Archive for November, 2010

It actually scares me when economists push housing as a panacea to ending the recession. What short memories they have – the housing market was the primary driver of this recession.

If we continue to emphasize the housing market as one of the key legs of our economy, we run the risk of recreating another devastating bubble in the long-run. Such an emphasis will almost assure a return to the mindless policies that pumped the market to an unsustainable level.

The increased mortgage underwriting vigilance we are seeing today will eventually dissolve as long as housing is promoted as an economic activity generator. The same types of policymakers, developers, investors and financiers that tanked the real estate market will be drawn back into the game like moths to a flame. We cannot allow that to happen.

How to unwind the debilitating effects of foreclosures and negative equity, along with defining what role housing should play in the economy going forward, must be the primary focus of our leaders and lenders.  By contrast, too much time was wasted on a health care overhaul instead of fostering business growth, and stimulus money for “shovel-ready” projects was handed out like mortgages during the bubble expansion.

Allowing mass foreclosures amounts to a losing strategy.  Mass foreclosures will continue to depress prices and leave vacant homes rotting in the sun.  Some regions are more susceptible than others to this type of economic and social decay.

In all but the worst of cases, lenders should agree to allow the current owners on the verge of default to rent the properties and even allow a repurchase option if their circumstances change for the better.  It would entail signing over the homes to the banks, but the alternative is worse.  Renting back might even offer a path to solvency and stability for some.   

Both the lenders and investors (including the government), need to bite the bullet, book the losses and move on. 

How  actual foreclosures are resolved depends on location.  It pays for the lenders to fix and maintain properties in desirable markets with an eye to selling or leasing them.

Properties in undesirable, over-built markets, such as exburb subdivisions that never should have been constructed, need to be bulldozed.  The cost to undo deterioration and maintain vacant homes does not make sense in weak markets. There is little chance a largely abandoned single-family tract on the outskirts of Victorville will ever attract prices adequate to recover repair and maintenance costs.  The land should be rezoned to commercial use.  Manufacturing should be encouraged to fill the vacuum, especially where infrastructure was established to support large housing tracts.

There will be pain, so get it behind us sooner than later. 

Owners who have the resources to keep current on their mortgages despite being underwater are prisoners of their own homes.  They can’t unload them unless their lenders agree to do shortsales, but that will leave sellers with no cash and a scarred credit rating – hardly the foundation to start anew.

However, there is hope for these owners.  It requires patience and resolve.

Consider this example.  A home purchased for $625,000 five years ago during the height of the boom.  The buyer financed 80%, or $500,000, at 5.5% interest for thirty years.

The value declined 40% to $325,000 and is underwater compared to its outstanding mortgage balance of $462, 303 (the borrower is current).

If the housing market where the property is located makes a very modest recovery – assume 2% annual average annual appreciation – the equity and the value will be almost equal in another five years.  OK, it’s still a loss, but once a property is above water, equity will build faster than most would imagine.  Leverage will then be working for the owners; not against them.

This scenario would be better if lenders were to re-finance owners who have kept current into lower rate mortgages.  There is at least one such program, but it is limited to loans owned by FNMA and FHLMC.  How long the program will last is uncertain (Chase was part of the program and might still be. You have to be current and the loan must still be serviced by the original lender.  Income documentation is minimal).

There should be a requirement to force lenders to re-finance their non delinquent portfolio loans.  It’s just good business and it is far preferable to having those borrowers walk away out of frustration.

What about the future of housing and the role it should play in the economy?

The most important step before any housing strategy is developed is to eliminate the notion that most people should own homes. 

It’s a goal everyone should consider, but whether you should depend on many factors, any one of which could make purchasing a home an unwise decision. 

But don’t count on the lenders and government officials to know what is good for you.  Even with today’s tougher underwriting standards, the personal circumstances of the buyers will never be addressed by loan officers fixated on debt to equity ratios, incomes and credit scores. 

Government officials have always been obsessed with the increased consumer spending activity that accompanies home purchases.  However, the correlation might not be anywhere close to what it was in the past. The “wealth effect” of the boom years may take decades to re-establish itself.  Homeowners will likely clutch their wallets and save more as a reserve against another downturn. Also, many new homes are smaller, which means less furniture, accessories, carpets, paint, etc. 

Even if you can manage the mortgage, tax and insurance payments, the utility costs will continue to rise. If you are a customer of the Los Angeles Department of Water and Power, you will appreciate that.  It took Prop 13 to rein in real estate taxes.  However imperfectly it accomplished that, it did bring relief and some predictability. But there is no equivalent of a Prop 13 on the horizon for utility costs.

Then there are the prospects of employment.  The ability to advance  careers, increase the size of paychecks or just stay employed may require more geographic mobility.  If you own a home, unloading it in a reasonable amount of time might not be possible.  Goodbye job opportunity. Renting, then, might be the  sensible option for most people.

As gloomy as all of this sounds, in the long-run an economy less dependent on housing  will be healthier.

Houses will return to what they were in the post World War 2 era – a roof over your head and a source of pride; not a commodity to be traded for a fast buck.

Saving, while it diminishes consumer spending, helps stimulate investment in plant and equipment.  Restoring some of the lost manufacturing segment would help improve our exports and create lasting jobs rather than the boom and bust employment from home construction.

If we want to compete with China, Brazil, India and other emerging economic powers, we must return to a more balanced economy backed by production capacity, not an economy built on buying and selling homes to each other.

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It is impossible to provide a comprehensive summary of the key figures who played critical roles in the Civil War, much less touch all the issues they faced.

Instead, this segment will focus on the people most would agree represent the big four of the conflict: Abraham Lincoln, Jefferson F. Davis, Ulysses S. Grant and Robert E. Lee,  and how these iconic figures felt about slavery.

Jefferson Davis was unequivocally pro-slavery.  He spent most of his antebellum life in Mississippi where he started a plantation.  While a United States Senator, he was known as being very uncompromising on measures designed to block the spread of slavery.  He fought all such attempts.  Although, interestingly, he vetoed an attempt by the Confederate States Congress to diminish the prohibition in the Confederate Constitution against the importation of slaves from foreign sources (the United States not considered a foreign nation for this purpose).

The deep South had a reputation for slaveholders who physically abused slaves or allowed abuse by overseers. The expressions  “sold down river” or “being sold down south” originated from the fear slaves had of being traded to plantations in Mississippi and Louisiana. Davis was an exception and provided for the physical well being of his slaves and allowed them autonomy in governing their internal affairs – but they were still slaves.   

The views of Lincoln, Grant and Lee were consistent with the general sentiment concerning slavery that prevailed before the war –  a mixture of acquiescence, ambivalence and subconscious guilt. Abolitionists were in the minority.

Grant and Lee married into established slave-holding families.  Lee had also inherited a few slaves from his mother.

Lee married Mary Custis, great-granddaughter of Martha Washington by her first husband (Martha had no children from her marriage to George Washington).

When Mary’s father passed away in 1857, Lee became executor of his estate, which included the Arlington plantation, and was bound by Mr. Custis’ will to free all of the family’s slaves within five years, which he did.  By then, the war was raging and the Arlington was occupied by Union troops (it was converted to a cemetery in 1864). It is difficult, then, to ascertain if Lee and his spouse would have freed the Custis slaves on their own in absence of the will’s provision.

Custis-Lee Mansion in Arlington, VA pre-1861

Lee was on record as describing slavery as a “moral and political evil,”  but possessed a paternalistic and unenlightened view of it as well.  His position was that slaves were “better off  here than in Africa.”  In general, he did not believe slaves were prepared to deal with freedom without intellectual preparation and discipline.  He also may have considered slavery an economic burden.

Mary Custis Lee shared her father’s opinion that slaves should be educated and eventually allowed to repatriate to Liberia where they could form a democratic republic of their own.  To that end, she taught slaves to read and write, in violation of a state law prohibiting it (such laws were standard in the South). I assume Mr. Lee was aware of her teaching activities and was supportive.

Overall, it was apparent that Lee was conflicted on the issue.

Grant’s father was an abolitionist.  He was aghast when his son married into the slaveholding Dent family of Missouri.

If Lee was conflicted over slavery, Grant seemed indifferent.  He appeared not to have suffered a moral dilemma while assisting in the administration of the Dent family plantation.  He did free at least one slave, one that was given to him.

In a letter he wrote during the war to his staunchest supporter in Congress, the Hon. Elihu Washburne, Grant stated, “I never was an abolitionist, not even what could be called anti-slavery, but I try to judge fairly and honestly and it became patent in my mind early in the rebellion that the North and South could never live at peace with each other except as one nation, and that without slavery.”

Lincoln, although he was clearly against slavery, was very reluctant to interfere with it where it existed.

This dichotomy was best illustrated in a speech he delivered in 1858: “I have always hated slavery, I think as much as any Abolitionist. I have been an Old Line Whig. I have always hated it, but I have always been quiet about it until this new era of the introduction of the Nebraska Bill began. I always believed that everybody was against it, and that it was in course of ultimate extinction.”

“I have said a hundred times, and I have now no inclination to take it back, that I believe there is no right, and ought to be no inclination in the people of the free States to enter into the slave States, and interfere with the question of slavery at all.”

Lincoln, as did the Custis family, supported repatriating liberated slaves to Central Africa, even compensating the slaveholders for their freedom. His position was contrary to several of his close advisors as well as Frederick Douglass, who considered the plan  a ruse to deflect criticism of slavery.

According to Doris Kearns Goodwin in her book, Team of Rivals, Lincoln was aware of the great logistical and financial enormity of repatriation.  He finally concluded the slaves, even if freed, were staying here, but realized few Americans would recognize them as equals.  Lincoln, himself, had reservations.

Lincoln even supported the candidacy of Zachary Taylor, a hero of the Mexican War …and a slaveholder.  There’s a little twist to this – Taylor was the father-in-law of Jefferson Davis for a short while (Sarah Knox Taylor died of malaria a few months after her marriage to Davis).

Lincoln’s wife – Mary Todd – was from a slave-holding family in Kentucky.  Although she was attended by slaves growing up, she must not have been emotionally tied to the southern plantation lifestyle, or she would not have severed herself from it for a rather ordinary station with Lincoln.  

The country did not have opinion polls in the mid-nineteenth century; however, I cannot help but believe that the views held by these four leaders were in line with most of their contemporaries. 

The four came from diverse backgrounds, were well traveled by comparison to the vast majority of their countrymen, were literate and supported democracy. Yet, they ended up on opposite sides in a conflict rooted in basic human rights.

It is sobering that they shared similar prejudices and misconceptions.

But I am not going to judge them through the filters of the 20th and 21st centuries.  The human race has, and will always be, comprised of imperfect people. Our descendents will undoubtedly look back at us and shake their heads in frustration over some of  our beliefs.

One way or another, though, civilization has managed to progress, although the path towards social equality has been indirect at best and tortuous at worst. We have stumbled rather than sprinted forward, but, throughout history, we have raised the bar of human rights in defiance of seemingly insurmountable obstacles created by the most vile of oppressors.

It is an endless struggle.

We can only hope “the better angels of our nature” will prevail in the end.

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I can only explain the paradox of California’s citizens opposing service cuts but not wanting to raise taxes as a mass case of schizophrenia.

My philosophy of government is simply: we can have anything we want as long as we are willing and able to pay for it.

Apparently, very few people share my view throughout the state, or at least that’s the impression I get from today’s article in the LA Times.

If any good comes out of this financial crisis, it will be a reconciliation of the voters with reality.  We need to decide if we are willing to pay for the government we want, whatever it is – socialist, laissez-faire, libertarian.

Something has to give…and soon.

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I commented on the controversy concerning the City of Bell audits earlier this week.

I also looked at the audit reports issued by Simpson and Simpson for the City of Los Angeles, the latest available report covering the fiscal year ended June 30,2009.

The report stated that the financial statements were presented in accordance with GAAP and fairly represented the financial condition of the city.  There was a qualification concerning the internal controls as they related to the process used to prepare the statements; I commented on that as well.

There was nothing in the reports pertaining  to the future prospects for Los Angeles.

Given the state of the city’s pension plans, the escalating costs of health care, and the erosion of the general fund, I was surprised there was no mention of whether the city could continue as a going concern in the absence of major cost reductions.

Let’s go back a few years in time to when the City of Vallejo was in a fiscal death spiral.

Vallejo voted to declare bankruptcy in May 2008, but the external auditors gave the taxpayers a heads-up as early as the issuance of the June 2007 financial statements.  In Maze and Associates’ independent auditor’s report accompanying the statements, a qualified opinion was given concerning whether Vallejo would continue as a going concern. https://phinvv.files.wordpress.com/2010/11/vallejo-auditors-report.pdf – read the third paragraph from the bottom of the first page.  It told the story in no uncertain terms.

Los Angeles is facing similar problems to the ones that drove Vallejo into bankruptcy, but there was no hint of them in Simpson and Simpson’s report covering  the 2009 fiscal year.

I believe the City Council’s Finance and Budget Committee should question Simpson and Simpson about the assumptions they used to determine whether the city will continue as a going concern.

I am not suggesting the city should or should not receive a qualified opinion. However, in light of what many experts consider to be a weakening trend for the city, the auditors and the Council owe the stakeholders an independent assessment of where we are headed.

By the way, the June 2006 Vallejo financial reporting package included a Certificate of Achievement for Excellence in Financial Reporting – the same type of certificate that has been displayed in the Los Angeles reports for years (these certificates are awarded to the city department responsible for preparing the information, not the CPA firm).

These certificates amount to ninth-place ribbons and have no place in a report.  To a layman, they could give a misleading impression that the information presented indicates a state of financial health.

Please read this excellent synopsis about “going concern.”

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According to the LA Times, auditors missed red flags and gave the City of Bell “a clean bill of health.”

Back when the scandal became public, I checked Bell’s website for financial reports, but could not find any. That alone made me suspicious even before the steady stream of allegations about Rizzo and company started to flow.

Perhaps the audit firm did not see the handwriting on the wall, but I would have to know what the scope of the audit was, the reports issued and their contents before really weighing in on culpability. 

I do have a problem, though, with connecting a financial audit report with the term “clean bill of health.”

Allow me to get hypothetical – absurdly so – to make a point.

It is possible that Al Capone could have produced complete and accurate financial statements for his criminal operation; maybe even filed his tax returns.  They may have indicated that his organization was financially sound.  However, I doubt anyone would have described them as a “clean bill of health.”  Also pity the poor accountant whose job it would have been to prepare Al’s reports and returns.  He would  have had to swap his wingtips for a pair of cement shoes.

You have to distinguish between financial audits and forensic audits.

The primary purpose of a financial audit is to determine if the financial statements and disclosures by an entity are reasonable representations of its actual condition.  An entity does not have to be “healthy” to receive an unqualified opinion; nor does a favorable audit mean there is an absence of fraud.

Part of any audit is an evaluation of the internal controls – the checks and balances designed to prevent material errors or misrepresentations.  Good internal controls also make fraud more difficult to commit, although nothing completely eliminates its possibility.  Collusion involving key people could defeat sound controls, at least for a time.

The Times article quotes from a report issued by State Controller John Chiang, ” We found the city of Bell’s administrative and internal accounting control system to be, in effect, nonexistent, as all financial activities and transactions revolved around one individual — the former chief administrative officer — who apparently had complete control.”

If this is true, Bell violated one of the most sacred of internal control rules: separation of duties.  You always read stories about the bookkeeper who tracked the cash receipts, deposited the checks, paid the bills and prepared all of the accounting entries.  The end is always the same – the bookkeeper takes the company for all it is worth.

When auditors encounter weak internal controls, they are supposed to modify their procedures, including (but not limited to), expanding transaction samples, performing more analysis, asking more questions of the client’s staff, etc.

If the increased scrutiny turns up evidence of anomalies or fraud, a forensic audit is probably advisable, assuming the client is cooperative.  Because of its objective, a forensic audit is more detailed and focused on activities rather than financial statement presentation and disclosures.

The Times suggests that sloppy auditing might be prevalent throughout the state.

I do not suspect the City of Los Angeles has a problem with its external auditors, but one should not assume their objective is to discover fraud.  If anything, their audit reports (see pages 1 and 2) clearly state the purpose, as they should, as “obtaining reasonable assurance about whether the financial statements are free of material misstatement.” 

That leaves a lot of wiggle room in a multi-billion dollar organization. Los Angeles is large enough to have several Bell-style operations occurring within its departments.  A scheme in the DWP was only recently uncovered despite operating for years.

It is worth noting that the auditor’s report to the City in 2010 stated there was a deficiency in internal control over financial reporting .  The deficiency was considered significant, but not material (https://phinvv.files.wordpress.com/2010/11/simpson-and-simpson-internal-control-report.pdf).

The nature of the deficiency is not described in the report, but was said to be included in a schedule of findings.  I could not locate that document.

Even if the deficiency was not material at the time of the report’s issuance, the fact that it is significant could make it material at a later date.

It is interesting that Controller Greuel did not distribute an e-mail blast as she routinely and immediately does when problems are uncovered in other areas of the city.

The external auditor’s finding concerned her department.

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$25.4 billion in the hole.

That’s what is expected over the next year and a half for California as reported by the LA Times.

Comparable deficits are expected into fiscal year 2015-16.

Don’t you think our legislators had a fair idea of where we were heading prior to election day?  Many days prior to election day?

Assemblyman Mike Feuer didn’t offer as much of a hint as to the extent of the shortfall when he appeared at a meeting of the Valley Village Homeowners Association on October 20th.

I asked him how the state was going to cover the $7 billion in unrealistic assumptions underlying the current budget.  Feuer cavalierly replied that the Legislature would simply create another $7 billion in assumptions.

I realize there was a ballot measure before the voters that would make it difficult to raise  fees.  Prop 26 passed but, until it did, its impact was fuzzy; so, I could cut Feuer a little slack, but nowhere near enough to justify why he would not divulge the possibility of an additional $18 billion deficit.

What has been known for a long time, though, is that there is no economic recovery in sight capable of bailing out California.

As a member of the Budget Committee, it seems reasonable to assume Feuer could see the deficit developing – say within plus or minus $5 billion and change.  I just don’t believe he has the stomach to discuss the single most difficult issue facing us, nor does he want to deal with it.

I do not mean to single out Feuer. At least he attended a public meeting and took a few questions.

What bothers me more is that the possible growth of the deficit was not adequately covered by the gubernatorial candidates. It was as if Brown and Whitman had a tacit agreement not to even present a strategic plan to deal with it.

Brown faces a constitutional requirement to present a balanced budget in January (note: two separate links).  Whitman would have faced the same challenge.  The lack of any meaningful discussion from their campaigns about a framework for dealing with state finances was inexcusable and disrespectful to the voters.

Now it’s time to face reality.  Can Brown and the Legislature produce without creating another layer of bogus assumptions that will flow into the next budget year?

I’m not betting on it.

For certain, the state needs to consider modifying Prop 98.  This proposition, which was passed in 1988, earmarked 40% of state revenues for education.

No one doubts that education needs a substantial piece of the budget pie, but handing over 40% without strings attached is unconscionable.  The voters were hoodwinked into the “it’s for the kids” argument sold by the teachers’ unions.  

You do not hand over that kind of money to anyone without asking for concessions in costs and performance.

Just as the federal deficit cannot be reduced without cuts to defense, the state budget will have to target education.

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We have just received word that Neighborhood Council Valley Village board member Lory Oberg passed away.

I first became acquainted with Lory through her efforts to stop the division and development of a large lot on her block into smaller parcels.

Had the owner succeeded, homes would have been built as narrow as a typical unit you would find in a mobile home park.

At the time, it appeared as if the City Planning Department was leaning in favor the division, but that did not discourage Lory from organizing and driving the effort to stop it.

And stop it she did.

She became an inspiration to all of us. It was the best example of a David vs. Goliath triumph I can think of in Valley Village.

On a personal note, Lory and I would always sit at one end of the table during NCVV meetings and chat both before and after them.  She and her husband Ken would occasionally stop by my house while taking walks and we’d discuss what was going on in the neighborhood and the city.

She set the bar high for all of us here.

We will always honor her memory.

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Patt Morrison has never had the reputation of scratching much below the surface.

However, her interview with Wendy Greuel, published in Sunday’s Los Angeles Times, set a new standard for banality.   It was more appropriate for People Magazine than the editorial page of a major daily newspaper.

I heard someone characterize it as a softball interview.

That’s being generous.  T-ball would be a better description.

The former Miss Teen South Carolina could have handled the questions.

OK, enough with the wisecracks.  They are as lame as the Q&A of Morrison’s interview.

Here’s my real concern. You have seen those full-page advertisements in newspapers that appear as if they are legitimate stories.

Well, I get the impression that Morrison’s piece on Sunday was nothing more than an infomercial for Wendy Greuel.  It had the look and feel of a campaign ad.

Greuel did not lose any time sending an e-mail blast with a link and touting the article as a “great piece.”

The race for mayor will heat up in less than two  years.  Could it be Greuel is trying to get a head start?

Perhaps Patt Morrison should offer other potential candidates equal time.

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Valley Village was in the news this year, but for reasons no one wanted.

First there was the fatal shooting of four patrons at a local restaurant in what was a personal rift between a few members of the Armenian community.  Neither the victims nor the shooter were from Valley Village.

It was followed by a brutal slaying of a young bride-to-be just across the street from the restaurant where the mass shooting occurred. Chere Osmanhodzic was the victim.

All of this in a community where violent crime is extremely rare.

The murders were solved quickly and the suspects were apprehended in relatively short order despite both having fled the state. 

 That did not deter the LAPD.  Detectives worked with officials from other states, federal agencies and Mexico (where Ms. Osmanhodzic’s alleged murderer fled).

On Sunday, the community showed their appreciation for the diligence of the LAPD, particularly the North Hollywood Division.

The father of Chere Osmanhodzic presented plaques on behalf of the family to LAPD officers and to the office of Council Member Paul Krekorian for their unrelenting efforts to solve the case and apprehend the murderer. 

The event was organized and staged by Neighborhood Council Valley Village and the Valley Village Homeowners Association.  It was held at Marie et Cie, a popular cafe at the corner of Riverside and Colfax.

Valley Village has always had an excellent working relationship with the LAPD.  The bond has grown stronger as a result of the grief shared by all from these twin tragedies.

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As you would expect, Brown is getting involved with the state’s budget crisis right out of the gate.

According to an article in today’s Los Angeles Times, he found his meeting with the state budget director “very sobering.” 

It should not have taken a meeting to come to that conclusion.  I think the public figured it out the day the legislature approved the current budget.

I do not know if that meeting preceded the one he had with Senate leader Darrell Steinberg on Thursday.  The Times reported that he and Steinberg discussed restoring funds cut by Schwarzenegger.  That thought should have sent the budget director into apoplexy.

It is shocking to think that restoring any cuts would even be on someone’s mind when you consider there are at least $7 billion in unrealistic revenue assumptions in the current budget.  $5 billion of that is for increased federal assistance.

I do not know what election coverage Brown and Steinberg watched the other night, but they have a better chance of getting Meg Whitman to cough up another $140 million as a contribution to the state’s general fund than counting on the largesse of the incoming US Congress.

There is no time for moonbeam politics.  Brown has to learn to say “no” to the party leadership and the unions.

Let’s see what happens.

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