In a widely cited interview, Paul Dales of Capital Economics noted, “Home sales were eye-wateringly weak in July.” (CNNMoney.com, August 24, 2010).  The fear that housing is hampering the general economic recovery is now widespread.  More observers worry not only about a double-dip recession but increasingly, a move toward the “D” word … (Depression).

What’s been going on in Pennsylvania? 

While we don’t have July sales data yet, we can show results for the previous several months.  At the beginning of 2010, for a majority of the reporting regions, sales activities were down, however, sales uniformly picked up in the second, third and fourth months.

For all Pennsylvania regions, there were almost 65 percent more transactions in February than during the previous month and activity continued throughout the quarter and beyond.  The monthly results in the second quarter were very strong statewide. By June, all regions had significantly higher sales (except Adams, where sales had increased earlier). 

While there is seasonality in the data coming out of winter, it is clear that Pennsylvania buyers were responding to the home-buyer tax credit during the first and second quarters of 2010. Table 2 shows the same phenomena.

What can we conclude?

Both the monthly and quarterly transaction data showed robust responses to the tax credits.  In the monthly series, all regions had very large percentage increases in February and these continued (although at a declining rate) into May. Data for June picked up in many regions, most likely stemming from seasonality and the expiring credits. The tax credit impact significantly elevated the 2009 annual results.

Most commentators predict slower third and fourth quarters in 2010 without the tax credits in place. In fact, the very recent evidence surprised most analysts by its magnitude (i.e., the sales declines were about twice what was expected).  Buyers were motivated to accelerate their purchases to qualify for the federal money and the fear was that there would be a significant decline when the tax credit sales expired. These fears have now been realized.

The next few months are being watched closely. Markets are expected to be weak (i.e., sales and prices may decline further).  Housing demand is largely absent — or at best, dormant — and inventories are large (12 months or more) and likely to grow in the months ahead.

We are in for a rough several months nationally as well as in Pennsylvania.

FHA will offer the new FHA-insured mortgage to certain “underwater” non-FHA borrowers who are current on their existing mortgage and whose lenders agree to write off at least 10 percent of the unpaid principal balance of the first mortgage.

This and other programs that have been put in place will help the administration meet its goal of stabilizing housing markets by offering a second chance to up to 3 to 4 million struggling homeowners through the end of 2012.

“This is an exciting new program that could help keep more people in their homes,” said David McCarraher, senior account liaison, for the FHA Office of Single Family Housing in Philadelphia.

“This is an incentive for borrowers who have been making the mortgage payments but their home isn’t worth what they owe on the mortgage,” McCarraher explained. “These homeowners are having trouble refinancing with better rates because they don’t have any equity in their home. We’re encouraging lenders to participate in the program and the U.S. Treasury Department will provide incentives to existing second lien holders as well.”

FHA Commissioner David H. Stevens said, “We’re throwing a lifeline out to those families who are current on their mortgage and are experiencing financial hardships because property values in their community have declined. This is another tool to help overcome the negative equity problem facing many responsible homeowners who are looking to refinance into a safer, more secure mortgage product.”

FHA’s mortgagee letter explains how lenders can implement this new enhancement.  Participation is voluntary and requires the consent of all lien holders.  To be eligible, homeowners must:

• Owe more on their mortgage than their home is worth
• Be current on their existing mortgage payments
• Have a credit score of at least 500
• House must be primary residence
• First lien holder must agree to write off at least 10 percent of unpaid principal balance.

FHA’s goal is to give underwater borrowers payment relief that is safe, to help them stay in their homes and to benefit communities impacted by lower values.

For more information on FHA Short Refinance option, read FHA’s mortgagee letter and the accompanying fact sheet. REALTORS® can also contact the FHA Resource Center at 800-225-5342.

Fueled by rising prices, some cities –  Atlanta, Houston and Phoenix — grew without limit. Yes, some regions of the country rebelled against such “sprawling” subdivisions and their attendant strip malls. But continuing subsidies for home ownership and the myth of fabulous returns to housing as an investment fueled the continuous expansion of suburban America.  “Trading up” and more recently, “flipping” houses became the norm. HGTV is alive and well on cable television even now.

Now I am not one to lament that the population should have been required to live within the traditional boundaries of America’s older cities. Nor am I sympathetic to the repeated propositions from those who claim that Americans should give up their cars for bus or train passes. The cultural values of the urban-built environment have enabled American citizenry to obtain and maintain the best housing stock in the world. Certainly, immigrants to the U.S. view access to quality housing as a real dream: it is one of the most important features of life here.  Despite housing problems in many cities for the poor and working class groups (often made worse by restrictive land use controls), the availability and development of residential space throughout the nation is something of which we can rightfully be proud.

But in the post-housing bubble (after 2007), there is a new debate arising: will the future lead to a continuation of urban decentralization with the re-population of distant, new subdivisions (so-called “McMansions”)? Or will declining prices at the center of cities lead to a return to “downtown living,” often in the form of upscale condominiums where central land values are sufficiently expensive that development must go “up” rather than “out?”

In one corner are those such as the Urban Land Institute (ULI), which predicts that while the recovery of the housing market will take place throughout urban space, there will be a   “reurbanizing” of the American suburbs. In a well-done report I wrote on recently, ULI predicts that cities will undergo dramatic changes as a result of the current housing crisis. There are expected to be fundamental differences between the population cohorts: Baby Boomers, Generation X, Generation Y and others.  Many will be stuck in their suburban McMansions due to negative equity or limited new construction options.  Those with less income may be sent to distant subdivisions where there will be plenty of foreclosed choices at good prices but longer-than-hoped-for commutes.

On the other hand, “pundits, planners, and urban visionaries … have been predicting for years that America’s love affair with the suburbs will soon be over,” notes Joel Kotkin, a well-known housing expert, in a recent story in the Wall Street Journal (July 6, 2010).  But he fails to see evidence of a return to city centers and cites a host of evidence to support his doubts. One of the main problems is the over-building of condominiums in many of America’s large cities. He notes that in Miami, a city of extensive urban redevelopment, condo prices are down 75 percent from their peak, while single-family homes are off 50 percent. In Los Angeles, house prices have risen about 10 percent over the past year but condo prices are said to be off 18 percent. In Las Vegas, there is a condo inventory of 21 years!  The reason for these differences, according to Kotkin, is a fundamental misunderstanding of household preferences.

So, as with other conceptual disputes, there are competing visions for the future. Cities are complicated organisms to be sure and they take different forms at various times. There is much at stake for households, neighborhoods, communities, cities, suburbs and the entire real estate profession. Alas, life would be so much simpler if we could just predict the future.

Five hundred Pennsylvanians who encountered home foreclosure during the last 12 months were surveyed by Florida-based polling firm Strategic Guidance Systems (SGS) between June 22 and 27, 2010.  Fifty-seven percent of the sample said their household had experienced a wage-earner’s job loss in the 12 months prior to their foreclosure, while 47 percent said they had been hit by unexpected medical bills. Thirty-six percent indicated they had other “unexpected bills.”

Subprime mortgages, which many regarded as the main culprit in the meltdown of the U.S. housing market, appear to have played a minor role in Pennsylvania foreclosures. Forty-one percent of survey respondents held prime fixed-rate mortgages and 12 percent had prime adjustable-rate loans. Only 14 percent carried a subprime mortgage.

“It’s clear that housing market conditions are closely tied to economic conditions, especially employment. Subprime mortgages have never really driven foreclosures in Pennsylvania,” said Austin Jaffe, Ph.D., PAR’s consulting economist and head of the Department of Insurance and Real Estate at the Smeal College of Business at Penn State University.

“The study represents a significant number of Pennsylvanians who have personally experienced foreclosure in some way.  They’re people from all walks of life, various socio-economic backgrounds and all parts of the Commonwealth,” SGS pollster Joel Searby said.

 Many of those surveyed also did not know about the state and federal programs available to those undergoing the foreclosure process:

• 67 percent of respondents “never heard of” the federal Home Affordable Foreclosure Alternatives Program (“HAFA”)
• 57 percent never heard of the federal Making Home Affordable program
• 61 percent were unfamiliar with the Homeowner Equity Recovery Operation program of the PA Housing Finance Agency.

Ninety-one percent of those surveyed said they attempted to contact their lender about a solution to their pending foreclosure but 48 percent said their lenders were “not at all” willing to work with them. The 30 percent who worked with their lenders said it made no difference. Nineteen percent said it “made things worse.”

Most of the survey respondents were between the ages of 40 and 59. At the time of foreclosure, 71 percent had lived in their home for more than five years. Forty-one percent of the sample personally experienced foreclosure; 57 percent narrowly avoided or are currently in foreclosure.

The survey has a margin of error of +4/-4 percent.

The association commissioned the study to understand the impact foreclosures have on individual Pennsylvanians, said Don Roth, PAR president.

The study was funded by a grant from the National Association of REALTORS®.

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Times have changed.  Currently the conventional wisdom is that housing is hurting the overall economy’s ability to recover from recession. Once housing was a performance leader; now it is a drag on the general economy.  The real estate industry finds itself in a new position compared with where it has stood for the past several decades.

The fundamental reason for the change is the unprecedented decline in house prices since 2005 (which followed the unprecedented rise in prices the decade before) in virtually all housing markets. It is true that some markets have declined more than others (and Pennsylvania has experienced only moderate declines in most markets) but the American housing market had not fallen significantly for consecutive months since the 1930s.

Many commentators warn that if there is additional bad economic news, house prices may react sensitively in the short run. For example, recent poor jobs growth reports have already limited housing’s recovery. Rising unemployment could lead to additional defaults and foreclosures and perhaps to the feared “double dip” recession. On the other hand, positive economic growth can lead to much better expectations about house prices for the future and in turn could stimulate new demand for housing.  Regrettably, few economists are predicting a return to high rates of growth.

Sometimes the absence or costliness of mortgage finance constrains housing demand. Current mortgage interest rates remain at record low levels and inflation is nowhere in sight (at least not yet).  In this case, the availability of housing finance is not really an issue in U.S. housing markets.

Edward Learner, a UCLA business economist, argues that a “tepid economic recovery” is the best we can expect since the housing sector cannot pull the overall economy back to positive growth. In fact, he and others look for a weaker second half of 2010 for housing markets compared to the first half and the expiration of the tax credits. Diane Swonk, chief economist at Mesirow Financial, is quoted as saying, “this is a recession that was induced by housing, and housing is not going to carry us out like it has done in the past.” (realtor.org, June 23, 2010)

So what should we expect? Much depends on the employment picture and its impact on house prices over the next several months. If job growth returns, prices will continue to stabilize and market demand will improve. But without additional jobs and with the anticipated drop after the tax credit expiration, foreclosures may rise during the remainder of the year and into 2011. This will increase the supply of homes on the market and put new downward pressure on prices.  Negative equity already affects up to 40 percent of households in the country. There is also talk of some 4.5 million homes in “shadow inventory,” homes being held off the market as households wait for better news.

Optimists often talk about pent-up demand appearing any month now. My fear is that this illusory demand, if it does appear, will be dominated by a macroeconomic-induced new supply of housing.  NAR President Vicki Cox Golder recently wrote that homeownership remains the American Dream. (www.usatoday.com, June 22, 2010)  I certainly agree but the future continues to remain a challenge for the months ahead.

The Facts

In 2008, Congress passed (and then-President Bush signed into law) a $7,500 tax credit “to provide an incentive for first-time homebuyers” purchasing a home on or after April 9, 2008 until July 1, 2009.  Then, as part of the American Recovery and Reinvestment Act of 2009 (which President Obama also signed into law), Congress passed the 2009 First-Time Home Buyer Tax Credit.  This bill established an $8,000 tax credit for all virtually all first-time purchasers of real property between January 1, 2009 and December 1, 2009. 

As the end of 2009 approached, it was clear that many buyers would not be able to make the December 2009 date so the Home Buyer Assistance and Improvement Act extended the closing deadline to April 30, 2010. (A $6,500 Repeat Home Buyer Tax Credit was also added for other buyers.)  Very recently, Congress passed the Home Buyer Tax Credit Extension, which enables buyers with pending contracts as of April 30, 2010 to qualify for the credit through September 30, 2010. President Obama signed the bill earlier this month.

It has been estimated that as many as 200,000 buyers would miss the credit without the current extension. It has also been widely reported that some 1,300 prison inmates claimed the credit (costing $9 million) from jail! Despite the fraudulent claims, it is clear that the home buyer tax credit programs are enormously popular. So, let’s look at the politics and the economics of this policy.

The Politics

Led by the National Association of REALTORS® and the National Association of Home Builders, the effort to claim federal support for their industries has been very well received throughout the country. There are many justifications provided for the legislation: to stimulate the US housing market, to assist housing markets in difficult times, to stabilize battered housing markets and take advantage of low-interest rates. But none of these are really needed: in an era of dramatic government spending in trying to stimulate a recession-weary economy, any of these reasons appear to be sufficient. Perhaps the best reason is that housing retains its place as a cornerstone of the American Dream; assistance to enable market participation is almost viewed as an American right of citizenship.

Some have advocated making the tax credits permanent. The reasoning is that additional assistance is needed, especially for first-time buyers who lack capital and experience. The state provides assistance, including subsidies in many other areas such as mortgage financing, so why not induce individuals into home buying?

Put aside the fact that we have just come through a painful period when encouragement of home ownership for many without sufficient income or creditworthiness has not worked out so well.  The politics of home buying tax credits are clear: households purchasing housing like the credit and the industry views the policy as supporting house prices. The credits accelerate the number of offers to purchase to take advantage of the credit.  Thus, tax credits are very popular.

The Economics

It is virtually certain that tax credits have no long-term impact on the market, however, the objective is to support the housing market and real estate industry in the short-term. Endorsing a short-term subsidy is one thing; observing a lasting effect is quite another.

The recent experience of these housing tax credits has become clear in recent weeks. It is widely acknowledged that as much as one-half of all real estate transactions since 2009 have been associated with the first-time tax credit. This is good during a period of significantly fewer transactions. The problem is that some buyers are already over-extended.  More importantly, in what appears to be a market recovery, now with expiration of the credits, normalcy in the market seems to be an illusion,

Existing home sales fell 2 percent in May 2010 but were stronger than they would have been without the credits. But new home sales plunged 33 percent in May to the lowest sales level since 1963 when the Commerce Department began to keep track (CNNMoney.com, June 23, 2010).  “We fear that the appetite to buy a home has disappeared alongside the tax credit,” said Paul Dales, an economist with Capital Economics (YAHOO! Finance, June 23, 2010). “We all knew there would be a housing hangover from the expiration of the tax credit.  But this decline takes your breath away,” noted Mike Larsen of Weiss Research (YAHOO! Finance, June 23, 2010).

NAR’s pending home sales index fell 30 percent as well. “Sales fell off a cliff after the tax credit expired.  It’s the biggest monthly decline ever and the index is at its lowest level since NAR began tracking it in 2001,” concluded Larsen (CNNMoney.com, July 1, 2010).

Conclusion

Getting a direct inflow of government cash feels good if one qualifies or if one’s business is directly affected. Given the pervasiveness of support for homeownership, even now, it is not surprising that tax credits of this type are popular. This does not mean they are effective. Over and over again in a wide range of markets (remember “cash for clunkers”), people respond to incentives by accelerating their purchases during the subsidy period. What happens afterward is also clear: sales fell off a cliff. 

The next few months are particularly risky but the tax credit story has been told.

Housing in America: The Next Decade

The current assessment is that markets are beginning to stabilize, at least with respect to prices.  The author is well aware of the destruction of values throughout the country and even endorses the idea of further price declines through 2010; this is consistent with many other economists. McIlwain’s prediction for stable prices for 2011 is predicated on declining unemployment rates during 2010, something which seems a bit more uncertain these days. Additional employment is expected to prop up housing demand; a “jobless recovery” may not do the trick.

By the end of 2010, the report predicts as many as 40 percent of all households with mortgages will have negative amortization (a.k.a. being “underwater”). It is well known that the absence of equity for homeowners is a serious problem and not only because of the reduction in the homeowner’s wealth. More importantly, such a situation changes the homeowner’s attitude towards the asset as well as his obligation to continue to service the debt. Previous estimates of underwater households were 25 to 30 percent. At 40 percent, the magnitude of the problem cannot be over-emphasized.

The report emphasizes the need for financial reform but not the financial reform talked about in the latest 2000+ page tome coming out of Washington. There is a need to reform or replace Fannie Mae and Freddie Mac, the now government-dominated agencies crucial to the American housing finance system. (For political reasons, reforming these agencies has been completely avoided by Washington politicians to date.)  In addition, the Federal Housing Administration (FHA) is backing 90 percent of the mortgages made today, where historically they were involved with only up to 30 percent of all mortgages.  The report also calls for new rules and regulations for mortgage securitization. Clearly, we need a new system of securitized instruments for the future.  Just read The Big Short by Michael Lewis (2010) or other recent books if you need convincing.

The long-run predictions are also interesting.  In addition to identifying various demographic classes for future housing demand, the report envisions a future for housing different than the past: 

• Demographics will favor housing demand but at lower home ownership rates than at the peak or even currently. Rental markets will rejuvenate.
• Families with moderate or limited income will struggle as increases in household income will be “constrained” and house prices, despite their recent declines, will continue to be too expensive for many potential buyers. Such buyers will consider moving to distant suburbs but be faced with significantly higher commuting costs. 
• New homes will reflect sustainable development objectives and over time, will become very energy efficient.

Consider this set of conclusions and visions for the future:

The age of suburbanization and growing homeownership is over.  The demographics of the next decade indicate that the market for urban living will continue to grow. There will be regional winners and losers as markets recover, and the strongest markets will be found in places that provide a vibrant 24/7 lifestyle. Many central cities will experience strong demand for housing. People who want an urban lifestyle but either do not want to live in a “big city” or cannot afford to will look to live in the many suburban town centers that have been emerging in metropolitan regions across the country.  

Herein is the optimism: the changes which have been foisted upon households, financial institutions and the real estate industry since 2006 will result in new opportunities in the markets of the future.  Metropolitan areas throughout the land will be altered by these changes in many fundamental ways.

There is much more to the ULI study and it is definitely worth a look. Housing markets and the housing industry are undergoing dramatic changes. The winners and losers have yet to be drawn. Will you be prepared for the road ahead?

Fannie Mae announced changes to its Selling Guide as part of its Loan Quality Initiative earlier this year. This update requires lenders to determine that all the homebuyer’s debts are disclosed on the final loan application. If the borrower takes on more debt before the closing, the lender should update its underwriting. If it fails to do so, it may be required to buy back the mortgage. In response, many lenders are expected to run a second credit check prior to closing.

“It seems clear that the purpose of the policy is to make sure that homebuyers don’t take on more debt than they can afford which, of course, would increase the likelihood that they may default,” said Jeff Lischer, National Association of REALTORS® (NAR) managing director for regulatory policy.

“REALTORS® may wish to counsel their clients about the risk of taking on additional risk, especially before they close on their home and get a good understanding of the costs involved in owning a home,” he added. “Any debt taken after the loan approval but before closing could put the closing at risk.”

“This isn’t anything new,” said former banker and PAR President Don Roth. “Lenders can always call the credit bureau or the buyer’s employer to confirm the credit situation. I think many may have moved away from the practice several years ago,” he said.

Roth said it’s always a good idea to remind buyers of this possibility, especially first-timer homebuyers. “This is a reminder to the buying public not to apply for another credit card or buy a car before closing. Lenders were always able to verify credit or employment. It’s just becoming more commonplace today for them to run a check a few days before closing,” he added.

'It seems we’re at a fork in the road: will housing finally begin to recover or is there more trouble ahead?'

National and local commentators seem to be filled with welcome optimism regarding the recovery of the economy and its impact on housing markets. New home sales were up 14.8 percent in April for the second straight month and sales were nearly 50 percent higher year-over-year, according to CNNMoney.com. Toll Brothers, a major builder of residential communities, is reportedly buying large amounts of land in anticipation of a better future for home building.

It’s also widely reported that new jobs are being created. This aids in strengthening demand for real estate.  A recent report of nearly 100 economists agreed that the economic recovery is underway and housing may show signs of recovery by 2011.

But there is reason to be cautious. The very same news outlet, CNN.com, also ran a piece called “Think Housing is Recovering?  Think Again.” It seems we’re at a fork in the road: will housing finally begin to recover or is there more trouble ahead?

Despite all of the good news for housing, one major problem remains — the huge inventory of housing already on the market and the expected additions to it. Many widely cited economists expect further price reductions where supply is an issue. Moody’s Economy.com predicts an average price decline of an additional 10 percent in 2010.  Those raising concerns indicate that the misleading indicators showing strong recoveries in March and April stem from the now- expired tax credits and current low interest-rate levels.

It’s an empirical fact that sales drop off directly after the expiration of tax credits. It happened with the “cash for clunkers” program and it’s expected to happen in residential housing. The increase in activity is stimulated by the government program, not necessarily in the form of additional purchases, just accelerated ones. In the period which follows the program, there are fewer purchasers left since they moved faster to get the rebate. Thus, the expectation is for a sluggish second half of 2010 in housing markets.

In addition, we continue to see low mortgage rates, typically a sufficient condition for strong housing demand. But not in this recession. The Fed finished purchasing mortgages and mortgage-backed securities this spring and the conventional wisdom is that this has kept interest rates lower than they would have been without the program. Yet the number of borrowers seeking a mortgage has fallen to its lowest level since May 1997.

As a result of these two factors — tax credits and artificially low interest rates – the Federal Housing Administration’s (FHA) David Stevens noted on CNNMoney.com, “This is a market purely on life support sustained by the federal government.”  Without a reduction in unemployment or growth in household income, house prices will remain flat or perhaps “double dip” (i.e., a new round of price declines will occur after recent months of stabilized prices).    

Meredith Whitney, a highly visible New York banking analyst, predicts that prices will be falling again due to the tremendous pressure from additional foreclosures coming in the months ahead.  Moody’s predicts 1.9 million foreclosures in 2010 and more than a million in 2011. With the inventory already on the market, prices cannot be expected to rise. Also, with the recent rising optimism sellers are reportedly ready to come back to the market, a trend that will further dampen.

We can hope that the housing market in the future will be different than it is now but it will take some time. Slow growth with high unemployment is like this. In the next blog, I’ll review a major report by the Urban Land Institute on housing prospects and strategies for the decade ahead.  There are indeed reasons for long-term optimism.

Austin Jaffe, Ph.D.

Goldman Sachs was — before the financial crisis and even more so now — the finest investment bank on Wall Street based on its market capitalization, earning capacity, historical performance and reputation.  It drew an enormous amount of attention when it appeared that Goldman soured on the mortgage-backed securities market and liquidated its holdings long before anyone else did. Firms failed (e.g., Lehman Brothers) or were taken over (e.g., Merrill Lynch) due to their large respective positions in the housing and mortgage markets (which are clearly tied together).  At Goldman they decided that what proved to be the biggest housing bubble in history could not last and they would avoid going where others had been investing. But as money-hungry Wall Street firms often do, Goldman continued to create trading instruments and helped make a market for institutional investors who are also hungry to make big money.

Here’s where the story gets technical.

In December 2006, Goldman began selling mortgage-backed security products even though they believed the market was overheated and headed downward. Yet the federal government’s lawsuit claims it was not until September 2007 that the bank failed to disclose what it was doing — “shorting” (betting against) the market it was helping to create. A Goldman spokesman was quoted in the Centre Daily Times as saying last month, “We are not required to disclose individual trading positions.  Rather, we disclose the financial performance of the firm. In this regard, net revenues from the residential mortgage business represented around 1 percent of the firm’s total net revenues in 2007.”

Perhaps. But the Securities and Exchange Commission (SEC) claims that Goldman violated disclosure rules that information “material” to a company’s performance should be announced. No doubt Goldman was quiet about its revised strategy against the housing market and the sustained house price appreciation. Therein lies the legal issue: Is this a securities law violation and if so, how can it be proven?

The case is further complicated by the choice of investment vehicle. In the 1990s, mortgage-backed securities (MBSs) were “plain vanilla” — pools of first mortgages where the cash flows from repayment of borrowers’ loans were passed through to institutional investors. Then came CMOs (collateralized mortgage obligations) where the pools were sliced into different “tranches” and sold throughout the world.  By the mid 2000s, Goldman and others created even more complex instruments, now called CDOs (collateralized debt obligations) since other debts such as credit cards and even delinquent property tax bills could be included in the pools. The number of pieces of individual mortgages or other obligations in any investment pool could be in the tens of thousands.

The next development would expand the possibilities even further with synthetic CDOs.  In this security, a new derivative was used — the infamous credit default swap from AIG — to make bets on whether, in this case, mortgage pools would keep producing cash flow as borrowers continued to repay their mortgages. Credit default swaps were pure bets on the future of MBSs (based on prepayment risk) and every transaction required a buyer and a seller. In the government’s complaint against Goldman it is argued that the bank failed to warn investors that the hedge fund Paulson & Co. was betting against the securities. Yet as commentators reported at the time of the government’s charges, by definition both sides of the market must be in play for the bet to be made using credit default swaps. The use of credit default swaps in the Goldman synthetic CDOs is the core of the lawsuit.

None of us on the outside can tell whether securities law violations occurred, however, it’s apparent that there were billions at stake. Beware: this market is not one for novice investors. The millions made annually in salary and bonuses at Goldman and elsewhere for hundreds of employees, not only executives, are not simply because they have signed on with the firm!

One other thing: CNNMoney.com ran a story (“Always Bet on Blankfein”) on April 28, 2010.  Apparently, a British firm called Intrade is making a market inviting bets for a fee on whether Goldman CEO Lloyd Blankfein will survive the SEC lawsuit and its fallout. That’s right: people can place bets on virtually anything in the UK, in this case whether Blankfein will be fired or will resign. Interestingly, such wagers allow Goldman shareholders to hedge their positions against the decline in Goldman stock. Ironically, this strategy is not different than what Goldman did against the housing market.

It’s very difficult to say what will happen to Goldman. This type of securities law violation is very difficult to prove. There is recent talk of a financial settlement. In the meantime, I think The Economist put it best on April 24^th when it ran this headline: “Greedy Until Proven Guilty.”