[Continued from yesterday's Part 1.]

Now they know how many holes it takes to fill the Albert Hall

– The Beatles, A Day in the Life

If all you took from the February 11 Economic Times of India were the clips we highlighted yesterday, one could be forgiven for being depressed about India’s potential – so it’s time to look on the bright side of things.

Ahmedabad home-sales billboard: February, 2010

4. The Economic Times on loan pricing

Finance is the engine of housing improvement, and transparent information is the handmaiden of finance:

MUMBAI: Borrowers can now look forward to a more transparent pricing of their loans, with the Reserve Bank of India (RBI) proposing to introduce a new benchmark from April that will more accurately reflect movement in interest rates.

The Bank is also trying to remove barriers to banks going down-market:

At the same time, banks have been granted the freedom to price loans below Rs 2 lakh [$4,000 – Ed.], which effectively paves the way for their entry into microfinance at commercially-viable rates. 

That’s a start, and the Rs 200,000 floor is significant because a great many semi-formal houses can be purchased in roughly this price range, but it will take more than merely small-loan permission to get the banks to move down. 

SEWA Bank in Ahmedabad, February 2010

The central bank plans to introduce a so-called ‘base rate’, which will be computed on a cost plus basis by each bank and which will now be the floor price for all lending by it. The ‘base rate’ system seeks to replace the prime lending rate (PLR), the present benchmark used by banks. 

The RBI on Wednesday announced that the new base rate system would be made applicable from April 1. The guidelines are not yet finalised, but a draft circular issued on Wednesday evening has the broad contours of the new regime. 

“All categories of loans should henceforth be priced only with reference to the base rate. The base rate could also serve as the reference benchmark rate for floating rate loan products, apart from the other external market benchmark rates,” the RBI said in its circular. 

If a bank chooses to base its floating rates on external benchmarks, it should ensure that the external rate is equal to or above the base rate at the time of sanction or renewal of the loan. 

Although there’s a long way to go — as in lending for home improvement, not just on new-build with mortgageable title – it’s a step in the right direction.

Nancy with Indian girls at Chittaugarh, Rajasthan, February 2010

5. The Times of India on development of accurate slum data

NEW DELHI: Aiming to meet ambitious target of making India slum-free, the government has embarked on a plan of remote mapping to get a ‘‘reliable figure’’ of people living in slums by collecting foolproof data on both notified and non-notified slums across the country. 

As I’ve posted before, among the many definitions of a slum is when the physical reality and legal records are wildly at odds.  Thus, when they are brought into harmony, the place is no longer a slum, it’s not merely a low-income neighborhood.  Moreover, in reconciling the two, it is always the law that moves, not the physical reality.

While the current estimate of slum dwellers is based mostly on surveys of notified slums, most non-notified slums have been left out. 

Notification is a legal process both granting rights (to slum dwellers) and giving powers (to government).

Local office of SAATH, Ahmedabad: February, 2010

Serving about 2,000 households on government’s behalf

Maps of cities prepared through remote sensing would give a clearer and more authentic picture of slums in a city and would include non-notified slums.

It’s critical; knowing where the people are is a first step both to enumeration and citizenship, and also to providing financial and physical dimensions on the problem. 

Housing minister Kumari Selja

Housing minister Kumari Selja said: “Most of the time the plans are based on projections rather than hard data. We plan to map the entire country so that we know about slums in each town and city. This would also include non-notified slums which are usually not accounted for.” 

Once you have counted them, you cannot ignore them.

The ministry, which has set a target of making India slum-free in the coming five years with the launch of the Rajiv Awas Yojana (RAY), expects to get the exact figure by GIS mapping and including non-notified slums too.

The GIS mapping will have to be supplemented by on-the-ground enumeration, but when the two are combined, the findings will be well-nigh indisputable.

With involvement of Isro in this project, the land-mapping and slum surveys are being done through remote sensing with GIS-enabled software. 

I read this with encouragement and no small sense of recognition, since two weeks earlier, at the beginning of my trip, I participated in a two-day a World Bank sponsored workshop on Rajiv Awas Yojana (RAY).

The ministry has also asked states to develop a Slum Information System and the Centre has provided them funds for the purpose. “We want the mapping to be completed in two years,” Selja said. 

Riverfront slums, Ahmedabad, February, 2010

As we saw when reviewing The Ghost Map and The Blackest Streets, ever since we created modern urban sums – which I date from the Industrial Revolution – they have been corrected with a combination of tools, including liberal social reformers, enumeration and surveys, vote power, and eminent domain.  India is harnessing twenty-first century technology to accelerate its addressing of a nineteenth-century problem.

However, the ministry says it is facing delays in implementing its plans due to slow response from the states to its draft guidelines for which their opinion has been sought. The ministry has sanctioned more than 1.4 million houses for the poor. As many as 1,327 projects of affordable housing and basic amenities to the urban poor with an outlay of more than Rs 34,791 crore have been approved. 

That’s $7 billion in funding – a meaningful sum, even for massive and populous India.

As further explained in an accompanying DNA India story:

The ministry of housing and urban poverty alleviation (Hupa) will do satellite mapping of all slums in the country under the slum-free cities initiative of the government. Indian Space Research Organisation (Isro) will be collaborating in the project.

Any resemblance to the Star Fleet logo?

Mumbai will be among the four metros to be mapped first.

Hupa believes mapping will help governments find new slums taking shape and prevent their illegal spread.

That I doubt – but it may accelerate their remediation.  Evidently the article’s author shares my skeptical optimism (that revealing ‘besides’):

Besides, it will be effective in analysing slum communities, providing them sanitation and other amenities, and relocating them to suitable locations.

This I believe.

A similar satellite mapping done by Indian Institute of Remote Sensing on Dehradun’s slums showed that the number of slums in the city had increased from 75 in 1996 to 113 in 2000.

Less important than the number of slums – which, after all, can grow and meld into one another – is the overall scale, particularly including the number of people living in them.

Toward the future: Chittaugarh, February, 2010

Hupa is working with experts for a model legal regulatory framework for according property rights to slum dwellers.

I would love if it we at AHI were part of that activity.

A total of 5,161 towns are being surveyed to prepare a profile of household poverty and livelihoods of the slum dwellers. According to data available, Maharashtra has the highest number of slums in the country (32%), followed by West Bengal (15%) and Andhra Pradesh (15%).

Undoubtedly this directly correlates with the rate of urbanization.

The expanding blue city of Jodhpur: February, 2010

6. The Times of India on binding Public Sector Undertaings (PSU’s) into corporate social responsibility

Norms to bind PSUs with social duty in a month 

The department of public enterprises (DPE) will soon come up with norms on corporate social responsibility (CSR) for central public sector enterprises (CPSEs). 

This is how it begins; when government creates what the Economist calls quangos – quasi-non-governmental organizations, in effect state enterprises – it imbues them with unique powers, resources (such as large sums of money) and responsibilities.  Over time, as the PSU’s and CPSE’s become large and successful, government is within its rights to charge Rumpelstiltskin’s fee, and demand that the corporation take some of its profits – all of which derive ab initio from government largesse – and redeploy them into further expanding their social mission.

As per the proposal, cleared by the committee of secretaries (CoS), profit-making PSUs may have to set aside up to 2-5 % of their net profits for CSR activities.

Indian CSR is about to grow teeth.

 
The new norms will be formulated within a month and there will be no escaping from CSR, which will no longer be a photo opportunity for the chairman, said DPE secretary Bhaskar Chatterjee. “I would put a timeline of two to three weeks,” he added. 

Chatterjee looks implacable and inescapable

I love the phraseology, and the implicit political capital behind it.  Will there be follow-through, I hope?

There ought to be, as these are government entities, not purely private companies.

New construction residential: metropolitan Ahmedabad, February 2010

Even though most CPSEs earmark funds for CSR activities, most of them are on a voluntary basis.

Allowing them to arbitrage visibility against cost to maximize the headline-to-rupee ratio –

The CSR would no more be confined to organising blood donation camps or some charity event.

– which is less cost-effective than maximizing the impact-to-rupee ratio.

The proposal is now awaiting approval by heavy industries and public enterprises minister Vilasrao Deshmukh.

Deshmukh is the decider

The CPSEs with net profit of more than Rs 100 crore may be asked to contribute up to 2% of the amount, Mr Chatterjee said.

In other words, roughly $450,000 annually.  That’s enough for each CPSE to undertake initiatives of some reasonable municipal or local scale.

Of the 244 PSUs, 160 earned a net profit of Rs 91,083 crore in 2007-08, 2% of which amounts to Rs 1,821 crore. 

 
Based on their 2007-08 results, PSUs would have to spend at least Rs 1,500 crore.

Or $300,000,000 – enough to represent a major set of flows, structured in a manner similar to the so-far-stillborn housing trust fund intended to be funded with GSE profits.  [You remember alleged GSE profits, don't you? – Ed.]

The CPSEs would be obliged to take up specific projects to help people affected directly or indirectly by their businesses. This would be their primary obligation, out of the profits that they make. “You (CPSE) must recycle it to help the society,” the DPE secretary said.

For these enterprises, housing is a natural.  They have a vast pool of employees, for whom better quality employer-assisted housing is an employee loyalty and employee productivity issue.

 
Chatterjee said the guidelines would provide for measurement of the CSR. “This is happening not just in India but across the world,” he said. These obligations would be set in the memorandum of understanding, which sets targets for an individual CPSE.

Echoes of South Africa’s Financial Sector Charter.

Community organization, Ahmedabad-style: February, 2010

The performance evaluation would also have CSR as one of the parameters. 

The world’s largest democracy is serious about tackling its challenge of slums.  That’s heady stuff.

Bikaner, February 2010: I command the PSUs to dance to my tune

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I read the news today, oh boy

– The Beatles, A Day in the Life

One day’s newspaper clippings – in this case, The Times of India, Thursday, February 11 – represent an info-montage of the world’s largest democracy muscling its way into the twenty-first century, and along the way the world’s largest and most urgent national affordable housing and slum upgrading challenge.

Ahmedabad retail street, February, 2010

[Recently Nancy and spent three weeks in India, a week of it for AHI at the South Asia Housing Finance Forum (Delhi; two days), a World Bank sponsored workshop (Udaipur) on India's new slum upgrading initiative Rajiv Awas Yojana (RAY), and then (z) in Ahmedabad with our customer SEWA Housing Finance and our working partner the Ashoka Foundation. 

Listening with interest at the SAHF Forum, January 27

Along the way and afterwards, we went all over Rajasthan, the old Rajputana or the India of princely states.  I will have a post forthcoming on the range of Indian housing alternatives, complete with pictures – truly remarkable.]

Boy musician, Jaswand Tanda, Jodhpur, February, 2010

India will overwhelm you – at least, it overwhelmed us.  It’s too large, too rambunctious, too cacophonous, too pungent to be absorbed into any totality in any short interval.  I can see why people hate the place, and I can also see why people become enraptured by it. 

Downtown Jodhpur, rush hour, February, 2010

What follows are representative clips from one day’s Economic Times of India.  They are related an unrelated, consistent and contradictory, serious and silly.  All of them are India, and all of them are now.

Start with the challenges:

1. The Economic Times on the housing deficit in homes and rupees

NEW DELHI: The government on Wednesday said the country needs investment to the tune of Rs 3,61,000 crore [Roughly $7.0 billion – Ed.] to meet the shortage of nearly 25 million housing units. 

That’s called paying the piper!

“There was approximately housing shortage of 24.7 million dwelling units at the beginning of the 11th Five year plan…”

Government bodies love quantifying a housing ‘deficit,’ if only to give a macro scale to the problem.  Personally, I think the deficit has to be even larger than this, since it must include people living in inadequate housing, people living in too little housing, and people who are moving to India’s cities at an unprecedented rate.

“The investment requirements would be to the tune of Rs 3,61,000 crore for overcoming this massive housing shortage,” Minister of State for Urban Development Seagate Roy said at the CII real estate concave here. 

Ray thinks it’s 3.6 lakh crores of rupees

Of the total housing requirement, about 99% is constituted by the economically weaker section and the low income groups, he added. 

Housing demand being elastic, as these people become less poor, they will want more housing, so even if India magically conjured up 25,000,000 homes tomorrow, the nation would need an equal number the day after.

“The massive urbanisation in the past few decades has led to severe housing shortage for the urban poor… providing affordable housing is one of the most formidable challenges that our country faces today,” Roy said. 

As I said in my World Bank presentation, I’ve previously hypothesized that not only are slums economically rational, they may be an inevitable phase in urbanization, a phase that governments and cities escape by investing their way out.

Pushing a bicycle carrying petroleum, Jodhpur, February 2010

He said availability of land at cheap rates is the greatest challenge in providing affordable housing in the country. 

We know that the value of urban land is a residual, so as India urbanizes (today it is only 28% urban), those land prices will only rise – unless something is done to head them off.

Measures like increasing density by [a] hiking the floor-area ratio and [b] encouraging public-private partnership, should be considered in fulfilling the housing need of the country. 

It’s important to distinguish the potential utility and impacts of these two. 

A. Floor-to-area-ratio (FAR) and its close Indian cousin the floor space index (FSI) are the principal means by which India controls its formal development.  The effect, not necessarily a desirable one, is that developable urban land rises dramatically in price.  Tweaking the FSI and FAR can add value to selected land – in the right location, almost as much value as one wants – while at the same time inflating the value of all other land.  (And on the third hand, managing the preservation of open space for municipal infrastructure such as highways, urban rail lines, and even public green space.)

Good thing Lord Ganesha has four hands

B. Public-private partnership is merely a means by which the public sector can get technical functions – land development, construction, ownership – performed faster, cheaper and better.  Public-private partnership cannot conjure up subsidy or value from thin air, nor will the private sector embrace and internalize essentially governmental functions – like owning public-policy imperatives – unless it is very well paid to do so.

“The government has sought to create an enabling and supportive environment for expanding credit flow to the housing sector and increasing home ownership in the country,” Roy said.

Absolutely, creation of the enabling environment is one of government’s four essential roles.

Schoolgirls on a field trip: Jodhpur, February 2010

2. The Economic Times on land grabbing

Her Excellency’s husband a land grabber?

You’re just electing me, not my brother

NEW DELHI: In a major embarrassment to President Pratibha Patil, her husband Devisingh Ransingh Shekhawat has been asked to return over two acres he grabbed from a poor Dalit  [Untouchable – Ed.] farmer in Amravati of Maharashtra. 

She’s India’s first woman president

The president, the First  Gentleman, and the Queen

The farmer, Kishore Bansod, had last year found that most of his land had been transferred to Mr Shekhawat in the government records. The President’s spouse was accused of forging papers to grab 2.5 acres near the highway in Chandrapur two years ago. The farmer went to court in June, 2009. The Daryapur court gave its verdict in the case in December stating that the land belonged to Kishore Madhav Bansod and not Mr Shekhawat and that it be returned to the farmer. However, Mr Bansod got the copy of the judgement only earlier this week. 

Later that day, I read elsewhere that Mr. Shekhawat vigorously disputes the characterization of his land transaction.  All I know is what I read in the newspapers …

The President’s husband took the help of local revenue officers. An inquiry by local officials revealed that five others — all his relatives — colluded with him. 

Though the Rashtrapati Bhavan [The Indian White House – Ed.] has refrained from commenting saying that the President’s husband is a private citizen and enjoys no special privileges, the allegations against him are bound to haunt the President. 

Government buildings, Rajpath, Delhi, Republic Day, 2010

Following the farmer’s complaint last year, SDM Ashok Amankar had issued notices to Shekhawat and seven others, including his nephew Bhanwarsingh Lalsingh Shekhawat and brothers Kishorsingh, Omsingh and Raghusingh. The then revenue inspector was also served a notice. 

The farmer had said that officials who went for land measurements had told him that his land was in the name of the Shekhawat family. The three-acre farm was purchased by his father Mahadevrao in 1985-86 from a Bapurao Chaudhary, he had said.

Indian land use records are an infinitely recursive tangle of documents.  At the India RAY conference, Bimal Patel of HCP Design in Ahmedabad gave a superlative presentation illustrating the land-use and legal history of Jadibanagar in Ahmedabad, a public infrastructure project of our customer SEWA Bank.  It would have been hilarious had it not been so real.  Because land history is inevitably lost in the mists of time, land-use disputes are common. 

Informal neighborhood with municipal infrastructure (streets) added, Ahmedabad, February, 2010

Mr Shekawat is a member of the Congress and has also served as the Mayor of Amravati. This is not the first time that the President’s family has come under a cloud over financial dealings. 

In 1973, [President Patil] had set up a co-operative bank named Pratibha Mahila Shahkari Bank to empower women but its license of the bank was revoked in 2003 by the RBI over alleged financial irregularities. According to reports, one of the reasons listed by RBI for cancellation of the license was the faulty loan policy of the bank and waivers on loan interests given, among others, to Ms Patil’s relatives.

Everyone I talked with bemoans corruption in India.

A new currency created to try to shame people into refusing bribes

3. The Economic Times on the black-market economy

11 Feb 2010, 0542 hrs IST, Mythili Bhusnurmath , ET Bureau

Can you see her tongue in her cheek?  Mythili

The Great Recession might have laid mightier economies than ours struggling but the Indian economy has emerged relatively unscathed. Yes, you’ve heard that before. But chances are that as the global economy lurches from one crisis to another while the Indian economy gathers speed, you will hear that repeated in many quarters, especially in official fora. 

To hear it from government sources, there are many reasons for the Indian economy’s resilience: the Goldilocks fiscal stimulus, monetary easing, our large domestic market, demographic dividend, calibrated opening up of the economy, and so and so forth. But before we pat ourselves on the back, could there be another, no-so-happy reason why the Indian economy has been less affected by the Great Recession? 

If research by Deutsche Bank economists is to be believed, yes, our black economy! 

Doors for sale, Ahmedabad, February, 2010

A vast portion of India’s economy and employment is informal – meaning in cash transactions.

Paper money has no memory

Now, black money has long been regarded the bane of our development process. It results in huge wastage of resources , lowers the rate of growth, leads to criminalisation in society and breakdown of institutions, undermines the capacity of Indian businesses to face the challenge of globalisation, jeopardises our security, leads to poor governance, in short, to every conceivable ill we can think of. 

But there just might be something to be said for it. According to researchers at Deutsche Bank, empirical analysis shows countries with a very high or very low share of activity in the shadow economy appear to be much less affected by growth fluctuations in the world economy than countries that have an average-sized shadow economy. 

Because they have a much larger economy, and its financing is countercyclical.  Thus the formally conducted economy – the one we can observe – may be only the tip of the iceberg of economic activity.

What’s under the surface is more important

Alas! Countries where ‘the population cannot really decide whether it wants to offer its labour ‘honestly’ in the official economy or rigorously off-record are hit particularly hard’ . So, countries such as Germany, Ireland and some Scandinavian ones whose shadow economies are around 15% of GDP, saw their GDP plunge by around 5% in 2009, and in the case of Ireland and Finland, by over 6.5%. 

The report does not include India, but there’s no disputing which end of the scale we occupy when it comes to the share of the black economy. At close to 40% of GDP, i.e., $400 billion, according to Arun Kumar, professor of economics at the Capital’s Jawaharlal Nehru University, who has done a great deal of work on black money, black money vitiates every aspect of our life. 

Kumar tracks the black economy

I’ve posted extensively that lack of electronic – hence, formal and reported – financial activity is a huge barrier to bringing the poor into the formal city – and hence to enabling them to claim their economic citizenship. 

Self-employed food vendor, Ahmedabad, February, 2010

So, is the report a vindication of the rampant corruption and growing scourge of black money? Not at all! The downside of black money far exceeds any possible upside. To the rhetoric question of where would we have been without the black economy shoring up growth, the answer could well be, like the Scandinavians, perhaps! With a growth rate far lower than our present 7-8%, but guess what! I have a feeling that given a choice, most ordinary Indians might happily swap their present lot for that of the Scandinavians, 9% growth be damned! 

If urbanization is a process, and housing formalization is a process, then too the visible manifestation of money is a further process. 

From Nancy’s and my India trip: Friendly tuk-tuk driver and passenger, Ahmedabad

[Continued tomorrow in Part 2.]

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When everyone else gets sick, even the healthy start having symptoms too.

Oh, I should never have gorged on those ‘07 and ‘08 loans

As one of only three stores left open, still selling single-family and multifamily long-term financing, the Federal Housing Administration – the GSE from the right side of the blanket, as it were, the one always acknowledged as part of the Federal government – is showing stresses in its portfolio of new loans.  As reported by The Washington Post:

The share of borrowers who are falling seriously behind on loans backed by the Federal Housing Administration jumped by more than a third in the past year, foreshadowing a crush of foreclosures that could further buffet an agency vital to the housing market’s recovery.

As I posted back in September, FHA’s loan losses will not ‘buffet’ the entity because it is a direct arm of the Federal government, and as such cannot go bankrupt independent of a Federal bankruptcy – and while sovereign bankruptcy is on the horizon for Dubai and Greece, we are not in that situation (thankfully) (yet).

About 9.1% of FHA borrowers had missed at least three payments as of December, up from 6.5% a year ago, the agency’s figures show.

Not only is a 9.1% serious delinquency rate high, that’s atop an already high 6.5% rate.  The homeownership arena is still hurting – now not because of declining property values, but rather because of the ongoing structural weakness that the so-called stimulus legislation has clearly done nothing to reverse.

Year-over-year delinquency rate change; it’s worse in the West

Although the FHA’s default rate has been climbing for months and eating into the agency’s cash, the latest figures show that the FHA’s woes are getting worse even as the housing market shows signs of improvement. The problems are rooted in FHA mortgages made in 2007 and 2008.

Loan defaults have an incubation/ contagion phase delay.  As we saw in the decade’s biggest invisible stories, during 2007 and 2008 originators like Countrywide offloaded swaths of their inventory onto long-term government players (like naive Fannie Mae).

Those loans are now maturing into their worst years because failures most often occur two to three years after a mortgage is made.

By now we know it’s regionalized: California/ Nevada, Florida, and the Upper Midwest

If the trend continues and the FHA’s cash reserves are exhausted, the federal government would automatically use taxpayer money to cover the losses –

Which I noted months ago:

The Federal Housing Administration, the original government lender and hence the precursor to Fannie Mae and Freddie Mac; as a forerunner, FHA’s government connection was and is more direct.  It’s an arm of HUD, hence its securities carry the full faith and credit of the United States, unlike its GSE heirs Fannie and Freddie, which borrowed money on the capital markets without direct Federal support.

[Uh, until recently.  – Ed.]

“It’s pronounced ‘feefa’ not ‘fiefdom’”

That means that unlike Fannie and Freddie, who are likely to return to a non-guaranteed state some day, the government is always exposed for the entire FHA portfolio.  And FHA has a further tool that Fannie and Freddie do not: in addition to making direct loan, it offers mortgage insurance. 

Now the piper may need to be paid:

– a first for the agency, which has always used the fees it charges borrowers to pay for its losses.

Uh – except for that Great Depression thing we had during 1934, when FHA was created.

And back then, we had much lower homeownership rates

As these loans from 2007 and 2008 go bad and clear off of the FHA’s books, agency officials said, losses are expected to taper off, aided by the housing market’s anticipated recovery and an influx of more creditworthy borrowers, who have flocked to the FHA’s home-buying program in the past year.

We thus have a race of sorts.  Which will mature first – the capitalized value of the new insurance premiums, or the recognized losses from the recent vintages?  Fortunately, because FHA is already owned by the Federal government, it’s more of an academic and economic-efficiency question than one of national consequences. 

Agency officials said they have cracked down on poorly performing lenders and announced higher qualifying fees for borrowers. On Monday, the agency projected that the fees should generate $5.8 billion in fiscal 2011 [Which ends 30 Sep 10 – Ed.], up from $2 billion this year.

That seems highly plausible.  With Fannie, Freddie, and FHA the only games in town, they are all gulping new market share.

Two whose patrimony was only recently acknowledged

One who always knew who was its mother and its father

That would fatten the FHA’s cash cushion, used to cover unexpected losses.

An exasperating imprecision – FHA has no banks accounts of its own, it draws from the Treasury as required.  A better formulation is that the incoming premiums will significantly increase FHA’s net worth, giving reassurance to the check-writers at Treasury.

The FHA does not make loans but insures lenders against losses. And claims have already spiked. The agency had to pay out on 47% more loans in October and November than in the corresponding period a year earlier, according to an FHA report.

Ouch!

Didn’t see that coming

The number of loans in foreclosure, including those that have not yet been billed to the agency, has also increased. They were up 26% in the last quarter from a year earlier.

Ouch.  Foreclosure, though, is simply a lagging indicator of claims, as claims as a lagging indicator of serious delinquencies.  Neither is an independent variable in itself.

Nice dependent variable

FHA Commissioner David H. Stevens, who joined the agency in July, flagged his agency’s troubles with the 2007 and 2008 loans in October, when he told a House panel that “rogue players on the margin” immediately migrated to the world of FHA lending after the subprime mortgage market collapsed.

Oh, you think?

I don’t like being linked to a phrase like ‘rogue player’

Their aggressive lending tactics attracted borrowers with unusually poor credit profiles to the FHA. “That clearly impacted the books of business in 2007 and 2008, and that performance data is showing up very clearly in today’s balance sheet,” Stevens said at the time.

Even so, at the time Mr. Stevens was optimistic, and no one was under any illusions about the essentiality of keeping FHA in business.  As I posted in October:                            

Would that elected officials and journalists could refrain from politicizing what should be bipartisan evaluations of entity performance and importance.

“FHA has stepped into the void left by the private market,” Representative Maxine Waters, Democrat from California, said at the hearing. “Let’s be clear; without FHA, there would be no mortgage market right now.”

Ms. Waters knows where she stands

Together with Fannie and Freddie, FHA is the credit backstop for about 80% of all US residential lending right now.  While it’s terrifying to think of that much lending being concentrated behind the government, it’s more terrifying to think of any one of the three stopping cold.

No more lending?

But [Stevens] acknowledged that some 20% of FHA loans insured last year — and as many as 24% of those from 2007 — faced serious problems including foreclosure, offering a preview of a forthcoming audit of the agency’s finances.

This shouldn’t be entirely surprising, recognizing that in 2008 FHA was the lender of last resort, and as we have chronicled, many of these refinancings were done hopefully.

“Let me simply state at the outset that based on current projections, absent any catastrophic home price decline, FHA will not need to ask Congress and the American taxpayer for extraordinary assistance — we will not need a bailout,” Mr. Stevens said in his testimony.

That is a direct and clear statement.  Let’s hope it’s true. 

If I’m wrong, strike me dead

Is Commissioner Stevens rethinking his view?

With  new facts, I have no choice but to rethink

Plunging home prices have exacerbated matters by leaving some FHA borrowers unable to sell or refinance their homes because they owe more than their homes are worth. Yet with unemployment running high, many borrowers can’t afford to keep up their payments.

Adding to the trouble was a now-defunct FHA program that enabled sellers to cover the down payments of buyers. This meant many borrowers had no skin in the game and were more likely to walk away at early signs of trouble.

In May, 2007, I first wrote about this scandalous program, lambasting it:

It’s sounding more and more like the buyer is merely a patsy, and the non-profits are acting as the sellers’ paid agent.   Do the non-profits act as surrogates for the buyer, making sure prices are held down?

Sellers have tried to recover the cost of the fee they pay nonprofits by raising the price of the house an average of 3%, a 2005 study [text version here -- Ed.] by Congress’s nonpartisan Government Accountability Office found [also referenced here -- Ed.].  

So let’s keep score here:

In a cruder world, what the non-profits are doing might be called ‘procuring.’  In such a procurement, two entities get screwed: buyers and the Federal government (that’s us taxpayers).

This is for us taxpayers

By June, 2008, it was clear FHA was looking at $4.6 billion in losses, mostly from Nehemiah.  That number has now more than doubled:

The program resulted in excessive defaults before it was ended in late 2008, and it is projected to cost FHA an additional $10.5 billion in losses, Stevens said.

Every time I revisit this subject, I become more angry about it.  Congress birthed this atrocity, and Congress protected it against diligent and persistent Bush Administration efforts to kill it. 

For all these reasons, the FHA projects that it will pay out claims to lenders on one out of every four loans made in 2007 – the worst rate in at least three decades.

A 25% claim rate is hideous – but fortunately, Risk = P x L, where P is Probability of default and L is Loss given default.  We can hope for improved recoveries, since the newer-vintage delinquencies are borrower weakness, not property weakness.

The claim rate should be nearly the same on the vastly larger volume of loans made in 2008.

In any case, we can see FHA coming out the other side.

Dirty but still breathing

The FHA-backed loans made in 2009 tended to go to borrowers with higher credit scores than in previous years. These borrowers turned to the FHA when the mortgage market collapsed and other lending sources dried up. By then, reputable lenders doing business with the agency were already imposing tougher restrictions on FHA borrowers, further boosting the credit profile of those loans. The average credit score of an FHA borrower is now 690, up from 630 only two years ago, agency officials said.

These higher-quality loans are expected to result in lower losses, so the agency should make money on loans issued this year and over the next few years, according to an independent audit designed to gauge the agency’s health.

The audit, released in November, found that the cash the FHA set aside to pay for unexpected losses had dipped to historic lows, well below the level required by law. As of Sept. 30, those reserves were estimated at $3.6 billion, down from nearly $13 billion a year earlier. The most recent figure represents 0.53% of the value of all FHA single-family-home loans – far lower than the 2% required by Congress.

Certainly that is low, but compare that against the $3.8 billion “extra” premium FHA earned this year, and if you add that back, you’re at 1.06%, which is not great but is heading the right way.

Yes, I admit it’s getting better

It would become even rosier if, as most private lenders do (and the GSEs did), one counts the capitalized value of the future servicing rights as assets.

But Ann Schnare, a former Freddie Mac official, said the situation could be even worse. She said the audit underestimates future losses because it does not take into account all loans that are now overdue, only those that the FHA has paid claims on.

True enough, but with FHA mortgage insurance, the lender normally assigns the loan as quickly as possible, thirty days after the default.

Stevens said his agency has pored over its data to analyze risk and is taking steps to shore up its financial health. “You have a limited set of options under these circumstances: Raise fees [for borrowers] or make policy changes,” Stevens said in an interview. “We’ve done both.”

In short, tighten credit, limit losses, hence increase profits.

The agency banned 268 lenders from making FHA loans last year, more than double the total terminated in the previous eight years. The FHA suspended six other firms. Among them were some of the largest FHA lenders – Taylor, Bean & Whitaker and Lend America, both of which shut their doors soon thereafter.

The long-overdue cleanup continues.

You made the mess, you clean it up

The agency also proposed a rule that would require banks to hold up to $2.5 million in capital that they can use to repay the agency for losses if they were involved in fraud.

Absolutely!  Originators should always take first loss, and should have liquid capital to cover a substantial loss rate; otherwise the principal-agent risk is too great.

Banks are now required to hold only $250,000.

Not enough.  A ten multiple is a good idea.

Borrowers are also facing tougher scrutiny from the agency. People taking out FHA loans will have to pay higher upfront fees, perhaps as early as this spring. Those with especially weak credit scores will also have to put down at least 10% instead of the usual 3.5% down payment. The amount of money sellers can kick in toward closing costs and other fees will also be limited.

Another Nehemiah abuse being shut down.

Should have pressed the Nehemiah shut-down button a long time ago

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[Continued from yesterday's Part 1.]

Yesterday, in our real-world metaphor for capital markets’ shenanigans, we encountered probabilistic meteorologist Cliff Bryant, who parlayed his interest in White Christmases into two tickets that, if honored as he thinks they should be honored, will be worth several million pounds.

Might two slips of paper be worth £7,000,000?

As reported in The Wall Street Journal, Mr. Bryant placed his bets about White Christmas on December 9, more than two weeks before the event and beyond the horizon of any reliable long-range weather forecasts.  He thought they were valid, right until the moment the manager turned white:

Then he placed a phone call to headquarters and reported that the ticket was invalid.

Right … uh huh .. the ticket …was … in-vallll-id

In effect, Mr. Bryant had bought Mr. Devious’s never-pay policy.

Vicar: It’s about this letter you sent me regarding my insurance claim.

Devious: Oh, yeah, yeah – well, you see, it’s just that we’re not…as yet…totally satisfied with the grounds of your claim.

Vicar: But it says something about filling my mouth in with cement.

Devious: Oh well, that’s just insurance jargon, you know.

Vicar: But my car was hit by a lorry while standing in the garage and you refuse to pay my claim.

Devious: (rising and crossing to a filing cabinet) Oh well, reverend Morrison…in your policy…in your policy… (He opens the drawer of the filing cabinet and takes out a shabby old sports jacket; he feels in the pocket and pulls out a crumbled dog-eared piece of paper then puts the coat back and shuts the filing cabinet)… Here we are. It states quite clearly that no claim you make will be paid.

Vicar: Oh dear.

Devious: You see, you unfortunately plumped for our ‘Neverpay’ policy, which, you know, if you never claim is very worthwhile…but you had to claim, and, well, there it is.

Vicar: Oh dear, oh dear.

Paying claims?  Very bad for the bottom line

Where I come from, such a claim would be a strong case for fraud in the inducement.  Ladbroke’s didn’t invalidate the ticket when Mr. Bryant submitted it – they took his money.  Presumably he’s made many similar bets in the past – for Ladbroke’s took his money.  Now, white as a sheet, they decide the ticket is invalid.  Here’s how the Daily Mail put it:

An independent solicitor confirmed Mr Bryant was unlikely to see his winnings.

Commercial dispute resolution partner Rick Munro, from Lamport Bassitt, said: ‘You rely on the goodwill of the people you are placing the bet with.

‘It’s about one of the only contracts in public policy where the contracts are unenforceable – he wouldn’t have a leg to stand on.’  

Aside from my advice to Mr. Bryant – come to America, you could certainly sue here! – I am aghast that a presumably capable solicitor believes a betting contract to be unenforceable, and a huge win against an unlikely event uncollectible.  Why, if payments against really unlikely events are uncollectible, then credit default swaps are uncollectible, and behemoths of industry like AIG might as well fold up shop, taking us with them.  Oh, wait …

Is it too late to sell my AIG stock?

Let’s hear Ladbroke’s defense:

Ladbrokes did indeed have rules against such betting, but they were hard to find. On a Web page Ladbrokes hosts for White Christmas bets, there was no mention of accumulator bets. But deeper in the Ladbrokes Web site, a page of terms and conditions bars accumulator betting on novelty wagers.

On this rickety leg stands Ladbroke’s case. 

Totally sound

Out of curiosity, I went to Ladbroke’s site, swatted away the numerous poop-ups and flashing banners encouraging me to put down money on this or that proposition, and my eye was caught by this:

At Ladbrokes.com we want to resolve any query you may have as quickly and fairly as possible. On the very rare occasions when we cannot resolve a query to the customer’s satisfaction we are always happy to see the matter referred to IBAS an independent arbitrator whose decision we will abide by.

When you bet with Ladbrokes.com you can be assured of fairness.

And this:

Specials is our description for bets on, normally, non-sporting events such as politics, current affairs or financial matters.

Bets on “Special” markets are available as singles only, unless otherwise stated on our site.

Specific rules and conditions relating to each individual “Specials” market will be displayed onsite as these markets become available online.

The maximum payout on any bet which includes a selection, or selections, from a “Specials” market is £10,000, unless otherwise stated for a particular event. This maximum applies to the payout to any one customer, in any one day.

Do you think those two pages – which, mind you, I found not by navigating the Web site itself but by using a Google search knowing precisely what I was after – constitute full and fair disclosure?  Especially when bookmaking is as pervasive as it is in England:

Pervasive?  Naow, just a cottage industry

Such wagers, on everything from snow to reality-television developments to proof of alien life, are a longstanding fixture of the British bookmaking culture. “A guy walked into one of our shops in the mid-’60s and said he wanted to bet someone will walk on the moon by the end of the decade,” says Rupert Adams, a spokesman for William Hill, which gave the man 1,000-to-1 odds; he won about $24,000. “We realized, Christ, we can bet on anything.” (Not so in the U.S., where only certain forms of gambling are legalized, and only in certain jurisdictions.)

Stock markets and securities markets are betting environments.   Betting by itself isn’t a bad thing; gambling as an addiction is a bad thing.

The poor choice of odds on the moon bet wasn’t unusual. The probability of such events is hard to quantify.

Precisely!  Back to our securities-markets metaphor.  Probabilities of things that have never happened before are really hard to estimate, and human beings being the short-horizon optimists we are, we tend to overestimate our chances of success (cf. high school football players who expect to make It to the NFL) and underestimate our chances of failure (cf. people who took out adjustable-rate subprime loans to buy houses that were appreciating in value).

And exposure to obscure events can be meddlesome in other ways. Mr. Adams says William Hill’s potential losses of more than $8 million, should Elvis Presley be found alive, was a stumbling block in the ultimately successful acquisition of rival Stanley Leisure’s betting shops.

Thankyouverramuch for bettin on me

Cost of contingent liability. You were happy enough to take the money, but you have to book the liability and reserve for it.  Headache.

Combine the wide range of bettable events with the possibility of accumulator bets, and what results is a complex system that defies modernization. “There are so many options, it’s very, very difficult to computerize it entirely,” says Ladbrokes spokesman Mr. O’Brien.

Oh, it’s easy to computerize – Wall Street did it.

You think we couldn’t computerize accumulator bets?

Had Mr. Bryant’s bets been entered into a computer, software might have flagged the invalid snow bets.

The computers did so well at catching the accumulation of exposure in real estate securities, didn’t they? 

In point of fact, automation detaches insight from data, and so I have a personal rule never to automate any process until I am ultra-sure we have all the bugs out of it.

The bets would have been disqualified in any case because each of his two winning tickets stood to yield payouts far greater than the £10,000 maximum set for snow bets.

In stock-market terms, that’s called a stop-loss, and as we’ve seen in numerous posts on this blog, a world drunk on risk merrily cashed through all the stop-loss warning signs.

What barrier?

At a minimum, Ladbroke’s should pay out £20,000.  If I were Mr. Bryant, though, I wouldn’t settle for less than £1,000,000.  Between Mr. Bryant’s righteous justice – he made a bet, it won, now they’re refusing to pay – and the bad publicity attendant, my non-numerate instincts suggest that the betting shop would be happy to get out of this fiasco for anything in six figures or fewer.

Instead Ladbrokes offered to divide the £5 placed on each winning bet into individual bets for each region, and pay each one out individually — which would add up to barely £30, or about $50.

If you made me that offer, I’d laugh at you.

Mr. Bryant didn’t like the offer and says he has filed a complaint with the Independent Betting Arbitration Service.

Readers will not that Ladbroke’s pledges this:

We are always happy to see the matter referred to IBAS an independent arbitrator whose decision we will abide by.

If I were on the IBAS, my ruling would be, He wins.  As Teddy KGB put it, Pay that man hees money.

Ladbrokes’s Mr. O’Brien says, “We’re happy to continue a dialogue about what we can do to address the error. What’s been done to date is not necessarily the final chapter.”

Better fix it

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Want to bet whether it’s going to snow tonight? 

Odds of winning slim?

Every now and then, nature offers us a visual metaphor for an abstract principle of finance – so for our little tale of complex derivatives and interdependency among financial instruments, we need look no further than a heartwarming English tradition – betting on White Christmas. 

At least, that’s the Dickensian moral I extract from this tale, via The Wall Street Journal [January 14, 2010 – Ed.]:

For Cliff Bryant, it was very nearly a perfect storm.

For our little story, cast Mr. Bryant as the inventor of a complex derivative security – say, a CDS written against a CDO. 

Mr. Bryant’s security – which clearly says “£5 accumulator” in his handwriting

Mr. Bryant wagered that snow would fall in various regions of the country, and he placed what is known as accumulator bets, which can pile up winnings like the wind-driven snow.

Mr. Bryant’s security didn’t involve much capital, it was a unique object of his own creation, and it offered insane payoff potential.

Mr. Bryant believed his bets had netted him about $27.5 million in winnings.

Mind you, all this from a single $10 bet.

To win 275,000x one’s bet, one must have wagered on something incredibly unlikely to occur – like snow falling all over the UK on the same night.  It doesn’t snow much in England, so the bookie who took Mr. Bryant’s fiver doubtless thought he was ringing up an easy profit for his shop.

That’s how it is with black-swan risks.  They are so unlikely that you are tempted to take the bet and not worry about the details.

A lot of us are out there

Yet the winning bets so far have gone mostly unrewarded. Ladbrokes, a major British bookmaker, says its employees took Mr. Bryant’s so-called accumulator bets in error, and has declined to honor them in full.

Remember I said this was a metaphor about CDS’s and CDO’s.  Welcome to counterparty risk – the risk that, having won your bet or placed your reliance on the other party, they can’t or won’t pay off. 

Ever received a flyer saying We will not honor typographical errors?  I’ve always believed that bordered on consumer fraud in the inducement, although the damages would be modest – my lost-opportunity cost of coming to your store, waving my flyer, and discovering that when you said you’d sell me a plasma television for $4.99, you actually meant $499.00.

Counterparty risk multiplies in an interlocking and interdependent system.  That interdependence is illustrated here by Ladbroke’s accumulator bet, where each bet triggers the next one:

Accumulator bets allow gamblers to turn ordinary wagers into a lucrative lottery. They work like this: The bettor places simultaneous bets. If the first comes through, the initial stake plus the winnings are placed on the second bet. If that comes through, the entire pile is placed on the third bet, and so on. If all parts of the wager are won, the winnings accumulate quickly. If even one part of the bet loses, though, there are no winnings.

Those of you who remember your multiplication rules – it’s commutative and it’s associative – know that it doesn’t matter which bet you consider first, they’re all essentially simultaneous.  (In Vegas, they call it a two-team parlay.) 

The odds against the Arizona Cardinals beating the New Orleans Saints next Saturday [January 16 – Ed.] were 5 to 2 at Ladbrokes on Tuesday. So a $10 bet would pay $35 if the Cardinals won. And the odds against the New York Jets upsetting the San Diego Chargers the next day were 14 to 5. So a $35 bet on the Jets would pay $133.  An accumulator bet of $10 taking the Cardinals and Jets, then, would pay $133 if both teams won.

Parlay-vous?  New Orleans 45, Arizona 14

Bettors like parlays because they offer eye-popping payoff odds – risk £5, win £2,750,000.

[By the way, I can't make Mr. Bryant's arithmetic work.  If we take the listed odds on his betting slip and multiply them together, his total odds are 20,000 to 1, not the 550,000 to 1 implied by his claimed £2,750,000 payout.  If, on the other hand, we're to understand that he gets his stake back each time, so a 2 to 1 initial bet means he has £15 to bet on the next round, as suggested by the WSJ's example, then I get a payoff of 2,953,690 to 1. 

That is puzzling

I did find this Daily Mail commentary:

Rival bookmaker Paddy Power confirmed that the first bet, which contained 13 locations, would have won £4,922,800.31.

The second, which listed 11 locations, would have brought in £2,233,492.73.

Implicit in an accumulator bet is independence, or non-correlation – that the results of one event do not in any way correlate with any other.  That was implicit too in CDS's and CDO's – that circumstances triggering a default in one tranche of one security would not spill over into other tranches of other securities.  But, as we saw with David Li's copula function – one of the decade's biggest invisible stories – as one expands the complexity of any system, the likelihood of interdependence and correlation increases.

"I thought this was it, that something had gone right for me this time," says Mr. Bryant, a longtime Christmas-snow bettor who guesses he is slightly in the hock over his years of snow bets.

Bettors always think they're 'just down a little' – Las Vegas and Ladbroke's depend on that fallacy of human perception. 

"Apparently not, but it was nice to have that dream."

For Mr. Bryant, as for the millions of people who are not gambling addicts, the net expected loss on the bet is the cost of his entertainment.

But a bookmaker that takes such bets on the weather of neighboring regions is asking for a fleecing.

I have no sympathy for Ladbroke's.  Nobody made the bookie take the bets.

To understand why, it helps to first consider scenarios when accumulator bets make sense for both parties. For the odds to be fair, each individual wager must cover an independent event.

The core premise of David Li's function, and the core suspension-of-disbelief of the naughty Aughties.

That way, the winnings multiply at the same rate that the cumulative probability of winning all bets declines.  For instance, multiple sports bets are allowed to be bundled when the score of one game shouldn't affect the score of another.  

That presupposes no causal link between two games – different players, different environments – yet it's easy to imagine multiple ways the two games could correlate. 

(1) Start with changes in behavior, known as scoreboard watching.  During the NFL's Week 17, for example, teams would take the field knowing whether the game they were about to play had enormous meaning, or no impact whatsoever.  In games between a team that desperately needed to win and a team that only wanted to avoid crippling injury, guess who won?

Not the guys in orange and black, that's for sure!

(2) Then there's mutually-affected-by-a-third cause.  Suppose both games feature teams one of which relies on passing (better in good weather), the other on defense and running (better in bad weather).  If both games are outdoors, the independent exogenous variable could swing both in the same direction, a fact certain punters take into consideration when developing their automated spread-betting Systems.

It's all up here

Curious too is that two seemingly unthreatening innovations can be combined by a clever structurer:

Mr. Bryant hoped that the same mathematical approach would lead to an accumulation of winnings as snow piled up across the U.K. His strategy was to play off of a longstanding yuletide tradition: betting on whether it would snow on Christmas in specific U.K. cities or postcode areas. Mr. Bryant's innovation was to bundle these so-called White Christmas bets and set himself up for big payouts.

If I read this right, Ladbroke's had never thought of someone combining accumulator bets with weather bets – though why in heaven's name not is beyond me. 

As he tells it, he went to a local shop of Ladbrokes and placed nine accumulator bets on a White Christmas, choosing groups of neighboring areas. "In Britain, if you've got a shower coming across, it's going to go across lots of postcodes," Mr. Bryant says.

Clearly, if Mr. Bryant (the banker) is able to choose which bets he clusters and accumulates, he will choose those that correlate.

Does any of this make you shiver with worry about our last decade's securities markets?

We have more rapids to run?

We had literally thousands of customized instruments, including multiply-replicable credit default swaps, which could be bought and sold pretty much by anybody – meaning that secondary market makers could create their own accumulator bets, and pile up on one side or another of a correlated risk. 

Ladbrokes spokesman Ciaran O'Brien says the bets shouldn't have been accepted in the first place, because "if it snows in one city, it's likely to snow in another city."

For Ladbroke's, think Moody's or Standard & Poor's – or, for that matter, JP Morgan Chase CEO Jamie Dimon, explaining to the Financial Crisis Investigative committee that his bank didn't model a 40% decline in house prices. 

We didn't need models to tell us we would be totally trucked

At the most basic level, Mr. Dimon's statement is sensible – because if house prices were going to fall 40%, then everybody who held secondary or derivative instruments was going to lose a boatload of money, and there was nothing anyone could do about that.

In other words, these weren't independent events. Snow in Leeds suggests a greater chance of a dusting over nearby York from the same storm. The probability of neighboring areas both getting snow is particularly high in the densest parts of the country, where postcode areas are so close together – such as in and around London.

I have neither the time nor the inclination to answer that question

Yes – but did you take the bet?

You're damn right I took the bet!

As it happened, snow skipped London but fell in at least some part of nearly every northern postcode area.

Think there's correlation in which post codes got snow?

Ladbrokes and its competitor, William Hill, knew they had taken a hit from the annual White Christmas bets.  But the scope of their potential losses wasn't apparent until three or four days after Christmas once Ladbrokes had posted the official list of postcodes that saw snow.

Tangentially, let's note the value of post codes: they are clear boundaries, not fuzzy boundaries, and therefore decisively adjudicable.  This is a further value of enumeration – when communities turn from unbounded land into delineated post codes, they can be absorbed into digital records – and hence, elements in financial and judicial systems.

Mr. Bryant recalls going into his local shop and producing one of his two winning accumulator betting slips. He recalls that the manager "started doing the math, and turned a bit white."

We owe how much?

Wouldn't you?

As far as I can tell, 80% of the business done in my local 7-11 – the franchise heir to the corner bodega – is cigarettes, phone cards, and lottery tickets, which collectively constitute about 1% of the total floor space.  The lottery is popular with customers because it's instant, and with vendors because the payouts come from the state, not the store.  Not so with Ladbroke's – when the punters win, the house loses.

Then he placed a phone call to headquarters and reported that the ticket was invalid.

This is about where I would blow a gasket:

Let those who would hear

[Continued tomorrow in Part 2.]

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