Wall Street traders and commentators again were engaged in discussions about the tendency markets have in leading the economy by 6-9 months, suggesting that today’s early rally may be the precursor to an expanding economy by year-end 2009. Though most would agree that such speculation is premature, we can’t ignore that the US markets continue to be grossly oversold and that a meaningful equities rally for 2009 is likely. Unfortunately, what is at least as likely is an increase in the jobless rate by as much as another 2-3 percent, continued declines in GDP for the 1st and 2nd quarters, and a housing market that will continue to put pressure on consumers, bankers, and credit markets.
Expectations of an economic recovery/stimulus package remain high and as resources make their way through the economy we will certainly see some relief. But economists look for results that can be described using terms such as ‘efficiency’ and ‘optimization’, and the various proposals making their way through the executive and legislative branches appear less and less efficient each time we see them. Though these efforts will undoubtedly help strengthen our ailing economy in the near term, what they will ultimately optimize may simply be various re-election campaigns.
Regardless, most investors shy away from discounted markets for fear of further downside risk, though it is just these types of markets that eventually create wealth for those prepared to strategically position their assets in diversified portfolios. Many believe that profits are made when assets are sold, but most often the truth is just the opposite; profits are generated as assets are purchased at discounted prices for those willing to hold them until the market once again recognizes the full value of the asset.
The Market’s ‘Gift’ to President Obama
Wall Street offered newly-inaugurated President Barak Obama a gift, of sorts, on Tuesday by providing a 317 point drop in the DOW on the day of his inauguration. Gift may not be the correct term, perhaps it was a message, or maybe it wasn’t even intentionally offered, regardless, it was too loud to be ignored. The question is, what does it mean and why did it happen?
The range of possibilities is too broad to completely explore, but the following are a few of the more likely explanations:
Though many Wall Street decision makers have reflected the same optimism and hope for Obama’s administration as that of many Americans, the decline and the resulting market volatility may have been telling the administration that there is more to be done than can be accomplished with populist phrases and declarations of hope and change.
Many in the market have suggested that Tuesday’s decline reflected a realization that regardless of how optimistic we are for the success of Obama’s policies of change, the challenges at hand are too great to expect any near-term solution or recovery.
The investment markets may have been firing a shot across Obama’s decks to let him know that while there may be tolerance, or even support, for his recovery policies, there will be little acceptance for the ‘share the wealth’ doctrine offered during the election.
It may simply be that Obama’s election ‘shine’ has already worn off for the markets and the decline was more of a response to earnings declarations and this week’s economic reports than to his inauguration and the attending celebrations.
Here’s my favorite (if for only comedic value and without foundational merit): The market may have been expressing fear of the legal repercussions of Chief Justice Roberts bungling of Obama’s oath of office and the possibility that Joe Biden may have quickly become the ‘legal’ president without a constitutional remedy to the situation.
My favorite aside, the reality is that each of these various sentiments was expressed this week by decision makers and investors alike. In truth, closer inspection of the inaugural-day sell off reveals that it was more of an indictment of our banking complex and the employment markets than it was a message for the incoming administration or Obama himself.
Wall Street decision makers offered mixed support for Obama in the presidential elections, and there were virtually as many proponents for his agenda of change as there were detractors. However, most agree that his broad-based popularity extends across most segments of our economy, and whether they voted for the Obama/Biden ticket or not, business leaders around the country have voiced optimism and respect for the new presidential team and their administration.
The Current Refinance Boom
With mortgage interest rates on conforming loans having dipped to the 5% range, in some cases as low as 4.75%, the US mortgage industry is experiencing another refinance boom, though far different from the refi booms of recent years. For today’s homeowners to succeed in their refinance efforts, most must have credit scores in excess of 700 points, loan to value ratios of no more than 80%, primary debt-to-income ratios of 28% or lower, and have little expectation of walking away from the closing table with extra cash. There are exceptions, of course, but without question, we’ve entered a very different era of mortgage financing from that of the last 10 years - one that closely resembles the more responsible lending environment of much of the late 20th century.
As always, there are pros and cons to mortgage refinancing, and the mortgage markets is filled with creative and hungry brokers whose business revenues have been drastically reduced in the wake of the housing and credit crisis. I had an opportunity to help a client assess the value of a refinance this week that looked like an excellent opportunity on the surface, but in fact represented a mixed bag of costs and benefits once looked at in the light of full disclosure. We thought an exploration of its details might prove useful to others.
The client has a 7.15%, 30-year, fixed rate loan on a home that was purchased only 6 months ago. An offer had been extended for a 5.5% fixed rate, 30-year FHA loan. The qualification and underwriting process had progressed swiftly towards a scheduled closing date without a detailed Good Faith Estimate (GFE) or Truth In Lending Statement (TIL). In most markets the law requires that these be provided at or close to the filing of an application, but in truth, those that are made available are often based on limited information and are subject to substantive changes as the underwriting process proceeds. However, based on the information at hand, the client surmised that 5.5% is better than 7.15%, and was enticed by the mortgage broker’s reports of $35,000 - $40,000 in savings over the life of the loan – who wouldn’t like these numbers? The answer lies in the details.
The GFE and TIL provided just one day before the scheduled closing revealed that the combined cost of the refinance was in excess of $7,200, which cost, in addition to approximately $2,800 cash out at closing, would be added to the existing loan balance of $122,000. Paying off the existing loan, paying for the loan origination fee, FHA fee, title insurance, and so on, resulted in a new loan balance of $132,000. The client’s monthly payment would decrease by just over $20 per month for the first five years and then would decline by another $53 per month thereafter as an FHA mortgage insurance fee is scheduled to drop off. Though the client would receive $2,800 in cash at closing, and would realize a total savings of some $23,000 over the life of the new loan, there would be 360 payments due under the new loan as opposed to 354 under the existing loan, bringing the adjusted benefit to just under $20,000. Again, who wouldn’t want to close on this new loan?
What happens if the client chooses to move or refinance in 5-7 years as most Americans do? Would the combination of the cash offered at closing and the cost savings still provide a benefit? No. The economic benefit of the new loan can’t be realized for almost 12 years as the client’s new loan balance would begin at $132,000 versus the existing balance of $122,000. What if the client chose not to accept the $2,800 offered at closing and continued to make their current payment instead of the new, lower payment? The benefit of the new loan would be accelerated by a few years, but the client would still be disadvantaged for more than the 5-7 year time frame. And, if one takes into account the effect of inflation on the dollars saved in the future, their net present value, and the effect of having fewer tax-deductable dollars in home mortgage interest expense, the real savings is yet less.
In this case, the client chose the new loan. In part out of his certainty that he will buck the national trend towards refinance or relocation in less than 8 years, in part because 5.5% just feels better than 7.15%, and in large part because when facing a possible refinance, most people are simply ill-equipped to accurately calculate the long-term effect of some cash offered today and a little bit of savings provided tomorrow versus the impact of a larger debt to pay off and several more payments to be made some 29 years from now.
Treasury Secretary Nominee Timothy Geithner’s Income Tax Disclosure
The news media and the US House and Senate have made much over the last few weeks regarding Treasury Secretary Nominee Tim Geithner’s disclosure that he only recently paid some $43,000 in past-due federal taxes. Even pragmatic economist, turned news commentator Lawrence Kudlow (CNBC) stated that Geithner’s actions reflected a lack of character. But what are the real issues here and how should we look at a senior policy maker’s handling of their own finances? Most of the Senators responsible for Geithner’s confirmation asserted that the revelation was disconcerting, but not sufficient to derail his confirmation as Obama’s Treasury Secretary. Many media representatives have decried his actions as ‘deplorable’ or indicative of a level of corruption and abuse prevalent in today’s society. Geithner and his supporters have feigned innocence and offered apologies for a simple mistake.
Had such a disclosure taken place prior to the Clinton administration, it is almost certain that the nominee would have withdrawn. But in an age in which many have determined that one’s private values have little bearing on public judgment. Much can be forgiven, or at least overlooked.
Geithner is already a senior Federal Reserve official and is under constant scrutiny. In truth, his error in not properly filing his 2001-2004 tax returns may reflect a lack of judgment, depending on whether or not one believes that the error was made in innocence or was deliberate. Regardless, a choice to delay payment of taxes is a legitimate, albeit expensive, option offered by the IRS. Geithner is a businessman and economist, and hopefully makes financial decisions in a pragmatic, deliberate manner. When faced with the decision to put off paying an obligation, an informed business person weighs the costs and benefits of the situation. Delaying payment increases the expense by the imposition of interest and penalties, while making the payment in a timely manner may strain current resources or require costly borrowing. Depending on the situation and the attending costs and benefits, delaying payment may be the most efficient economic choice. What Geithner may not have considered was the political fall out, but even then, most of the members of the Senate committee charged with confirming him to one of the most powerful posts in the country, one that will likely include disbursing trillions of dollars over the course of his likely tenure, have offered him their support and suggested the issue only represents a small distraction in the confirmation process.
Signature Update is offered by Richard Haskell, Managing Director of Signature Wealth Management
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