This post first appeared on Minyanville and Cirios Real Estate.
Looks like all those option adjustable rate mortgages (ARMs) weren’t such a good idea after all: 1% teaser rates and loans that grow, rather than shrink, over time just aren’t meant for questionable borrowers buying overpriced homes.
Newport Beach-based Downey Savings (DSL), the fifth largest originator of option ARMs, was seized by federal regulators late Friday. The scraps were sold to US Bancorp (USB) for a song, which included almost $10 billion in deposits. Pomona First Federal, another Southern California lender highly levered to the real estate market, was also taken over by Minneapolis-based US Bank.
According to Bloomberg, the 2 failures will cost the FDIC more than $2 billion to clean up. US Bank agreed to assume the first $1.6 billion in losses from the banks’ loan portfolios, but anything above that will be split with the FDIC.
Each of the 5 biggest option ARM writers have now collapsed. Countrywide was purchased by Bank of America (BAC) in July; IndyMac collapsed into the arms of the FDIC just a few weeks later; Washington Mutual was scooped up by JP Morgan (JPM) in September; October saw Wells Fargo (WFC) best Citigroup (C) for the right to buy Wachovia (WB); now Downey is gone.
It didn’t have to end this way.
Traditionally meant for savvy borrowers capable of managing multiple payment options, Washington Mutual is often cited as having invented the option ARM in the early 80s.
The loan gives a borrower a series of payment choices, the lowest of which is so tiny the loan balance increases each month instead of being paid down. ARMs also typically include a teaser rate -- sometimes as low as 1% -- which can last anywhere from1 month to 5 years.
Ideal for real estate investors, salespeople with choppy income or families hopping between 1 and 2 earners, the flexible payment options and strict underwriting guidelines made option ARMs some of the best performing loans on the market.
But that was then.
As securitization took off, interest rates fell and the housing market heated up, lenders turned these once-safe loans into jet fuel for their ballooning mortgage businesses.
Option ARMs came to epitomize the irresponsible lending that ran rampant during the boom. Lenders abused their ability to qualify borrowers at absurdly low rates, jamming them into homes they could never afford once their mortgage payments rose.
Due to their complexity, mortgage brokers and loan officers rarely bothered to make sure borrowers fully understood the loan terms. A complete explanation would have lasted hours, providing adequate cover for the fraud already so prevalent in the business.
Banks loved option ARMs because accounting rules allowed them to book the fully indexed mortgage payment as income, even if the borrower made the minimum payment each month. That meant a juicy bottom line, even if cash barely trickled in the door.
Mortgage brokers and loan officers loved option ARMs because they could earn fat commissions on loans that were easy to sell - since they never had to explain them.
And borrowers loved option ARMs because they could buy their dream homes, rationality be damned.
Option ARMs flourished in boom states like California, Florida, Arizona and Nevada since homeowners could simply sell or refinance their way out of any problems as home values kept rising. Delinquencies remained remarkably low, creating years of "historical" data upon which to base assumptions about future loan performance.
Back in New York, Bear Stearns pioneered Wall Street’s foray into Option ARMs. The mortgage gurus at Bear figured out how to turn them into highly profitable mortgage-backed securities.
After that, it was a race to the bottom. Bear, Countrywide and IndyMac literally competed for business based on who could buy the loans faster - and with less scrutiny.
When home prices stopped rising, however, it all came crashing down.
Faced with a rising loan balance, higher monthly payments as teaser periods ran out and falling property values, borrowers were stuck. Defaults rose, losses mounted and banks couldn’t unload the paper without taking significant hits. Instead, they chose to hold on and try to ride it out.
We now know how that strategy ended.
As I have written previously, in the face of unprecedented government intervention, the free market has still managed to punish the mortgage boom's worst offenders. Not every guilty party will be brought to justice, but the firms that have failed thus far were deserving of their fate.
To be sure, not every employee at the likes of Bear, Lehman, Countrywide and Downey were culpable, but when the dust settles, the weak hands will have been truly cleaned out. Banks that maintained even marginally prudent lending standards are now reaping the benefits.
This fact gives me hope - hope that despite their best efforts, bureaucrats will always lose in their battle against the free market.
Showing posts with label WB. Show all posts
Showing posts with label WB. Show all posts
Monday, November 24, 2008
Thursday, November 6, 2008
Keepin' It Real Estate: Do Loan Modifications Work?
This post first appeared on Minyanville and Cirios Real Estate.
With millions of homeowners falling behind on their monthly payments, one in 6 underwater, and countless more struggling to keep up, politicians and banks alike are jumping on the loan modification bandwagon.
With millions of homeowners falling behind on their monthly payments, one in 6 underwater, and countless more struggling to keep up, politicians and banks alike are jumping on the loan modification bandwagon.
A modification -- or “mod,” as it’s known in the industry -- is simply the bank agreeing to change a borrower’s loan to make it more affordable. Mods usually result in a lower interest rate, principal forgiveness or some combination thereof.
For banks, adjusting loan terms is a way to keep cash coming in the door - even if it’s less than they’d been hoping for when they originally wrote the loan. For troubled borrowers, mods can provide an alternative to default and eventual foreclosure. It’s for these reasons that FDIC Chairman Sheila Bair and big banks like JPMorgan (JPM) and Bank of America (BAC) are aggressively promoting mods as the best way to fix the housing market.
The flood of troubled mortgages has also fostered a cottage industry that caters to distressed borrowers. Some are honest folks aiming to help struggling borrowers by using their mortgage expertise and contacts to negotiate better deals on behalf of their clients.
Others, however, are less upstanding.
According to Mandana Nejad, a real estate attorney and founder of Silver Lining Legal Group, a loan modification firm based in California, troubled borrowers have a lot to be wary of.
"Most loan modification companies are compromised of former lenders and brokers who put homeowners in these horrible loans in the first place," says Nejad. "Meanwhile, credit repair and debt consolidation firms are simply out to collect fees, regardless of whether or not they can actually successfully modify a loan."
Last year, the Bush administration formed HOPE NOW, a government-led effort to get banks and the loan servicers who collect payments on their behalf to step up loan-modification efforts. By most accounts, results were underwhelming, as HOPE NOW counselors often asked for too much, and banks gave too little.
Data show that mods done at the outset of the mortgage crisis ended up in default, despite the lower payments. Without proper screening criteria, mods simply delay the inevitable.
For a mod to work, lenders and borrowers must be able to find common ground. Falling home prices, job losses and massive fraud at the time of origination have exacerbated the challenge of finding new loan terms that make sense for both parties. To complicate matters, if a loan has been packaged into a security, loan servicers are obligated to follow predetermined modification standards set by myriad third-party investors.
Borrowers looking to handle modifications on their own face a maze of legal and bureaucratic complications - not to mention the stress of negotiating to save one’s own home. Nejad tells her clients that anyone can attempt to modify their loan themselves, but doing so requires knowledge of the best strategies for success.
Banks treat mods almost like a fresh loan. In order to get the best deal, borrowers must submit a complete application, write a compelling hardship letter, include verification of income, and often support the home’s current value with an appraisal.
While this is no easy task, troubled borrowers shouldn’t run out and answer the first debt consolidation or mortgage relief advertisement they hear on the radio.
Upstanding modification firms should offer:
- Money back guarantees with no exclusions
- At least one experienced attorney assigned to each case
- Direct access to the borrower’s lender(s)
- No more than a 50% charge up front
- Verifiable success stories, not just web testimonials
Still, successful mods require lenders to take losses. Armed with billions in bailout money, banks are now in a better position to allow their borrowers more affordable loans, even if it means more writedowns and less interest income going forward.
Time will be the true arbiter for the success of Bank of America and JPMorgan’s recent plans, but as pressure mounts to seriously curtail foreclosures, more and more federal money will be thrown at the problem. Other banks are likely to follow suit.
Wells Fargo (WFC) has yet to announce a plan of its own, but -- given its recent purchase of Wachovia (WB) and its inheritance of a massive portfolio of California option-ARMs -- we shouldn’t have to wait too much longer.
While mods are by no means the magic bullet many are searching for to fix the housing mess, they do offer a way for lenders to retain a cash-generating loan - and borrowers to keep their homes.
Monday, November 3, 2008
JPMorgan Tackles Troubled Mortgages
This post first appeared on Minyanville and Cirios Real Estate.
The mortgage bailout parade marches on.
Just days after rival Bank of America (BAC) announced plans to modify hundreds of thousands of mortgages, JPMorgan (JPM) released details of a homeowner rescue plan of its own on Friday afternoon.
Following its takeover of both Bear Stearns and Washington Mutual, JPMorgan's inventory of distressed mortgages has risen dramatically in the last 8 months. The bank's modification efforts, which mirror Bank of America’s plan, are focused largely on subprime loans and option ARMs. The acquisition of WaMu saddled CEO Jamie Dimon’s firms with billions of these loans - $16 and $54 billion, respectively, according to the Wall Street Journal.
JPMorgan plans to identify borrowers with both the willingness and ability to pay, lower interest rates and, in some cases, forgive loan principal. For Option ARMs, borrowers may have the opportunity to replace their negatively amortizing mortgage with a safer, fixed rate 30-year loan.
Look out for more of these plans coming from the remaining big American banks, particularly Wells Fargo (WFC): Its recent acquisition of Wachovia (WB) included the Charlotte-based bank’s massive option ARM portfolio.
The plan is certainly a step in the right direction. It's nice to see that some of the recent $25 billion injection from the government will be funneled toward the taxpayers that ponied up the money in the first place.
Both JPMorgan and Bank of America's new programs, are, however, evidence of the government's -- and banks’ -- inclination to deal with problems that already exist, rather than ones that are on the horizon.
Friday, October 10, 2008
Insurers Next In Line For Bailout?
This post first appeared on Minyanville.
Months ago, Citigroup (C) and Merrill Lynch (MER) kicked off what has now become a worldwide deluge of writedowns on mortgage and credit-related assets. It was believed at the time that losses would be limited to those securities tied to risky mortgage debt. This viewpoint has been proven false.
Now, as the credit crisis spills over into markets once believed to be virtually risk free, even conservative financial institutions are feeling the pinch.
The New York Times is reporting the insurance industry may be the next to see years of consolidations packed into a few short months.
Everyone knows about the troubles at American International Group (AIG), the world's largest insurer, which is now owned by Joe and Jill Six-pack (thank you, Governor Palin, for re-introducing this archetype to the lexicon). But it was believed that AIG was an insolated incident, that its unique exposure to the treacherous credit default swap market sealed its fate.
Troubling action yesterday in other larger insurers is turning that supposition on its head.
Prudential Insurance (PRU) fell more than 30% after warning profits would slump and indicating it may need to raise capital. Lincoln National (LNC) tumbled 35%, Principal Financial (PFG) lost 27% and Unum Group (UNM) dropped 30% in other southward moves within the industry. The group as a whole fell almost 17%, making it the second worst performing sector behind the automakers.
Analysts now fear mounting losses may force weaker hands to fold, as stronger firms gobble up smaller, less buoyant ones. Just as Wells Fargo (WFC) ultimately won out over Citi in the battle for Wachovia (WB), insurers with stronger balance sheets and more fervent risk aversion are likely to rise to the top.
It wasn't supposed to be like this.
Insurance companies, long believed to be safe and boring behemoths slothing their way through the dizzying world of highly rated debt, have been roiled by unprecedented dislocation in the credit markets. Taking in millions of tiny premiums each month, insurers invest that money in (supposedly) safe securities yielding low, but steady returns. The hope is that incoming cash flow offsets payouts on claims - and the firm gets to keep what's in the middle.
The Times notes that even as investment-grade debt has fallen in value this year, insurance companies have been loathe to write down their losses, hoping instead their investments would rise before year's end. But now that rolling over short-term funding is next to impossible, other assets must be sold to raise cash. Real losses on these sales are taking a toll.
Washington has its hands full trying to prop up the banking system, which sinks deeper into the abyss seemingly by the hour.
It's too early to know whether the insurance industry will be next in line for a government handout, but if the credit markets don't start to improve in short order, the queue in front of the Treasury Department's door could get a lot longer.
Months ago, Citigroup (C) and Merrill Lynch (MER) kicked off what has now become a worldwide deluge of writedowns on mortgage and credit-related assets. It was believed at the time that losses would be limited to those securities tied to risky mortgage debt. This viewpoint has been proven false.
Now, as the credit crisis spills over into markets once believed to be virtually risk free, even conservative financial institutions are feeling the pinch.
The New York Times is reporting the insurance industry may be the next to see years of consolidations packed into a few short months.
Everyone knows about the troubles at American International Group (AIG), the world's largest insurer, which is now owned by Joe and Jill Six-pack (thank you, Governor Palin, for re-introducing this archetype to the lexicon). But it was believed that AIG was an insolated incident, that its unique exposure to the treacherous credit default swap market sealed its fate.
Troubling action yesterday in other larger insurers is turning that supposition on its head.
Prudential Insurance (PRU) fell more than 30% after warning profits would slump and indicating it may need to raise capital. Lincoln National (LNC) tumbled 35%, Principal Financial (PFG) lost 27% and Unum Group (UNM) dropped 30% in other southward moves within the industry. The group as a whole fell almost 17%, making it the second worst performing sector behind the automakers.
Analysts now fear mounting losses may force weaker hands to fold, as stronger firms gobble up smaller, less buoyant ones. Just as Wells Fargo (WFC) ultimately won out over Citi in the battle for Wachovia (WB), insurers with stronger balance sheets and more fervent risk aversion are likely to rise to the top.
It wasn't supposed to be like this.
Insurance companies, long believed to be safe and boring behemoths slothing their way through the dizzying world of highly rated debt, have been roiled by unprecedented dislocation in the credit markets. Taking in millions of tiny premiums each month, insurers invest that money in (supposedly) safe securities yielding low, but steady returns. The hope is that incoming cash flow offsets payouts on claims - and the firm gets to keep what's in the middle.
The Times notes that even as investment-grade debt has fallen in value this year, insurance companies have been loathe to write down their losses, hoping instead their investments would rise before year's end. But now that rolling over short-term funding is next to impossible, other assets must be sold to raise cash. Real losses on these sales are taking a toll.
Washington has its hands full trying to prop up the banking system, which sinks deeper into the abyss seemingly by the hour.
It's too early to know whether the insurance industry will be next in line for a government handout, but if the credit markets don't start to improve in short order, the queue in front of the Treasury Department's door could get a lot longer.
Wednesday, October 8, 2008
Wall Street Battles Fear, Hopelessness
This post first appeared on Minyanville.
Then, just when things seem like they couldn't possibly get any worse, they do: Investors abandon all hope, throw up their collective hands and trample children on their way to the exits.
It’s called capitulation, and it can drive otherwise ordinary people to acts of desperation.
For those who are more morbidly inclined, urban legend and fact collide when distraught traders, having lost millions or more, leap to their deaths from the windows of Wall Street. Indeed, this self-defenestration is tragic. That a life can be so wrapped up in the pursuit and acquisition of wealth that failure can mean in death reveals the fragility of the human psyche.
Nevertheless, and insensitive as it may sound, these suicides are signs of fear, loss and abject hopelessness - and therefore often signify market bottoms. Make no mistake: This isn't a call for the bottom, or even necessarily a bottom - simply an observation of history and the present facts.
This morning, the New York Times reported that a Los Angeles man took his own life, and that of his family, over his bleak financial situation.
By most accounts, Karthik Rajaram was a successful businessman, having started and sold his own company for a substantial profit. He managed his own estate and that of his family, but had recently fallen on hard times. The decision to end his life and take his family with him was, according to his suicide note, to preserve their honor.
I could no more make light of this situation than I could revel in millions of Americans watching their retirement accounts wither away, years being tacked onto careers seemingly by the hour. It is, however, stark evidence that this crisis has migrated from the narrow byways of lower Manhattan to the wide, tree-lined avenues of Main Street.
It is, however, still a road whose path, as we often say in the ‘Ville, is more important than the destination. The road must be traveled, the destination must be sought, and for those brave enough, savvy enough and deft enough to protect their capital along the way, opportunities abound on the other side.
Whether it's the wrangling of Wells Fargo (WFC) and Citigroup (C) over what's left of Wachovia (WB), Bank of America's (BAC) most recent attempt to raise capital, rumors that Morgan Stanley's (MS) cash infusion from Mitsubishi may be in jeapardy, or the absolute terror in overnight money markets, the newsfeed is certainly bleak enough to represent a low.
Bottom-picking, however, can be dangerous business. One can't help but remember Joe Lewis, the British billionaire who famously invested $1 billion in Bear Stearns just months before it collapsed.
So before we bravely follow anyone bold enough to don his bull costume -- even temporarily -- let's remember that the bottom will be a process, not a point - and when true, legitimate recovery takes hold, there will be plenty of time to join the party.
Then, just when things seem like they couldn't possibly get any worse, they do: Investors abandon all hope, throw up their collective hands and trample children on their way to the exits.
It’s called capitulation, and it can drive otherwise ordinary people to acts of desperation.
For those who are more morbidly inclined, urban legend and fact collide when distraught traders, having lost millions or more, leap to their deaths from the windows of Wall Street. Indeed, this self-defenestration is tragic. That a life can be so wrapped up in the pursuit and acquisition of wealth that failure can mean in death reveals the fragility of the human psyche.
Nevertheless, and insensitive as it may sound, these suicides are signs of fear, loss and abject hopelessness - and therefore often signify market bottoms. Make no mistake: This isn't a call for the bottom, or even necessarily a bottom - simply an observation of history and the present facts.
This morning, the New York Times reported that a Los Angeles man took his own life, and that of his family, over his bleak financial situation.
By most accounts, Karthik Rajaram was a successful businessman, having started and sold his own company for a substantial profit. He managed his own estate and that of his family, but had recently fallen on hard times. The decision to end his life and take his family with him was, according to his suicide note, to preserve their honor.
I could no more make light of this situation than I could revel in millions of Americans watching their retirement accounts wither away, years being tacked onto careers seemingly by the hour. It is, however, stark evidence that this crisis has migrated from the narrow byways of lower Manhattan to the wide, tree-lined avenues of Main Street.
It is, however, still a road whose path, as we often say in the ‘Ville, is more important than the destination. The road must be traveled, the destination must be sought, and for those brave enough, savvy enough and deft enough to protect their capital along the way, opportunities abound on the other side.
Whether it's the wrangling of Wells Fargo (WFC) and Citigroup (C) over what's left of Wachovia (WB), Bank of America's (BAC) most recent attempt to raise capital, rumors that Morgan Stanley's (MS) cash infusion from Mitsubishi may be in jeapardy, or the absolute terror in overnight money markets, the newsfeed is certainly bleak enough to represent a low.
Bottom-picking, however, can be dangerous business. One can't help but remember Joe Lewis, the British billionaire who famously invested $1 billion in Bear Stearns just months before it collapsed.
So before we bravely follow anyone bold enough to don his bull costume -- even temporarily -- let's remember that the bottom will be a process, not a point - and when true, legitimate recovery takes hold, there will be plenty of time to join the party.
Tuesday, October 7, 2008
Who Gets Wachovia?
This post first appeared on Minyanville.
In what already seems like ancient history, just weeks ago investors fretted over Wachovia's fate in the wake of Washington Mutual's dramatic collapse into the waiting arms of JPMorgan Chase (JPM).
Weighed down by a toxic balance sheet of souring mortgages, Wachovia was in trouble. A stealth bank run had begun, as firms and consumers alike hoarded cash.
Then, to the surprise of many, Citigroup (C) teamed up with the FDIC to save Wachovia from the abyss. Toting a federal backstop for its quickly eroding loan portfolio, Citi snatched up Wachovia's retail branches and various other operations for a mere $2.1 billion.
The move was surprising: Citi has plenty of troubles of its own. Once the largest financial company in the world, Citi has become a poster child for mortgage and credit troubles - it didn't need to go out and buy any more.
At the time, many puzzled over Wells Fargo's (WFC) reluctance to step into the fray, as Wachovia's footprint out East seemed a perfect fit with Wells' strong presence in the West.
But then last Friday, in a stunning development, Wells stepped in with what appeared to be a far superior offer. Rather than dumping a chunk of Wachovia's risky loan portfolio on taxpayers via the FDIC, Wells not only upped the purchase price to $15 billion, but shunned government money to complete the transaction.
You could almost hear the lawyers licking their chops for high drama in the New York courts.
Citi claimed Wells had unfairly infringed on its right to buy Wachovia, that their agreement prevented other suitors from upping the ante.
Wells, for its part, found a loophole, asserting that the newly minted bailout package -- just hours old -- contained a clause allowing it to make a legal counteroffer.
Accusations flew, motions were filed, and judges, courts, attorneys and bankers dug in for a bloody fight.
Washington, in an attempt to save face after a botched bank bailout at the very time it couldn't afford to slip up, urged cooler heads to prevail. Given the vast, systemic dislocations in the financial system, a protracted takeover battle would benefit no one.
Just hours after filing its lawsuit, Citi repented. The 3 banks signed a truce of sorts, agreeing to stay out of the courts for at least the next 48 hours. There's now talk Wells and Citi will divvy up the spoils, carving up Wachovia's branch network along geographic lines.
As I write this morning, Wachovia's fate is unknown. Whether that will be the case by lunchtime is anyone's guess.
By all accounts, Wells' bid makes more sense, it being the far stronger firm and eschewing the FDIC's involvement in the transaction. Citi, however, has yet to capitalize on the bank firesale its competitors are taking advantage of, and it doesn't want to miss the party.
JPMorgan has already snatched up Bear Stearns and WaMu for a song apiece. Meanwhile, Bank of America (BAC) grabbed Merrill Lynch (MER) during the turmoil following the implosion of AIG (AIG) and Lehman Brothers. B of A also managed to complete its Countrywide takeover - in which it arguably acquired nothing more than a truckload of pending lawsuits and a broken business model.
However the drama ends in addition to lawyers raking in millions in fees, the net result will be the removal of another wounded player from the financial field. This is a positive development, and a step in the direction of remaking the banking landscape with a more solid foundation.
Losses on Wachovia's mortgage portfolio, jammed full of option arms from its ill-timed purchase of Golden West, will likely result in higher losses than expected. Home prices in California's more affluent areas, to which Golden West was highly levered, are poised for dramatic whoosh down.
Washington would be well advised to decide Wachovia's fate such that months from now, the winner won't come knocking for a bailout of its own.
In what already seems like ancient history, just weeks ago investors fretted over Wachovia's fate in the wake of Washington Mutual's dramatic collapse into the waiting arms of JPMorgan Chase (JPM).
Weighed down by a toxic balance sheet of souring mortgages, Wachovia was in trouble. A stealth bank run had begun, as firms and consumers alike hoarded cash.
Then, to the surprise of many, Citigroup (C) teamed up with the FDIC to save Wachovia from the abyss. Toting a federal backstop for its quickly eroding loan portfolio, Citi snatched up Wachovia's retail branches and various other operations for a mere $2.1 billion.
The move was surprising: Citi has plenty of troubles of its own. Once the largest financial company in the world, Citi has become a poster child for mortgage and credit troubles - it didn't need to go out and buy any more.
At the time, many puzzled over Wells Fargo's (WFC) reluctance to step into the fray, as Wachovia's footprint out East seemed a perfect fit with Wells' strong presence in the West.
But then last Friday, in a stunning development, Wells stepped in with what appeared to be a far superior offer. Rather than dumping a chunk of Wachovia's risky loan portfolio on taxpayers via the FDIC, Wells not only upped the purchase price to $15 billion, but shunned government money to complete the transaction.
You could almost hear the lawyers licking their chops for high drama in the New York courts.
Citi claimed Wells had unfairly infringed on its right to buy Wachovia, that their agreement prevented other suitors from upping the ante.
Wells, for its part, found a loophole, asserting that the newly minted bailout package -- just hours old -- contained a clause allowing it to make a legal counteroffer.
Accusations flew, motions were filed, and judges, courts, attorneys and bankers dug in for a bloody fight.
Washington, in an attempt to save face after a botched bank bailout at the very time it couldn't afford to slip up, urged cooler heads to prevail. Given the vast, systemic dislocations in the financial system, a protracted takeover battle would benefit no one.
Just hours after filing its lawsuit, Citi repented. The 3 banks signed a truce of sorts, agreeing to stay out of the courts for at least the next 48 hours. There's now talk Wells and Citi will divvy up the spoils, carving up Wachovia's branch network along geographic lines.
As I write this morning, Wachovia's fate is unknown. Whether that will be the case by lunchtime is anyone's guess.
By all accounts, Wells' bid makes more sense, it being the far stronger firm and eschewing the FDIC's involvement in the transaction. Citi, however, has yet to capitalize on the bank firesale its competitors are taking advantage of, and it doesn't want to miss the party.
JPMorgan has already snatched up Bear Stearns and WaMu for a song apiece. Meanwhile, Bank of America (BAC) grabbed Merrill Lynch (MER) during the turmoil following the implosion of AIG (AIG) and Lehman Brothers. B of A also managed to complete its Countrywide takeover - in which it arguably acquired nothing more than a truckload of pending lawsuits and a broken business model.
However the drama ends in addition to lawyers raking in millions in fees, the net result will be the removal of another wounded player from the financial field. This is a positive development, and a step in the direction of remaking the banking landscape with a more solid foundation.
Losses on Wachovia's mortgage portfolio, jammed full of option arms from its ill-timed purchase of Golden West, will likely result in higher losses than expected. Home prices in California's more affluent areas, to which Golden West was highly levered, are poised for dramatic whoosh down.
Washington would be well advised to decide Wachovia's fate such that months from now, the winner won't come knocking for a bailout of its own.
Thursday, October 2, 2008
Credit Crunch Won't Pick on Anyone Its Own Size
This post first appeared on Minyanville.
Each day that the engine of economic growth -- credit -- is prevented from flowing freely, the crisis worsens - and its effects on the broader economy keep piling up.
Even as Congress rushes to pass the latest iteration of the bailout plan -- or emergency rescue plan, or stimulus plan, or whatever it happens to be called to make it sound politically expedient and palatable to confused and frightened Americans -- the economy is grinding to a halt.
After years of fudging the numbers to make growth look stronger than it actually is, policymakers may have to finally accept the fact that recession is inevitable. Weekly jobless claims rose to a 7-year high, new car sales are tumbling, and the stock market is gyrating wildly on an almost hourly basis.
The recession they promised wouldn't come is just around the corner.
There's a long-held belief that economic slowdowns allow small businesses to thrive, since larger competitors are scaling back and hunkering down to wait out the storm. Meanwhile, entrepreneurs -- who are typically less risk-averse than big companies -- can seize on the opportunity to expand, open new stores and comb through the ranks of unemployed to hire skilled workers on the cheap.
Banks are apt to rein in lending during a downturn as defaults on existing loans rise and cash becomes pricier. Credit standards tighten, loan amounts fall and lenders scrutinize applicants more thoroughly before extending loans. Still, small businesses are usually able to find enough money to continue their existing business strategies, at the very least - albeit with the higher risk associated with tough economic times.
The credit crunch, however, is throwing that assumption out the window.
Both the Wall Street Journal and New York Times ran stories this morning about how small businesses and entrepreneurs are "feeling the chill" as banks squeeze cash flow to a mere trickle. Mounting defaults on loan portfolios, fear about future losses and frozen short-term money markets are forcing banks to deny credit in droves.
As the banking system continues to jam years of consolidation into a few weeks, the survivors -- Wells Fargo (WFC), Bank of America (BAC), JPMorgan (JPM), Citigroup (C) TD Ameritrade (AMTD) and countless small, regional banks -- must choose between customers and shareholders.
Extending credit to customers and thereby maintaining sometimes longstanding relationships runs the risk of wasting precious balance-sheet space on what could be a losing bet. Washington Mutual and Wachovia (WB) both experienced firsthand what happens when banks load up on what turn out to be bad loans.
On the other hand, banks make money -- well, they used to, anyway -- by the simple business strategy of borrowing cheap (deposits), lending out at higher rates (mortgages, credit cards, construction loans, etc.) and picking up the spread in the middle. If they don't engage in this, their core business, future earnings prospects could be dire.
Banks must carefully balance continuing profit-generating business while protecting against future losses. And with the risk management track record many have racked up in the past year, it shouldn't come as a surprise if most choose prudence over profits in the years to come.
Meanwhile, back on Main Street, business owners who just weeks ago couldn't spell "credit default swap" are starting to learn why the tangled web of untested, unregulated financial derivatives that tied the world's financial system together matter to even the smallest of businesses.
It''s official: This is no longer just Wall Street's problem.
Each day that the engine of economic growth -- credit -- is prevented from flowing freely, the crisis worsens - and its effects on the broader economy keep piling up.
Even as Congress rushes to pass the latest iteration of the bailout plan -- or emergency rescue plan, or stimulus plan, or whatever it happens to be called to make it sound politically expedient and palatable to confused and frightened Americans -- the economy is grinding to a halt.
After years of fudging the numbers to make growth look stronger than it actually is, policymakers may have to finally accept the fact that recession is inevitable. Weekly jobless claims rose to a 7-year high, new car sales are tumbling, and the stock market is gyrating wildly on an almost hourly basis.
The recession they promised wouldn't come is just around the corner.
There's a long-held belief that economic slowdowns allow small businesses to thrive, since larger competitors are scaling back and hunkering down to wait out the storm. Meanwhile, entrepreneurs -- who are typically less risk-averse than big companies -- can seize on the opportunity to expand, open new stores and comb through the ranks of unemployed to hire skilled workers on the cheap.
Banks are apt to rein in lending during a downturn as defaults on existing loans rise and cash becomes pricier. Credit standards tighten, loan amounts fall and lenders scrutinize applicants more thoroughly before extending loans. Still, small businesses are usually able to find enough money to continue their existing business strategies, at the very least - albeit with the higher risk associated with tough economic times.
The credit crunch, however, is throwing that assumption out the window.
Both the Wall Street Journal and New York Times ran stories this morning about how small businesses and entrepreneurs are "feeling the chill" as banks squeeze cash flow to a mere trickle. Mounting defaults on loan portfolios, fear about future losses and frozen short-term money markets are forcing banks to deny credit in droves.
As the banking system continues to jam years of consolidation into a few weeks, the survivors -- Wells Fargo (WFC), Bank of America (BAC), JPMorgan (JPM), Citigroup (C) TD Ameritrade (AMTD) and countless small, regional banks -- must choose between customers and shareholders.
Extending credit to customers and thereby maintaining sometimes longstanding relationships runs the risk of wasting precious balance-sheet space on what could be a losing bet. Washington Mutual and Wachovia (WB) both experienced firsthand what happens when banks load up on what turn out to be bad loans.
On the other hand, banks make money -- well, they used to, anyway -- by the simple business strategy of borrowing cheap (deposits), lending out at higher rates (mortgages, credit cards, construction loans, etc.) and picking up the spread in the middle. If they don't engage in this, their core business, future earnings prospects could be dire.
Banks must carefully balance continuing profit-generating business while protecting against future losses. And with the risk management track record many have racked up in the past year, it shouldn't come as a surprise if most choose prudence over profits in the years to come.
Meanwhile, back on Main Street, business owners who just weeks ago couldn't spell "credit default swap" are starting to learn why the tangled web of untested, unregulated financial derivatives that tied the world's financial system together matter to even the smallest of businesses.
It''s official: This is no longer just Wall Street's problem.
Tuesday, September 30, 2008
Calpers Gambles, Loses - Again
This post first appeared on Minyanville.
Americans should be wary of letting the government invest $700 billion of taxpayer money on highly illiquid, difficult-to-price assets. To say that we're virtually guaranteed to turn a profit is offensive and insulting to anyone with a sense of how convoluted, risky and opaque these securities really are.
Indeed, it appears even politicians are no longer sure this is a such good idea.
For evidence of just how well government-run bureaucracies manage vast pools of money, one need look no further than the nation’s largest pension fund, the California Public Employees’ Retirement System, or Calpers.
This June, a joint venture between the fund and a California developer filed for bankruptcy. Calpers had dumped almost $1 billion into raw land outside Los Angeles at the height of the real estate boom, which turned out to be kind of a bad idea: Calpers could lose its entire investment.
In late 2006, the fund made another equally ill-timed bet on highly speculative real estate.
Together with developer Tishman Spears, Calpers plunked down $500 million to buy the 80-acre swath of housing developments that make up Peter Cooper Village and Stuyvesant Town on Manhattan’s east side. After much debate in New York about the fate of the developments -- whose thousands of units were formerly reserved for low-income renters -- MetLife sold the 56-building complex for $5.4 billion.
With the New York economy beginning to slow and property values showing cracks up and down Manhattan, Calpers may have yet again bought at the top.
According to the Wall Street Journal, the deal was financed with $4.4 billion in debt from Wachovia (WB) and Merrill Lynch (MER). Now, Standard and Poor’s (MHP) has downgraded a portion of that debt connected with a $3 billion mortgage used to fund the project.
S&P is concerned not only about the 10% drop in the property’s value, but also about whether rental cash flow and money generated from selling off individual units will be able to cover the debt service. Tishman, for its part, says cash flow is improving, and that credit markets have prematurely written an unhappy ending for the investment.
The continued inability of government-run investment funds to make good decisions is deeply unnerving, given the fact that bureaucrats could soon have their grubby little paws on a slush fund of unparalleled size.
Americans should be wary of letting the government invest $700 billion of taxpayer money on highly illiquid, difficult-to-price assets. To say that we're virtually guaranteed to turn a profit is offensive and insulting to anyone with a sense of how convoluted, risky and opaque these securities really are.
Indeed, it appears even politicians are no longer sure this is a such good idea.
For evidence of just how well government-run bureaucracies manage vast pools of money, one need look no further than the nation’s largest pension fund, the California Public Employees’ Retirement System, or Calpers.
This June, a joint venture between the fund and a California developer filed for bankruptcy. Calpers had dumped almost $1 billion into raw land outside Los Angeles at the height of the real estate boom, which turned out to be kind of a bad idea: Calpers could lose its entire investment.
In late 2006, the fund made another equally ill-timed bet on highly speculative real estate.
Together with developer Tishman Spears, Calpers plunked down $500 million to buy the 80-acre swath of housing developments that make up Peter Cooper Village and Stuyvesant Town on Manhattan’s east side. After much debate in New York about the fate of the developments -- whose thousands of units were formerly reserved for low-income renters -- MetLife sold the 56-building complex for $5.4 billion.
With the New York economy beginning to slow and property values showing cracks up and down Manhattan, Calpers may have yet again bought at the top.
According to the Wall Street Journal, the deal was financed with $4.4 billion in debt from Wachovia (WB) and Merrill Lynch (MER). Now, Standard and Poor’s (MHP) has downgraded a portion of that debt connected with a $3 billion mortgage used to fund the project.
S&P is concerned not only about the 10% drop in the property’s value, but also about whether rental cash flow and money generated from selling off individual units will be able to cover the debt service. Tishman, for its part, says cash flow is improving, and that credit markets have prematurely written an unhappy ending for the investment.
The continued inability of government-run investment funds to make good decisions is deeply unnerving, given the fact that bureaucrats could soon have their grubby little paws on a slush fund of unparalleled size.
Monday, September 29, 2008
Wachovia Runs Out of Ground
This post first appeared on Minyanville.
Saddled with mounting losses in its huge mortgage portfolio, Wachovia (WB) has become the latest bank to lose its independence.
Rumors swirled over the weekend: The company was said to be in advanced talks with both Wells Fargo (WFC) and Citigroup (C) about a potential merger. Formerly the nation's sixth-largest bank, Charlotte-based Wachovia would have provided either suitor a retail stronghold in its native southeast. For Wells Fargo in particular, this would have nicely complemented their strong presence on the West Coast.
In the end, Citigroup managed to close the deal, with a little help from its friends at the FDIC.
Citi will pick up the majority of Wachovia’s operations, as well as the bulk of its assets and liabilities. With respect to its $312 billion mortgage portfolio, the Wall Street Journal reports, Citi will assume the first $42 billion in losses and the FDIC will be on the hook for the rest. In return, the FDIC will receive $12 billion in preferred stock and warrants.
Notably, Wachovia didn’t fail, as Washington Mutual did just last week. Citigroup will be assuming the company’s senior and subordinated debt, which is good news for the credit default swap market. After the collapses of Lehman Brothers and WaMu triggered billions in insurance obligations, the giant unregulated market is struggling to sort out the chaos of tangled contracts.
The transaction’s sticking point was Wachovia’s massive portfolio of Option Adjustable Rate Mortgages, or Option ARMs. After its ill-fated purchase of California thrift Golden West at the peak of the housing market in 2006, Wachovia has seen falling home prices and rising delinquencies chew through its balance sheet.
Golden West was one of the biggest issuers of Option ARMs in California during the housing boom. These loans were used to jam homeowners into houses well beyond their means. Borrowers could choose to pay interest rates as low as 1% per month - but would see the balance of their loan grow over time. Known as a negative amortization mortgage, the difference between the low teaser rate and a market rate would be tacked on to the loan balance each month.
The scheme worked well when home prices were on the rise, as homeowners could simply sell their way out of trouble. When property values began to fall however, borrowers become stuck inside a ticking time bomb.
Option ARMs were popular with many now-extinct mortgage lenders; Countrywide, IndyMac, Bear Stearns and Washington Mutual were all leaders in the space. These major players literally competed with each other to see who could buy the loans faster, with less due diligence and at the highest price.
As the credit crisis evolved, so too did the extent of Wachovia’s woes. When the company reported earnings in July, I noted a myriad of unsavory business practices under investigation in addition to loan loss provisions 3100% higher than the previous year.
A month before that report, former Undersecretary of the Treasury Robert Steel replaced Kenneth Thompson as chief executive. In all likelihood, Steel traveled from Washington to Charlotte with the intention of finding a buyer for the troubled bank.
The merger marks the latest in rapidly developing consolidation in American’s banking landscape. Two of the most wounded players, WaMu and Wachovia are now off the field.
With many more, smaller casualties waiting on line to be carted off -- like National City (NCC), Downey Savings (DSL) and Zions Bancorp (ZION) -- this process has only just begun.
Saddled with mounting losses in its huge mortgage portfolio, Wachovia (WB) has become the latest bank to lose its independence.
Rumors swirled over the weekend: The company was said to be in advanced talks with both Wells Fargo (WFC) and Citigroup (C) about a potential merger. Formerly the nation's sixth-largest bank, Charlotte-based Wachovia would have provided either suitor a retail stronghold in its native southeast. For Wells Fargo in particular, this would have nicely complemented their strong presence on the West Coast.
In the end, Citigroup managed to close the deal, with a little help from its friends at the FDIC.
Citi will pick up the majority of Wachovia’s operations, as well as the bulk of its assets and liabilities. With respect to its $312 billion mortgage portfolio, the Wall Street Journal reports, Citi will assume the first $42 billion in losses and the FDIC will be on the hook for the rest. In return, the FDIC will receive $12 billion in preferred stock and warrants.
Notably, Wachovia didn’t fail, as Washington Mutual did just last week. Citigroup will be assuming the company’s senior and subordinated debt, which is good news for the credit default swap market. After the collapses of Lehman Brothers and WaMu triggered billions in insurance obligations, the giant unregulated market is struggling to sort out the chaos of tangled contracts.
The transaction’s sticking point was Wachovia’s massive portfolio of Option Adjustable Rate Mortgages, or Option ARMs. After its ill-fated purchase of California thrift Golden West at the peak of the housing market in 2006, Wachovia has seen falling home prices and rising delinquencies chew through its balance sheet.
Golden West was one of the biggest issuers of Option ARMs in California during the housing boom. These loans were used to jam homeowners into houses well beyond their means. Borrowers could choose to pay interest rates as low as 1% per month - but would see the balance of their loan grow over time. Known as a negative amortization mortgage, the difference between the low teaser rate and a market rate would be tacked on to the loan balance each month.
The scheme worked well when home prices were on the rise, as homeowners could simply sell their way out of trouble. When property values began to fall however, borrowers become stuck inside a ticking time bomb.
Option ARMs were popular with many now-extinct mortgage lenders; Countrywide, IndyMac, Bear Stearns and Washington Mutual were all leaders in the space. These major players literally competed with each other to see who could buy the loans faster, with less due diligence and at the highest price.
As the credit crisis evolved, so too did the extent of Wachovia’s woes. When the company reported earnings in July, I noted a myriad of unsavory business practices under investigation in addition to loan loss provisions 3100% higher than the previous year.
A month before that report, former Undersecretary of the Treasury Robert Steel replaced Kenneth Thompson as chief executive. In all likelihood, Steel traveled from Washington to Charlotte with the intention of finding a buyer for the troubled bank.
The merger marks the latest in rapidly developing consolidation in American’s banking landscape. Two of the most wounded players, WaMu and Wachovia are now off the field.
With many more, smaller casualties waiting on line to be carted off -- like National City (NCC), Downey Savings (DSL) and Zions Bancorp (ZION) -- this process has only just begun.
Bailout Treats Symptoms, Not Disease
This post first appeared on Minyanville and on our sister site Cirios Real Estate.
The bailout is done! Time to breathe a sigh of relief.
Or is it?
As details emerge about the financial bailout package that was jammed through Congress over 10 days of political theater at its most nauseating, there’s still a striking omission from the plan to right American’s economic ship.
The failure of bureaucrats and regulators to propose a realistic solution for the foreclosure problem is emblematic of their inability to treat the root cause of an issue, focusing instead on simply applying band-aids to the visible symptoms.
The bailouts of Bear Stearns, Fannie Mae (FNM) and Freddie Mac (FRE), and AIG (AIG) all claimed to remove the cancer - but all they did was hasten the patient's demise.
Treasury's plan will deliver money into the banking system to sop up toxic assets sitting on the balance sheets of our financial institutions. This is a necessary -- albeit unfortunate -- step, but it still doesn't address the root of the rot: Milions of homes are worth less than the outstanding balance of the owner's mortgage.
Billions of dollars in negative equity are destroying Main Street’s balance sheet even as it devours Wall Street, eroding the value of the very securities Taxpayers are about to start buying.
As long as Washington tries to fight foreclosures with ineffective loan modification programs that simply prolong the problems, foreclosures will continue to set records. Modifying a mortgage for someone who is barely scraping by is sort of like rescuing him from the side of a cliff, only to leave him on the edge, dangling by one arm.
Foreclosures are often blamed for spiraling home prices and the resulting collapse in value of securities tied to the mortgages used to buy those houses. According to Bloomberg, the government’s aid package is designed to support “financial companies reeling from the record number of home foreclosures.”
Foreclosures don't cause houses to lose their value. Foreclosures happen when a home loses value such that it’s worth less than the mortgage used to buy it, and the homeowner can’t sell or refinance if his interest payments become overwhelming.
Defaults become delinquencies, which become foreclosures, which become evictions, which become repossessions, which flood the market, depressing prices as supply outstrips demand.
Back in what seems like ancient history, when home prices only went up, banks weren’t too concerned with defaults, since homeowners could almost always sell themselves out of a problem. Foreclosures stayed low because the liquid, appreciating housing market bailed out troubled homeowners on its own. That's part of the reason the industry is so ill-equipped to handle the scope of the current problem: it never had to before.
But now, with so many borrowers underwater -- owing more on their house than it's worth -- defaults result in not only eventual liquidation of the property, but profound distress in the homeowner’s life and real losses for investors. Furthermore, delinquent borrowers are less inclined to pay for upkeep or security, and many foreclosed homes are seriously damaged by the time a bank is able to take possession of it.
Being underwater is debilitating. To sell, not only does a homeowner have to pay a Realtor 6% whether he gets a raw deal or not, but he has to pay the bank the difference between where his home sells and the outstanding balance of his loan.
For many who have seen the value of their homes fall hundreds of thousands of dollars, this is an impossibility. Most homeowners, once they’re upside down, just want to stay in their homes.
A more effective plan to curb foreclosures would require an independent reviewer to evaluate each delinquent mortgage, determine the borrower’s ability to pay going forward and the amount, if any, of negative equity that needs to be destroyed to bring the loan amount back under the home’s value.
Since the notion that buying Wall Street’s toxic assets will result in windfall profits is a willfully distributed fallacy aimed at getting the public on board for the bailout, Taxpayers would be well-served dumping money into a blender that’s at least in their own backyard.
British Prime Minister Gordon Brown recently proposed a similar plan, where the government will buy delinquent mortgages from banks for the outstanding balance of the loan. The home is then rented to the existing tenant or a new one and managed by a local housing association.
The government would absorb the difference between the loan amount and the resale value, which would hasten increase sales activity, clearing out the glut of homes listed too high for the simple reason that the owner can't afford to sell at a lower price.
This type of personalized bailout, unfortunately, reeks of moral hazard. Many individuals who made bad financial decisions will get to keep their homes, albeit without actual ownership. But the current socialization of our free markets is simply moral hazard be design, so if Congress is so hell-bent on bailing out Wall Street, why not share the spoils with Main Street.
If Congress wants this bailout to help the American people and keep the financial system in tact, a sizable portion of the funds should be directed at fixing the asset that’s at the center of this turmoil: the residential property.
Home prices need to come down further. They will come down further. It’s only a matter of time. We can either let home prices bleed down, slowly eroding the value of the securities they support and violently uprooting families, or the government can plug the hole.
Washington Mutual (WM) is already off the field, as JP Morgan (JPM) continues to play widowmaker for the financial system. Wachovia (WB) isn't likely to remain independent for long. The sooner the rebuilding process begins, the better.
This crisis, and the resulting ebb and flow of what remains of the free market has already tipped the scales, started us sliding down a path of deflation in everything from stock prices, to cereal boxes, soda bottles, not to mention homes.
This is a good development. The hardest lesson Americans will learn from this crisis, should learn from this crisis, is that sometimes it’s necessary to live within our means. There is virtue in simplicity. More is not always better. Bigger is not always better. Sometimes, amazingly enough, less is often better.
This progress is the only true way we'll make it out of this mess.
The bailout is done! Time to breathe a sigh of relief.
Or is it?
As details emerge about the financial bailout package that was jammed through Congress over 10 days of political theater at its most nauseating, there’s still a striking omission from the plan to right American’s economic ship.
The failure of bureaucrats and regulators to propose a realistic solution for the foreclosure problem is emblematic of their inability to treat the root cause of an issue, focusing instead on simply applying band-aids to the visible symptoms.
The bailouts of Bear Stearns, Fannie Mae (FNM) and Freddie Mac (FRE), and AIG (AIG) all claimed to remove the cancer - but all they did was hasten the patient's demise.
Treasury's plan will deliver money into the banking system to sop up toxic assets sitting on the balance sheets of our financial institutions. This is a necessary -- albeit unfortunate -- step, but it still doesn't address the root of the rot: Milions of homes are worth less than the outstanding balance of the owner's mortgage.
Billions of dollars in negative equity are destroying Main Street’s balance sheet even as it devours Wall Street, eroding the value of the very securities Taxpayers are about to start buying.
As long as Washington tries to fight foreclosures with ineffective loan modification programs that simply prolong the problems, foreclosures will continue to set records. Modifying a mortgage for someone who is barely scraping by is sort of like rescuing him from the side of a cliff, only to leave him on the edge, dangling by one arm.
Foreclosures are often blamed for spiraling home prices and the resulting collapse in value of securities tied to the mortgages used to buy those houses. According to Bloomberg, the government’s aid package is designed to support “financial companies reeling from the record number of home foreclosures.”
Foreclosures don't cause houses to lose their value. Foreclosures happen when a home loses value such that it’s worth less than the mortgage used to buy it, and the homeowner can’t sell or refinance if his interest payments become overwhelming.
Defaults become delinquencies, which become foreclosures, which become evictions, which become repossessions, which flood the market, depressing prices as supply outstrips demand.
Back in what seems like ancient history, when home prices only went up, banks weren’t too concerned with defaults, since homeowners could almost always sell themselves out of a problem. Foreclosures stayed low because the liquid, appreciating housing market bailed out troubled homeowners on its own. That's part of the reason the industry is so ill-equipped to handle the scope of the current problem: it never had to before.
But now, with so many borrowers underwater -- owing more on their house than it's worth -- defaults result in not only eventual liquidation of the property, but profound distress in the homeowner’s life and real losses for investors. Furthermore, delinquent borrowers are less inclined to pay for upkeep or security, and many foreclosed homes are seriously damaged by the time a bank is able to take possession of it.
Being underwater is debilitating. To sell, not only does a homeowner have to pay a Realtor 6% whether he gets a raw deal or not, but he has to pay the bank the difference between where his home sells and the outstanding balance of his loan.
For many who have seen the value of their homes fall hundreds of thousands of dollars, this is an impossibility. Most homeowners, once they’re upside down, just want to stay in their homes.
A more effective plan to curb foreclosures would require an independent reviewer to evaluate each delinquent mortgage, determine the borrower’s ability to pay going forward and the amount, if any, of negative equity that needs to be destroyed to bring the loan amount back under the home’s value.
Since the notion that buying Wall Street’s toxic assets will result in windfall profits is a willfully distributed fallacy aimed at getting the public on board for the bailout, Taxpayers would be well-served dumping money into a blender that’s at least in their own backyard.
British Prime Minister Gordon Brown recently proposed a similar plan, where the government will buy delinquent mortgages from banks for the outstanding balance of the loan. The home is then rented to the existing tenant or a new one and managed by a local housing association.
The government would absorb the difference between the loan amount and the resale value, which would hasten increase sales activity, clearing out the glut of homes listed too high for the simple reason that the owner can't afford to sell at a lower price.
This type of personalized bailout, unfortunately, reeks of moral hazard. Many individuals who made bad financial decisions will get to keep their homes, albeit without actual ownership. But the current socialization of our free markets is simply moral hazard be design, so if Congress is so hell-bent on bailing out Wall Street, why not share the spoils with Main Street.
If Congress wants this bailout to help the American people and keep the financial system in tact, a sizable portion of the funds should be directed at fixing the asset that’s at the center of this turmoil: the residential property.
Home prices need to come down further. They will come down further. It’s only a matter of time. We can either let home prices bleed down, slowly eroding the value of the securities they support and violently uprooting families, or the government can plug the hole.
Washington Mutual (WM) is already off the field, as JP Morgan (JPM) continues to play widowmaker for the financial system. Wachovia (WB) isn't likely to remain independent for long. The sooner the rebuilding process begins, the better.
This crisis, and the resulting ebb and flow of what remains of the free market has already tipped the scales, started us sliding down a path of deflation in everything from stock prices, to cereal boxes, soda bottles, not to mention homes.
This is a good development. The hardest lesson Americans will learn from this crisis, should learn from this crisis, is that sometimes it’s necessary to live within our means. There is virtue in simplicity. More is not always better. Bigger is not always better. Sometimes, amazingly enough, less is often better.
This progress is the only true way we'll make it out of this mess.
Monday, September 22, 2008
And Then There Were None: Goldman, Morgan Become Bank Holding Companies
This post first appeared on Minyanville.
Regulators were at it again over the weekend, rewriting the rulebook of America’s financial landscape.
Late Sunday, Goldman Sachs (GS) and Morgan Stanley (MS) announced plans to become banks, seeking the sounder funding base of traditional deposit-taking institutions. The last remaining independent Wall Street brokerages will be transformed, now supervised by the Federal Reserve and other national regulators.
According to the Wall Street Journal, the Fed allowed Goldman and Morgan to reorganize themselves as bank holding companies, thereby subjecting them to more restrictive rules and regulations. The new designation offers greater access to federal lending facilities and gives the 2 firms the chance to open retail branches and accept customer deposits -- widely considered a more reliable method of funding.
The money markets, until recently the brokerages’ primary source of liquidity, were in a historic state of disorder following the collapse of Lehman Brothers and the governments’ seizure of Fannie Mae (FNM), Freddie Mac (FRE) and AIG (AIG). The uncertainty surrounding once-strong firms made access to cash highly unreliable.
Rather than merging with commercial banks, Goldman and Morgan decided to retreat, delever and rebuild under a more conservative business model.
Deposit-taking institutions face tighter capital requirements and can’t use leverage as freely as investment banks, which reduces their ability to make outsized profits when times are good. It does, however, create more insulation to protect against losses when bets go sour.
Bad bets by the truckload saddled both Goldman and Morgan with assets of such questionable value that investors feared the once-proud institutions would sheepishly follow Merrill Lynch (MER) into the arms of a big commercial bank.
Morgan had been holding talks with Wachovia (WB) about a potential merger, while Goldman adamantly refused to even consider the idea of a buyout.
When traders went to bed 10 short days ago, 4 big investment banks -- storied firms deeply entrenched in the American ideology of entreprenuership and risk-taking -- still existed, however tenuously.
Now, there are none.
William Isaac, a former chairman of the Federal Deposit and Insurance Corporation, told Bloomberg: "The decision marks the end of Wall Street as we know it. It's really too bad, as our country has benefited greatly from the entrepreneurial risk-takers on Wall Street."
Many, fearful of free markets, wary of trusting men and women to make their own decisions, will welcome Wall Street’s demise, calling it a victory for the little guy, a much-needed punishment for the greediest of the greedy. And while some of the bankers who poured into lower Manhattan each morning certainly exemplified self-interest at its worst, the positive impact Wall Street’s risk-taking has had in building this country cannot be downplayed.
Bridges, skyscrapers, our highway system and countless other industrial cornerstones of our economy would not have been possible if crafty financiers hadn’t figured out how to use credit and risk to enhance economic growth. Risk-taking is a natural, healthy part of capitalism. In fact, without it, the free markets cannot function.
We got out over our skis, to be sure, but that doesn't mean the entire concept of lending, borrowing and taking on projects that may or may not turn out well should be condemned in its entirety.
The destruction of debt required to bring our economy back into balance and enable healthy growth to sprout anew must be led by those willing to take risk, to wade bravely into markets before they're fully healed. Now that the foremost private risk-takers in this country are out of the way, public speculators are poised to step in and sop up $700 billion in toxic assets sitting on the financial industry’s collective balance sheet.
Don’t forget to pay your taxes this spring.
Regulators were at it again over the weekend, rewriting the rulebook of America’s financial landscape.
Late Sunday, Goldman Sachs (GS) and Morgan Stanley (MS) announced plans to become banks, seeking the sounder funding base of traditional deposit-taking institutions. The last remaining independent Wall Street brokerages will be transformed, now supervised by the Federal Reserve and other national regulators.
According to the Wall Street Journal, the Fed allowed Goldman and Morgan to reorganize themselves as bank holding companies, thereby subjecting them to more restrictive rules and regulations. The new designation offers greater access to federal lending facilities and gives the 2 firms the chance to open retail branches and accept customer deposits -- widely considered a more reliable method of funding.
The money markets, until recently the brokerages’ primary source of liquidity, were in a historic state of disorder following the collapse of Lehman Brothers and the governments’ seizure of Fannie Mae (FNM), Freddie Mac (FRE) and AIG (AIG). The uncertainty surrounding once-strong firms made access to cash highly unreliable.
Rather than merging with commercial banks, Goldman and Morgan decided to retreat, delever and rebuild under a more conservative business model.
Deposit-taking institutions face tighter capital requirements and can’t use leverage as freely as investment banks, which reduces their ability to make outsized profits when times are good. It does, however, create more insulation to protect against losses when bets go sour.
Bad bets by the truckload saddled both Goldman and Morgan with assets of such questionable value that investors feared the once-proud institutions would sheepishly follow Merrill Lynch (MER) into the arms of a big commercial bank.
Morgan had been holding talks with Wachovia (WB) about a potential merger, while Goldman adamantly refused to even consider the idea of a buyout.
When traders went to bed 10 short days ago, 4 big investment banks -- storied firms deeply entrenched in the American ideology of entreprenuership and risk-taking -- still existed, however tenuously.
Now, there are none.
William Isaac, a former chairman of the Federal Deposit and Insurance Corporation, told Bloomberg: "The decision marks the end of Wall Street as we know it. It's really too bad, as our country has benefited greatly from the entrepreneurial risk-takers on Wall Street."
Many, fearful of free markets, wary of trusting men and women to make their own decisions, will welcome Wall Street’s demise, calling it a victory for the little guy, a much-needed punishment for the greediest of the greedy. And while some of the bankers who poured into lower Manhattan each morning certainly exemplified self-interest at its worst, the positive impact Wall Street’s risk-taking has had in building this country cannot be downplayed.
Bridges, skyscrapers, our highway system and countless other industrial cornerstones of our economy would not have been possible if crafty financiers hadn’t figured out how to use credit and risk to enhance economic growth. Risk-taking is a natural, healthy part of capitalism. In fact, without it, the free markets cannot function.
We got out over our skis, to be sure, but that doesn't mean the entire concept of lending, borrowing and taking on projects that may or may not turn out well should be condemned in its entirety.
The destruction of debt required to bring our economy back into balance and enable healthy growth to sprout anew must be led by those willing to take risk, to wade bravely into markets before they're fully healed. Now that the foremost private risk-takers in this country are out of the way, public speculators are poised to step in and sop up $700 billion in toxic assets sitting on the financial industry’s collective balance sheet.
Don’t forget to pay your taxes this spring.
Friday, September 19, 2008
Fed Amputates Invisible Hand
This post first appeared on Minyanville.
A week ago, the United States had the most efficient capital allocation system in the world.
Our free-market economy enabled money, credit and resources to be sent to the economic players who needed it. Entrepreneurs could raise money to start new, innovative businesses; researchers could seek out cures for diseases that touch millions of lives, as well as those that afflict just thousands; firms that made enough bad decisions went bankrupt.
The job of regulators was to ensure the system functioned and to set up rules by which honest business could be conducted. It wasn't a perfect system, but it was better than the alternative.
This is the alternative.
When government invades free markets to the extent it has -- specifically in the last 24 hours -- the system ensuring capital gets where it needs to be breaks down. Money is instead doled out to the firms well connected enough in Washington to lobby for handouts.
Beltway bureaucrats have been trying to rewrite this country's economic rules and protect Wall Street from its own mistakes for over a year. Still, the free market prevailed, punishing the firms that made the most egregious bets during the housing boom: Countrywide, Bear Stearns, IndyMac, Merrill Lynch (MER), AIG (AIG), Lehman Brothers, National City (NCC), Washington Mutual (WM) and Wachovia (WB).
According to our once-free market, these firms needed to be wiped out, gobbled up and liquidated, so real economic growth could take hold from a stronger foundation.
This morning, we heard many claim the government's actions -- temporarily banning short selling, the creation of a Treasury Department distressed-asset hedge fund, the establishment of a federal backstop for money markets, to name but a few -- were necessary to prevent a wider financial and economic crisis. The shortsightedness of this argument is astounding.
A couple hundred years ago, Charles Darwin opined that nature has long been engaged in weeding out the weak, protecting the strong. This natural ebb and flow of dominance according to a given species' inherent characteristics has governed the world's socioeconomic landscape for more than 4 billion years.
The actions taken overnight seem to refute Darwin's claim that Mother Nature can manage her own backyard. Adam Smith's invisible hand is capitalist Darwinism, moving the weak aside so the strong can survive.
To take that power away from the market is tantamount to shoving God aside and rewriting the evolutionary playbook.
The effects of these actions, this fundamental ideological shift from capitalism towards socialism, represents a seismic shift in the history of this country. The events of the past week -- and what it says about our collective ability to take our lumps, drink our medicine and recognize that the path to the ultimate goal is one littered with hairpin turns and drop away cliffs -- will not be lost on future generations.
The events of the upcoming months and years, whether we're content to continue to hand over more and more power to the few, elected and non-elected alike, will show the true mettle of the American spirit.
A week ago, the United States had the most efficient capital allocation system in the world.
Our free-market economy enabled money, credit and resources to be sent to the economic players who needed it. Entrepreneurs could raise money to start new, innovative businesses; researchers could seek out cures for diseases that touch millions of lives, as well as those that afflict just thousands; firms that made enough bad decisions went bankrupt.
The job of regulators was to ensure the system functioned and to set up rules by which honest business could be conducted. It wasn't a perfect system, but it was better than the alternative.
This is the alternative.
When government invades free markets to the extent it has -- specifically in the last 24 hours -- the system ensuring capital gets where it needs to be breaks down. Money is instead doled out to the firms well connected enough in Washington to lobby for handouts.
Beltway bureaucrats have been trying to rewrite this country's economic rules and protect Wall Street from its own mistakes for over a year. Still, the free market prevailed, punishing the firms that made the most egregious bets during the housing boom: Countrywide, Bear Stearns, IndyMac, Merrill Lynch (MER), AIG (AIG), Lehman Brothers, National City (NCC), Washington Mutual (WM) and Wachovia (WB).
According to our once-free market, these firms needed to be wiped out, gobbled up and liquidated, so real economic growth could take hold from a stronger foundation.
This morning, we heard many claim the government's actions -- temporarily banning short selling, the creation of a Treasury Department distressed-asset hedge fund, the establishment of a federal backstop for money markets, to name but a few -- were necessary to prevent a wider financial and economic crisis. The shortsightedness of this argument is astounding.
A couple hundred years ago, Charles Darwin opined that nature has long been engaged in weeding out the weak, protecting the strong. This natural ebb and flow of dominance according to a given species' inherent characteristics has governed the world's socioeconomic landscape for more than 4 billion years.
The actions taken overnight seem to refute Darwin's claim that Mother Nature can manage her own backyard. Adam Smith's invisible hand is capitalist Darwinism, moving the weak aside so the strong can survive.
To take that power away from the market is tantamount to shoving God aside and rewriting the evolutionary playbook.
The effects of these actions, this fundamental ideological shift from capitalism towards socialism, represents a seismic shift in the history of this country. The events of the past week -- and what it says about our collective ability to take our lumps, drink our medicine and recognize that the path to the ultimate goal is one littered with hairpin turns and drop away cliffs -- will not be lost on future generations.
The events of the upcoming months and years, whether we're content to continue to hand over more and more power to the few, elected and non-elected alike, will show the true mettle of the American spirit.
Monday, August 25, 2008
Mortgage Future Now, Have One Later
This post first appeared on Minyanville.
If only home prices would stop plummeting, we could put this whole credit crunch nonsense behind us.
Unfortunately, a meaningful stabilization in property values is unlikely. Housing inventories are still at excessively high levels, unemployment is creeping up, consumers are stretched and mortgage underwriting guidelines are tighter than they've been in years. The outlook is bleak.
Left to the free market, these issues will take years to work through, as homeowners gradually scrape together the requisite finds to unbury themselves and banks grudgingly realize their losses. While this is the healthiest path economically, it’s also the least acceptable politically.
Short of immediate, full-scale nationalization of the mortgage market through seizure of Fannie Mae (FNM) and Freddie Mac (FRE), there's little the government can do to halt the decline and stem the knock-on effects rippling through the national -- and indeed the international -- economy.
Much of regulators’ efforts thus far have been aimed at solving the problem of negative equity, where a borrower owes more on his home than it’s worth. Congress's recent housing bill allotted $300 billion for the Federal Housing Administration and other taxpayer-backed institutions to shoulder the growing burden.
Progress has been slow; the nasty realities of the situation have impeded plans that were largely ill-conceived to begin with.
Each day, thousands more homeowners find themselves underwater. Unable to sell without coughing up the difference between the unpaid balance on their loan and the sale price, borrowers are left with few options: Continue paying for a losing bet, fall behind and hope their lender will modify the loan, or simply walk away.
Banks like JP Morgan Chase (JPM), Wachovia (WB) and Bank of America (BAC) don’t have many palatable choices, either. Loath to accept short sales (agreeing to a sale price below the loan balance and forgiving the difference) because their beleaguered balance sheets can’t handle the pain, or to modify loans lest they anger securities investors, lenders are hoping they can just ride it out.
Mark Zandi, chief economist at Moody’s Economy.com, estimated earlier this year that as many as 10% of all U.S. homeowners, or 8 million borrowers, are upside-down. With the median home price hovering around $200,000, this means the true value of housing stock (around $1.6 trillion) cannot be determined.
Thus far, home prices on a nationwide basis have fallen around 15% (depending on whose data you believe), which means roughly $240 billion in home equity is yet to be wiped out - despite the fact that it no longer exists.
Since the majority of upside-down homeowners live in California, Arizona, Nevada and Florida, where homes are more expensive, it’s not unreasonable to think this number is closer to $300 billion. It’s no mystery as to how Congress arrived at the total figure for their ineffective housing bill.
The challenge is to sop up negative equity without torpedoing the dollar, as would happen if the Treasury Department simply cut the mortgage industry a $300 billion check. But the money is out there; it’s just a question of tackling the prickly issue of exactly where it is.
According to data compiled by the Census Bureau, in 2005 the collective balance in Americans’ 401k accounts stood at $1.2 trillion. If homeowners were allowed to tap their retirement funds without penalty to pay for their negative equity, 75% of our retirement war chest would remain intact - and the economy could begin a real healing process.
That I’m even proposing such a solution shows how dire the situation is, and how few good options are left.
This may not be an entirely popular idea for a host of reasons.
Many would argue it’s unlikely borrowers who are underwater would have sufficient retirement savings for such a scheme to work. That argument is based on a common misconception, however: That subprime and being upside-down go hand in hand.
During the boom, many good-quality borrowers with good jobs and money in the bank were jammed into Alt-A or even Agency (backed by Fannie or Freddie) loans with high loan-to-value ratios. That means typical middle-class families that bought at the peak are in the same boat as their subprime brethren: A boat dangerously below the waterline.
Others may argue the cost of paying for our longer lives is already likely to bankrupt Social Security and endanger the retirement of millions.
Pilfering retirement accounts truly is mortgaging the future for the sake of the present. But consider the assumptions upon which current retirement cost expectations are based.
ING (ING) runs a snazzy ad campaign depicting concerned citizens toting around their “numbers,” toiling each day in hopes of reaching the net worth required to retire comfortably.
"Comfortably" -- as defined by our McMansions, SUVs, strip mall consumerism -- means a beachfront condo in south Florida, a 4000 square foot Toll Brothers (TOL) luxury track home in Scottsdale, or sweeping vistas from a custom-built manor on the Pacific. Your “number,” as determined by the investment advisors and stockbrokers at Merrill Lynch (MER), is based on pre-credit crisis consumption trends.
Social mood has shifted. We’re seeing the beginnings of a migration towards simplicity, minimalism and attendant revulsion at our past excesses. The future, in short, won’t be nearly as expensive as we think.
30 years from now, when today’s underwater homeowner becomes tomorrow’s retiree, the good life may be defined as a quaint bungalow on the Sea of Cortez, a loft in Buenos Aires’ Palermo district or a remote cabin perched on the edge of a Norwegian fjord. All these options provide just as much, if not more, opportunity for relaxation, peace and the quiet contemplation so many desire in their waning years - at a fraction of the cost.
Mortgaging a piece of our future may be our best bet to have one at all.
If only home prices would stop plummeting, we could put this whole credit crunch nonsense behind us.
Unfortunately, a meaningful stabilization in property values is unlikely. Housing inventories are still at excessively high levels, unemployment is creeping up, consumers are stretched and mortgage underwriting guidelines are tighter than they've been in years. The outlook is bleak.
Left to the free market, these issues will take years to work through, as homeowners gradually scrape together the requisite finds to unbury themselves and banks grudgingly realize their losses. While this is the healthiest path economically, it’s also the least acceptable politically.Short of immediate, full-scale nationalization of the mortgage market through seizure of Fannie Mae (FNM) and Freddie Mac (FRE), there's little the government can do to halt the decline and stem the knock-on effects rippling through the national -- and indeed the international -- economy.
Much of regulators’ efforts thus far have been aimed at solving the problem of negative equity, where a borrower owes more on his home than it’s worth. Congress's recent housing bill allotted $300 billion for the Federal Housing Administration and other taxpayer-backed institutions to shoulder the growing burden.
Progress has been slow; the nasty realities of the situation have impeded plans that were largely ill-conceived to begin with.
Each day, thousands more homeowners find themselves underwater. Unable to sell without coughing up the difference between the unpaid balance on their loan and the sale price, borrowers are left with few options: Continue paying for a losing bet, fall behind and hope their lender will modify the loan, or simply walk away.
Banks like JP Morgan Chase (JPM), Wachovia (WB) and Bank of America (BAC) don’t have many palatable choices, either. Loath to accept short sales (agreeing to a sale price below the loan balance and forgiving the difference) because their beleaguered balance sheets can’t handle the pain, or to modify loans lest they anger securities investors, lenders are hoping they can just ride it out.
Mark Zandi, chief economist at Moody’s Economy.com, estimated earlier this year that as many as 10% of all U.S. homeowners, or 8 million borrowers, are upside-down. With the median home price hovering around $200,000, this means the true value of housing stock (around $1.6 trillion) cannot be determined.
Thus far, home prices on a nationwide basis have fallen around 15% (depending on whose data you believe), which means roughly $240 billion in home equity is yet to be wiped out - despite the fact that it no longer exists.
Since the majority of upside-down homeowners live in California, Arizona, Nevada and Florida, where homes are more expensive, it’s not unreasonable to think this number is closer to $300 billion. It’s no mystery as to how Congress arrived at the total figure for their ineffective housing bill.
The challenge is to sop up negative equity without torpedoing the dollar, as would happen if the Treasury Department simply cut the mortgage industry a $300 billion check. But the money is out there; it’s just a question of tackling the prickly issue of exactly where it is.
According to data compiled by the Census Bureau, in 2005 the collective balance in Americans’ 401k accounts stood at $1.2 trillion. If homeowners were allowed to tap their retirement funds without penalty to pay for their negative equity, 75% of our retirement war chest would remain intact - and the economy could begin a real healing process.
That I’m even proposing such a solution shows how dire the situation is, and how few good options are left.
This may not be an entirely popular idea for a host of reasons.
Many would argue it’s unlikely borrowers who are underwater would have sufficient retirement savings for such a scheme to work. That argument is based on a common misconception, however: That subprime and being upside-down go hand in hand.
During the boom, many good-quality borrowers with good jobs and money in the bank were jammed into Alt-A or even Agency (backed by Fannie or Freddie) loans with high loan-to-value ratios. That means typical middle-class families that bought at the peak are in the same boat as their subprime brethren: A boat dangerously below the waterline.
Others may argue the cost of paying for our longer lives is already likely to bankrupt Social Security and endanger the retirement of millions.
Pilfering retirement accounts truly is mortgaging the future for the sake of the present. But consider the assumptions upon which current retirement cost expectations are based.
ING (ING) runs a snazzy ad campaign depicting concerned citizens toting around their “numbers,” toiling each day in hopes of reaching the net worth required to retire comfortably.
"Comfortably" -- as defined by our McMansions, SUVs, strip mall consumerism -- means a beachfront condo in south Florida, a 4000 square foot Toll Brothers (TOL) luxury track home in Scottsdale, or sweeping vistas from a custom-built manor on the Pacific. Your “number,” as determined by the investment advisors and stockbrokers at Merrill Lynch (MER), is based on pre-credit crisis consumption trends.
Social mood has shifted. We’re seeing the beginnings of a migration towards simplicity, minimalism and attendant revulsion at our past excesses. The future, in short, won’t be nearly as expensive as we think.
30 years from now, when today’s underwater homeowner becomes tomorrow’s retiree, the good life may be defined as a quaint bungalow on the Sea of Cortez, a loft in Buenos Aires’ Palermo district or a remote cabin perched on the edge of a Norwegian fjord. All these options provide just as much, if not more, opportunity for relaxation, peace and the quiet contemplation so many desire in their waning years - at a fraction of the cost.
Mortgaging a piece of our future may be our best bet to have one at all.
Wednesday, August 20, 2008
With Fannie Falling, All Eyes on Paulson
This post first appeared on Minyanville on August 8th.
You can almost hear Treasury Secretary Paulson firing up his bazooka.
This morning, Fannie Mae (FNM) joined its smaller cousin Freddie Mac (FRE) in announcing losses that exceeded Wall Street's already dour expectations.
The company lost $2.3 billion in the second quarter and plans to slash its dividend to a paltry $0.05 per share, down from $0.25, according to Bloomberg.
All eyes now turn to Paulson, who just weeks ago asked for -- and received -- a blank check from Congress to support the beleaguered government sponsored enterprises, should the need arise. He had hoped the mere existence of the backstop would calm Investors' nerves such that he wouldn't need to step in.
Reality, it appears, had other plans: Shares of the 2 companies have slid back down to where they were when markets feared they'd collapse under the weight of their massive loan portfolios.
Fannie and Freddie are hopelessly levered to the U.S. housing market, which slides deeper into disarray every day. The 2 companies collectively back over $5 trillion of American mortgages, which are going sour at a record pace.
As I wrote earlier this week, after Freddie announced equally dismal results, it's no longer a matter of if they collapse, but when.
It turns out buying mortgages with nothing but a superficial glance at the paperwork -- something Fannie and Freddie excelled at during the housing boom -- just isn't good business.
Although the 2 firms only lightly dabbled in subprime loans, originators easily duped their automated risk engines into buying fraudulent or otherwise shoddy loans.
But since banks like Citigroup (C), Bank of America (BAC) and Wachovia (WB) are saddled with troubles of their own, Fannie and Freddie have been asked to expand their role in the market. They now provide the only liquidity left for new mortgages.
The government has little choice but to bail out their wayward children. If it doesn't, Hank will need a lot more than just a bazooka to save the ship.
You can almost hear Treasury Secretary Paulson firing up his bazooka.
This morning, Fannie Mae (FNM) joined its smaller cousin Freddie Mac (FRE) in announcing losses that exceeded Wall Street's already dour expectations.
The company lost $2.3 billion in the second quarter and plans to slash its dividend to a paltry $0.05 per share, down from $0.25, according to Bloomberg.
All eyes now turn to Paulson, who just weeks ago asked for -- and received -- a blank check from Congress to support the beleaguered government sponsored enterprises, should the need arise. He had hoped the mere existence of the backstop would calm Investors' nerves such that he wouldn't need to step in.
Reality, it appears, had other plans: Shares of the 2 companies have slid back down to where they were when markets feared they'd collapse under the weight of their massive loan portfolios.
Fannie and Freddie are hopelessly levered to the U.S. housing market, which slides deeper into disarray every day. The 2 companies collectively back over $5 trillion of American mortgages, which are going sour at a record pace.
As I wrote earlier this week, after Freddie announced equally dismal results, it's no longer a matter of if they collapse, but when.
It turns out buying mortgages with nothing but a superficial glance at the paperwork -- something Fannie and Freddie excelled at during the housing boom -- just isn't good business.
Although the 2 firms only lightly dabbled in subprime loans, originators easily duped their automated risk engines into buying fraudulent or otherwise shoddy loans.
But since banks like Citigroup (C), Bank of America (BAC) and Wachovia (WB) are saddled with troubles of their own, Fannie and Freddie have been asked to expand their role in the market. They now provide the only liquidity left for new mortgages.
The government has little choice but to bail out their wayward children. If it doesn't, Hank will need a lot more than just a bazooka to save the ship.
Thursday, July 24, 2008
New Countrywide Suit Tries To Foreclose Foreclosures
This post first appeared on Minyanville.
When Bank of America (BAC) agreed to buy Countrywide, it didn’t just take on a mountain of questionably valued mortgage-related assets. It also took on huge legal liability.
San Diego City Attorney Mike Aguirre, who has a penchant for punitive lawsuits that rarely result in much more than a media frenzy, is accusing Countrywide of defrauding thousands of San Diego homeowners. A lawsuit has already been brought at the state level by California Attorney General Jerry Brown, as well as in several other states, including Washington and Illinois.
San Diego's suit takes aim at Countrywide’s alleged practice of coercing borrowers into risky adjustable rate mortgages (ARMs). Aguirre hopes to make San Diego a “foreclosure sanctuary” by preventing foreclosure proceedings on any property secured by a subprime ARM where the borrower owes more than the home is worth. (For more on what the glut of upside-down homeowners means for the future of the housing market, please read Finding the Bottom in Housing.)
The litigious City Attorney isn’t satisfied with just taking aim at Countrywide (and, by extension, Bank of America). Aguirre said he’s planning similar suits against Washington Mutual (WM), Wells Fargo (WFC) and Wachovia (WB).
While Aguirre’s heart may be in the right place, foreclosure moratoriums aren’t part of the road to recovery for the housing market. Opportunistic mortgage market participants are buying delinquent mortgages on the cheap, forgiving some part of the debt and giving borrowers a fresh start. Government intervention in this process will simply scare off lenders, since they'll have limited recourse if the loan goes sour.
At best, such suits will simply drive up the cost of new mortgages. At worst, they'll bring the recovery process to a standstill.
Foreclosures are nasty, painful and tragic. They are, however, a necessary part of the mortgage process, enabling lenders to recoup losses on bad loans.
Mandating an end to foreclosures is like telling the IRS it can’t go after tax evaders or preventing cops from chasing down burglars. This is not to say victims of foreclosures are criminals or necessarily deserve to be thrown out on the street, but living in a law-abiding society means that contracts must be enforced.
The moment we waive one group’s obligation to honor their collective word, the floodgates are open.
This certainly isn't the last lawsuit we’ll see following the collapse of the mortgage market. In fact, it’s just the tip of the iceberg. A couple years from now, when Option ARMs begin to reset, class action lawsuits will bear down on lenders like a rumbling avalanche rolling down a steep slope.
Banks would be wise to get long on lawyers.
When Bank of America (BAC) agreed to buy Countrywide, it didn’t just take on a mountain of questionably valued mortgage-related assets. It also took on huge legal liability.
San Diego City Attorney Mike Aguirre, who has a penchant for punitive lawsuits that rarely result in much more than a media frenzy, is accusing Countrywide of defrauding thousands of San Diego homeowners. A lawsuit has already been brought at the state level by California Attorney General Jerry Brown, as well as in several other states, including Washington and Illinois.
San Diego's suit takes aim at Countrywide’s alleged practice of coercing borrowers into risky adjustable rate mortgages (ARMs). Aguirre hopes to make San Diego a “foreclosure sanctuary” by preventing foreclosure proceedings on any property secured by a subprime ARM where the borrower owes more than the home is worth. (For more on what the glut of upside-down homeowners means for the future of the housing market, please read Finding the Bottom in Housing.)
The litigious City Attorney isn’t satisfied with just taking aim at Countrywide (and, by extension, Bank of America). Aguirre said he’s planning similar suits against Washington Mutual (WM), Wells Fargo (WFC) and Wachovia (WB).
While Aguirre’s heart may be in the right place, foreclosure moratoriums aren’t part of the road to recovery for the housing market. Opportunistic mortgage market participants are buying delinquent mortgages on the cheap, forgiving some part of the debt and giving borrowers a fresh start. Government intervention in this process will simply scare off lenders, since they'll have limited recourse if the loan goes sour.
At best, such suits will simply drive up the cost of new mortgages. At worst, they'll bring the recovery process to a standstill.
Foreclosures are nasty, painful and tragic. They are, however, a necessary part of the mortgage process, enabling lenders to recoup losses on bad loans.
Mandating an end to foreclosures is like telling the IRS it can’t go after tax evaders or preventing cops from chasing down burglars. This is not to say victims of foreclosures are criminals or necessarily deserve to be thrown out on the street, but living in a law-abiding society means that contracts must be enforced.
The moment we waive one group’s obligation to honor their collective word, the floodgates are open.
This certainly isn't the last lawsuit we’ll see following the collapse of the mortgage market. In fact, it’s just the tip of the iceberg. A couple years from now, when Option ARMs begin to reset, class action lawsuits will bear down on lenders like a rumbling avalanche rolling down a steep slope.
Banks would be wise to get long on lawyers.
Tuesday, July 22, 2008
Wachovia Bleeding Cash
This post first appeared on Minyanville.
Robert Steel has his work cut out for him.
Steel, the new CEO of Wachovia (WB), took over last month after the company booted former head Ken Thompson. He's now facing the daunting task of righting a ship that has very much veered off course. The bank’s second-quarter results were nothing short of abysmal. According to The Wall Street Journal, Wachovia reported:
Robert Steel has his work cut out for him.
Steel, the new CEO of Wachovia (WB), took over last month after the company booted former head Ken Thompson. He's now facing the daunting task of righting a ship that has very much veered off course. The bank’s second-quarter results were nothing short of abysmal. According to The Wall Street Journal, Wachovia reported:
- Net losses of $8.7 billion or $4.20 per share, compared with net income of $2.3 billion last year.
- $6.1 billion in writedowns, largely on mortgage-related assets.
- Higher loan loss provision of $5.6 billion, up from $179 million a year ago.
- Charge-offs (loans the company has given up on) now 1.1% of total loans, compared to 0.14% last year.
- Lowered dividends from $0.375 to $0.05 per share.
- 6,350 job cuts - 5% of the company’s workforce.
Wachovia, like many of its banking peers, has been blindsided by credit losses. For Minyans with an abacus handy, the higher loan loss provision represents a 3100% increase over last year's, which shows just how unprepared management was for the current financial crisis.
The bank is now squirreling away cash to absorb further losses.
Steel, the former Undersecretary of the Treasury, appears to be taking aggressive measures to insulate the company from a mortgage portfolio that’s likely to deteriorate, along as the housing market continues to slide. Many analysts point to Wachovia’s ill-timed purchase of Golden West -- one of California's largest Option ARM issuers during the boom -- as the beginning of Wachovia's current crisis.
However, details of troubles throughout the bank’s business lines continue to emerge, and it’s becoming apparent that the Golden West debacle was only a symptom of a more systemic disease. In fact, Wachovia seems to have had little regard for prudent business practices, including:
- Charges stemming from rogue telemarketers ripping off clients total $150 million.
- A securities division under investigation for its role in the collapse of the auction-rate securities market.
- A $975 million charge related to a court ruling involving leasing transactions.
Hopeful shareholders may take solace from regarding this as a “kitchen sink” quarter in which the bank confronts its worst-case scenario and writes down assets accordingly. With Steel at the helm, management could plug enough holes to keep the ship afloat long enough to turn it around.
Unfortunately, with revenues falling in most of the bank’s businesses, persistent malaise in the mortgage and real estate markets, and speculation the company may have to sell itself to remain solvent, the future still looks rather bleak.
Monday, June 16, 2008
AIG Sends CEO Packing
This post first appeared on Minyanville.
Reeling from huge losses in its financial products division, a federal inquiry over questionable accounting and a barrage of angry shareholders, American International Group (AIG) is the latest big financial services firm to shake up its top brass.
The Wall Street Journal reported over the weekend that AIG's board of directors forced out CEO Martin Sullivan, replacing him with its chairman, Robert Willumstad. Sullivan had been under pressure for months ater unexpected writedowns and faltering shareholder confidence overwhelmed the insurance giant.
The company joins a dubious group: Citigroup (C), Merrill Lynch (MER), Bear Stearns, Wachovia (WB) have all sent their chief executives packing since the credit crisis began 12 months ago.
Late last year, AIG assured investors its balance sheet was safe and that its investments were sound and well-hedged. Months later, the firm announced massive losses and raised $20 billion in fresh capital. Shares plunged and now hover at levels not seen since 1998.
Professor Shedlock notes that, according to the Financial Times, AIG had written $78 billion in credit default swaps on ill-fated collateralized debt obligations (CDOs). Translated into English, AIG was on the hook if the CDOs went sour. They did, it was.
AIG's largest shareholder, Hank Greenberg, who ran the company for four decades, led a group of angry investors in slamming management for its missteps. Regulators joined in, alleging the company misrepresented the value of various mortgage-linked assets. The board succumbed to the pressure, ousting Sullivan at a special board meeting yesterday in New York.
Willumstad now has the herculean task of repairing the massively complex company Greenberg engineered from what was once a relatively simple insurance business. According to The Journal, AIG has its fingers in insurance, derivatives, asset management and aircraft leasing. The former Citigroup president and co-founder of private equity firm Brysam Global Partners hopes to draw on a long banking career to turn the firm around.
AIG is emblematic of the far-reaching effects of the credit crunch. The company didn't originate or securitize subprime mortgages, but it played an active role in the shadow banking system. What was once a significant profit center is now a cancerous tumor, destroying the firm's balance sheet from the inside. As we enter the second year of the ongoing crisis, we can expect the fallout to extend outward, ensnaring companies further and further from its epicenter.
Position in WB
Reeling from huge losses in its financial products division, a federal inquiry over questionable accounting and a barrage of angry shareholders, American International Group (AIG) is the latest big financial services firm to shake up its top brass.
The Wall Street Journal reported over the weekend that AIG's board of directors forced out CEO Martin Sullivan, replacing him with its chairman, Robert Willumstad. Sullivan had been under pressure for months ater unexpected writedowns and faltering shareholder confidence overwhelmed the insurance giant.
The company joins a dubious group: Citigroup (C), Merrill Lynch (MER), Bear Stearns, Wachovia (WB) have all sent their chief executives packing since the credit crisis began 12 months ago.
Late last year, AIG assured investors its balance sheet was safe and that its investments were sound and well-hedged. Months later, the firm announced massive losses and raised $20 billion in fresh capital. Shares plunged and now hover at levels not seen since 1998.
Professor Shedlock notes that, according to the Financial Times, AIG had written $78 billion in credit default swaps on ill-fated collateralized debt obligations (CDOs). Translated into English, AIG was on the hook if the CDOs went sour. They did, it was.
AIG's largest shareholder, Hank Greenberg, who ran the company for four decades, led a group of angry investors in slamming management for its missteps. Regulators joined in, alleging the company misrepresented the value of various mortgage-linked assets. The board succumbed to the pressure, ousting Sullivan at a special board meeting yesterday in New York.
Willumstad now has the herculean task of repairing the massively complex company Greenberg engineered from what was once a relatively simple insurance business. According to The Journal, AIG has its fingers in insurance, derivatives, asset management and aircraft leasing. The former Citigroup president and co-founder of private equity firm Brysam Global Partners hopes to draw on a long banking career to turn the firm around.
AIG is emblematic of the far-reaching effects of the credit crunch. The company didn't originate or securitize subprime mortgages, but it played an active role in the shadow banking system. What was once a significant profit center is now a cancerous tumor, destroying the firm's balance sheet from the inside. As we enter the second year of the ongoing crisis, we can expect the fallout to extend outward, ensnaring companies further and further from its epicenter.
Position in WB
Friday, June 6, 2008
Mortgage Companies: A Courtroom Drama
This post first appeared on Minyanville.
The City of Baltimore and Wells Fargo (WFC) are engaged in a legal fight over who's to blame for the city's foreclosure problem. The row highlights the broadening search for guilty parties in the collapse of the mortgage industry.
MortgageDaily.com reports Baltimore has filed a lawsuit alleging the San Francisco-based bank is responsible for "tens of millions of dollars" in lost tax revenues. During the past seven years, Wells Fargo accounted for 313 of the 33,000 foreclosures filed in Baltimore. The city claims Wells intentionally marketed predatory loans to minorities, many of which ended up in foreclosure.
As a result of the increased foreclosure activity, Baltimore lost tax revenues, incurred property maintenance costs and had to boost police and fire protection in the affected areas. Despite the relatively small share total foreclosures, the city claims Wells should shoulder part of the burden.
For its part, Wells Fargo dismissed the claim as unfounded. It also countered with the assertion that the city is responsible for its own troubles, largely stemming from its policy of assessing liens for unpaid utility bills. The city sold the tax liens to investors, who then forced borrowers to pay exorbitant fees to keep their homes. In its motion, the bank said homeowners were forced into foreclosure for unpaid water bills as low as $272.
States and municipalities are stepping up legal proceedings, looking to recoup cash and punish lenders that may have been involved in predatory lending. The State of Massachusetts just filed a similar lawsuit against Option One Mortgage Corporation, a subsidiary of H&R Block (HRB).
Many of the court cases focus on the effect of predatory lending on minority communities. Plaintiffs assert that lenders targeted minorities for loans with higher interest rates than comparable white borrowers. Such discrimination lawsuits have ensnared many of the country's biggest lenders, including Wells Fargo, Option One and Countrywide (CFC). The lenders vehemently deny any wrongdoing.
The lawsuit parade in the aftermath of reckless subprime lending has only just begun. In January of 2006, privately held Ameriquest Mortgage coughed up $325 million to resolve a predatory lending class action lawsuit. Despite the settlement, the company denied the allegations.
Although much of the focus on mortgage-related losses is centered on delinquencies stemming from adjustable rate resets and eroding economic conditions, the potential for massive class action lawsuits could further impede the industry's recovery efforts.
The storm brewing on the horizon is in the form of Option Adjustable Rate Mortgages, or Option ARMs. These loans allow borrowers to choose from a variety of interest payments, some of which result in negative amortization (see number five).
Complicated loan terms were in many cases not fully explained, and falling home values are exacerbating borrowers' already precarious position. Impending rate resets (see chart below, courtesy of Credit Suisse) will set off another wave of delinquencies. Borrowers -- and their attorneys -- will demand retribution.
It's no coincidence that the biggest issuers of these loans, Countrywide, Bear Stearns (BSC) and Washington Mutual (WM), have suffered the most during the mortgage crisis. Wachovia (WB) is also in the hot seat, as its ill-timed and now well publicized purchase of Golden West saddled the Charlotte-based bank with over $100 billion in Option ARMs. 60% of that portfolio is located in California, where property values are falling precipitously.
Future litigation will shape the regulatory response to the mortgage crisis. State authorities are already clamping down on the previously unregulated mortgage brokers and other small originators. Tighter restrictions will thwart some of the predatory practices prevalent during the boom, but they will also increase borrowing costs.
Mortgage industry professionals counter that overly restrictive regulations will lock out borrowers with mediocre credit. Faced with a web of rules and potential legal liabilities, banks just won't lend to anyone on the fringe of traditional loan qualifications.
Lenders need to be held accountable for their transgressions, especially if it can be proven they unfairly discriminated on the basis of race. Regulators will overreact, as they're apt to do. Despite its best efforts to rationalize away the need for tighter lending requirements, the mortgage business will feel the pain from its excesses for longer than many would like to believe.
Tuesday, May 20, 2008
Banks Bet With Employee Insurance Premiums, Lose.
This post first appeared on Minyanville.
Citigroup (C) can't catch a break, as another bizarre type of structured investment has gone awry. The latest troubled fund, however, has nothing to do with subprime mortgages.
According to The Wall Street Journal, nearly 700 banks hold a total of $117.5 billion in what are known as bank-owned life insurance programs, or BOLIs. Banks take out policies on their employees and collect if the workers die. The income is tax free, leading critics to call the practice a tax shelter.
Banks park the insurance premiums in fixed income investments like Citigroup's Falcon Strategies fund. The fund was marketed to banks and sophisticated retail investors, who claim the opportunity was called a "haven."
Now, the fund having lost nearly 75% of its value, Citi may have to pony up millions to pacify angry investors. The two biggest, Wachovia (WB) and Fifth Third Bank (FITB), have a combined $1.6 billion in exposure - much of which came from the banks' BOLI proceeds. Fifth Third is already suing a broker and insurance company that helped facilitate the investment.
Citi has agreed to reimburse private investors for any losses stemming from Falcon's demise. The bank may end up doing the same for its institutional investors.
Financial markets have become adept at absorbing such news - a potential loss of $1.6 billion just isn't what it used to be. Investors seem convinced government bailouts will soften the blow of the endless parade of imploding investment schemes.
Risk management wasn't just lax for the PhDs and traders dreaming up CDO squareds and credit default swaps. Mispriced risk was endemic, a system-wide malaise caused by the exploitation of nearly limitless easy credit.
While these latest losses may not sink the offending banks, they're a few more hacks at a tree that's not getting any sturdier.
Position in WB
Citigroup (C) can't catch a break, as another bizarre type of structured investment has gone awry. The latest troubled fund, however, has nothing to do with subprime mortgages.
According to The Wall Street Journal, nearly 700 banks hold a total of $117.5 billion in what are known as bank-owned life insurance programs, or BOLIs. Banks take out policies on their employees and collect if the workers die. The income is tax free, leading critics to call the practice a tax shelter.
Banks park the insurance premiums in fixed income investments like Citigroup's Falcon Strategies fund. The fund was marketed to banks and sophisticated retail investors, who claim the opportunity was called a "haven."
Now, the fund having lost nearly 75% of its value, Citi may have to pony up millions to pacify angry investors. The two biggest, Wachovia (WB) and Fifth Third Bank (FITB), have a combined $1.6 billion in exposure - much of which came from the banks' BOLI proceeds. Fifth Third is already suing a broker and insurance company that helped facilitate the investment.
Citi has agreed to reimburse private investors for any losses stemming from Falcon's demise. The bank may end up doing the same for its institutional investors.
Financial markets have become adept at absorbing such news - a potential loss of $1.6 billion just isn't what it used to be. Investors seem convinced government bailouts will soften the blow of the endless parade of imploding investment schemes.
Risk management wasn't just lax for the PhDs and traders dreaming up CDO squareds and credit default swaps. Mispriced risk was endemic, a system-wide malaise caused by the exploitation of nearly limitless easy credit.
While these latest losses may not sink the offending banks, they're a few more hacks at a tree that's not getting any sturdier.
Position in WB
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