At issue is what constitutes a “nonperforming asset.” For reporting purposes, the banks appear to be counting only loans in nonaccrual status and foreclosed real estate. Unfortunately, this badly misrepresents the banks’ actual asset quality and earnings.

For example, look at Bank of America, which reported 2Q earnings of $3.1 billion and nonperforming assets (nonperforming loans, leases & foreclosed properties) of only $35.701 billion. Unfortunately, regulatory data for 2Q will not be available until late August, but we can compare information for 1Q 2010, for which BofA reports nonperforming assets of $35.925 billion. Yet, on its 1Q 2010 Y9C regulatory filing for the consolidated holding company, BofA reports $38.819 billion in nonaccrual loans, $3.274 billion in foreclosed real estate, but also $37.060 billion in loans past due 90 or more days and still accruing interest, and $24.938 billion in loans past due 30 – 89 days and still accruing interest. In other words, non-current assets total $104.091 billion, while “nonperforming assets” total only $35.925 billion. How convenient!

As bad as this looks, things get worse. Bof A is still accruing interest on $37 billion in loans that have missed at least three monthly payments. Assuming an average interest rate of 5%, this translates into accrued interest of almost $2 billion per year on loans to borrowers that are highly unlikely to ever make another payment.

This is really bad, but things get even worse. If and, most likely, when the bank has to move these loans into nonaccrual status, it will have to charge off the loan, resulting in a future hit to earnings of up to $37 billion. Even if the ultimate recoveries are 50%, this implies a future hit to earnings of more than $18 billion.

Bank of America is not alone in this shady accounting practice. Wells Fargo reports 2Q 2010 nonperforming assets of $32.936 billion. For 1Q, Wells reports nonperforming assets of $31.500 billion and an additional $5.957 billion in loans 90+ days past due and still accruing interest. (I credit Wells with at least making a partial effort to report its past due portfolio!) Yet on its 1Q 2010 Y9C filing, Wells reports $27.408 billion in nonaccrual loans, $3.976 billion in foreclosed real estate, $38.629 billion in loans past due 90 or more days and still accruing, and $20.914 billion in loans past due 30 – 89 days and still accruing interest. In other words, noncurrent assets total $90.927 billion while “nonperforming assets” total only $31.500 billion.

As with BofA, Wells is still accruing interest on $38 billion in loans that have missed at least three monthly payments. Again, this translates into almost $2 billion per year in earnings on loans to borrowers that are highly unlikely to ever make another payment.

But what about that paragon of banking virtue—J.P. Morgan Chase? Surely, JPM would never engage in such shady reporting? Think again! For 1Q 2010, JPM reports nonperforming assets of $19.019 billion. Yet on its 1Q 2010 Y9C filing, JPM reports $28.079 billion in nonaccrual loans, $2.216 billion in foreclosed real estate, $24.006 billion in loans past due 90 or more days and still accruing, and $14.250 billion in loans past due 30 – 89 days and still accruing interest. In other words, noncurrent assets total $68.551 billion while “nonperforming assets” total only $19.019 billion.

As with BofA and Wells, JPM is continuing to accrue interest on its past due 90+ portfolio, but its smaller past due portfolio translates into a smaller gain—only about $1.5 billion per year in earnings on loans to borrowers who are highly unlikely to ever make another payment.

So, I now await publication of the 2Q 2010 regulatory filings, which I’m sure will confirm that these three banks, which control $5.6 trillion in banking assets, have materially misrepresented their true asset quality and earnings.

How can they get away with this? It is difficult to answer that question. The reporting rules are quite clear. A loan past due more than 90 days is supposed to be reclassified as nonaccrual and charged off unless it meets two criteria: (1) it is adequately secured; and (2) it is in the process of collection, which means that collection efforts are expected to result in the prompt repayment of the debt or its restoration to current status.

I challenge these banks to document how their past due loan portfolios meet these two criteria.

More than 17 months have passed, during which the government has run a deficit of more than $2 trillion, yet the economy has lost more than 2.6 million jobs, regulators have closed more than 200 banks, and more than a million of homeowners have lost their houses to foreclosure. While GDP may be growing in response to the massive increase in deficit government spending, clearly the economy has not healed, and there are calls from the left for yet more stimulus spending, including $34 billion to yet again extend unemployment benefits from a maximum of 99 weeks to 126 weeks. That is almost two and a half years of unemployment benefits—enough to make a French socialist blush.

And yet, according to figures at www.recovery.gov, less than half of the stimulus money authorized by the 2009 Act has been spent—only $425 billion out of $862 billion. (Earlier this year, the CBO estimated that the true cost of the Act had risen by $75 billion from the initial estimate of $787 billion; no telling how large will be the final tab!). The remaining $437 billion has been held back—for what? Who knows? While we can debate the merits of extending unemployment benefits, certainly we can agree that it should be funded out of the unspent 2009 money rather than adding another $30 billion to this year’s already staggering deficit.

As for the rest of the $400 billion in unspent stimulus money, how about returning it to the taxpayers? In a 2007 article, Obama economist Christina Romer and her husband David estimate that the economy will grow by $3 for each $1 in tax cuts. In other words, by cutting taxes with the $400 billion, we can boost GDP by $1.2 trillion. Certainly we don’t want to accomplish this by rewarding the Wall Street oligarchs, so let’s return this money to taxpayers through the payroll tax by declaring a payroll tax holiday for the rest of 2010. This will have the impact of immediately boosting the working person’s take-home wages by 17.6%.

Now that would be change I could believe in!

The hardest-hit states as measured by non-current mortgages are Florida (22.4%) and Nevada (21.8%--say goodbye to “Senator” Harry Reid (D-NV) and hello to “Mr.” Harry Reid). Other hard-hit states are Missisippi (16.2%), Georgia (14.8%), Arizona (14.6%), California (13.8%), and Illinois (13.6%). It is no coincidence that most of these states are heavily over-represented among the almost 200 banks that have failed during the past two years, Mississippi being the exception. Florida is suffering through an 11.2% foreclosure rate, far ahead of second place Nevada (7.3%).

More depressing is the observation that the volume of loans rolling into early stages of delinquencies are on the rise, returning to 2009 levels. More than 550,000 mortgages moved from current to 30-60 days past due and another 450,000 moved from 30-60 days past due to 60-90 days past due. New problem loans are concentrated in Arizona, Nevada and Florida.

Cure rates (the percentage of delinquent loans returning to current status) declined in April and May to a six-month low of less than 10%, after several months of improvement reaching a high of almost 30% in March. Overall, 4.1% of loans deteriorated in status while only 1.7% improved.

All in all, the May report paints a dismal picture of a residential housing market that is unlikely to improve until the labor market leads the way. With 16 million workers officially classified as unemployed and another 10 million under-employed, working part-time instead of full time, or having given up looking for a job, we have 16.5% of U.S. workers in financial straits that make it difficult for them to pay their mortgages or even keep food on the table.

Look for the housing market to follow the labor market, and the outlook for the labor market is grim.

President Obama emerged from the Oval Office to assert that “we are headed in the right direction” and that the jobs report “shows continued signs of gradual labor market recovery.” Is the President correct, or does the jobs report contain much more ominous signs for the labor market?

If we dig into the report beyond the headline numbers, we won’t like what we find. First, let’s explore why the unemployment rate declined, even though employment declined. How can that happen, you ask? It happens because the denominator declined by more than the  numerator (remember that lesson on fractions from grammar school?). In fact, employment as reported by the Household Survey, which queries households rather than employers, declined by not 125,000 but by  301,000. This number is far in excess of the decline in Census employment, indicating that total private sector employment declined by more than 50,000 workers. The Household Survey includes self-employed workers and workers hired by recently established businesses that are missed by the Establishment Survey, so this discrepancy is especially disturbing.

Even more disturbing is what happened to the size of the civilian labor force, which is the denominator of the unemployment rate. That number declined by a stunning 842,000 workers. This reflects the 301,000 workers who reported that they became unemployed during June, 350,000 unemployed workers who gave up looking for jobs during June, and a 191,000 increase in the size of the civilian non-institutional population. The 191,000 number is how many jobs the U.S. needs to create just to “break even” when we lose no jobs and no one leaves the labor force.

An informative exercise is to calculate what the unemployment rate would have been had the 651,000 employed and unemployed who left the labor force remained in the labor force by looking for work during the past four weeks: the unemployment rate would have risen by 0.2 to 9.9% rather than declining by 0.2 to 9.5%.

The ranks of the chronic unemployed—those out of work for at least 26 weeks—was virtually unchanged at 6.75 million, or almost half of the 14,623 unemployed. The median duration of unemployment rose to 25.5 weeks in June from 23.2 weeks in May.

First of all, 411,000 out of the 431,000 new payroll jobs were attributable to temps hired by the U.S. Census. All of these workers will lose their job within the next few months as the 2010 Census winds down. Without these temps, a meager 20,000 new payroll jobs were created during May. But, it gets worse, because 31,000 new payroll jobs were in temporary help services, so that full-time employment actually declined in May by 11,000 workers.

With regard to the decline in the unemployment rate, this decline was totally attributable to unemployed workers giving up and moving into the discouraged ranks, which are not considered part of the labor force. While unemployment fell by 287,000, 493,000 workers “left the labor force,” moving into the ranks of “discouraged workers.” In fact, total employment actually declined by 35,000 workers. These are not the sort of trends that we should be heralding.

In other distressing news, the ranks of the long-term unemployed, those out of work at least 26 weeks, grew by 47,000 to 6.76 million. The average duration of unemployment rose to 34.4 weeks in May from 33.0 weeks in April.

Perhaps the only really good news was that the number of persons working part-time for economic reasons fell by 343,000, but it appears that most of these workers left the labor force rather than moving into full-time jobs.

Closely related was the decline in U-6, the broadest measure of unemployment, from 17.1% in April to 16.6% in May. However, this change also likely reflects the almost half million workers who left the labor force in May.

However, the broadest measure of unemployment, which includes discouraged workers and is known as U6, rose to 17.1% in April, up from 16.9% in May and 16.5% in January. This translates into a staggering 26.5 million unemployed or underemployed workers. How can we reconcile these figures? We do so by noting that U6 also includes part-timers who wanted to work full-time but were unable to find full-time jobs). This is also a dirty little secret of the current employment market—the jobs number includes a growing number of part-timers who can’t find full-time work.

The number of part-time workers doing so because they couldn’t find full-time work or because of slack work or business conditions rose by 192,000, accounting for the bulk of the growth in payroll jobs. Their inclusion in U3 masks the continuing deterioration in the labor market.

More evidence of growing problems in the labor market are the “long-term unemployed,” which is the category of workers out of work for more than 26 weeks. This category grew to 6.72 million, up from 6.55 million in March and 6.31 million in January.

This jobs market is especially cruel to the less educated and to minorities. The overall unemployment rate of 9.9% masks the 10.6% rate for high-school grads and 14.7% rate for those without a high-school diploma, and the 12.5% rate for Hispanics and the 16.5% for African Americans. Interestingly, these are the same demographics that voted overwhelmingly for President Obama, essentially putting him in office. Yet their employment prospects have uniformly deteriorated during Obama’s now 16-month tenure. This bodes poorly for Democrat prospects come the November 2010 elections, unless the job market turns around quickly.

Also of note is the impact of Census workers. Census reports that it had hired 66,000 workers in April and will employ more than 600,000 temporary workers by the end of May. These temporary workers will skew the employment numbers upwards and unemployment downward during their six-months of work, and will lose their jobs just before voters go to the polls in November. Democrats can only hope that these job losses show up in the November employment report and not the October employment report. Look for Census to “find” some way to keep these workers on the government dole through October to ensure that this unpleasant news doesn’t reach voters until after the 2010 elections are history.

Most discussions about implications of this portfolio relate to rises in mortgage interest rates that undoubtedly will accompany any announcement of intentions to sell of the securities. What isn’t being discussed is the impact on the Fed’s own portfolio. This portfolio is composed largely of 30-year fixed-rate mortgages; what portion we do not know because the Fed has not revealed this information. Such a portfolio carries with it a tremendous amount of interest-rate risk: when interest rates go up, the price of rate-sensitive bonds go down.

Financial economists have developed tools for measuring the price impact of interest changes on such securities that collectively go under the name of “duration.” In general, duration is a measure of the percentage price change for a one-percentage point change in the interest rate. For the sake of argument, let us assume that the duration of the Fed’s $1.1 trillion portfolio is 10, meaning that it has the same interest-rate sensitivity as a portfolio of 10-year zero coupon bonds, then the value of the portfolio will fall by 10 percent for each one percentage point increase in interest rates. In other words, if mortgage interest rates rise by one percentage point, the Fed’s portfolio will fall in value by an astonishing $110 billion dollars! Even if the duration is only 5, then the decline in value would be $55 billion dollars. In other words, the Fed’s reckless actions taken to provide yet another subsidy to the housing market (don’t forget the $500 billion per year subsidy provided by the mortgage-interest tax deduction or the $20 billion first-time home-buyer tax credits), has exposed the Fed, and, therefore, U.S. taxpayers, to huge potential losses should rates rise.

Worse yet, these securities have compromised the Fed’s ability to shape monetary policy in a way that is in the best interests of the economy because, if that means raising rates, it hits the Fed’s own pocketbook. This stacks the deck in favor of continuing the easy money policy that largely  helped to create the housing bubble, and that risks stoking inflationary fires that are not easily extinguished.

What is the easy way out of this conundrum? Look back to Christmas Eve, when the Obama administration quietly removed the $400 billion limit on Treasury’s credit line to Fannie and Freddie. Look for the administration to direct Fannie and Freddie to purchase the Fed’s mortgage-backed securities with cash borrowed from Treasury. This will unfetter the Fed’s ability to conduct monetary policy, but will put the future losses on this mortgage portfolio squarely on the taxpayer’s shoulders.

There is a better way. Up until about 20 years ago, a similar problem existed in the U.S. market for residential brokerage services. If you wanted to buy a house, you contacted a broker who was hired and compensated by the seller of the house, and who had a fiduciary duty to the seller, but not to you—the buyer. This led to myriad problems, such as failure to disclose material problems with the house. To deal with this problem of duty and asymmetric information, we moved to a system where the buyer also hires a broker, known as the buyer-broker, who has a fiduciary duty to represent the buyer, but is paid by the seller. The brokerage fee is then split between the seller’s broker and the buyer-broker. Isn’t it time that we move to a similar set-up for the rating of financial securities?

Last Friday’s fraud complaint filed by the SEC against Goldman Sachs highlights three of the critically important areas of reform tackled by the bill: (1) lack of transparency in the derivatives market, especially the market for credit default swaps; (2) the utter failure of the three primary ratings agencies in classifying the risks of credit-default obligations—the securities at the heart of the housing crisis; and (3) too-big-to-fail (TBTF)—the inability of governments to deal with the financial collapse of large, systemic institutions such as AIG or Goldman Sachs. (A summary of the bill's provisions appears here.

Reining in Derivatives: No one really knows how big is the over-the-counter (“OTC”) market for credit default swaps (“CDS”) market because these swaps are simply bilateral insurance contracts between two parties who usually prefer to remain anonymous. Industry estimates put a value of around $60 Trillion (yes, trillion with a capital TEE—trillion is the new billion!) at the beginning of the crisis in 2007 and currently at about $30 Trillion. By comparison, the entire U.S. bond market is valued at about $30 billion. Most economists now agree that credit default swaps played a crucial role in the financial crisis by obscuring who owed what to whom. Because there is no central registry of these transactions, no one could evaluate the true creditworthiness of counterparties. When it was revealed in September 2008 that AIG has written insurance on more than $100 billion in CDS contracts that it did not have sufficient capital to honor, creditors around the world almost instantaneously began to cease lending. Central banks around the world stepped in to intermediate, saving the world financial markets from a total meltdown.

The proposed legislation would force standardized contracts onto exchanges. This move would all but eliminate the counterparty risk, as exchanges require margin accounts that are marked-to-market daily, and positions are closed when a party cannot make its margin call. The problem with this approach is that exchange-traded contracts need to be highly standardized, whereas CDSs are typically highly customized. Consequently, it simple will not be possible to put the vast majority of CDSs onto exchanges.

Many in academia and industry are pushing an intermediate step, which is to force CDS contract onto clearinghouses, where, at a minimum, the identities of traders and sizes of exposures are collected, providing transparency to all market participants regarding aggregate exposures of each firm.

Regulation of the Ratings Agencies: The financial crisis could not have taken place without the complicity of the three primary U.S. ratings agencies—Fitch Ratings, Moody’s Investor Services, and Standard & Poor’s. Ratings by these agencies are ensconced in statutory and regulatory limitations on investments by mutual funds and money managers, who typically can only invest in so-called “investment grade” assets. Without an investment grade rating, a security can only be sold to a small group of investors. By slapping triple-A ratings on the bulk of CDO securities, the ratings agencies gave a seal of approval to these toxic securities, leading financially unsophisticated investors to buy what they thought were extremely safe securities—equivalent to the risk of U.S. Treasury bonds. Instead, these investors would have been no worse off had they placed their money with Bernie Madoff himself.

The proposed legislation strikes at the ratings agencies from a number of directions. It bars the agencies from consulting with any company that they also rate. During the crisis, reports emerged in the Wall Street Journal and elsewhere regarding how employees of the ratings agencies worked together with investment bankers to maximize the percentage of a securities pool that would receive the highest ratings and minimize the percentage that would not be rated—the so-called equity tranche, also known as “toxic waste.” The bill enhances transparency by requiring agencies to disclose the amount of fees paid by an issuer, by requiring different symbols to be used for structured products than are used for traditional corporate bonds, and by requiring additional disclosure of the risks measured by the agencies, such as probability of default, estimated loss given default and sensitivity of ratings to changes in assumptions.

Unfortunately, the legislation fails to address the fundamental conflict of interest arising from the business model of the ratings agencies, where the issuers of financial securities pay the ratings agencies to rate those securities. This is equivalent to the now widely discredited model in residential real estate where brokers were paid by sellers and had not fiduciary duty to the buyer. In most states, buyers how have their own brokers who represent them and have a fiduciary duty to the buyer rather than to the seller. The legislation also perpetuates the oligopoly created by statutes and regulations that only recognize ratings by these three fundamentally conflicted agencies.

What the legislation fails to do the market may take care of. What investor in his or her right mind would place an credence into a structured product rating, given the agencies’ track record with CDOs? If you ate at a five-star restaurant and got food poisoning, would you trust Michelin to help you choose a restaurant your next dinner out?

Ending Too-Big-To-Fail: The most contentious parts of the bill relate to Democrat claims that the bill “Ends Too Big to Fail Bailouts.” The Republicans are dead on when they dispute this claim. There is one way—and only one way—to end too-big-to-fail, and that is to limit the size of financial institutions, as has been proposed by Simon Johnson and others. Professor Johnson has proposed 4% of GDP as an upper limit, which, in the U.S. today, would translate to about $500 billion. In my opinion, this is far too generous. One percent of GDP would be more appropriate—limiting U.S. banks to about $130 billion. Currently, the four largest U.S. bank holding companies—BofA, Citi, JPM and Wells Fargo—are larger than $1 Trillion.

The proposed bill includes the so-called Volker provision, which would prohibit banks from so-called proprietary trading and investments in hedge funds, and an amendment by Blanche Lincoln would go even farther, prohibiting banks from trading derivatives. What is really called for here is a return to the Glass-Steagall Act, which mandated a separation of commercial banking from investment banking. Glass-Steagall was repealed in 1999 on a bipartisan basis by the Gramm-Leach –Bliley Act, which was signed by former President Clinton.

With the exception of Wells Fargo, the remaining four largest bank holding companies have substantial investment banking subsidiaries. Even worse, the only two large stand-alone investment banks—Goldman Sachs and Morgan Stanley—were converted to bank holding companies by Bernanke in order to give them access to loans from the Fed. Talk about a move in the wrong direction. It is time to remove the “casino” from the FDIC-insured commercial bank.

The proposed bill would require large financial institutions to submit so-called “funeral plans” documenting how they could be rapidly shut down, but, as we know, in times of crisis, plans are changed. This provision, and several others, only serves to provide cover for the failure of the bill to address the real issue—the continued existence of trillion-dollar companies.

One of stupidest provisions of the bill is the creation of a $50 billion fund that would be used to cover the costs of liquidating a large financial institution. This fund would be capitalized by charges on the largest financial firms. Why would anyone propose sucking $50 billion in scarce tangible capital out of the thinly capitalized large banks, especially at a time when the Administration and Congress are seeking ways to expand bank lending? That $50 billion can support $500 billion or more of bank lending. Sucking it out of the banking system would virtually guarantee a credit contraction in the range of $500 billion.  Moreover, we already know that $50 billion would be woefully inadequate—even if only a single firm got into trouble. The U.S. government pumped $180 billion into AIG alone during 2008. Where would the additional $130 billion come from? Guess. The answer is you, me and the rest of U.S. taxpayers.

Most troubling is what appears to be a new trend in the broader U-6 measure of unemployment, which includes discouraged workers and part-time workers who were unable to find full-time jobs. This measure of unemployment rose to 16.9%, up from 16.8% in February and 16.5% in January, and translates into more than 26 million unemployed workers.

Also troubling is a shift in the distribution of the unemployed by duration of unemployment. The chronic unemployed—those out of work for more than 6 months—rose during March by 414,000 to 6.547 million, while the median duration of unemployment rose to 20.0 weeks from 19.4 weeks in February. Workers out of work for so long see their skills atrophy and find it increasingly difficult to compete against other workers for jobs.

Even within the standard U-3 definition of unemployment, which excludes discouraged workers and part-time workers who would prefer to work full-time, unemployment rose by 134,000. The unemployment rate actually rose by 0.06% from 9.687% to 9.749%. The BLS rounds to the nearest tenth of a percent, so both of these numbers "round" to 9.7%. Had the number of unemployed risen by as little as 2,000 additional workers, the official unemployment rate would have "ticked up" to 9.8%. So  much for "unchanged."

And within the 162,000 new nonfarm payroll jobs are 48,000 temporary Census workers and another 40,000 private-sector temporary workers. During the past six months, temp employment has grown by more than 300,000. The U-6 numbers suggest that most of these workers would prefer, but are unable to find, full-time jobs.

So, before we take a victory lap, let's wait for some additional data points. Things could get worse before they get better.

With this background, the Obama administration announced yesterday that it was dipping into the $50 billion kitty for its foreclosure mitigation program know as Home Affordable Modification Program (“HAMP”) for $14 billion. This portion of the kitty, which was taken from the $787 billion Troubled Asset Relief Program (“TARP”), is to be used incentivice lenders to modify delinquent mortgages not only by reducing interest rates and extending maturies, but also by reducing outstanding principal balances. Research has shown that reduction of principal is the most effective component of successful mortgage modifications, although redefaults within 12 months of modifications remain above 50% for all modifications. Of the permanent modifications done under HAMP, only about one in four have included principal reduction. The newly announced changes to the HAMP also would allow unemployed borrowers to skip from three up to six months of mortgage payments.  

As finance professionals, why do we like NPV for valuing a project? Primarily for three reasons: (1) It values only the incremental cash flows relevant to the project (2) it values all of the relevant cash flows relevant to the project and (3) it discounts all of the relevant cash flows relevant to the project properly using a risk-adjusted discount rate. Now, let us use these three reasons to examine how the CBO values the project known as health-care reform, and why I, and most finance professionals, assign the CBO a grade of “F” in Finance 101.

First, the CBO includes cash flows that are irrelevant to the project. The most obvious of these are the cash flows associated with the student loan program and Medicare. These projects are irrelevant because they occur whether or not we do the project known as health care reform.  This old trick allows bad managers to hide bad projects by tying them together with good projects.

Second, the CBO includes only the cash flows from the first ten years of the project; it fails to include all of the relevant cash flows. In many projects like health care reform, the majority of the value comes from cash flows after ten years. We include these by capitalizing the cash flows in year ten and discounting them back to the present. CBO fails to do this. Instead, CBO includes ten years of costs but only about four years of benefits.

Third, CBO appears to be ignorant of the most fundamental concept in all of finance—the time value of money. The time value of money simple states that a dollar received today is worth more than a dollar received next year. We relate the two by the annual interest rate. When dealing with cash flows across ten years, as the CBO does, it is critically important to account for the time value of money. At an interest rate as low as 4%--the current rate on a ten-year Treasury Bond rate—a dollar received in ten years is worth only 67 cents today. At 12%—the 1981 rate on ten-year Treasury Bonds in 1981 that we are likely to see in coming years if we do not reign in the national debt—a dollar received in ten years is worth only 32 cents today. Yet the CBO treats a dollar received in ten years as exactly equal to a dollar received today. Compounding this problems is the fact that much of the cost comes during the early years, whereas the benefits only come much later during the project, when they are worth less. So much for the most important concept in all of finance.

Beyond these three points, another critical part of the NPV valuation process is what is known as sensitivity analysis, which is where we test how sensitive are our estimates of value to our assumptions. Of special interest are assumptions about growth rates. The CBO makes a number of heroic assumptions that drive its analysis, including changes in the growth rates of health costs with and without the reform project, yet  it does so without doing any analysis of how different costs would be if it’s assumed growth rates are wrong (as they most probably are). What if growth in future medical costs don’t decline as the bill assumes? What if we can’t “save” $500 billion from Medicare? Is it still a good project? No.

So we see, on al l four of these counts, the CBO earns a failing grade in its approach to valuing health-care reform—and everything else. How am I, as an educator, supposed to teach my students the right way to value a project when our government’s “watch dog” violates virtually every rule I am trying to teach. Let’s reform the CBO’s arcane and inaccurate costing methodology before it bankrupts our country. Finance 101 is a good place to start.

As the program reaches its one year anniversary, we must ask about how responsibly the Administration is spending $75 billion of our taxpayer dollars. Treasury released the most recent numbers on Feb. 16, which covers the program results through January 2010. According to this report, about 1.3 million borrowers have been extended an offer for a trial modification, 1.0 million borrowers have started a trial modification, of which 830 thousand are still active, 60 thousand have been canceled, and 117 thousand permanent modifications were started.

So, after 11 months, the program has “reached” more than a million of the targeted 3 to 4 million at-risk homeowners, but has produced permanent loan modifications for only a hundred thousand. That said, the January results were a vast improvement over November and December 2009, when only 31 thousand and 66 thousand permanent modifications had been started, respectively. So it appears that the program is beginning to hit its stride, but it will need to continue this progress if it is to make a real dent in the problem because the problem continues to grow.

On Feb. 19, 2010, the Mortgage Bankers Association released results from its National Delinquency Survey for the fourth quarter of 2009. This report showed that the combined percentage of loans in foreclosure or at least one payment past due reached 15.02%, the highest level on record, up from 14.41% in the third quarter of 2009. In the fourth quarter, the percentage of loans in foreclosure was 4.58% and the percentage past due was 10.44%, up from 4.47% and 9.94%, respectively, in the third quarter. This translates into an additional 335 thousand new delinquencies and an additional 60 thousand foreclosures during the fourth quarter.

On Feb. 23, 2010, First American CoreLogic released a report in which it estimated that, in the fourth quarter of 2009, 11.3 million residential properties representing 24% of all properties with mortgages were “under water,” meaning that the borrower had negative equity because the value of the property had fallen to where it was less than the outstanding mortgage balance. This was an increase of approximately 600 thousand properties from the third quarter of 2009. More than 10 percent of properties are estimated to be underwater by more than 25% of loan value. The report goes on to demonstrate a strong correlation between negative equity and foreclosure.

So we see that delinquencies are growing by 100 thousand per month, foreclosures by 20 thousand per month, and underwater mortgages by 200 thousand per month. Against this backdrop, HAMP has managed a total of only 120 thousand permanent modifications, although 50 thousand of these took place during January. In order to reach its goal of 3 million permanent modifications by 2012, HAMP will need to average 125 thousand permanent modifications per month. Good luck with that.

Unaddressed thus far is the knotty issue of re-defaults. Some researchers estimate that re-default rates on modified mortgages will exceed 50% within 12 months of modifications.

Forty-five banks failed during the fourth quarter of 2009, raising the total for the year to 140—the largest annual total since 1992. The number of “problem banks”—those that bank regulators consider to be in danger of failing—rose to 702 at the end of December 2009, up from 552 at the end of September 2009, and from 252 at the end of December 2008. The assets of problem banks rose to $403 billion at the end of December 2009 up from $346 billion at the end of September 2009 and from $159 billion at the end of December 2008.  Both the number and assets of problem banks are at the highest levels since 1993. Clearly, these numbers don’t include any of the four largest banks, in spite of stress tests indicating that these banks are insolvent. Too-Big-To-Fail is alive and well at the FDIC and other bank regulatory agencies.

Asset quality continued to deteriorate, as measured by loan losses, past-due and nonperforming loans and foreclosed real estate. Loan losses rose for the twelfth consecutive quarter to a 2.89 percent annual rate of net charge-offs, up from 1.95 percent from a year earlier. The 2.89 figure is the highest rate on record during the 26 years banks have reported this item.

Non-current loans and leases (past due 90+ days or in nonaccrual status) rose to $391 billion, or 5.36% of all loans and leases—the highest percentage in the 26 years that banks have reported these data. This includes the banking crisis years of 1985 – 1992, when more than 1,000 banks failed, which gives us an indication of the number of bank failures to expect during the coming years. Noncurrent loans were concentrated in the real estate sector, both residential and commercial: 9.3 percent of residential mortgages were non-current and 15.9 percent of construction & development loans were non-current. Surprisingly, only 1.8 percent of home equity loans were non-current, indicating that homeowners are staying current on second liens while defaulting on first liens. In total, banks hold $1.92 trillion in residential mortgages, $661 billion in home equity lines and $451 billion in construction & development loans. They also hold an additional $1.09 trillion in commercial real estate loans.

An additional $140 billion in loans and leases were past due by 30 – 89 days, so that the combined value of past due and nonaccrual loans is $531 billion, or 7.28 percent of total loans and leases. By sector, 3.2 percent of residential mortgages and 2.6 percent of construction & development loans were past due 30 – 89 days.

Other real estate owned (OREO), which consists primarily of real estate seized through foreclosure on previously delinquent loans, rose to $41.4 billion in December from $37.2 billion in the September. When combined with the $531 billion in bad loans, the total book value of nonperforming assets was $572 billion or 7.85% of total loans and leases. Banks hold reserves against loan losses of 3.12 percent of total loans and leases—the highest level in the history of the FDIC.

Total assets declined for the fourth consecutive quarter to $13.1 trillion, down 5.3% from a year earlier. Total loans and leases declined for the sixth consecutive quarter to $7.29 trillion down from $7.88 trillion a year earlier—a 7.5 percent year-over year decline that is the largest since the 1940s.

Earnings during the fourth quarter of 2009 were $914 million, which translates into a miserable return on assets of only 0.01 percent, but a dramatic improvement over the $37 billion loss recorde during the fourth quarter of 2008. The percentage of banks that were losing money rose to 29.5% in December, up from 24.8 percent in December 2008 and 12.1 percent in December 2007.

Obama-land is a fantasy world where up is down and down is up; where a trillion-dollar health care bill is projected to reduce the natiotal debt; and where 2 million jobs were “saved or created” during the same period of time when almost 4 million U.S. workers lost their jobs. Yes, Obama-land is a magical place that is "long on fantasy" and "short on facts," just like Tim Burton's fantasy world.

This morning, President Obama and Vice-President Biden took a victory lap—celebrating the one-year anniversary of the Stimulus Act of 2009. In his prepared remarks, the president claimed that “the Recovery Act is responsible for the jobs of about 2 million Americans who would otherwise be unemployed” and that “it is largely thanks to the Recovery Act that as second depression is no longer a possibility.” Of course, the President provides no facts to support these statements, but instead refers to unnamed “nonpartisan economists across the spectrum.” Certainly, far-left-leaning Paul Krugman of the New York Times might be one of these economists, but I know of no right-leaning, or even center-leaning, economists who possibly might fit this description. Like the 2 million “saved jobs,” this is just another Obama fantasy. Into the "rabbit hole" we go. 

Let’s look at the facts instead of fantasy: According to the Bureau of Labor Statistics (“BLS”), 3.9 million U.S. workers have lost their jobs since Obama took office on January 20, 2009, and another million unemployed workers have given up looking for a job, thereby falling out of the official labor force. The number of chronic unemployed—those out of work for more than 26 weeks—has more than doubled from 2.7 million in January 2009 to 6.3 million in January 2010. Currently, there are 14.8 million unemployed U.S. workers, and another 10.5 million who have given up looking for work or been forced to take on part-time work when the would like to work full-time.