Financial Stability and Improvement Act of 2009

The Financial Stability and Improvement Act of 2009, otherwise known as draft legislation for the “Too Big Too Fail” institutions, was proudly unveiled last week by Treasury and the House Financial Services Committee. Here’s the meat of what it proposes:

Creation of another (?!) Council, this one the Financial Services Oversight Council, which first identifies financial companies and activities that pose a threat to systemic stability, and then monitors them. No really – without other elaboration as to how to identify or effectively achieve any of that, this is what the draft legislation proposes. This Council, evidently, has a massive data-gathering responsibility (data generated by various federal financial agencies), and has the ability to name concerns for federal action.

A fairly aggressive approach to holding company regulation. Specifically, the draft legislation removes Gramm-Leach-Bliley Act restrictions on federal power (specifically, this would allow various federal agencies to regulate). Background: Gramm-Leach-Bliley, alternatively known as the Financial Services Modernization Act of 1999, rolled back Glass-Steagall (1933) in part. But a big part. Glass-Steagull said investment banks are investment banks, and commercial banks are commercial banks, and insurance companies – very big surprise – are insurance companies >> keep your buckets separate. Gramm-Leach-Bliley, among other things, allowed these separate actors to consolidate. So one bank could offer all variety of financial services, and voila, usher in the dawn of the financial service industry.

• Following presumed enactment, no further commercial companies will be allowed to own banks, industrial loan companies ("ILCs"), or any specialty bank charters.
• Thrift holding companies would be subject to fed supervision, and such charters would be reserved for entities focused on mortgage lending.

The draft legislation has a very federal bankruptcy code-type idea. The draft legislation contains language that provides for wind-down activities. Specifically, “that shareholders and unsecured creditors bear the losses, not taxpayers.” The draft legislation delegates the FDIC with this wind-down responsibility, and costs are to be provided for by the failed company (presumably priority above the creditors; *yay* lawyer drafters). VERY INTERESTING: if the company actually does not have enough money to wind-down, a “Resolution Fund” will pay the deficit. This fund is created by “assessments on all large financial firms” (later defined as companies with assets of $10 billion or more).

Not as interesting: there are new organization models; ie., the Treasury Secretary must approve any Fed effort to provide liquidity; and banking regulators and the SEC have to come together to write rules requiring creditors (or securitizers where the loan was not originated by the creditor) to retain 5-10+ percent of any credit risk associated with loans for securitization (is it me, or was that the rule right there?).

What Price: a Home?

Recent housing market statistics have many asking if the housing bottom is at hand. This is an important question for many reasons, particularly the health of the banking sector, but a more important question for most individuals is: are prices right for me? Calling a bottom is a fool's game for most people, but that does not mean that purchasers can't determine a fair value for a home.

Housing has a rational price based on economic fundamentals, but this comes as a surprise to many. I hear people cite metrics such as comps (the price of a similar, or comparable, property in the same area), price per square foot, and cost to build. But in my view, the single best determinant of property value is the amount it would return as an investment. That is, how much money could you earn if you bought the property to rent to others (discounted using a risk-adjusted rate).

To those who believe that renting is just throwing money away, look closely at the statistics of the last few years. Most American home owners lost significant equity during that time and now may be upside down (the mortgage principal is greater than the value of the home). Home ownership entails many responsibilities, including property taxes, maintenance, mortgage, and insurance. By and large these costs do not exist for renters. Renters don't put 20% (or more) down for the "privilege" of ownership, an amount which can exceed $100,000 in many areas of this country for a very ordinary home. That amount of money would make a nice safety cushion for a rainy day. There are more than a few cons to renting, but I'll focus on the pros. Every year your lease comes up, which gives you the flexibility to move with no need to sell a very large and illiquid asset (a home). With that flexibility comes (potential) mobility in career, ability to take advantage of falling rents (of course, the converse is true as well), and limited downside should you lose your income--you won't lose your home and the significant savings you sunk into it.

The main tool used to value assets is the discounted cash flow (DCF) model, and there are many good resources for learning this (Aswath Damodaran's Investment Valuation is my favorite), but you could use rules of thumb as well. A good one is price to annual rent. The point is, however, that the value of a home should be based on fundamentals, such as the rent (and cash flow) you could generate from a home as an investment. Due diligence in evaluating value this way adds a level of protection in the form of healthy skepticism. After all, most home buyers can't afford to make such an expensive mistake, and it is possible to overpay, even in an environment of falling prices.