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Tag Archives: Loan Modification

Bankruptcy or home price rebound: What will save the day?

Morgan Brennan of Forbes.com runs a fantastic commentary and blog upon economic issues.  I have read a recent post she made and I refer to it because I think it is so important.

Many people are “holding on” to houses that are way under-water e.g., much more is owed against the home than it is worth.  These hopefull folks want the good old days of the early 2000s – they hope that housing prices will rebound and that they can perhaps sell their home or borrow against new-found equity in order to pay off medical bills, credit card debts and other obligations.

But Ms. Brennan thinks otherwise – she doubts that there is really any true national “recovery” in housing set to take off anytime soon.  She provides lots of good explanations and reasons why.  She also discusses with clarity something I have long sought to express – that houses are not necessarily “investments”, but rather a localy based asset that has utility for household needs – like a washing machine, fridge or station wagon.

Here is what Ms. Brennan has to say:

_______________________

“The Foreclosure Crisis Isn’t Over Just Yet”, December 1, 2012, by Ms. Morgan Brennan of Forbes.com

 

‘As we move into the last month of 2012, real estate pundits have been eagerly pouncing on the notion of a recovery in housing.

Looking at the national numbers, they are somewhat right to do so. Pending home sales hit a five year high in October, according to the National Association of Realtors, and the brisk pace of existing home sales is 11% higher than a year ago.  Just this week the S&P/Case-Shiller Home Price Index reported that September home prices were up for the sixth consecutive month. Even in terms of economic growth, housing has provided a so-called bright spot, contributing 0.3% to gross domestic product in the third quarter, according to the Commerce Department.

Looking at these relatively rosy statistics, it’s easy to see why the word “recovery” is getting tossed around and why many housing-sector stocks have been teetering in over-bought territory. Now, the positive numbers even have media outlets like Bloomberg.com asserting that the

It’s a gutsy assertion — and one that I’m prone to disagree with.

A major reason the housing crisis was not staved off when the first warning signs manifested in the mid-2000s was the fact that Wall Street, Washington and even Main Street America had stopped assessing housing as what it truly is: a locally-based asset class, not a national one.  Housing is local and as we have been relearning since the downturn, market health — including foreclosures — breaks down by state, city, neighborhood and in some places, even street. The wave of foreclosures has been manifesting at these more local levels — even while national-level data reflects a recovery.

Since 2007, the foreclosure crisis, which has claimed nearly four million homes, has played out very differently across the U.S. After the robo-signing scandal of late 2010, lenders, flush with defaulted mortgage notes, delayed their processing of foreclosures, most notably in judicial states, where filings circulate through a  court system. That delay created an artificial decrease in the rate: 830,000 homes were foreclosed upon in 2011, a 24% decrease from the year before, according to CoreLogic, a Santa Ana, Calif.-based data firm. With the advent of the $25 billion mortgage relief plan in February, real estate experts projected a notable pick-up in activity since lenders sitting on delayed filings would hopefully process them more quickly.

This expected uptick has been referred to as a so-called second wave of foreclosures. It’s this second wave — which is technically distressed inventory overhang from the bursting of the housing bubble — that Bloomberg is asserting has been averted.

Nationally the number of foreclosure filings in October was down 19% from a year earlier, according to Irvine, Calif.-based data firm RealtyTrac. And lenders are finally instituting better foreclosure-prevention policies like loan modifications and short sales that keep homes from hitting their books as REOs. But it comes back location. Dig into the more local data and the wave is evident. You’ll find it playing out in the states where the foreclosure process has been taking the longest and backlogs have built up.

“There’s been a pronounced shift in foreclosures from the Sand States to the East Coast, in particular the judicial foreclosure law states with the longest time lines like Florida, New York and New Jersey,” says Mark Fleming, chief economist for CoreLogic. According to CoreLogic, Florida, as of October, now leads the country in terms of foreclosures with an 11% rate. New Jersey is second with an 8% rate and New York has a 5% rate. (In general, 1% is considered a healthy rate in a healthy market.)

The average time for a mortgaged home to transition from default to bank reposession in each of these three states has been over two years. Now those backlogged filings are pushing through the system at robust rates — in a wave of activity, if you will. New Jersey experienced 140% increase in filings in October year-over-year and New York nearly a 123% increase, according to RealtyTrac. Florida’s rate has been high for years, and while other hard-hit Sun Belt states like California and Arizona have seen activity decrease dramatically by about 35%, Florida’s rate has not.

“There are a set of states that are not improving year-over-year like the others,” adds Tim Martin, group vice predisent of U.S. housing at TransUnion, which tracks mortgage delinquencies of 60 days or more. That set includes New Jersey, Arkansas, Washington, New York, New Mexico, Connecticut, Maine, Maryland and Washington, D.C.  Martin says most of these locales still have incredibly high rates of mortgage delinquencies. In New Jersey for example, 8.3% of mortgage borrowers have missed two or more payments. Once those borrowers miss third payments, their homes officially fall into default and foreclosure filings eventually follow.

 

Here is a link to Ms. Brennan’s excellent article:  http://www.forbes.com/sites/morganbrennan/2012/12/01/the-foreclosure-crisis-isnt-over-just-yet/

A look at FHFA home price data for the third quarter indirectly reflects the renewed wave of foreclosures in these states also. The states posting the largest home price drops this year are many of the same states where the foreclosure rate has increased this year, including New York, New Jersey, Illinois and Maryland. Foreclosures add downward pressure to overall home prices.

Still, there’s good news on the horizon even in these markets. New borrowers aren’t significantly adding to the default pile and TransUnion projects that the fourth quarter will register a decrease in delinquencies. CoreLogic and others believe the worst of the foreclosure crisis has passed. But in the states where foreclosures are finally pushing through the system, it won’t necessarily feel that way for some time. Thanks to the ‘wave’.

“The housing market is like a large ocean vessel that when heading one direction, takes a while to turn around” explains Fleming. “So it will take time in terms of clearing out all of these foreclosures.”’

 

Again, this is a great article.  Here is a link to it: http://www.forbes.com/sites/morganbrennan/2012/12/01/the-foreclosure-crisis-isnt-over-just-yet/

 

-What to do with your underwater home?

– What to do with a first and second mortgage?

-What to do about a pile of medical bills, credit cards and car loans?

Come in to consult with James H. MaGee, Washington Bankruptcy Attorney in order to gain some fresh perspective as you organize your game plan.  We have offices in Bremerton, Chehalis, Olympia, Puyallup, Renton and Tacoma where you can meet for a private and confidential consult with Mr. MaGee  Just give us a call 253-383-1001!

HAMP modifications 7 of 7: HAMP Modifications – Documents and info normally including in your HAMP request.

How do I apply for a modification under HAMP?

If you meet the general eligibility criteria for a modification under HAMP, you should gather the financial documentation that your servicer will need to determine if you qualify (See “What information and forms will I need in order to be considered for HAMP?”). Once you have this information, you should contact your servicer and ask to be considered for a modification under HAMP. The servicer’s phone number and email address is on your monthly mortgage bill or coupon book. Please be patient yet persistent. Your servicer may be handling a large volume of inquiries about the program and it may take some time before your servicer is able to process your application.

If you would like to speak to a housing counselor, call 888-995-HOPE (4673). HUD-approved housing counselors can help you evaluate your income and expenses and understand your options, and apply to your servicer for HAMP. This counseling is FREE.

If you have already missed one or more mortgage payments and have not yet spoken to your servicer, call your servicer immediately.

What information and forms will I need in order to be considered for HAMP?

Recently, Treasury announced a more streamlined homeowner evaluation process. Now, in order to apply for a Home Affordable Modification, homeowners can submit proof of income (See “What proof of income will I be required to provide with my HAMP application?”) plus the following two forms:

The MHA Request for Modification and Affidavit Form (RMA). This Form captures information on borrower income, expenses, subordinate liens on the property, and liquid assets. It includes a Hardship Affidavit, fraud notice, and information about the Trial Period Plan.

The Internal Revenue Service (IRS) Form 4506T-EZ (Short Form Request for Individual Tax Return Transcript). This form gives permission for your mortgage servicer to request a copy of the most recent tax return you have filed with the IRS. After you have completed the form, print two copies—one for your records and one to send to your mortgage servicer.

Visit the “Request a Modification” section of MakingHomeAfordable.gov for more detailed information.

What proof of income will I be required to provide with my HAMP application?

Be prepared to submit a copy of your two most recent pay stubs that show year-to-date earnings. If you are self-employed, you must provide your most recent quarterly or year-to-date profit/loss statement. Visit the “Request a Modification” section of MakingHomeAfordable.gov for more detailed information. If you cannot find the required documentation, or have questions about the paperwork required, please call 888-995 HOPE (4673) and ask for “MHA HELP.”

I’m self-employed. How do I get a copy of my most recent quarterly or year-to-date Profit and Loss Statement?

Contact your CPA (Certified Public Accountant) or the licensed tax professional who assisted you in completing your tax documentation.

What types of documentation would be considered reliable enough to validate “Other Earned Income” for HAMP?

148B

Other earned income (bonus, commission, fee, housing allowances, tips, overtime) must be documented by your employer in either your paystubs or other employment paperwork/contracts. Homeowners are encouraged to work with their employers to gather this information to describe the nature of the income and the continuity of the income.

51.

57BHow do I get evidence of benefit income (e.g., social security, disability, death benefits, pension, public assistance, adoption assistance)?

149B

You can provide a copy of benefit letters/statements, disability policy, or receipt of payments such as copies of two most recent bank statements showing electronic deposit of benefits. For additional information regarding social security, disability or death benefit income, contact Social Security directly toll-free at 1-800-772-1213 or visit their website at www.socialsecurity.gov. For all other benefits, you must contact the provider directly for additional information.

52. How do I get evidence of unemployment benefits?

Evidence of unemployment income may currently be obtained through the Department of Labor UI benefit tool, which is available at http://www.ows.doleta.gov/unemploy/ben_entitle.asp. After the Home Affordable Unemployment Program (UP) becomes effective on July 1, 2010, unemployment benefits and severance pay will no longer be acceptable sources of income for HAMP consideration. (See “Home Affordable Unemployment Program (UP)” for more information about help for unemployed homeowners.)

My rental income was not reported on last year’s tax returns because the property was vacant. What documentation do I need to validate rental income?

In such cases where a property has recently been rented, a signed Rental Agreement contract must be provided to show: the property address, date of contract, lessees name and address, rental amount and rental period. The contract must be signed by all parties (lessor, lessee, rental agents etc.)

How do I get a copy of my Divorce Decree, Separation Agreement or other legal written agreements filed with a court (e.g., alimony or child support)?

Gather the information listed below and contact the Office of Vital Statistics in the state where your divorce occurred. The homepage of the state’s website will provide a link/information on how to contact the office of Vital Statistics. Generally, the documentation needed may include, but is not limited to, the following:

Date of your divorce

Full name of spouse

Your driver’s license number

Purpose for which record is needed

Your name and address, together with a self-addressed, stamped envelope

See the June 8, 2010, government publication re: info relevant to this post: http://makinghomeaffordable.gov/docs/BORROWER%20FAQs_6-8-10.pdf

“Robo-signer” problem unlikely to afford relief to Washington homeowners in foreclosure – despite big problems at GMAC and J.P. Morgan Chase bank.

[catagories: Washington bankruptcy attorney]

The Seattle Times reported on Sunday, October 3, 2010 (columnist Blythe Lawrence) and the New York Times reported on September 30, 2010 (columnist David Streitfeld) that J.P. Morgan Chase and GMAC were quietly halting or delaying foreclosures in up to 23 states which require "judicial foreclosures". Unfortunately, Washington is a state which allows non-judicial foreclosures, so it seems unlikely that Washington residents will receive the benefit of a postponed or stopped foreclosure because of "robo-signer" foreclosure procedural inconsistencies.

Just what is a "robo-signer"? Take the case of Jeffrey Stephan, 41, who was a modest to low paid employee at GMAC. From his cubicle in Pennsylvania, "robo-signer" Mr. Stephan signed off on as many 10,000 foreclosures per month. This is about one foreclosure per minute, assuming an eight hour work day. The problem is that Mr. Stephan’s signature indicated that the information in the legal foreclosure documents was accurate to teh best of his knowledge, and that he signed in the presence of a notary. The problem was, that didn’t always happen, according to depositions that Mr. Stephan gave in December and June for court cases involving families trying to keep their homes, reports Brady Dennis of The Washington Post. (See Sunday, October 3, 2010, Seattle Times article).

Mr. Dennis reports that "Stephan’s admission has cast into doubt thousands of mortgage-foreclosure filings. Ally Financial, the nation’s fourth-largest home lender and GMAC’s parent company, halted evictions in 23 states that mandate a court judgment before a lender can take possession of a property."

IDEAS FOR ACTION: I have seen a few court cases in bankruptcy court where hopeful individuals are trying to stall or stop a foreclosure by complaining that the foreclosing bank cannot produce copies of original notes or produce a "chain of assignments" showing the various transfers of ownership of the loans. These hopeful (but misguided) borrowers may successfully see a slight delay in the bankruptcy courts, but they should not hold their breath for a permanent injunction against foreclosure. Our local judges are not inclined to give anyone a free house. Remember, one of our local bankruptcy judges ran a foreclosure/garnishment/repossession law firm for many years and thus enjoyed bread buttered by the mortgage lenders for most of a long legal career; It is unlikely in my opinion that this judge will put up with such anti-foreclosure stall tactics for any appreciable length of time. No observation here is meant to disparage the judge or any judge for that matter, but to just point out a widley known fact in the reasonable exercise of first amendment freedoms. Most of the foreclosure stall tactics you might read about on the internet mostly originate from more distantly liberal jurisdictions; I doubt they are going to meet with much traction in this jurisdiction. However, this unlikely strategy of a permanent injunction against foreclosure is absolutely distinct and different from a perfectly allowable "lien strip" of a second mortgage. A "lien strip" which is fully permissible and legal under the bankruptcy code. In a lien strip, a Chapter 13 debtor may be able to completely write off his/her second mortgage and remove the lien from the property without having to pay one dime to the second mortgage holder.

Mortgage modifications failing, meeting only 16% of intended goals, says NY Times

NY Times columnist David Streitfeld reports that the dropout rate from the Making Home Affordable Program (HAMP) is very high. 96,000 trial modifications were canceled by the lenders in July 2010. The number of canceled trial modifications now exceeds 616,000.

Those numbers are leading some housing experts to call the program, which modestly rewards lenders for modifying mortgages, a failure.

About 422,000 mortgage modifications overseen by the government were considered permanent as of July 2010, up from 389,000 in June. But the pool of candidates is shrinking rapidly. Only 17,000 trial modifications were started in July, down sharply from the 150,000 enrolled in September 2009 when the program was new according to a report by NY Times columnist David Streitfeld.

After reviewing the new data, Calculated Risk, a popular financial blog, wrote, “Those borrowers are still up to their eyeballs in debt after the modification,” and many will default again.

“My concern is that if we have another protracted housing dip, it’s going to bring the economy down.” Mr. Feder, chief executive of the real estate data firm Radar Logic explains, saying that he expects prices to ‘get whacked’  in the Fall of 2010.

“If consumers don’t think their houses are worth what they were six months ago, they’re not going to go out and spend money. I’m concerned this problem isn’t being addressed,” says Mr. Feder as quoted in the article by Mr. Streitfeld of the NY Times, published on Saturday, August 21, 2010.

Mortgage modifications well below target: Americans need more help says NY Times 300,000 foreclosure filings for third month in a row — 92,858 homes repossessed in July, 2010

“As repossessed homes are put up for sale, house prices are likely to fall further. As prices fall, more borrowers end up “underwater”–they owe more on their mortgages than their homes are worth. That’s a big risk factor for default.

Moody’s Economy.com estimates that 1.9 million homes will be lost this year, down only slightly from 2 million in 2009.

So far only 398,198 loans have been permanently modified, and only $321 million of the $30.1 billion allocated to the home modification program has thus far been spent.

Part of the problem is poor administration. Homeowners, who apply to their bank or mortgage service company, complain about confusing procedures and lost paperwork. Banks have complained of frequent rule changes from the government.

Another big problem is that many lenders, whose participation in the program is voluntary, have been reluctant to aggressively rework bad loans. Reducing a loan’s principal balance–rather than lowering interest levels or extending pay out periods–is often the chance of keeping underwater borrowers in their homes. Banks have been loath to accept the bigger losses that come with lowering principal. Fearing that banks will drop out of the program altogether, the Treasury has not pushed them hard enough.”

The August 20, 2010 NY Times OpEd piece proposes that the use of the states to give money directly to temporarily unemployed or under-employed individual homeowners to make mortgage payments through the Hardest Hit program (part of HAMP, which is part of TARP), through about which 4.1 billion has thus far been disbursed, may be a better route than the loan modification programs emphasized thus far to date.

Ideas for Action: Don’t expect to modify yourself out of a bad situation. You will never see a mortgage loan principal balance deduction. If you don’t mind a temporarily lower payment but still remaining underwater on your home, then I suppose a mortgage modification is not so bad. You might want to consider a “lien strip” through Chapter 13 bankruptcy if you have a second mortgage and if the value of the home is less than the amount owed on the first mortgage.

Financial Reform: Will the Dodd-Frank Financial Reform Law destroy the private mortgage industry and lead to risky government lending?

Banks lend money (a mortgage) against your house. The banks then put 1,000 mortgages or so together and sell the package of mortgages to an investor in a “pooled mortgage”. Some pooled mortgages have held a government guarantee of performance through FHA (Federal Housing Administration), Fannie Mae, or Freddie Mac, other pools were not insured because they were supposedly riskier loans, as the borrowers did not qualify under loan risk guidelines established for Fannie Mae or Freddie Mac.

Under the new rules contained in Dodd-Frank, the original lender must retain 5% of the risk in the pool if it is not a federally guaranteed (e.g. FHA, Fannie Mae or Freddie Mac) loan pool.

CNBC.com editor John Carney writes that exempting FHA, Fannie Mae and Freddie Mac from the 5.0% risk retention requirement will destroy the private mortgage industry and make the US government the unintentional backer of all mortgages:

“…a little-noticed provision of the Dodd-Frank act threatens to undermine efforts at rebuilding an innovative and healthy private sector for mortgages. Under Dodd-Frank, financial firms that securitize mortgages are required to retain 5.0% of the risk of those securities. The goal, a laudable one, is to encourage companies to more closely monitor the quality of the mortgages they securitize (sell off in pooled bundles). But it is also likely to increase the cost of affected mortgages, because banks will seek to pass on the costs of the risk to home buyers. Mortgages guaranteed by the F.H.A., however, are exempt from the 5 percent risk-retention requirement. This means that lenders will find that it costs far more, and involves more risk, to offer mortgages they back themselves than those covered with a guarantee from the agency. There’s little doubt this will lead to a huge increase int he volume of business done by the F.H.A., as banks creating securities will seek out mortgages on which they don’t have to cover the risk. Purely private mortgages will quickly be pushed out of the market.”

The complete article by Mr. Carney was published in the NY Times on August 12, 2010.

Is there a “flexible mortgage” in your future? – new thoughts and trends in mortgages – article by UCLA Law Professor Katherine V.W. Stone

Professor Katherine V.W. Stone, of UCLA law school writes that in the “old economy”, periods of joblessness were a clear sign of an unreliable borrower, but not any more, as we are in a “new economy”. Professor Stone’s article is entitled “The 30 Year Prison”, and appears in the August 12, 2010 edition of The NY Times.

Professor Stone calls for a major changes to mortgages–a “flexible” mortgage with the borrower having an option to request a two-year period of “interest only” payments. She suggests that the Federal Housing Administration require that any mortgages it insures be set up to mandate that borrowers who are involuntarily out of work be allowed to convert to an interest-only loan for up to two years. She points out that since the FHA insures almost one-third of the mortgage housing market, in short order the mortgage industry would very likely follow suit, and that this practice would become the norm for all mortgages.

Professor stone writes: “It’s not as if the 30-year self-amortizing mortgage has been around forever. In fact, it is a fairly recent invention. Before the 1930s, homes were financed by three-to-five-year balloon loans. Homeowners made interest-only payments for the duration of the loan, then typically rolled them over into new loans when they came due. During the Great Depression, however, many borrowers were unemployed when their loans came due; banks were reluctant to offer new loans, and owners had not accumulated enough money to pay off their loans. The result was a wave of foreclosures. In response the Home Owners’ Loan Corporation, created as part o the New Deal, developed a new kind of loan: instead of a few years of small payments followed by a very large one, homeowners would make regular payments of interest and principal for 30 years. In the old economy, periods of joblessness were a clear sign of an unreliable borrower. Today, they are simply a function of the job market, which flexible mortgages would take into account.”

Loan Modifications in Washington: How much is the government spending through HAMP and TARP?

Washington will get some share of the $1 billion disbursed to HUD to help with house payments so if you are unemployed and falling behind on house payments, hit HUD up for a loan.

Unfortunately, Washington homeowners get NOTHING from the recent $2 billion disbursed by the Troubled Asset Relief Program to other states. The benefited states as to the $2 billion include Alabama, Illinois, Kentucky, Mississippi, New Jersey, and Washington D.C., as part of the Hardest Hit Fund disbursements.

This $2 billion is the third large grant to the Hardest Hit Fund. Washington has not received any portion of those three grants. The Hardest Hit Fund receives disbursements from the $45.6 billion set aside for housing issues in the Troubled Asset Relief Program. Hardest Hit Fund disbursements to those favored states to date now total about $4.1 billion in three disbursement. The Hardest Hit Fund is, for now, out of money.

To date, the other funds in the $45.6 billion earmarked from TARP to be expended for housing issues include $30.6 billion for loan modification programs (such as HAMP, AKA the Housing Made Affordable Program) and $11 billion for a FHA refinancing program. Thus, there would now seem to be no funds–zero dollars–left to disburse to the Hardest Hit Fund except that, as reported by Mr. Streitfeld in the New York Times, the government has up until October 3, 2010 (the two-year anniversary of TARP) to shift the $45.6 billion in committed funds around within the housing assistance program. Perhaps the government could issue one more Hardest Hit Fund disbursement which would make house payments for people by giving them outright grants or interest free loans to make house payments while unemployed, underemployed or suffering from some other sort of financial stress or strain. If the past is a guide to future policy actions, I doubt that Washington state would be a beneficiary.

While frozen out of the $2 billion Hardest Hit Fund to date, Washingtonians may see a little benefit from the $1 billion that was just disbursed to HUD (Housing and Urban Development) from the new Financial Overhaul Law. This $1 billion HUD disbursement apparently is not part of TARP, so it is $1 billion in “new money” in addition to the $45.6 billion in TARP for housing issues. As to this $1 billion, Mr. Streitfeld reports that HUD indicates it will work with local aid groups to offer bridge loans of up to $50,000 to eligible borrowers to help them pay their mortgage principal, interest, insurance and taxes for up to 24 months by way of interest-free loans to such affected homeowners.

Mr. Streitfeld reports that between the $1 billion HUD funds from the Financial Overhaul Law and the $4.1 billion pumped into the Hardest Hit Fund in three installments, up to 400,000 borrowers could ultimately benefit. However, given the reported 14.6 million unemployed or the 3 million households contemplating foreclosure, this assistance is modest, given the size of the foreclosure problem.

Loan Modifications: Washington state homeowners are “out of luck” — no help from TARP “Hardest Hit Fund” which just received $2 billion from Obama

Congratulations Illinois and Ohio homeowners! Sorry Washington homeowners – you lose!

Washington homeowners will receive no part of the round number #3 of “Hardest Hit” funds, which includes a disbursement of $2 billion recently committed from TARP funds to help homeowners in Alabama, Illinois, Kentucky, Mississippi, New Jersey, and Washington, D.C.

The Hardest Hit Fund draws on the total $45.6 billion set aside for housing in the TARP program; the TARP program started in the fall of 2008.

Ohio announced that it would use its $172 million share of the $2 billion to aid 15,356 homeowners by helping bring delinquent mortgages current for owners experiencing hardship because of a loss of income. The assistance will last up to 12 months, according to the report by NY Times reporter David Streitfeld on August 12, 2010.

In addition to losing out in round #3, Washington state also lost out in rounds #1 and #2 of the Hardest Hit Fund.

Round #1 contained a grant of $1.5 billion in the fall of 2008 to Arizona, California, Florida, Michigan, and Nevada.

Round #2 contained a grant of $600 million to North Carolina, Ohio, Oregon, Rhode Island and, South Carolina.

Information for this blog post appears thanks to an article by Mr. David Streitfeld of the NY Times. Please see the August 12, 2010 issue, page B-1.

Economy slowing down again, and Federal Reserve Bank is running out of traditional stimulus options says UCSC Economics Professor Carl E. Walsh

The economy is slowing down again despite interest rates being lower than ever: What is the government going to do next? Here is the answer, by NY Times Reporter Sewell Chan:

“The challenges the Federal (Reserve Bank) faces aren’t going to get any easier in the coming months,” said Carl E. Walsh, a professor of economics at the University of California, Santa Cruz. “The choices ahead are only getting worse as the economy seems to be slowing down.” Professor Walsh was quoted in the New York Times Thursday, August 12, 2010 edition, Section B1

Sewell Chan’s August 12, 2010 NY Times article introduces us to a new term, “Quantative Easing”, and says that after lowering short term interest rates, about the only thing that the Federal Reserve can do is to pursue a policy of “Quantitative Easing”. According to Mr. Chan, Quantitative Easing is a controversial and uncertain central bank tactic. There is little modern historical precedent by which Quantitative Easing can be studied and analyzed by economists to predict results.

Mr. Chan explains that because short term interest rates are already close to zero, that now the Federal Reserve Bank’s last and final option is more “Quantative Easing”. Will it work?

What is “Quantative Easing”? Simply put, it is the printing of additional money to purchase financial assets in the market place, by using government money to buy instruments held by investors. The instruments purchased by the Government Treasury in “Quantitative Easing” are things such as (a) mortgage backed securities (b) buying/cashing out debts owed by the government such as Fannie Mae and Freddie Mac obligations/bonds and (c) buying Treasury Securities like government bonds.

How does “Quantative Easing” seek to help the economy? My understanding is that Quantitative Easing intentionally creates some inflation as it increases the money supply, and thus with more money rolling around, there is an incentive to invest it by lending it to others. People and investors who now have this freshly borrowed cash then go on spending sprees, and it is these sprees which are supposed to stimulate economic growth by more lending to people who buy things with the newly borrowed proceeds.

In short, more people buying things with borrowed money increases demand for goods and services and such. Increased demand keeps prices for goods and services higher, which is supposed to offset the deflation of prices of goods and services that is occurring in this recession. (See following blog post describing why deflation is “bad”)

Shortly put, deflation is supposed to be “bad” during a recovery from economic recession because deflation will result in a further economic slowdown as people conserve their cash and do not spend it in order to wait for lower prices on everything from TVs to cars to houses to ocean cruises.

This would be a “Second Wave” of “Quantitative Easing” as the Federal Reserve Bank already took a first “Quantitative Easing” step between January 2009 and March 2010 by printing money in the amount of $1.725 trillion (that is 1,000,000,000,000!) dollars to purchase $1.25 trillion in mortgage-backed securities (essentially buying mortgages from private investors), $175 billion in debts owed by government-controlled entities like Fannie Mae (more mortgages) and $300 billion in Treasury securities.

Here are the pros and cons:

Pros of “Quantitative Easing” to buy mortgages and investment instruments held by private investors when lowering interest rates doesn’t seem to be getting the job done to stimulate the economy: Sewell Chan of the NY Times writes that the Federal Reserve Bank’s Chairman Ben Bernanke is an astute student of the Great Depression and that Mr. Bernanke has long argued that the central bank (The Federal Reserve Bank) has the additional tool of Quantitative Easing which should be somewhat readily used to avoid deflation in prices, as deflation will slow, stop or reverse a recovery as people look at cash as an investment in and of itself instead of spending the cash. For example, if you know that the $500 TV set will reduce to $475 in six months (a mere 5.0% deflation in price) then you are more inclined to wait six months to purchase. If you know that your $300,000 home you are looking at buying will decrease 5.0% in one year to $285,000 then you will keep in renting one additional year and will not buy the home, thus stagnating the housing market.

Cons of “Quantitative Easing” More conservative voices (according to the NY Times Swell Chan) propose that the Federal Reserve Bank should not go out into the marketplace to buy mortgages, and that the most aggressive steps taken should be to lower short term interest rates (please note that short term interest rates are almost zero!)

Problem #1: Those economists wary of “Quantitative Easing” say that in a “perfect storm” of circumstances, Quantitative Easing can lead to 1970s style “stagflation” as the government floods the economy with too much available money when it buys out the debt obligations of (a) mortgage backed securities (b) debts owed by government entities to investors such as Fannie Mae bonds and (c) Treasury securities, in an atmosphere when the economy is operating at a reduced level, because there is a surplus or bumper crop of money floating around, but not so much to buy.

Problem #2: According to economists skeptical of “Quantitative Easing” say that further purchases of mortgages, government debts and treasury bills by the Federal Reserve will undermine faith in the US dollar as an accepted stable world currency and the safety of the US Treasury bill as keeping ahead of inflation because it fosters “perceptions of monetizing indebtedness,” according to Mr. Chan’s analysis of economist Kevin M. Warsh, in that it looks like it is the printing of money to pay off the public debt. “On a very simple level [with Quantitative Easing], the Federal Reserve Bank is printing money so the Treasury can spend more than it’s collecting in tax revenues…these are highly unusual circumstances, so no one is too worried about it [right now]. But it is always a temptation to use the central bank to finance government expenditures.”

Mr. Chan writes that economist Kevin M. Warsh notes that the Federal Reserve already has purchased 2.3 trillion worth of debt which includes vast sums of Treasury Bills, perhaps too much. The Treasury Bills are essentially a large share of the national debt. (Note that the Chinese probably now hold the remaining balance. That is a none too funny note for another day). Mr. Warsh notes that the Federal Reserve Bank’s institutional credibility is at stake, if it threatens the currency’s stability to pursue domestic growth.

Problem #3: Economists wary of Quantitative Easing relate that economists “don’t have a lot of good historical episodes in modern economies to know exactly what the effects of quantitative easing are.” Mr. Chan quotes Professor Walsh.