Political events of the past two years have delivered a more profound and devastating message: American democracy has been conclusively conquered by American capitalism. Government has been disabled or captured by the formidable powers of private enterprise and concentrated wealth. Self-governing rights that representative democracy conferred on citizens are now usurped by the overbearing demands of corporate and financial interests. Collectively, the corporate sector has its arms around both political parties, the financing of political careers, the production of the policy agendas and propaganda of influential think tanks, and control of most major media.

William Greider
" The End of New Deal Liberalism"
The Nation

Over the Christmas holiday, Secretary of the Treasury Timothy Geithner showed his enormous generosity by cutting settlement deals with Ally Financial (Q3 2010 Stress Rating: "A+") and Bank of America (BAC/Q3 2010 Stress Rating: "C") for much of their potential exposure to repurchase claims for loans sold to Fannie Mae and Freddie Mac. Once again it is proven that the greatest sins committed in Washington are acts of omission.

We described this transaction in The IRA Advisory Service this week, including why we believe this settlement is not the end of the story on Fannie exposures for BAC -- despite what BAC told analysts. Read the Fannie Mae press releasekiddies, then re-read the BAC call transcript. Wuz we lied to about the settlement covering all of the Fannie exposures during the Q&A? BAC IR won't let us ask questions on the call, so we could not ask for a public clarification.

After reading the latest missive from Laurie Goodman at Amherst Securities, we've got to believe that the losses on these 2004-2008 vintages of RMBS will go up as the year progresses and into 2012, causing the actual forgiveness of liability for BAC, Ally and other banks by the Treasury to increase. This also means that we could see an increase in the visible stress in the U.S. banking industry as measured by The IRA Bank Stress Index.

For those of you not familiar, Ms. Goodman is looking for an increase in defaults on the remaining body of home mortgages in the system, especially loans which have never shown default tendencies. This bearish view comes because of the problem of negative home equity and the related phenomenon of strategic default. With more than a third of the housing stock below water and the "owners" now really tenants, Goodman and others see increased defaults from the remaining body of performing mortgages.

Now not everyone believes that the strategic default problem is as severe as Goodman and others believe, in part because the mortgage payment on a house is essentially the equivalent of rent. Compared to what is the operative question. We all need a place to live, but as we have also described to subscribers to The IRA Advisory Service in some detail, a tiny change in the size of the average household has a big impact on the demand for housing -- especially when the GSEs, FDIC and banks are all involuntary sellers of foreclosed properties.

We agree that 2011 is not so much an apocalypse as an accelerating liquidation, but such points are small comfort in a market that is illiquid and still seeing prices fall. The power of the argument of Goodman and others with respect to strategic defaults increases the further underwater residential properties sink. As we have noted in past comments, you don't have to be a believer in a secular increase in strategic defaults to be bearish on U.S. home prices.

The weight of involuntary sales is already pulling the Case-Shiller home price index down. In this regard, it looks like our down 4% estimate for the HPI in 2010 is going to be pretty close, but this is more luck than deliberation. Without a change in policy in Washington, we expect that our down 10% estimate for 2011 will be adjusted further downward. More on this below.

But first we have a comment from our friend Robert Feinberg on the state of the political economy as seen from Washington, D.C. Everything Bob predicted in our first interview in The IRA back in March 2008 ( "GSE Nation: Interview with Robert Feinberg", March 17, 2008) has come to pass. Given that the equity market value of the zombies has been climbing since the end of Q3 2010, the Street clearly believes that the proverbial fix is in and that the Treasury will subsidize the losses of BAC et al. Bob confirms that view and that "too big to fail" is alive and well in Washington.

 

 

(c) Institutional Risk Analyst

www.institutionalriskanalytics.com

 

 

 

 

 

 

 

 

 

Remember, if you have a question or comment, send it to .