Sunday, June 27, 2010

Financial Regulatory Reform: A Mixed Bag

What's In It
Before you listen to pundits and talking heads, you may want to read a review by someone who's actually read the bill.  It's a mixed bag.  Some things are good.  Some things are not so good.
Let's take a look.
I.  What's In It
A.  Creates Consumer Protection Agency under the Federal Reserve Bank
B.  Increased capital requirements for financial institutions
C.  Creates a council to identify and address systemic risk
D.  Regulates most derivatives, asset-backed securities, hedge funds, mortgage brokers and payday lenders
E.  Streamlines bank supervision
F.  Provides shareholders with a non-binding vote on executive compensation
G.  New rules for credit rating agencies
II.  What It Says
A.  Consumer Protection Agency
The rationale for creating this agency was because "the economic crisis was driven by an across-the-board failure to protect consumers."  With this I disagree.  The economic crisis, in my judgment, was caused by
  1. The belief that historic national upward trends in housing prices would continue, regardless of the effect of  increasing demand by those whose credit would not have previously qualified them for a home;
  2. Granting a AAA rating securitized in part by these so-called sub-prime loans; and
  3. Allowing those who made these loans to completely offload their risk to purchasers of securitized loans.
While I agree that the buyers of mortgage backed securities whose brokers assured safety needed protection from reliance on a AAA rating by rating agencies, the problem was rooted in the fact that the rating agencies did not do their job.  In other words, it was not lack of consumer protection, but a complete lack of competence by rating agencies, paid by the issuers of these securities, that resulted in brokers selling them and consumers buying them.  Further, borrowers who bought $500,000 houses with a $50,000 annual income did not need protection.  They needed to be honest about their ability to afford a home.
I am not saying some level of consumer protection in finance is inappropriate.  I am saying, however, that to say that a lack of consumer protection caused the financial crisis is an overstatement.  Had ratings agencies done their job, mortgage backed securities would have been unsaleable, and no crisis would have occurred.
B.   Increased Capital Requirements
Banks now need to put aside more money as a cushion against risk.  The more risk taken, the more money that must be put aside.  So far, so good.
In the current economy, banks, as most businesses know all too well, are reticent to lend money.  They got clobbered in the economic meltdown, and are now erring on the side of caution.  It's a good thing that banks are more cautious, but a bad thing that they're too cautious because without credit, business expansion is all but impossible.  So, the more money they must put aside for capital, the less they'll have to lend.  And that will delay economic expansion, including new hiring.  Are new capital requirement bad?  No.
But there will certainly be an effect, and that effect will be that businesses will find it hard to borrow.  And expand.  And hire.
Also, the largest banks will be required to fund a $50 billion fund dedicated liquidating to "too big to fail" banks which are insolvent.  Taxpayers will be on the hook only for working capital collateralized by bank assets, and will be first in line for repayment.
Again, on the surface, a good idea, but these funds will not be available for lending either, and will further exacerbate the difficulty in obtaining business financing.
C.  Financial Stability Oversight Council
A new council will be formed that will be responsible to identify and respond to emerging risks throughout the financial system.  As a last resort, they'll be able to break up any company, bank or not, that threatens US financial stability.
A good idea, but, as with anything, it will be as good as its members.  Chaired by the Treasury Secretary, it will also include regulators from the Federal Reserve Board, SEC, CFTC, OCC, FDIC, FHFA, the new Consumer Financial Protection Bureau.
D.  Regulates Derivatives, etc.
During the height of the mortgage boom, financial institutions collected fees for guaranteeing each others' mortgage portfolio.  As long as everybody was repaying their loans, that was fine.  When things went south, though, these so-called insurance promises were called in.  AIG, Bear Stearns and Lehman Brothers had issued lots and lots and lots of these promises, and you know what happened when the banks started experiencing mortgage losses.  Bear and Lehman went bankrupt, and taxpayers rescued AIG, which had made more promises than they could possibly repay.
Now, most derivatives will be traded on an exchange, so we'll all know about how many are issued and can theoretically stop problems based in making promises that can't be kept before they become too large. 
Banks must trade most derivatives in subsidiaries (which are not insured by FDIC, and therefore not available for taxpayer bailout), except interest-rate swaps, foreign exchange swaps and instruments deemed as “hedging for the bank’s own risk.”
As always, the devil is in the details.  FDIC, under this bill, will be on the hook for interest-rate swaps, foreign exchange swaps and "hedging for the bank's own risk."  We'll need to make sure somebody's watching these exceptions closely, or the taxpayers will find themselves on the hook for a hedge that the bank convinced regulators was "for its own risk."
Hedge funds are now officially investment advisers (making one wonder exactly what they were before).
The big (if boring) news is that there is now an Office of National Insurance under the Treasury Department.  Hopefully, this will be the first step in regulating insurance on a national, rather than State level, which will encourage more competition and - hey, that might even serendipitously bring down health insurance costs.
E.  Streamlined Bank Supervision
State chartered banks and thrifts under $50 billion will be regulated by the FDIC.
All nationally chartered banks and federal thrifts, and the holding companies of national banks and federal thrifts with assets below $50 billion will be regulated by the OCC.
Banks and thrift holding companies with assets of over $50 billion will be regulated by the Federal Reserve.
While technically, this will preserve the state banking system that governs most of our nation’s community banks, the reality is that small community banks are likely to put themselves up for sale now that they have 2000 pages of regulatory compliance to deal with.  I used to do that job, and speak from experience.  A community bank with 75 employees would need to dedicate 10% of its staff to compliance.  Not feasible.
F.  Provides Shareholders Non-Binding Vote on Executive Compensation
Non-binding is the operative word here.
G.  Credit Reporting Agencies
I blame the majority of the economic meltdown on credit reporting agencies.  Had they done their job, mortgage backed securities would have been rated as what they were - risky.  Few would have bought them.  Investment bankers would not have been able to sell their risk in extending loans to people who couldn't afford them, and would have stopped making those loans.
Now, there will be an Office of Credit Ratings at the SEC.  Yes, the same SEC that was responsible for overseeing Bernie Madoff. Analysts will now have to pass exams, compliance officers will be forbidden to perform sales, and the SEC can deregister an agency for providing bad ratings over time.
My reaction to this is probably about the same as yours.  Too little.  Too late.
III.  Brace Yourself
Bank loans will be harder to get.
Bank fees will go up.
Watch for the exceptions in this legislation to be the source of the next financial meltdown.
There will be another financial meltdown.
Fear and greed cannot be legislated out of the financial system, but this legislation is better than nothing.

Tuesday, June 15, 2010

The Saga of Property Tax Appeal: A Mini-Series

Some people want the government to run almost nothing because of its inability to do so without a mountain of red tape, layers of bureaucratic nightmares and regulations that are nearly unintelligible.  Here's one woman's journey through a property tax appeal, and why, at certain times, she found herself sympathetic to anarchists' point of view toward government.
Part I - A beautiful new home
While renting a sweet little cottage long enough to make certain that we were planting our roots in a neighborhood we would love, a serendipitous real estate meltdown occurred that brought the price for the home of our dreams within reach.  We found a buyer for our rental, and everybody was happy.  One of the best selling points for our dreamy new home was the seemingly low property taxes.  Emphasis on "seemingly."
Imagine our surprise when we received our property tax statement nine months later with a 40% tax increase.
Part II - Follow the yellow brick road
After numerous calls to the Assessor's Office, we found that the first step toward  rectifying this situation was an appearance in front of BOPTA (that's Board of Property Tax Appeals, for those of you who speak non-acronym-ish).  Okay, fine.
We assemble a plethora of data that includes the fact that the Assessor's Office January 1 RMV (Real Market Value) for this home was 8% higher than our independent appraiser determined 55 days later on the following February 24.  The basis for thier valuation was the Assessor's Office in-person appraisal on the previous November 24.  Among possible reasons for the miscalculation was the fact that the assessor determined that there was a 1120 sq. ft. fully finished basement, when the actual finished area was 336 feet.  But the burden of proof was ours.
Prior to scheduling the appearance before BOPTA, we spoke to the Assessor's Office (many times) and were pressured (many times) to allow another in-person appraisal.  We were reticent to do so, thinking that the inflated appraisal may get even worse, but did agree to let them see the basement, which was apparently the basis for the problem.  "No can do," said the Assessor's Office.  They are an "all or nothing" kind of group, and wanted to see everything or nothing at all.
With their repeated requests, were admissions that "we didn't have to" let them in.  Okay.  We would take our chances with BOPTA.
The Board of Property Tax Appeals is a group of three persons who listen to your case for about 15 minutes, and make a determination of whether your property taxes are too high.  We assembled our data (appraisal, arm's length sale, pictures of the basement, etc.) and made our case to three elderly, slightly confused people who clearly never bothered to review the information.  They shared the one copy we had mailed to the Board three months ago, had difficulty locating the Addenda ("Addendum III?  Let's see here," flip, flip, flip.  "Oh, okay, I found it," said the BOPTA triumvirate leader, with obvious pride). 
Some pertinent quotes included, "This appraisal of yours isn't very long," "How do we know when these pictures of the basement were taken?", and "Property values dropped precipitously after the first of the year."  No evidentiary weight was placed on the fact that the appraisal was complete, the date on which the pictures were taken was noted by the camera at the bottom of the picture and RMLS data showed that property values increased 14.8% from January 1 to February 28.  "Your fifteen minutes are up," they said after ignoring our responses.  "If you disagree with our findings, here's a booklet that shows you the next steps you can take."
Two weeks later, BOPTA informed us by letter that they lowered our Real Market Value by 3.7% and kept our taxes just the same.
Would we care to critique the experience?
Part IV - The Magistrate
Tearing the critique form into tiny pieces, we moved along to the next step.  This required a $75 filing fee, completion of new forms enumerating (again) the reason(s) that we disagreed with the Assessor's Office, and mailing a copy to the Assessor and the Magistrate.  Our booklet noted that the basis of taxation in our state is "complicated," and gave several cites proving that description to be one of the great understatements of history.
We dutifully mailed off our paperwork, and received, almost immediately, a response from the Assessor's Office.  They agreed that we owned the house at the given address, and that it was indeed residential property.  They disagreed that the taxes were incorrect, and the burden of proof was ours.
Part V - Measure 50
Our state, possibly in a drunken stupor, enacted a property tax measure in 1997 called Measure 50.  Briefly, it goes something like this.  All property will be assessed at 90% of its current value on the tax rolls as of 1997.  From that point forward, property taxes can increase 3% per year UNLESS there is an exception, such as, your house burns down or you fix it up.  The value of the exception is the value that the market places on improvements (or loss), and will be assessed in addition to the 3% annual increase.
You pay taxes on the MAV (Maximum Assessed Value), but that value is based on the RMV (Real Market Value) of the property.
Okay.  Well, we bought a house from people who bought it in 2007, fixed it up and sold it to us in early 2009.  The value of the improvements, then will be the difference between what they bought it for and what we paid, less the change in general property values in the area.  Easy enough.
Part VI - The Case Management Hearing
Before you go to court, the Magistrate mandates a Case Management Hearing.  That means everybody gets on the phone and says what they think.  I wrote out our case ver batim in order that it was concise, to the point, and relevant.  Evidence was mailed (again) to both the Magistrate and the Assessor's Office.  Six months after our BOPTA appearance, the phone rang for said management hearing.
I told His Honor that we entered into an arm's length sales transaction to buy our house, for which an independent appraisal was effected on February 24.  The value of the home was clear, therefore, the value of the repairs was clear.  We pointed out the errors in the Assessor's Office appraisal.  We concluded by thanking all participants for their valuable time.
The Assessor's Office responded by saying that they needed to see the property.  We responded that they had seen the property, that our primary point of contention was the size of the finished basement and that we had been repeatedly told we were not obligated to let them in.
The Assessor's Office said, "Our appraiser never saw the interior.  He just walked around the house."
WHAT?  The burden of proof to refute some guy walking around the house and guessing how much it was worth - was MINE?
The Magistrate may have interpreted my shocked silence correctly, and said, "You need to let them in."
Jesus Tapdancing Christ.
Part VII - The Appraisal
The Assessor's Office appraisers came by at 9AM the day following our return from my step-son's wedding.  Groggy, but not unpleasantly, we let them in.  Yup, the basement isn't completely finished, they noted, as they measured the 336 sq. ft. we'd photographed, measured and presented last November.  They walked quickly through the house, measured nothing else, took a few notes, and left.
"We'll be in touch," they said.
Part VIII - The End
We had a detailed accounting of the expenditures made on the house from the previous owners, and applied the percentages of market value for each upgrade suggested by Century 21 on its website.  The market value of the repairs, according to these calculations, was $45,170.
When the appraiser called with his findings, he said, "Your exception value is $50,000."  "Really?" I responded.  "How did you determine that value?"
"We have a complex matrix . . ."  blah blah blah.  "The majority of the adjustment was the basement."
I refrained from saying, "The basement you didn't want to see last November?"
I paused, and instead said "I have a less complex matrix,  I applied the actual value of the repairs to the amount a national realty company suggests they are worth.  My value is $45,000."  Silence.
"We can't go any lower than $45,000," the appraiser snapped.
My thoughts then were inappropriate for writing here.  You could, however, describe them as "Expletives deleted."
We haggled about the square footage, and the real market value of the home, which they continued to think was 2.4% higher than the purchase price, but since it had nothing to do with the amount of taxes, I relented.  Close enough for government work, I guess.
"We'll send you a statement to sign, and will refund your overpayment,  Thank you for your cooperation," he ended.
"You're welcome," I responded, deleting more expletives.

Thursday, June 10, 2010

The Ugly Truth About US Debt

Only your closest friends will stop you before you leave the house in an unflattering outfit.  Maybe it takes a grown woman without an agenda to tell you to truth about US debt.
Here's an unbiased look.  Please refrain from the temptation to shoot the messenger.
All links are to most current US government promulgated reports.
The Budget
We're spending $3.5 trillion dollars, and taking in $2.1 trillion in revenue.  The $1.4 trillion we're spending beyond our means is our annual deficit, and is added to all prior year deficits.  The total of all deficits as of last September 30 is $11.9 trillion.  That amount, now just over $13 trillion, is our national debt.
Almost 40% ($1.35 trillion of our $3.5 trillion total annual expense) is Social Security, Medicare and Medicaid.
All the money we spend on national defense is is just over 15.5%, and rises to 22%, when including all other security programs.  Those two items are nearly 2/3 of what we spend.
The other third is non-security and other mandatory programs, like education, justice, commerce, state department and the like.
Individual income taxes are just over 40% of all taxes.  Corporate taxes are almost 7%.
Social security, medicare and unemployment taxes are the biggest chunk - just over 42%.  By the way, if you think your social security taxes are put into the so-called "Social Security Trust Fund," think again.  There is no trust fund.  We spend that money.  But we promise to pay you back.  That promise is almost 40% of our annual expense.
Personalizing the Budget
I can see your eyes rolling back in your head.  No one can think in trillions.  So, let's put this budget in terms of your community.  To keep the numbers easy, we'll say that your community spends $100,000 per year, and expenses are split up just like our Federal budget.
$38,500 is put aside for old age benefits.  About 13% of your population is 65 and older.
$29,700 goes to education, agriculture, commerce, energy, justice, labor and the like..
$22,000 is for security.  You live in a dangerous area, and you've been attacked within the last decade.
$5,300 is interest on loans you've taken out to finance the amount you've spent above your revenues in the past.
$4,300 was invested in your local banks, which nearly stopped making loans due to their bad condition last year.  You've been repaid about half the amount you lent them so far.
Reviewing the Budget
Right off the bat, almost 40% of your budget is spent for old age benefits for 13% of your population. .
You may be able to cut a little here and there, but nothing is as anywhere near as significant as that expense.  Even if you cut your security budget in half, it wouldn't be as much of a benefit as cutting the old age benefit by just one-third.
But you know that this is a "sacred cow."  Just look at the civil unrest in Greece and Spain for an idea of what you can expect when you cut benefits that you've promised - even if you can't afford them.
The fact is, though, you can't continue to promise 40% of the budget to 13% of the population.  Someone, at some point, is going to have to tell your community the truth.
The Truth
Old age benefits began during the Great Depression.  At that time, US life expectancies were 60 years of age, and benefits were available at age 65.  Now, US life expectancies are 77.2, and benefits are still payable at age 65.  The age at which benefits are available has not moved, despite the increase in life expectancy of 27.2 years.
When old age benefits began, there were 42 workers per retiree.  In 1950, there were 16.  Now there are 3.3 workers per retiree.
Some Possible Solutions
1.  Age at which benefits are available must be increased in relation to the increase in our life expectancy.
2.  Those of us who have provided comfortably for our retirements must consider reduction, or even elimination of our benefits for the viability of the program.
3.  The option for a portion of benefits to be available for young workers to invest in capital markets.
4.  You decide.  Those of us who are parents and grandparents have the responsibility to make tough decisions in order to keep this program viable for the next generations.  Yes, we paid into the system.  Yes, a promise was made.  But we're paying out much more than we're taking in, and no expense is anywhere near that of Social Security, Medicare and Medicaid.  It's our responsibility.
We need to acknowledge the problem and fix it.
As always, I welcome your comments and suggestions.