it just delayed the inevitable.

Actually, more than anything else it helped banks squeeze a few more payments out of people they were going to foreclose on anyway.

Diana Olick shares some recent foreclosure stats:

And then there’s this other report from Lender Processing Services (LPS), which also reports a drop in newly delinquent loans, but gives the actual, mind-numbing numbers of loans in trouble:

• Number of properties that are 30+ days past due, but not in foreclosure: (A) 4,187,000
• Number of properties that are 90+ days delinquent, but not in foreclosure: 1,921,000
• Number of properties in foreclosure pre-sale inventory: (B) 2,164,000
• Number of properties that are 30+ days delinquent or in foreclosure: (A+B) 6,350,000

There are more than six million properties in distress, a third of those in foreclosure. According to yesterday’s monthly home sales report from the National Association of Realtors, less than five million homes will sell this year, at the current sales pace. There are currently 3.72 million existing homes for sale, representing a 9.3 months supply; that does not include newly built homes nor does it include that six million number.

TARP, HAMP, and the other foreclosure-prevention programs simply kicked the can down the road. But now we’ve caught up to it again. So was it worth it?

The shadow inventory of foreclosures is simply too large to absorb. If all of these homes are allowed to come to market, home prices and the entire economy would crash quickly. The Fed, Treasury, and the rest will do everything they can to prevent this from happening.

Expect more acronyms to be created in the second-half of 2011.

5. Why 2011 is worse than 2008

In 2008, The Fed suggested we were in a liquidity crisis: not enough lending and debt. But while debt can grease the economy’s wheels, too much of it will destroy the engine. It isn’t a liquidity crisis, but a solvency crisis. Governments, corporations, and households have too much debt and not enough real assets.

If too much debt is the problem, more debt isn’t the answer. Though it can postpone the day of reckoning…

Minyan Peter explains:

Losses must be taken, and as I have written before; it is now all about the re-syndication of that loss and with whom the burden is shared.

And therein lies the real problem to this 2008 Redux. At the risk of over-simplicity, 2008 was a national banking crisis with international implications. The burden was principally shared among U.S. financial institutions (their creditors and shareholders) and U.S. taxpayers. And while historians will forever debate the outcome, a very small group of national leaders made decisions based on what they believed was in the best interest of their country.

In contrast, 2011 is a developed-nation sovereign debt crisis with pronounced global implications; and the complexity of the burden-sharing decision-making process is far greater than anything we have witnessed in our lifetime.

Losses will be shared across sovereign borders, public and private sector boundaries, national and supra-national divisions and social strata. And that is just at a primary level. As this week’s headlines reveal, investors are just beginning to grasp the enormity of the second derivative impacts (for example, money funds and municipal bonds). And I’d offer that those are just the most obvious. Wait until people start to wonder what all that “cash” on corporate balance sheets really is (and might I suggest where it is) or how Tier 1 Capital is impacted by deteriorating sovereign debt ratings.

In other words, The Fed, The Treasury, The ECB, and others could hold the markets together in 2008. Today, our problems are much more complex and global. There may simply be nothing else The Fed can do.

Think about this: over the next few months, we have QE2 ending and the conforming loan limit dropping. Unemployment isn’t getting better, especially with all of the cities, counties, and states that have yet to make their needed cuts. And, the existing foreclosure-prevention programs have largely run their course, succeeded really only in delaying the inevitable.

And, home prices are already falling again.

Oh yeah.. and Ireland, Greece, Spain, Portugal, Italy, Russia, and more are on the verge of default, which would make the financial crisis of 2008 look easy.

The waters are choppy. The real estate markets in 2012 and 2013 – what will happen to the price of your home – depend greatly upon how Ben Bernanke and crew navigate through the next 6 months.

But before we get there, two quick things. I want to really show my strong appreciation for the work done by my co-hosts, Altegris Investments, at the 8^th annual Strategic Investment Conference. We had a packed house with almost 500 people come to see what I think was the best line-up at an investment conference this year. Each year we say there is no way to get any better, and each year we somehow manage to do so. And that is due in no small part to the considerable effort of the team at Altegris. I am proud to be associated with them. This year we did video many of the speakers and panels, and over time we will figure out how to make some of this available. I will keep you posted.

Enemy of Spain

Second, Endgame continues to do well, so thanks to those who have purchased it, and if you haven’t already got your copy you should go to www.amazon.com and do so! And quick kudos to my co-author, Jonathan Tepper, brilliant young Rhodes scholar and head analyst at Variant Perception. Apparently, he’s on a small but prestigious list of enemies of Spain, according to El Mundo, one of the biggest Spanish newspapers, for the sin of pointing out that Spain is in a crisis (we have a whole chapter on Spain on the book). Their article appeared in print in the weekly finance edition, but is not online. Other papers have been called by government officials and asked not to quote him. Oddly, the people who helped inflate the enormous construction bubble and the incompetent government officials who denied for years there were any problems are not enemies of Spain. Go figure. I guess if you have to be on an enemies list, you could do worse than Spain (where, oddly enough, Jonathan spent most of his childhood growing up in a drug-rehab facility). Congratulations, young man! (Oh, and a publisher in Korea picked up the Endgame Korean-language rights, so we will soon be in bookstores in Seoul.)

And now to the second part of the Endgame. And for those who want to review the first part, you can read it here.

The Endgame, Part 2

There is an argument that the US should pursue a strong growth and jobs policy as its #1 goal and that growth, along with spending cuts and/or tax increases (depending on your views), will bring us out of the current doldrums and help us solve the budget deficit. I set the table in both the book and last week’s letter that the US is going to be growth challenged for years to come. Let me review a few items in brief and add a few more, then we will get to my predictions of what the next five years will look like. Don’t jump ahead. Without understanding the elements that are lining up to retard growth, the forecast will not make much sense.

First, job #1 MUST be to reduce the deficit below the nominal growth rate of GDP. Period. The level of debt threatens to overwhelm everything else, and at some point can produce a crisis like those evolving in Europe and Japan. I have outlined the reasons for this in depth, so here I merely make the assertion.

As I explained at length, if you increase government spending it will increase GDP IN THE SHORT TERM. The economic literature suggests this effect lasts about 4-5 quarters. Further, tax cuts will produce a growth in GDP of roughly 1 to 3 times the total amount of the cut over the next few years (depending on whose research you read, but the consensus is clearly that tax cuts make a difference). It sadly follows that increasing taxes will have a negative effect of roughly the same amount.

Now, basic economic accounting shows that if you reduce government spending you are going to reduce GDP over the short term by a rough equivalent (GDP = Consumption (C) + Investments (I) + Government Spending (G) + (Net exports)).

Therefore, the first headwind to economic growth over the next five years is the reduction of the deficit. While there is a longer-term difference between tax cuts and tax increases, in the short term (4-5 quarters) there is a simple drag effect. And we are going to need to cut government spending by about 1.5% of GDP per year every year for five years (allowing for some growth) to get the deficit to a manageable level.

Below is a chart I used last week that is from my friend Rob Arnott at Research Affiliates (and to whose annual conference I am flying to as I write this letter), but it bears looking at again. The chart needs a little set-up. It shows the contribution of the private sector and the public sector to GDP. Remember, the C in the equation is private and business consumption. The G is government. And G makes up a rather large portion of overall GDP.

The top line (in dark blue) is real GDP per capita. The next line (yellow) shows what GDP would have been without borrowing. So a very real portion of GDP the last few years has come from government debt. Now, the green line below that is private sector GDP. This is sad, because it shows that the private sector, per capita, is roughly where it was in 1998. The growth of the “economy” has come from government spending. Private-sector spending is where it was almost 13 years ago, accompanied by no growth in median real income and no growth since 2000 in the actual number of jobs, even as population grew by 30 million.

As we bring government spending down, unless it is accompanied by private-sector growth, we will see overall real GDP shrink. That is just the how it works. Now, in the fullness of time (or a few years), the smaller government expenditures and deficit will mean more money for private-sector investment and productivity growth, but the process of simply getting the deficit under control is going to mean slower growth. Wrap your head around that. While Republicans (including me) want to control Congress and the presidency in 2012, the policy choices made in 2013 will not be met with a robust return to 4% growth and immediate jumps in employment levels. It is going to take a lot of education to convince voters that there is no magic in spending cuts (or even tax increases) and that we will need to stay the course, even while there is a general malaise in the economy. My advice to my fellow Republicans? Do not sell the concept that voting Republican will provide a quick fix. It will get you slaughtered in 2014. More on why below, in the conclusions.

Let’s quickly list other headwinds.

· The next headwind we will face, in 2012, is a tax increase of about 2% for almost everyone, as we lose the reduction in Social Security taxes that was passed to 2011 as part of the Bush tax cut extension. This means less money in the pockets of everyone making below about $100,000, which is significant in terms of the drag on GDP.

· The stimulus package of 2009 is fading from view. There is little reason to think any of it will come back. Look at that graph again and see how much worse GDP would have been without it. But for all that, we are watching growth soften of late, with the economy now down to 1.8%. We didn’t get the organic growth in the economy that the Keynesians promised. Where is that multiplier effect? It actually seemed to be a negative multiplier, which Austrian economics suggested it would be. Score one for von Mises and Hayek.

· QE2 is stopping in June. The hope at the Fed is that the economy can take over from there. But the last time QE was stopped, in 2010, the results were not impressive; and now we can look across the pond to England to see what is happening as they are about 6 months further along in their ending of QE. It is hard to get encouraged from the data, as it looks like growth in England has slowed. And the real effects of their new austerity pursuits have not really been felt. Can the Fed start up again? Or more apropos might be the question, “Will the Fed start another round of QE?” My answer is that, when they see the economy slip into recession, they will use the only real tool they have left, and that is to inject liquidity into the economy.

· A McKinsey study on the aftereffects of debt crises (in numerous countries) that require deleveraging in one form or another, is that for the first two years there is a significant slowing of GDP, and the slower growth does not dissipate for 4-6 years. We have not started deleveraging as a nation. The real work now looks like it will be done in 2013; and thus the real pain, the study suggests, is in our future.

· Unemployment is back at 9%, rising this morning another 0.2%. The real level is easily above 10% if you count people who were in the work force as recently as 2008. Five percent of the nation’s workers are not paying income, Social Security or Medicare taxes. Many of them are on food stamps and unemployment, which are driving deficits at the federal and state levels higher. It is hard to imagine a robust economy that does not somehow figure out how to drive the unemployment level down, yet economic growth of 3% or more is required. We are simply not there.

· I noted above that private-sector jobs have gone nowhere for 11 years. But transfer payments as a percentage of private-sector income and wages have risen inexorably for the past 50 years. Below is a chart from Madeline Schnapp, the chief economist of Trimtabs. Let me quote from the email she sent me along with the chart:

“Here is the graph which generated a HUGE amount of controversy when published awhile back. For lack of a better term, I called the ratio the “TrimTabs Dependency Ratio.” What it is, using BEA data, is a ratio of ‘BEA’s government social benefits to persons’ divided by ‘BEA’s wages and salaries.’

“While wages and salaries are about 50% of total personal income (other sources of personal income are benefits, interest, dividends, etc.), it is the largest bucket of income that produces revenue for the government via our tax structure. Therefore wages and salaries are currently the engine of support for the government’s social programs.

“FYI, the BEA’s definition of government ‘Social Benefits to Persons’ includes Social Security, Medicare, Medicaid (the biggies), unemployment insurance, supplemental nutrition (SNAP, formerly food stamps), veteran’s benefits, etc.

“For the ratio to go back to something sustainable, e.g. 20%, either wages and salaries need to rise, benefits need to be trimmed, or taxes need to go up.

“Be careful not to confuse ratio with proportion. In this chart, I am comparing the size of one thing to the size of another (backpacker analogy); it is not a proportion, e.g. one thing as a part of another.

“Another useful analogy is:

“There is the engine (wages and salaries) pulling rail cars up a hill. In those cars are the Defense Department, the EPA, government social benefits to persons, etc. Since 1960, the size of the social benefits rail car has grown from 10% the size of the engine, to now 35%. The ‘Little Engine that Could’ is rapidly becoming the ‘Little Engine that Couldn’t.’”

· I showed two charts and research last week that clearly demonstrates that at some point the size of government becomes a drag on the economy. That may seem contradictory to my first point in this letter (reducing government spending will reduce GDP), but it is not. The first point was a short-term effect, and the size of government is a longer-term effect. We now have a government that is too large, and it acts as a headwind to growth.

· The research of Rogoff and Reinhart clearly shows that, as the debt-to-GDP level of a country approaches 90%, there seems to be a slowing of potential GDP growth by about 1%. This is an observation of the data, not a theory. And this graph from David Walker suggests we are getting there. Notice it does not include state and local debt, which it should. We are very close to this level, if not there already.

Muddle Through, or Crisis?

Betting against the power of the free-market economy in the US is generally a bad idea. Yet when I suggested back in 2003 that we would see a slow-growth Muddle Through Economy for the remainder of the decade, it turns out I was right. We only grew at 1.9% last decade, which was the worst performance since the Depression. Ugh.

So where are we for the next five years?

I think we have two choices as a country. We can elect to deal with the deficit proactively, or wait until there is a crisis and react. And make no mistake, there is a an approaching Endgame, with regard to how much debt the market will let us have. We don’t know that point now, but if it happens it will be quite a “surprise!”

What happens if we make the choice to get the deficit under control? What that really means is that we have to decide how much health care we want and how we want to pay for it. Let’s forget for the moment how that happens. Let’s just be optimistic and say we do make those decisions.

For me, that is the best-case scenario. But it means a slow-growth, Muddle Through Economy for quite some time, perhaps as long as 5-6 years, though getting better as time goes on. It also means it is highly likely we will have at least one recession during that period, as growth will be close to “stall speed” and any exogenous shock could tip us into recession. Recessions mean higher unemployment, lower tax revenues, and an even deeper hole that will require more fiscal discipline and work. It will make maintaining corporate earnings growth at today’s expected levels more difficult, which puts a headwind to the US-based equity markets. Of course, a recession will mean (on average) a 40% retrenchment of US equities. It will also mean another deflation scare and a likely QE3. Bernanke can bring back and polish his “helicopter” speech, but this time he will be able to tell us what happened.

Then there is the crisis scenario. Let’s assume we do not deal with the deficit in any meaningful way. Eventually the debt will rise to epic, Greek proportions. The bond vigilantes arise from the dead and start to push up interest rates. Interest as a percentage of government spending rises, crowding out other government expenses or increasing the debt still further.

Then we have a crisis. We are FORCED by the bond market to get the deficits under control, but now we are doing so in a crisis. Health care will have to be slashed by far more than it would in a more controlled scenario. Tax increases will be brutal. You think Social Security is untouchable? Not in this crisis world. Means testing and spending freezes will be the rule of the day. Military cuts will seem draconian. Our allies who depend on us for a defense shield will not be happy. Education? On the chopping block. The economy will not be Muddle Through, but Depression 2.0. Unemployment will go north of 15%.

What’s my basis for this? History. This movie has played over and over again in various countries in modern history. While we may be the world’s superpower, we are not immune from the laws of economic reality.

In such a scenario, I expect QE 3-4-5-6. Could the Fed literally monetize the debt and then “poof” it? When our backa are against the wall, don’t assume that what has been seen as normal will be the reigning paradigm.

Let me jump out on a real limb. I was having dinner last Monday with Christian Menegatti, the #2 economist at friend Nouriel Roubini’s economic analysis shop. We were comparing notes (imagine that), and he said their opinion is that the US has until 2015 before the bond market really calls the deficit hand. Knowing that Nouriel is seen as the ultimate bear, it makes me nervous to put out my own even more bearish analysis.

I think the crucial point will be reached in late 2013. If the bond market sees a serious move to control the deficit, I think they let us “skate.” Then we Muddle Through. But if not, I think we begin to see some real push-back on rates then.

Why so early? Because bond investors are going to be watching the slow-motion train wreck that is happening in Europe and especially Japan. It is one thing for Greece to default (which they will in one form or another, with lots of rumors flying this morning), yet another for Japan to do so. Japan is big and makes a difference. Japan could start to go as early as the middle of 2013. As I have said, Japan is a bug in search of a windshield. Whenever this happens, 2013 or a year or so later, it is going to spook the bond market. The normal indulgence that a superpower and reserve-currency country would be accorded will become much more strained. It will seemingly happen overnight. Think Lehman Brothers on steroids.

I think the chances we will deal with this potential crisis are about 75%. Not doing so is such a horrific outcome that I think politicians will do the right thing. See, I am an optimist. (What was it Winston Churchill said? “You can always depend on the Americans to do the right thing, after they have exhausted all the other possibilities.”)

And let me note that I have had some rather at-length, high-level (but very off-the-record) discussions with politicians on the right in recent weeks. More and more of them are really getting it. But as one said to me, “John, I can’t run on that platform.” And that is the reason that I give it a 25% chance that we’ll wait until a crisis hits us. If the “good guys” (my view, not yours, gentle reader – I know many of you are of the more liberal persuasion) need a real push to act correctly, we are not in good shape.

I totally recognize it will not be easy to fix it. It will probably mean tax increases, which will not be good for the economy. And spending cuts that will be painful. I get all the consequences. I have written about them. But the goal is to get rid of the cancer of the deficit. It could truly destroy our economic body. Sometimes, if you have cancer, you take very ugly chemicals into your body, which have very serious side effects. The prospect does not make me happy at all, but we have made bad choices as a country for decades, and now we have to pay the price.

Just a few more thoughts. Republicans should demand a total restructuring of the tax code in return for any tax increase. I would opt for lower corporate rates to help make us competitive (say 10-15%) and include all foreign corporate income, and get rid of the mass of exemptions. Lower personal rates and a consumption tax would suit me just fine, as both an economist and a businessman; but I know that’s not some people’s cup of tea. Just saying. I like David’s Walker’s thoughts about $3 of spending cuts for every $1 of tax increases. And can we get rid of some of the “tax expenditures,” like mortgage interest deductions? We all pay 4% in income tax so that a minority can have interest-rate deductions. (I have written about efforts we need to undertake that would more than offset any hit to real estate.) At least reduce it for mortgages over $1 million. If you can afford a mortgage that big, you don’t need the deduction.

Every one of those tax expenditures is someone’s else tax break that is vital to the future of the Republic, but if we got rid of all tax expenditures in one massive move (or over time) we could simplify the tax code and come within a few hundred billion of balancing the budget. Walker says the breaks total $1.2 billion. Basically, these are goodies that Congress hands out to get votes. Get rid of them all, I say. It will be politically difficult, but we need drastic action.

And I might suggest that Democrats should come to the table this year rather than waiting until 2013. If unemployment is north of 8% next election, as I think likely, you will lose more seats and (probably) the White House, given today’s polls. Why not negotiate now when you have the Senate and can get what you can? Maybe “my guys” are being obstinate, but the sooner we do this the sooner we get through it.

And that is my point. We do get through it, either as adults or forced to do so by the bond market. One way or another, by the latter part of this decade, in the fullness of time, this too shall pass.

The eternal optimist in me wants to quickly point out that neither scenario is the end of the world. Yes, we may have to tighten our belts, some more than others, but life goes on. We all figure out our own paths. While investing has been more difficult the last five years, we are all still alive, celebrating birthdays and grandchildren. New businesses that will dramatically change our lives are being formed every day. There are lots of opportunities for business and investment, perhaps just not the traditional ones we are used to. Maybe gold goes to $5,000, but I hope it goes to $500. Either way I will still buy some physical gold every month as insurance, with the dream that I’ll give it to my great-great grandchildren as a novelty from the days when we thought gold had value. But I will still buy, just in case. I simply don’t completely or naively trust the &*%@^&’s who are running the place.

Seriously, I expect that, beginning later this decade we will see the secular bear crawl back into hibernation and a roaring secular bull market cycle come charging out. We will all get to once again be geniuses.

The book I am starting to write this month (finally!) will be called The Millennium Wave, in which we’ll look at what our world may be in 2032. The journey there will be bumpy, but what a world it will be! So, over the next few months and quarters, we will keep our eye on the politicians and see what happens. I will be looking for good hedges and places to invest that don’t depend on Washington DC or the other capitals of the world. And I will keep on writing to you, gentle reader, every week.

Last thought: I encourage you to get involved in the process in whatever way you deem correct. This is going to be the most important national conversation we have had in a long time, and you should be a part of it. Make your voice and vote count!

Philadelphia, Boston, Trequanda, Kiev, Geneva, and London

I am in Laguna Beach at the Montage this afternoon for Rob Arnott’s annual client conference. He has an outstanding lineup of speakers: Lacy Hunt, Jim Bianco, Professors Burton Malkiel of Princeton and Nobel laureate Harry Markowitz, along with Rob and his associate Jason Hsu. They are known for the creation of Fundamental Indexes. This has become a (deservedly) amazing story of growth over the last few years. I remember writing about it and saying something like “This would be the fastest idea to grow to $100 billion in assets in history.” They are over halfway there, taking assets from what the research and results say is the inferior performance of cap-weighted indexes.

I fly back on Sunday and am home for two whole weeks in my own bed, then I fly to Philadelphia for a conference with the Global Interdependence Center. To find out more you can go to http://www.interdependence.org/Event-05-24-11.php. Then it’s to Boston for some business and a little relaxation, before flying on Sunday to Italy to stay for three weeks in a small village in Tuscany called Trequanda, where most of my kids will be for the first week or so, and then it will be a working vacation with Tiffani, while friends come to see us. Vacation for me is being in the same place for a few weeks. Then I’m off to Kiev for the weekend for a reunion of my classmates at Singularity University, then to Geneva for a few days and London for one day, where I will guest-host CNBC Squawk Box, which is always a few hours of fun. Then back home, and I’ll get to be in Texas for most of the summer – at least that’s how it looks now.

I feel somewhat awkward of late, going through airports and meetings wearing a large cast on my right foot, trying to keep it immobile to let the inflammation go down from doing too many lunges and straining the tendon. I can feel it helping, but it there is a long way to go.

This next week should be fun, as I will be taking a girls championship softball team to see the Texas Rangers. Most of them have never been to a professional game. Then good friend Cliff Draughn is in town, then (maybe) game six of the Mavericks-Lakers series, more family, and no alarm clocks. I need the rest. This last week, with cancelled flights and early mornings, has frankly been tiring. I really must get the schedule under better control.

Speaking of “brutal,” it is time to hit the send button. Rob’s conference starts with a soiree on the lawn and always features some mighty fine wine. I must go and indulge, while promising to get to bed early! Have a great week!

Your quite sure we get through all this analyst,

John Mauldin
John@FrontlineThoughts.com

The correct amount is zero because government should not be in the mortgage business at all. However, this is a small step in the right direction and it will increase costs of mortgages that exceed the maximum.

Reuters reports Home buyers try to beat “jumbo” loans squeeze

It was only in recent years that the loan limits went so high. Mortgages that are too big to be sold to Fannie and Freddie are termed jumbo loans and are backed privately. Until 2008, all home loans over $418,000 were considered jumbo loans. In that year, a stimulus-focused Congress twice raised the limit on loans the government would back in high cost areas, first to $625,500 permanently, and then to $729,750, temporarily.

Since then, Fannie and Freddie have backed an increasing share of that market. In 2010, so-called “jumbo conforming” loans, those over $417,000 and government-backed, made up 6.73 percent of loan originations, according to CoreLogic.

That top temporary limit was extended twice, but is expected to expire at the end of September.

Private lenders are preparing to step in, according to Guy Cecala of Inside Mortgage Finance, a research firm. In the last quarter of 2010, private lenders originated more loans over $417,000 (the traditional jumbo market) than did government agencies, he said.

Investors like the fact that jumbo loans tend to be safer and more profitable than smaller ones. The privately-backed mortgages require bigger downpayments (currently about 30 percent of the home’s value, instead of the 20 percent more typical in less expensive loans), which adds security.

Also adding to their allure, the loans carry higher interest payments; the spread between the so-called conforming loans backed by Freddie and Fannie and jumbo loans is running about 0.5 percentage points higher, said Cecala. Furthermore, a higher proportion of jumbo loans are made on a variable rate basis, which is less of burden for holders, Cecala said.

The article tells a sop story of a couple rushing to buy now ahead of the increase because the two bedroom house they live in will soon not be big enough because a child is on the way. The couple only wants to put down 10%.

For every person rushing to buy a bigger house now, there will be others who will simply be priced out. More importantly, if there is a “rush” of any nature between now and October, there will be a vacuum of buyers later, with falling prices as a direct consequence.

Regardless of which way it plays out between now and September, it will be increasingly more expensive and require a bigger down payment to get a jumbo-sized loan starting in October. This will have a dampening effect on home prices.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com

Why are we not surprised that the Fed took aim at mortgage fraud and ended up shooting the housing market in the gut. Here’s a simple guide to what’s good and bad for housing:

Things which makes it easier and cheaper to borrow money: good.

Things which make it harder and more expensive to borrow money: bad.

And that’s the fundamental problem with the Federal Reserve’s new regulations crimping mortgage broker compensation. Unless we expect mortgage brokers to take vows of poverty, then the system has to allow legitimate brokers to get paid in accordance with the amount of work the loan requires to get funded.

By severely limiting compensation, the Fed has basically wiped out small brokerages and lenders, reducing the availability of mortgages to a handful of–you guessed it–too big to fail banks, who already control the majority of mortgage origination.

The Fed’s ill-advised “reforms” simply act to further consolidate an already concentrated market, creating what amounts to a mortgage cartel by snuffing out smaller competitors in the mortgage market.

The goal of limiting mortgage fraud is necessary and laudable–the point here is that limiting compensation is like chopping off a toe to fix a tooth ache: the problem was lax underwriting rules, inadequate/zero oversight, fraudulent appraisals and ratings of mortgage-backed securities, etc. etc.

The Federal Reserve Board says that its regulatory goal is to “protect mortgage borrowers from unfair, abusive, or deceptive lending practices that can arise from loan originator compensation practices.” The basic idea is to prevent loan officers from steering borrowers into riskier types of loans or a higher than average interest rate to make a higher commission.

Officially titled “Loan Originator Compensation amendment to Regulation Z,” The new rules apply to mortgage brokers and the companies that employ them, as well as mortgage loan officers employed by banks and other lenders.

Since most of us only deal with mortgage loan origination fees when we buy a home or refinance a mortgage, the average citizen will have a tough time sorting out the often-arcane issues at stake. But the bottom line is straightforward: the already-limited mortgage market is about to become more limited, as small mortgage brokers are being shoved out of business. Call it “unintended consequences” or a cloaked plan to channel more of the mortgage business to the “too big to fail” big banks, but regardless of the motivations, the rules end up limiting consumer choice and making it harder for home buyers to get a loan.

That’s bad for housing in two ways: limited competition drives costs up, and marginal buyers will find nobody wants their business because it’s simply not worth the compensation allowed by the Fed’s new rules.

One size does not fit all–except in a Centrally Managed Economy (TM, Federal Reserve).

This is yet another case of closing the barn door after the horses have already left: the riskiest subprime-type mortgages that were the root cause of the problem have largely vanished from the mortgage market.

Since the rules largely apply to small lenders and brokers who must sell the mortgages they originate to larger banks–most banks and other direct lenders, including big mortgage companies that function like banks, are exempt from the new regs—then the limits will weigh entirely on smaller independent players.

Critics, including U.S. senators David Vitter and John Tester, observe that this will further concentrate a market which is already dominated by mega-large banks. According to the senators, two banks already originate 43% of the nation’s mortgages. (Can you spell “cartel”?)

What the regulations do is set some ground rules–consumers must be offered the lowest possible interest rate and fees for which they qualify, for example–and limit loan officer and broker compensation in several key ways.

“The loan originator may not receive compensation that is based on the interest rate or other loan terms.” In other words, a lender can no longer pay a loan broker a yield-spread premium, which is tied to the rate or terms of the mortgage. Currently, the brokerage firm and the loan officer typically split this rebate, which is typically stated in “points,” where each point equals 1% of the loan amount. Thus a loan origination might earn an $8,000 fee, $4,000 of which goes to the loan officer and $4,000 to the mortgage broker.

Under the new rules, the mortgage broker cannot pass on a part of the commission to the loan officer, who must now be paid an hourly wage or salary. The idea is to remove the incentive of the loan officer to push the consumer into a more lucrative loan, but the result is to remove the incentive to remain in the independent mortgage business.

Mark Helling, a licensed loan officer based in Ohio, summed up the view from inside the industry: “After April 1st, a Loan Officer will have to be paid the same rate whether it is an easy loan that takes two weeks to close or a foreclosed property in need of rehabbing for marginal borrowers that takes three months of work to close. Just when the country needs the most experienced and knowledgeable mortgage professionals to help liquidate the flood of foreclosed homes, the Fed is making it unprofitable for loan officers to accept these deals.”

From the point of view of those in the mortgage industry trenches, what the rules do is increase the regulatory expenses of being in sales but eliminates the commissions that are the lifeblood of any sales enterprise.

“Prohibits a loan originator that receives compensation directly from the consumer from also receiving compensation from the lender or another party.” In other words a loan originator cannot collect payments from both the consumer and the lender in a single transaction. If a broker is paid a commission by the lender based on the loan amount, then the broker is barred from charge the borrower “points” or fees for the loan processing.

This prohibits loan officers from paying borrowers’ fees or issuing them a credit from their own commission. This has been a common practice within the industry, and from the inside perspective, it that has offered a flexible way to lower borrower’s costs.

These major regulatory changes are being made in the service of fair lending practices, but to those seeing their livelihoods threatened, it looks like a sledgehammer is being used where a flyswatter would have sufficed.

“As far as trying to protect consumers from those seeking to charge a higher interest rate, with all of the competition out there for mortgage loans,” Helling observes, “all a consumer has to do is check one or two other banks and they can quickly find out if they are getting a fair deal or not.”

The rules will also interact in potentially harmful ways with the massive Dodd–Frank Wall Street Reform and Consumer Protection Act, the most sweeping financial regulation since the Great Depression.

At issue is section 1413 of the Dodd-Frank Act, which states that any violation of the loan originator compensation rules will offer the borrower a “defense to foreclosure” for the life of the loan.

In other words, if a delinquent borrower can go back and find some violation of the compensation rules in his/her mortgage origination, the lender is effectively barred from foreclosing on the borrower’s loan.

Given the risks this presents to banks, many observers, including the two senators, expect the large banks which typically buy mortgages from independent brokers and small lenders will shun these mortgages. Why buy a mortgage which could go sour via default that could preclude foreclosure as a remedy? Talk about putting a bullet in the housing market when it’s already down: the new rules create huge disincentives for banks, too big to fail or otherwise, to buy independently originated mortgages.

These rules will poison the housing market in several ways. If mortgage brokers can no longer make enough in commissions to stay in business, then the mortgage options for home buyers will shrink. The most productive loan officers will find reduced incentives to risk remaining independent, and so there will be less competition offered to the big banks which already dominate the industry.

What happens as mortgage sources and competition dry up? Mortgage costs rise, and marginal buyers will be shunted aside as unprofitable customers.

The need for carefully thought out regulation has been made painfully apparent by the excesses of the credit and housing bubbles, but squashing legitimate independent loan originators and further concentrating the mortgage industry into the hands of the “too big to fail” banks does nothing but hurt the housing market and eliminate the healthy competition to big banks offered by smaller lenders and legitimate mortgage brokers.

From MacroBusiness.au:

Merrill Lynch reverse-engineered the home-loan calculators used by banks – available on their websites – to work out the cost of living banks must use in assessing loans.

The analysis suggests that while banks, in theory and, according to them, in practice, make use of the Henderson poverty line for most cases, they may actually apply even lower living costs.

“Surprisingly, the average bank cost-of-living assumption is seven per cent lower than the poverty index, 14 per cent lower than our barebones budget, and even more for our adjusted [living costs, based on] ABS survey [data], says the report.

…

The Merrill Lynch analysts argue in their report that “the banks, using low default living costs, are able to artificially inflate the level of debt they can provide to borrowers.

“In our view, living at the poverty index would be unsuitable for mortgage borrowers, and the banks’ default living costs are even below the poverty index and well below any other comparable budget. We believe the banks’ default living assumptions underestimate the real cost of living for mortgage borrowers. While it might be plausible for a borrower to keep within such a low budget for the short-term, we question if it is sustainable.”

Using alternative and higher levels of living costs, modelled by Merrill Lynch, the researchers found that for a couple with one dependent a big bank’s “approval in principle” for a loan (and subject to a range of assumptions) would fall from the mid $400,000 level to less than $400,000 using what they term “normal” costs.

The maximum loan approval would fall by more than half, to around $200,000, using a higher level of living expenses that makes more realistic assumptions and is based on surveyed household living costs, and which makes adequate allowance for entertainment.

This cool new feature is a dream-come-true for analytical types.

Check it out…

The right-to-rent proposal floating around Washington would crash house prices as loan owners everywhere strategically default to lower their monthly payments and stay in their houses.

Man, living at home is such a drag
Now your mom threw away your best porno mag (Bust it!)
You gotta fight for your right to party

Beastie Boys — (You Gotta) Fight Your Right (To Party)

The idea of a right to rent has been floated by Dean Baker of the Center for Economic and Policy Research. His proposal is to give every loan owner the right to stay on in their foreclosure for five years paying market rents.

I first covered this issue in The Right to Rent Would Flatten the California Housing Market. I noted the following:

Dean Baker of the CEPR was one of the early public voices who called the housing bubble. He accurately noted the disparity between rent and payments and concluded housing prices were not sustainable. Like me, he was a renter looking to buy as prices were ramping up, and like me, he noted that since it didn’t make sense for him personally to buy, it didn’t make sense for anyone else either. Being an economist at an influential think tank, he was in a position to research and write about the issue and be heard.

I really like Mr. Baker’s proposal, but I have been afraid to write about it because I don’t think lawmakers fully understand what passing his legislation would do to the housing market. I would very much like to see it become law, but if it does, every inflated housing market in the country would crash very hard as loan owners accelerate their defaults.

My position on this issue hasn’t changed. I would like to see it be made a policy because of the impact it would have on the housing market and the economy in the long term. Short term, it will crush the banks as the remaining inflated markets crash under waves of strategic default.

Commentary: Right-to-Rent Would Ease Foreclosure Mess

By Dean Baker — April 11, 2011, 1:14 PM ET

Developments asked Dean Baker, co-director of the left-leaning Center for Economic and Policy Research in Washington, D.C., to weigh in on the housing market. Mr. Baker first proposed the right-to-rent idea in 2007.

While the rate of foreclosures may have finally peaked, it is not going to come down quickly. We are virtually certain to see at least a million foreclosures in 2011 and comparable numbers in 2012 and 2013. Many more homeowners will lose their homes through distressed sales.

This is a crisis for both the homeowners themselves and also for the communities where these foreclosures are concentrated. There is considerable research showing that foreclosed properties are a blight on neighborhoods, bringing down property values and creating eyesores and safety risks. For these reasons, there is a strong argument for taking measures to reduce the pace of foreclosures.

I think some of those arguments are spurious. In my opinion, foreclosure is the best form of principal reduction, and foreclosures are essential to the economic recovery. But assuming Dean Baker is right and
I am wrong, the impact of his proposal on the housing market would be catastrophic for lenders.

However, few would argue for yet another round of the federal Home Affordable Modification Program. HAMP has proven bureaucratic and ineffective. Only a small share of threatened homeowners have received permanent modifications and a large portion of this select group is expected to re-default.

I’ve said it before, and I’ll say it again: There is a simple alternative that involves no government money and no new bureaucracy. We could temporarily change the rules on foreclosure to allow homeowners the right to stay in their home as renters for a substantial period of time (e.g., 5 years) following a foreclosure.

During this period, they would pay the market rent as determined by an independent appraiser. They would have the same rights and responsibilities as other tenants, with the exception that they could not be evicted without cause. The lender would own the property and would be free to sell it, although the former homeowner would still have the right to remain as a tenant even if the home is sold.

If every loan owner in America had the right to stay in their current house and pay only market rents rather than an inflated house payment, then every underwater loan owner with a loan payment exceeding rent would have less of a dis-incentive to strategically default. The only thing stopping most loan owners from defaulting is the fact that they have to leave their houses when they do. If you take away that punishment, many more people will strategically default.

This policy accomplishes several important goals. First and foremost it provides housing security for homeowners who got caught up in the middle of the bubble. These people can be blamed for having made a mistake by buying homes at bubble-inflated prices. But this mistake is small compared with the mistakes made by the banks that made hundreds of billions of dollars of bad and often deceptive loans.

I agree with his assessment that banks made the bigger mistake and lenders are more culpable than borrowerswhen it comes to lending issues. However, borrowers can’t be given a free pass if our system of lending is to function.

We were willing to give these banks trillions of dollars of loans at below market rates. Allowing foreclosed homeowners to stay in their homes as renters seems a rather small concession in comparison. This right-to-rent provision can also be narrowly structured so that it only applies to owner-occupied homes of less than the median value that were bought during the bubble years. This will ensure that it is not exploited by wealthy homeowners or investors.

I like that provision, but those just above the median won’t feel quite as good about it. I am delighted that his proposal would not help HELOC abusers stay in their homes.

By changing the balance of power between lenders and homeowners, the right to rent provision would give lenders more incentive to voluntarily arrange modifications that allow homeowners to stay in their house as owners. This would be the best possible outcome.

The fact that foreclosed homes remain occupied will prevent the sort of neighborhood blight that has devastated many communities across the country. Tenants with security in their home will have an incentive to keep the property looking respectable.

I don’t think that is true. Holdover owner tenants will not spend anything to maintain the property during the period of bank ownership. In fact, the tenant demands on the landlord for routine maintenance will undoubtedly get out of control. Loan owners will quickly realize they can have the benefits of renting (owner pays for maintenance) at a lower cost, and they will likely be given a chance to repurchase again in the future. Does anyone really think strategic default would not become the norm?

Finally, the right to rent could free up money that is currently going to mortgage payments on homes where owners never accrue any equity.In some of the former bubble markets the difference between mortgage payments on a house purchased near the peak of the bubble and the market rent can be more than $1,000 a month. The money saved by former homeowners is money they will spend in the communities where they live.

I argued the same in foreclosures are essential to the economic recovery. Californian’s gain no long term benefit from making oversized mortgage payments. The money they currently send to a lender is a drain on the local economy. Only fresh borrowing and a return to Ponzi living can make the old system work.

So there you have it: A simple policy that requires no taxpayer dollars and no new bureaucracy.

I love his idea, but realistically, it will never happen because the resulting strategic default would make the foreclosure problem much worse for the banks. It would be a great thing for society because every inflated market would immediately crash down to cashflow levels and stay there. Lenders would be forced to limit house payments to comparable rents because that is all they can recover if the borrower defaults. The days of payments exceeding comparable rents would be over. I think that would be great.

Underwater reverse mortgages in concert with a change in government policy is causing widowed seniors to lose their homes.

Don’t bet your future,
on one roll of the dice
Better remember,
lightning never strikes twice

Huey Lewis and the News — Back in Time

I have made mistakes in my life that made me want to go back in time and undo them. Sometimes you can, but sometiimes you can’t go back and reverse the damage. Taking on a reverse mortgage is one mistake that is very difficult to undo.

I don’t like reverse mortgages. I don’t like many forms of debt, but reverse mortgages are one of the worst forms out there.

According to the Department of Housing and Urban Development:

A reverse mortgage is a special type of home loan that lets you convert a portion of the equity in your home into cash. The equity that built up over years of home mortgage payments can be paid to you. But unlike a traditional home equity loan or second mortgage, no repayment is required until the borrower(s) no longer use the home as their principal residence or fail to meet the obligations of the mortgage.

If you don’t have to make any payments, it shouldn’t be too difficult to meet the obligations of the mortgage. Also from the HUD website:

What’s the difference between a reverse mortgage and a bank home equity loan?

With a traditional second mortgage, or a home equity line of credit, you must have sufficient income versus debt ratio to qualify for the loan, and you are required to make monthly mortgage payments. The reverse mortgage is different in that it pays you, and is available regardless of your current income. The amount you can borrow depends on your age, the current interest rate, and the appraised value of your home, sales price or FHA’s mortgage limits, whichever is less. Generally, the more valuable your home is, the older you are, the lower the interest, the more you may borrow.

Reverse mortgages provide seniors with plenty of equity and limited income the ability to tap their equity to meet the needs of daily life. Basically, they didn’t want grandmothers to eat dog food if they had a lifetime of filet mignon tied up in home equity.

As you might imagine, loaning seniors money when they have no ability to repay has potential for abuse and predatory lending. Fortunately, the market is heavily regulated by HUD.

Good News for Spouses of Reverse Mortgage Holders

By RON LIEBER – April 7, 2011, 6:28 pm

This issue will rightfully embarrass HUD, but it will quickly fade from the headlines.

Why I don’t like reverse mortgages

First, needing a reverse mortgage is, IMO, a result of poor financial planning. The goal of good retirement planning should be to acquire assets that provide stable cashflow. Obtaining wealth without the ability to turn it into spendable cash is a big mistake. You can’t eat gold or diamonds, and you can’t sell part of your house.

The real reason I don’t like reverse mortgages is because they are a Ponzi virus seniors take on which invariably leads to distress and the unceremonious fall from entitlement. Do you remember the story of the old widow from that post?

The aging socialite

A reader emailed me about the property that became the post HELOC abuse Hollywood Style. The property was purchased in the early 70s in Hollywood for about $150,000. The property was owned by a frugal couple that paid down their debts. The husband died in the late 90s leaving the wife with a beautiful and historic property with millions in equity.

I can imagine the husband’s state-of-mind and heart on his deathbed; he knew he provided well for his family, and although his wife might outlive him for quite some time, he was leaving her comfortably and securely set up for life. The inner peace he felt is something I covet for my own death. So should we all.

If there is an afterlife, and if we have the ability to look in on loved ones after we pass, I hope for this man’s spirit that he resisted the temptation and rests in peace. Watching his wife either through foolish choices or bad advice spend the family fortune and be forced to abandon the family home — a home that had millions in equity at the moment of death — watching that from afar with no ability to intervene is more akin to hell than to heaven.

For the widow, she must move out of her stately mansion, destitute and alone with only memories of her life of entitlement and glamor to comfort her, or torture her, as she lives out her life in relative obscurity after her unceremonious fall from entitlement. …

Reverse mortgages have limitations on mortgage equity withdrawal that make them less dangerous than HELOC abuse, but the basic dynamic is the same. Once people start tapping their equity, lenders and their compound interest will consume most or all the equity in the home before the senior dies.

Compound interest grows like cancer. if there are no payments, as there aren’t in a reverse mortgage, if given enough time compound interest consume everything. Would you like to spend your retirement worried about running out of money? Let’s imagine a few scenarios and see how you feel about this.

I could’ve used that money

Imagine your late 60′s, your children are stable and prosperous, so you decide you are going to blow a little of their inheritance. It’s your money, you can do what you want with it; besides, the kids don’t need it.

So you take out a reverse mortgage, or worse yet a HELOC, and you spend a little money. You don’t go overboard and spend your house like the socialite in the story above, but you do spend enough that you feel worried that you might need it for yourself someday, so you stop using it.

After a while you forget about the loan since you aren’t making payments, and you go about your life. Years go by, and your in your mid 80s, and you want or need some elective medical procedures that require you to come out of pocket. You remember the old credit line and you dig for a statement. You open one up and realize the debt grew as fast as your house went up in value. You still have a little equity, but the debt cancer consumed everything you once had. You can’t afford your operation and you languish in discomfort in your final days — all because you took on that invisible Ponzi debt early in your retirement.

Riding the equity wave onto the rocks

Or imagine you are of retirement age, and you rationalize how you worked hard all your life so you deserve a few indulgences. You become a Ponzi accustomed to your great new life. This works great as long as you manage your debt in a sophisticated manner, right?

You do well until house prices crash again, your credit lines are cut off, and you lose your home. If your lucky one of your children is welcoming. If they’re not, your life really sucks.

Recognizing the cancer debt

At some point, seniors who take on reverse mortgages recognize them for what they are: a malignant financial cancer. These debt tumors grow until they crowd out home equity. There is no cure, and the tumor cannot be removed without selling the house. The only cure is prevention.

It’s worse than gambling

Nearly everyone who has gambled in Las Vegas has had a time when they lost more than they wanted to. Depending on how irrational you get, the financial pain can be mild or extreme. But when you lose in Las Vegas, your done. It’s over. The loss doesn’t get any worse. Your mistake doesn’t haunt you for the rest of your life.

Reverse mortgages are different. If you make a mistake and take on a reverse mortgage, the losses of equity due to compound interest go on and on and get bigger and bigger.

It must be horrible to realize you have a financial leak you can’t plug without going back to work or selling the house to pay off the debt. Your debt will continue to grow until you die.

Americans know that banks have mistreated borrowers in many ways in foreclosure cases. Among other things, they habitually filed false court documents. There were investigations. We’ve been waiting for federal and state regulators to crack down.

Prepare for a disappointment. As early as this week, federal bank regulators and the nation’s big banks are expected to close a deal that is supposed to address and correct the scandalous abuses. If these agreements are anything like the draft agreement recently published by the American Banker — and we believe they will be — they will be a wrist slap, at best. At worst, they are an attempt to preclude other efforts to hold banks accountable. They are unlikely to ease the foreclosure crisis.

All homeowners will suffer as a result. Some 6.7 million homes have already been lost in the housing bust, and another 3.3 million will be lost through 2012. The plunge in home equity — $5.6 trillion so far — hits everyone because foreclosures are a drag on all house prices.

…

The draft does not call for tough new rules to end those abuses. Or for ramped-up loan modifications. Or for penalties for past violations. Instead, it requires banks to improve the management of their foreclosure processes, including such reforms as “measures to ensure that staff are trained specifically” for their jobs. The banks will also have to adhere to a few new common-sense rules like halting foreclosures while borrowers seek loan modifications and establishing a phone number at which a person will take questions from delinquent borrowers. Some regulators have reportedly said that fines may be imposed later.