Remember what I said about the art department? I guess that’s not needed anymore. Unbelievable. Hat tip to Market Ticker.

Some of the saddest anecdotes that I have read relate elderly people being evicted as a result of foreclosure, even though they have lived in the house for many, many years. Of course, the problem is refinancing. Elderly parents seem to have often allowed their children to borrow money, using the parents’ house as collateral. And then the child defaults, for one reason or another, and the elders cannot afford the payments.

It is a myth that the high foreclosure rate is the result of interest rate resets. True, there is a coming tsunami of Options ARMS that will reach their maximum negative amortization, but it is not here yet. Early evidence suggests that somewhere between 40% and 50% will default immediately. But the real problem remains fraud, fraud and more fraud. First in subprime, now in Alt-A.

Buyers — many with Latino surnames — bought homes in new subdivisions in Watsonville for $600,000 to $700,000 with loans that didn’t require proof of income. In the industry, they were known as “no documentation loans.” Biancalana called them “don’t ask-don’t tell loans.”

Emilio Martinez, a private investigator running for City Council in Watsonville, said many Latino borrowers came to him claiming they had been cheated by their mortgage brokers.

But in reviewing the documents, he found that in a majority of cases, the incomes of the borrowers had been inflated to qualify for the loan. One example: a couple employed at a sandwich shop earning $35,360 bought a $628,000 home with 100 percent financing and no down payment.

It is interesting to me that the US, with its extreme religiosity, shows dishonesty on such a massive scale. Lenders are doing everything in their power to avoid recognizing this problem because it is a political and public relations disaster. Also, in many cases, the lenders were guilty of at least turning a blind eye. Although some went even further. Remember the art department? It should be no surprise that extending even more credit to allow borrowers to bring their payments current just puts off the problem.

Governor Schwarzenegger is proposing to raise the state sales tax by 1% on a “temporary” basis (don’t make me laugh). This is to raise revenues to close the $15 billion budget shortfall that California is facing, and will make the sales tax in some counties, which can add voter-approved surcharges, as high as 9.75%.

Government spending in California is completely out of control. Compensation of public employees is ludicrously high as powerful unions have extorted higher and higher settlements from compliant politicians, and non-union employees have ridden on their coat-tails. Gerrymandering has made elections a non-event, and the incumbent Democrats have thwarted all attempts at reducing expenditures.

Californians have revolted before, passing the now-legendary Proposition 13 to limit the increases in property taxes. The politicians then tried raising the state income tax on higher incomes, which actually resulted in a revenue decline the last time they tried it, as the affected taxpayers then worked harder at avoiding taxes. Failing that route, they then turned to borrowing. Past abuse and the credit crunch are closing that off also (The only state with a lower credit rating than California is Louisiana), so they’re back to the well for a higher sales tax. The outcome is predictable - people will move heaven and earth to avoid spending money on taxable items in California. Look for a big battle on sales tax collection with the out-of-state e-retailers, like Amazon, as well as more retailer bankruptcies.

The tax grab is getting bigger and bigger, even the little things like $4 to cross the state bridges, soon to be $5. A fleabite, you say? Not if you commute to work every day. Any move to cut expenses brings out the sob stories from the public sector unions, of course, with massive advertising. But the people are already hurting, the median house price was down 38% y-o-y as of last month and the foreclosure rate was at a 20-year high, up 260% from a year ago. At some point, the people are going to find the exactions of the bureaucrats intolerable and there will be another tax revolt.

Alexis de Tocqueville said that “in a democracy, people get the government that they deserve.” So true.

From Merrill Lynch’s press release:

On July 28, 2008, Merrill Lynch agreed to sell $30.6 billion gross notional amount of U.S. super senior ABS CDOs to an affiliate of Lone Star Funds for a purchase price of $6.7 billion. At the end of the second quarter of 2008, these CDOs were carried at $11.1 billion, and in connection with this sale Merrill Lynch will record a write-down of $4.4 billion pre-tax in the third quarter of 2008.

In other words, assets actually worth $6.7 billion were actually being carried at $11.1 billion. The sale represents 22 cents on the dollar for these “AAA” securities. And, even at that price, Merrill had to finance the sale on a non-recourse basis, so it is not exactly an arms-length fair market value.  Probably the Australian bank that recently announced that it had marked its CDO assets to 10 cents did so realistically. But let’s not single out Merrill Lynch. Bloomberg covers Fannie and Freddie’s balance sheet:

Without that $14.3 billion of tax adjustments, the fair value of Fannie’s net assets would have been negative $2.1 billion, by my math. Exclude deferred-tax assets entirely, and it would have been negative $19.9 billion as of March 31. (Fannie raised $7.4 billion of additional capital in May.)

As for Freddie, it showed $16.6 billion of net deferred-tax assets under GAAP as of March 31. Like Fannie, it put deferred taxes in “other assets” on its fair-value balance sheet.

Freddie said its other assets had a GAAP carrying value of $31.6 billion and a $42.5 billion fair value. By my calculations, using the methodology in Freddie’s footnotes, it looks like Freddie wrote up the deferred-tax assets on its fair-value balance sheet by about $10.1 billion.

So, take out the tax write-up, and Freddie’s net assets had a fair value of negative $15.3 billion. Exclude deferred-tax assets entirely, and that falls to negative $31.9 billion.

I think that you can take it for granted that most if not all financial institutions out there that have been involved with real estate finance are overstating their book values. Many of them have negative net worth if properly accounted for, marking their assets to their real market value. The FASB and the SEC have, deliberately, put so many loopholes into the accounting and pricing standards for financial assets that there is really no way to tell the true state of these companies. Sarbanes-Oxley is “just a piece of paper” as Mr Bush would say. The government agencies believe, as usual, that dishonesty is the best policy. If they can conceal the true state of the financial system for long enough, they think, they can buy time for it to recover and the fiction will magically become true. However, as Vytas’ comment points out, they’re just buying time for the looters to strip the valuable assets.