FedUpUSA

Archive for the ‘loans’ Category

Litigation may be slowly doing the job missed or only partially completed by various governmental investigations into the financial crisis. The Valukas report on the Lehman bankruptcy was revealing, and numerous foreclosure defense attorneys have opened cans of worms that the powers that be would rather pretend simply don’t exist.

The New York Times reports tonight that a case filed last year was unsealed last week. It plumbs a continuing sore point with the public, namely the generous terms of the AIG bailout, both to the company (which defied the government and insisted on remaining largely intact when the plan had been to sell its various units to repay the government funding) and to its credit default swap counterparties. The litigation has the potential to be revealing, particularly if it goes into discovery (various depositions are likely to become public in pre-trial jousting, um, motions). The Times gives an overview:

The lawsuit, filed by a pair of veteran political activists from the La Jolla area of San Diego, asserts that A.I.G. and two large banks engaged in a variety of fraudulent and speculative transactions, running up losses well into the billions of dollars. Then the three institutions persuaded the Federal Reserve Bank of New York to bail them out by giving A.I.G. two rescue loans, which were used to unwind hundreds of failed trades.

The loans were improper, the lawsuit says, because the Fed made them without getting a pledge of high-quality collateral from A.I.G., as required by law.

“To cover losses of those engaged in fraudulent financial transactions is an authority not yet given to the Fed board,” said the plaintiffs, Derek and Nancy Casady, in their complaint, filed in Federal District Court for the Southern District of California.

The lawsuit names A.I.G., Goldman Sachs and Deutsche Bank as defendants, but not the Fed.

The lawsuit itself names other defendants, including Merrill and its successor Bank of America, SocGen, and “Does 1 through 100.”

White shoe types will likely look down their noses at the filing. It makes rather eccentric use of graphics (for instance, including company logos) and includes charts, some of which are very helpful (tables with tabulations and timelines), while others are visual representations of arguments made in the text and hence would be deemed by style snobs to be redundant. It also is somewhat sensationalistic, even heated at points in tone (which does make for more lively reading) and does not unpack its arguments as much as appears to be typical in court filings.

Nevertheless, despite the rough style, there’s some intriguing reading, and the case does a clever job of juxtaposing e-mails and Congressional testimony by AIG executives with various disclosures of the AIG bailout process and the terms of the loan facilities.

To my non-expert eye, the case appears to hinge on the argument that begins on p. 43, that the Fed loans were in violation of the Fed’s authority under the widely-cited “unusual and exigent circumstances” clause. I had taken the reading of former central banker, now Citigroup economist Willem Buiter on this, that it gave the Fed the authority to lend against a dead dog if it chose to.

That appears to be inaccurate, and I wonder if the focus upon this section will embolden the Audit the Fed crowd to have another go at the central bank.

Specifically, the “unusual and exigent” language includes other restrictions, which I read as all being operative:

1. The central bank can lend against “notes, bills, and other drafts of exchange when such notes, drafts, and bills of exchange are indorsed or otherwise secured to the satisfaction of the Federal reserve bank

2. The “notes, bills, and other drafts of exchange” must be discounted

3. The Federal reserve bank making the loan must obtain evidence that the non-bank party seeking the loan can’t get credit from other banks

4. “….five or more members of the Board of Governors must affirmatively vote to authorize the discount prior to the extension of credit.”

The case focuses on allegedly fraudulent representations made by AIG and the various major dealers in the course of obtaining the financing. But the part I find interesting is the Fed’s evident non-compliance with the requirements of this section, particularly the fact that the central bank lent 100% against the face value of the AIG CDOs, between taking out the CDS and then lending the bailout vehicle Maiden Lane III the funds to buy the CDOs. Interestingly, the SIGTARP investigation missed this issue. If this was at all considered, the argument may have been that the AIG equity in MLIII was tantamount to a discount, but the lawsuit argues that notion is bogus. Since AIG was broke, any money for the AIG equity came from the outside (in fairness, it’s a bit more complex, thanks to reserves set aside over the collateral dispute).

The suit argues that the initial loan was made under false premises, since the loan was secured by all assets of AIG, when the assets were already pledged (all the regulated subs have prior claims on them, both to creditors and policy-holders). The understanding, as depicted in various less-than-official accounts, like the Andrew Ross Sorkin Too Big Too Fail, is that the loans were secured by the equity of the subs. Fine in theory, but in practice, that isn’t what the loan document says, and as important (although not argued in the case) is the amount of the loan was based on what AIG needed to stay afloat, not on any effort to find a market value of the assets pledged and discount that.

In addition, the notion that it was acceptable to lend against stock appears to be based on the discount schedule that the Fed posts and revises from time to time as to the types of collateral that are accepted for lending and the various discount rates established for them. But note that schedule is for depositary institutions. The Fed acted as if it could simply lend against the same assets held by non-depositaries, but the language of the germane section does not appear to support that idea.

The various disclosures of how the Fed lent against pretty much anything the banks could round up, including defaulted securities, is troubling. Defenders of the central bank argue no harm was done since the securities have recovered from crisis lows (well save the ones that went to zero). The problem is that the logic is circular. In many cases, the value of the securities now depends on the fact that the Fed is willing to lend at super low interest rates. So the “market” values are fictive and dependent upon Fed intervention, which is coming at the expense of savers. The interdependence between the Fed’s rescue facilities and its continued interventions is given a free pass, but those of us who are not at the top of the food chain are continuing to pay the cost.

Naked Capitalism

In response to $30 Billion Offer No One Wants – Small Businesses Hit by Deflation I received this email from a director of a small bank.

Hello Mish,

I sit on the board of a small community bank and I can attest to the fact that our loan portfolio is in excellent shape even when taking into consideration today’s dismal economy. That is not to say a loan is good when made can go bad but if that happens, our bank has sufficient collateral pledged against the loan to cover such short falls. We also review our loan loss reserve and increase as needed based on criteria established under current banking regulations.

Sure there are numerous troubled banks identified by the FDIC but I feel many of these banks will survive.

All banks should be making reasonable earnings with today’s low interest rate environment. For community banks, loans are vital and banks are interested in making loans to individuals or businesses that meet our underwriting standards but loan demand is down. A big majority of our loans are just loans leaving another financial institution. Why would someone leave one bank for another?

Of course loan interest rates play a part in the decision but I think a big part is the relationship a customer develops with the loan officer. Dealing directly with a local loan officer who understands your business and is genuinely interested in your business is vital.

Today many larger banks only use local loan officers to bring in the loan request but the decision to make the loan and the terms rest in some committee located in a town far away. Most small business persons will leave such a bank for a local bank with more personalized service.

It’s ridiculous that Congress passed and our president signed a bill to provide funds to smaller banks for more loans. As a bank director, there is no way this plan can work. If a bank needs more deposits for loans, assuming the bank has sufficient capital, a banker can easily get more deposits from the public at a much lower cost than the bill passed by congress.

Our government is totally out of touch with the real world and passed this legislation strictly as a political move to make the public think they are trying to help small businesses.

This bull, I mean bill, should be labeled TARP II or some similar acronym.

Bazooka Lending Theory and Practice

Unlike October 2008, when Paulson forced the CEOs of the 9 largest banks to accept funds (See Compelling Banks To Lend At Bazooka Point) no one is forcing small community banks to do anything.

This is what I wrote in 2008 …

For now, you can force banks to take money, but you can’t force them to lend it.

Bazooka Theory

There seems to be a fine line between …

1) Illegally forcing supposedly well capitalized banks at bazooka point to take money on questionable terms

2) And illegally forcing those same banks at bazooka point to lend it

Self Preservation

Thus the best thing banks can do with that money is sit on it. Yet the penalty for sitting on it is the difference between what the Fed will pay on bank reserves and the 5% interest banks have to pay at bazooka point for borrowing money they did not want in the first place. If banks do start lending like Paulson wants, defaults are guaranteed to increase dramatically.

Someone needs to tell Paulson to go to hell but no one at the table had enough courage to do it.

Here We Go Again

Banks paid back those “forced loans” as soon as they could. Small business lending did not go up, nor should it have. Credit worthy customers were (and still are) few and far between.

Nonetheless, here we go again, except this time it’s voluntary.

Hells bells, if a program that forced banks to take money at bazooka did not compel banks to lend, how is a small voluntary program supposed to do it?

Supposedly, this plan will create another 4 million jobs according to president Obama. Hmm. It seems we spent a trillion dollars yet created no jobs, so offering $30 billion (little if any will be taken) to create 4 million jobs would be a feat indeed.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com

By Stephane Fitch, Forbes.com

Did you think the housing collapse killed off “liar loans”–those infamous bubble-era mortgages for which people were allowed to get creative in portraying their ability to make the payments? Well, they’re back, and that may be a good thing.

All the rage during the peak of the housing boom, these mortgages went by names like “no-doc” (meaning no documentation of income required), “low-doc” or “stated-income” mortgages. In all cases, banks set aside their underwriting standards based on what borrowers could prove they were earning with pay stubs, tax returns and the like. Instead, lenders started trusting borrowers to “forecast” future income and underwrote loans based on those projections (using as a fallback the house itself as collateral).

In the height of the housing boom in 2006 and 2007, low-doc loans accounted for roughly 40% of newly issued mortgages in the U.S., according to mortgage-data firm FirstAmerican CoreLogic. University of Chicago assistant professor Amit Seru says that for subprime loans, the portion exceeded 50%.

Then came the housing collapse, with subprime loan defaults playing a leading role, particularly the low-doc “liar” variety. The delinquency rate for subprime loans reached 39% in early 2009, seven times the rate in 2005, according to LPS Applied Analytics.

Ashlyn Aiko Nelson, a public policy lecturer at Indiana University, studied the low-doc loan craze. She and two of her colleagues concluded that low-doc borrowers exaggerated their incomes by 15% to 19%. “Our sense was that investors knew that people were lying, but figured it was OK because house prices would keep going up and the homeowners could refinance,” says Nelson.

The most outrageous types of no-doc lending disappeared entirely in 2009. Many mortgage pros say they’re unaware of banks making any low-doc loans in recent months. (A Forbes editor was, however, approached by a leading bank recently with an offer to refinance his home without documenting his income.)

In fact, the financial reform package passed by the House of Representatives recently, and under consideration by the Senate, discourages them. It requires lenders who offer mortgages to borrowers without full documentation to post a reserve equal to 5% of the loan’s value before they are securitized. That rule, they say, will make low-doc loans even less appealing for banks going forward.

“There’s no large-scale bank that’s a real player in them,” says Tom Meyer, chief executive of Kislak Mortgage, a Florida-based residential mortgage lender.

Forbes has learned that banks are quietly reestablishing the no-doc and low-doc mortgage market. In fact, low-doc loans accounted for 8% of newly originated loan pools as of this February, FirstAmerican Corelogic reports.

Wall Street Funding of America, a mortgage lender based in Santa Ana, Calif ., was recently circulating offers to make low-doc loans to borrowers with credit scores as low as 660 on the Fair Isaac Corp. (FICO) scale, as long as the borrower was self-employed, seeking no more than 60% of the value of a home and had six months of mortgage payments in reserve. The lender was offering interest rates 1.5 to 2 percentage points over the going rate on conventional mortgages. A borrower with a credit score over 720 might get a slightly better rate, perhaps just 1.25 percentage points over.

On June 23 Wall Street Funding’s fliers caught the attention of Zillow.com blogger Justin McHood. Forbes’ calls to Wall Street Funding were not returned. (We’ll update you if they are.)

In New York City mortgage broker GuardHill Financial tells Forbes that it is making no-doc loans on behalf of four of the 50 lending mortgage lenders it represents (whose names GuardHill declines to disclose). Perhaps $100 million of the $2 billion in loans GuardHill handles this year will be low-doc, says Dave Dessner, its sales director. The banks extending these loans are small community and regional outfits attracted to their relatively high interest rates (anything from 25 basis to 200 basis points over a conventional loan’s interest rate). The lenders intend to keep the loans in their portfolios rather than securitize them.

Dessner insists it would be a mistake to associate the loans GuardHill and its bank network are originating with the doomed liar loans that lenders stuffed into mortgage pools between 2004 and 2007. “I’d be on my soapbox railing against those loans,” says Dessner. “The people in government who are now screaming about liar loans aren’t looking at the quality of the loans we’re making.”

GuardHill serves all kinds of borrowers, including a goodly number of self-employed folk, successful artists and financiers who tend to garner wealth in windfalls but don’t have a sheaf of pay stubs to staple to a conventional loan application. Case in point: One of Dessner’s people is toiling now on a loan application from a hedge fund manager wishing to borrow $800,000 against a $4 million home purchase. The hedge’s fund did poorly last year, so as a sign of good faith for his investors he’s drawing no salary. Good for his business, perhaps, but rotten for a conventional mortgage application.

“This guy made $5 million in 2007 and 2008. He’s liquid for $10 million, and he’s borrowing 20% LTV (loan-to-value),” says Dessner. A no-doc loan to that kind of borrower shouldn’t be political dynamite, especially at a time when the Federal Housing Administration is making 95% LTV loans to low-income borrowers with poor credit and little savings, he argues.

Indiana University’s Nelson says the return of a sensible level of low-doc lending may be a good sign. “The market may have overcorrected a bit by shutting these down entirely,” she says. “If the lenders are hewing to the original idea, where they could get a better spread making loans to insanely wealthy people who don’t mind paying a little higher rate, that may be a good thing for everybody.”

ABC News

Skittish Lenders, Bad Credit Slowing Economic Recovery

The dynamics for housing moving forward point to a very bleak future and a potential lost decade yet again from 2010 to 2020.  Housing has a treacherous path moving forward and deep down demographic shifts will keep a lid on any significant housing appreciation moving forward.  The economy is in the process of deleveraging from a market highly dependent on real estate.  Wall Street and the government are doing everything they can to bring back the economy of yesterday but have had little success.  This recession has shrunk the middle class so those looking to buy homes have declined simply because many can no longer afford to purchase a home even at today’s lower prices.  Focusing on housing first was a big expensive policy mistake where we should have focused on creating sustainable jobs.  The market is slowly shifting to a new housing paradigm.  Family growth rates, employment trends, baby boomers, and wages will all keep a lid on housing prices moving forward.

First we should break down the entire housing market:

Source:  Census

The U.S. has a large number of homeowners.  A total of 75 million Americans can lay the claim to owning their home.  23 million of this group (31 percent) actually owns their homes outright with no mortgage.  Of course not having a mortgage does not mean that these homeowners have no housing associated cost.  They still need to pay yearly property taxes, insurance, and all the cost in maintaining a home.  Another 37 million American households rent.  These are the basic dynamics of the housing market.

Of those homeowners with a mortgage, 7.2 million (14%) are in foreclosure or 30+ days late on their mortgage.  This practically guarantees a few years of cheaper housing hitting the market in a steady trickle.  This puts a herculean hold on any significant home building going forward.

From the recent Federal Reserve Flow of Funds Report, we find that current outstanding mortgage debt is $10.334 trillion.  We have to break out the renters and the homeowners with no mortgage and find that the average mortgage debt for homeowners is:

$10.334 trillion / 51.575 million mortgaged households =             $200,374

The current median home price comes in at approximately $170,000.  Now some would argue that housing will regain traction and go on to rising to new levels.  Yet this assumption assumes that middle class wages will be growing moving forward.  If we look closely at the data the only real winner so far in this economic crisis is Wall Street but average Americans have seen very little benefit from the current bailout measures.  Now those with big investment bank salaries can afford their piece of prime real estate in Manhattan or the Hamptons but this does not make up the bulk of the housing market.  The bulk of the housing market is highly dependent on how middle class Americans are doing.

If we look at the current unemployment levels by age group, we see that those in the household forming age ranges or those entering into these categories, are taking on the brunt of this recession:

You can see that up to age 34, the unemployment rate is trending much higher than the total national average.  These are prime age groups for forming households and if a family is not feeling safe financially, they will delay on purchasing a home.  The middle class young family is also delaying on having children so the necessity for a bigger home is also being pushed out.  This demographic shift is happening at the same time that baby boomers start entering retirement age and many will want to downsize.

And many of these people have a buffer for equity to sell since they bought prior to the housing bubble.  Take for example data on current owner households:

Moved in before 1989:                  20.5% of all homeowners

Moved in before 1990:                  40.9% of all homeowners

It is highly likely that in this group, you have many baby boomers that will sell to downsize in the years coming forward and the current decline in prices will only cut into their equity but not put them underwater given the decade long bubble.  They purchased before that.  Those that moved in before 1989 will have a much larger cushion.  So there is a large group of people that will sell regardless of market trends because they will have to simply because of life changing events.

And then on the other hand we have the fact that one-third of homeowners in certain states are underwater on their mortgages.  Take for example California:

California has a large renting population and most that own a home carry a mortgage (77 percent).  Of those that carry a mortgage a stunning one-third are underwater.  In other words 1.76 million mortgages in California are attached to homes that are worth less than the actual balance of the mortgage creating a large incentive to walk-away.  Many of these loans come from Alt-A paper and option ARMs.  These loans will impact the market at least until 2012 and hurt the state.  California isn’t immune and other states like Nevada, Florida, and Arizona have similar dynamics.  In fact, here is the amount of mortgage debt in a negative equity position according to a recent Deutsche Bank analysis:

California: $969 billion

Florida: $432 billion

Arizona: $140 billion

The only way that things would improve for banks is if prices moved higher.  But how can prices move higher if middle class Americans are dealing with high unemployment and stagnant wages?  The Federal Reserve and U.S. Treasury have really reached the end of options in terms of what they can do.  Even the 30 year fixed mortgage is at all time lows in the midst of all this turmoil:

The 40 year average for 30 year rates is closer to 9 percent. Today it is under 5 percent.  That is unsustainable and as we move forward with insurmountable levels of national debt, the rate will have to rise.  I know this seems impossible for many but as we have seen with other debt ridden countries, the market can turn on like a tornado and quickly change the dynamics of the situation.  For the housing market, this will mean even more pressure to keep prices muted.  

The only way home prices can rise in a healthy manner is if we start seeing wage inflation.  We saw some of this in the 1970s where wages went up in tandem with home prices.  In the last decade, wages moved sideways while home prices went into a bubble.  As far as the economy going forward, the big job sectors seem to be in low paying service sector jobs.  Certainly someone can purchase a house with these jobs but not at current prices even though they appear to be solid.

The Federal Reserve and the U.S. Treasury have done everything to slam the dollar and create some level of inflation.  Yet other central banks are doing the same.  So what happens is easy money flows to Wall Street for gambling while the real economy stagnates.  It is hard for many to believe that we will have another lost decade in housing but there is little reason to believe that prices will soon start to outpace inflation.  In fact, in the last year or two we have been dealing more with aspects of deflation.  We need to keep an eye on the real value of home prices adjusting for inflation/deflation.

My Budget 360