Sean Olender's  Instablog

Suppose that the Fed and Treasury are really trying to dupe investors and speculators into sinking private money into a housing and bank bailout?  That is to say suppose Fed and Treasury are trying to lure private investors knowing full well they will lose money to avoid the taxpayers having to lose it instead.

The ultimate taxpayer cost for all of these bank frauds is at least the cost of lost FDIC insured deposits and possibly also the cost of partially bailing out foreign sovereign bondholders that could withdraw from future Treasury auctions and drive up US interest rates.  Because of government corruption, the cost also appears to include absorbing banks' bad loan losses.  Wall Street bankers own the White House, Senate Banking Committe and House Financial Services Committee and desperately want to avoid criminal investigations.  Breaks in causation can eliminate criminal investigations by working over time to destroy evidence through homeowner refinancings, foreclosures and unloading "toxic" securities (meaning loans packed with fraudulent borrower information and where issuers knowingly misrepresented the securities with criminal intent, designed them to conceal known frauds in the loans underlying them).

If the banks own the government, then why would the government bother to create a ruse to draw in private money?  The answer is that it doesn't have enough money to bail out the banks by itself.

The current fiscal deficit suggests a $2 trillion shortfall by the time the government's fiscal year ends in October 2009.  It might even be $500 billion or $750 billion higher because of ridiculously optimistic tax revenue estimates for the second half of FY 2009.  The problem isn't whether taxpayers can be put on the hook for all of this, but whether the US government can convince buyers of treasury securities that it will be able to tax US citizens sufficiently over the next twenty years to pay interest and principal on this debt.  There is a limit to US borrowing and while no one knows exactly where it is, the Fed and Treasury seem to have come to the conclusion that it's not enough to bail out the banks.

So how do you eliminate all the fraudulent bad loans and help banks roll over debt and sell foreclosures?  First, the Fed and Treasury have bent over backward to try to create the impression that the banks can't lose.  The Fed and Treasury handed hundreds of billions of dollars to the big banks and then did a secret backdoor bailout using FDIC's new $500 billion credit line to help finance the toxic asset "auctions" where the only folks who can bid using 93% taxpayer nonrecourse loans are banks that have themselves lots of toxic assets.  They guaranteed bad debts.  They pushed fake "stress tests" where the test methodology is to be announced after the test suggesting that Treasury is specifically designing the tests to allow the banks to pass them.  And recently this did lure investors driving the financials index up 91% in about five weeks.  That makes it much easier for banks to raise capital by issuing shares.

How about using the Federal Reserve to buy down 30 year mortgage rates to 4.8% or 4.2%?  How about a tax credit for buying foreclosures?  These costly ruses aren't to help buyers "afford" foreclosures, they are to help sellers not drop their prices.  And according to the most recent statistics, about 50% of all homesellers right now are banks.  The price the banks get for these foreclosures determines the losses they have to report.

Recent media suggests that the uptick in foreclosures is due to various state moritoria expiring.  http://www.propertywire.com/news/north-america/rise-us-foreclosures-200904192968.html.  I think the more likely explanation is that the recent bear market rally (the greatest rally since the 1930s) and interest rates a full point below pre-2007 records (we're talking 200 years here) combined with the Spring/Summer home selling season are a good time to sell.

Foreclosures are rising because the Fed and Treasury indicated to the banks that this is the best time they have to get rid of those houses on the open market.  Banks had held off on instituting foreclosures and selling REO in quantities sufficient to clear their books because the market was in a horrible slump and they needed some traction.  Putting those homes on the market when buyer pessimism was at an all time high would have resulted in huge price drops and possibly many homes not selling at any price.

Now we have the Fed, Treasury, NAR, MBA, Congress and other groups all working together to make it appear to buyers that now is a great time to buy a house.  The sole purpose of this is to allow banks to clear their foreclosure inventory and to make as many new foreclosures as is necessary at this time.

Ask yourself this question: Would a new home buyer be better off with a lower interest rate and a tax credit, or a lower purchase price for the home that is roughly equal to the value of the lower rate and tax credit in the sense of keeping the monthly payment the same?  The answer is obviously the lower price.  A buyer will pay lower property taxes and have greater equity and less risk of interest rate shock buying at a lower price.  And a buyer can refinance a loan as rates fluctuate, but he cannot "re buy" the house at a lower price.  The low interest rate and tax credit are gimmicks that push up prices to help sellers.  Here, the sellers are overwhelmingly banks.

An interest only loan at 4.5% allows a borrower to qualify for double the loan he could qualify for at a 9% interest rate.  This magic applies throughout the income spectrum.

Clearly rates can't stay this low for long.  A year?  Two years?  The cost in keeping rates this low will eventually bankrupt the federal government, so they will do it for a while, but not long enough to threaten their ability to borrow, which is the source of their power.  When rates rise, home prices will continue their descent, and they may resume their fall before then as unemployment continues to rise.

There are currently more than 18 million homes sitting empty in the United States.  There are innumerable baby boomers, speculators and others who would desperately love to sell one or more homes each and are waiting for a "rebound" in housing to put their homes on the market.  This shadow inventory will quickly arrest any upward price movement.  Banks will move fast now to foreclose to get in front of other home sellers who will take a few months to "get" that this is the big housing rebound and it will be over by the end of summer.

The federal government wants to help its wealthy banker benefactors as much as it can.  But government generosity is limited by risks to its own power.  The one area where the Feds can't afford to lose is their ability to borrow.  So the Feds need your help to bail out the banks.  To help you feel better about it, they are engineering a temporary environment where bank stocks and houses look very attractive.  That environment will probably last no longer than the end of the summer selling season.

In short, beware government agents, real estate agents and mortgage brokers with big smiles claiming now is the time to buy homes and bank stocks.  There's a good chance that they are trying to unload a lot of inventory before it's too late.  My guess is that sometime between August and October of this year, it is going to become obvious that housing is in for another very painful year of losses.  Ben Bernanke and Tim Geithner are hoping you buy before then.

Disclosure: No positions.