Professor Cole's Finance Blog

Yesterday, the WSJ published an article on how a new Treasury rule on loan modifications is being used to bail out the big four banks yet again. In addition, this is yet another assault by the current administration on the sanctity of contracts that will have profound unintended consequences going forward.

The new rule, announced in April to help deal with the growing glut of residential mortgage foreclosures, gives loan servicers incentives to modify second mortgages, as well as first mortgages, for the majority of borrowers who took out multiple loans on their properties. Second mortgages have been a major stumbling block in modifying delinquent mortgages.

Second mortgages, typically known as "home equity lines of credit" or HELOCs, allowed borrowers to put down less than a 20% down payment. First mortgages that are securitized typically can be worth no more than 80% of the value of the property, in order to protect the investors in those securities. The first-loss positions are the equity of the borrower and then the amount of the HELOC. Without this protection, investors would require higher returns on securitized first mortgages, pushing up interest rates in the housing markets.

The new Treasury rule strips MBS investors of this protection, even though it was spelled out in their contracts that they would be paid in full before holders of second liens received a penny. Instead, second-lien holders are getting repaid, often on the same terms as first-lien holders. The unintended consequences of this new rule will be the continued freeze-up of securitization markets and, longer term, higher residential mortgage rates. Way to go, Geithner!

Why is this a bailout of the big four banks (BofA, Chase, Citi and Wells)? It turns out that the vast majority of HELOCs are held in portfolio by banks. The total amount is more than $1 trillion dollars, of which the "big four" own around $450 billion. Were these loans marked to market at current values, which are around ten cents on the dollar, these banks would essentially see their common equity all but wiped out again, requiring yet another unpopular bank bailout. To avoid this, Geithner and his buddies on Wall Street have come up with this subterfuge to bail them out through the back door, without having to go back to Congress and ask for more money.

If the big four banks can't make money in an enviroment when they borrow from depositors at less than 1% and lend out at 6% and more, then the industry is doomed. Today Citibank announced that it eked out a profit of only $101 million in the third quarter because it was forced to add $8.8 billion to cover expected loan losses as nonperforming loans grew from 4.7% from 4.2% in the second quarter. It is expected to lose almost $2 billion next quarter. But not if Geither has his way . . . .

Posted by m1rac01 at 10:37 AM | Permalink | Comments (0) | TrackBacks (0)

Today, a WSJ article indicates that Wall Street firms are on track to pay employees $140 billion this year, reigniting concerns about excessive executive pay. We are not talking about secretaries here; we are talking about the top managers and traders.

I offer a simple solution to this outrage. It is an outrage because this money belongs to shareholders, yet Wall Street boards of directors have abdicated their fiduciary duties and allowed this rape of shareholder wealth to continue, even in the shadow of Wall Street's 2008 meltdown.

My solution? Simple. Let the boards rip off shareholders as much as they want, but ensure that most of that money goes to the taxpayer rather than top managers and traders.

Supposedly, we have a progressive income tax in this country, yet the top rate is only 35% and kicks in at the relatively modest income of $357,700. (Modest relative to the multi-million dollar paycheck of Wall Street, not the the paychecks of Main Street and "Flyover Country.")

I propose we add a few of additional brackets:

50% at $1 million,

75% at $5 million and

90% at $10 million.

What would this accomplish? It would make it VERY expensive for the likes of Rubin or Mozillo to rip off shareholders as they did at Citibank and Countrywide, respectively. It would force directors to "just say no" to such payoffs, as it would cost companies ten times as much as it does now for the biggest of paychecks.

It would not deter investment, as it long-term capital gains would still enjoy a favorable rate of 15%.

Posted by m1rac01 at 08:59 PM | Permalink | Comments (0) | TrackBacks (0)

Coming in at #7 on my "Top Ten Reasons for Double-Dip Recession" (see Sep. 25, 2009) is freeze-up of the securitization market. During the past two decades, securitization has increasingly enabled banks to originate more and more loans with the same amount of capital by then selling those loans to investors in the form of securities, primarily mortgage-backed securities.

One of the biggest problems facing credit markets is the apparent demise of the "originate-to-securitize" model of bank lending. During the last two decades, banks have moved away from originating loans, especially residential and commercial mortgages, to hold in their portfolios towards orginating loans to package into securities and sell to investors around the world.

This move was an "unintended consequence" of risk-based capital regulations that require less capital be held against securities than against whole loans. With no "skin in the game," banks and other lenders made hundreds of billions, if not trillions in poorly underwritten loans that blew up in 2008, imposing massive losses on investors and drying up demand for mortgage-backed securities.  Of course, this required the complicity of the three major ratings agencies; without triple-A ratings, unsophisticated investors never would have purchased these securities.

Beyond government-insured issues, U.S. securitization markets essentially remain frozen. No CMBS have been issued in two years. The only player keeping residential securitization in action is the Fed, which has committed to buying up to $1.25 trillion in RMBS and already has bought more than $900 billion, accounting for about 4 of 5 mortgages securitized during 2009. Private securitization dropped from almost three-quarters of a trillion dollars in 2008 to less than 10 billion dollars in 2009.

What will happen when the Fed reaches its self-imposed cap? Most likely, one of two outcomes: either the RMBS market will come to a screeching halt, or the Fed will re-assess its cap and continue buying.

Posted by m1rac01 at 08:25 PM | Permalink | Comments (54) | TrackBacks (0)

Recently, the NY Times published one story about the continuing financial problems at Fannie Mae and Freddie Mac (losses of $165 billion since July 2007and counting), and another story on the growing financial problems at another mortgage giant—the Federal Housing Administration or FHA.

The FHA used to be a bit player in the mortgage market with less than 2% market share, until Fannie Mae and Freddie Mac were placed into conservatorship during 2008 and forced to tighten lending standards. No more would they buy or guarantee subprime mortgages to borrowers with low credit scores, poor or no documentation, and little or no down payment. Consequently, their combined market share of the mortgage market has dropped from 60% to less than 10% while FHA had jumped from 2% to more than 40%.

The reason for FHA’s growth has been its lax lending standards (3.5% down payment, low credit scores, sound familiar?) Now the FHA has reported that 20% of the loans it insured last year and 24% of the loans it insured in 2007 are delinquent or in foreclosure. Yet the FHA Commissioner has “assured” Congress that the agency will not need a bailout. (As I remember, the CEOs of Fannie and Freddie made similar assurances right up until those two agencies were put into conservatorship at a cost to the taxpayer of $80 billion.)

So, is FHA the next Fannie Mae, destined to cost the U.S. taxpayer tens of billion of dollars to cover its losses on insured mortgages? The answer to this question depends upon whether or not the housing market continues to crash and burn. As documented in yesterday’s blog, it appears that the housing market is continuing to deteriorate, making it highly probable that FHA will impose massive losses on us taxpayers.

Posted by m1rac01 at 08:22 PM | Permalink | Comments (4) | TrackBacks (0)

Yes, I know that the administration is focusing on the "health insurance crisis," but I really think that the housing crisis is more acute and deserves more of our attention.

During recent days, the press appears to agree with me, publishing a number of articles, including today's story in the NYTimes that reads much like the press release available on Treasury's website "hailing" a new milestone in home-loan modifications.

(Funny, the NYT headline first used the verb "claims" then changed it to "hails"; are these guys cheerleaders or reporters? One of my acquantances from New York, who works at the "Grey Lady," decried these young NYT "reporters" who, she said, sit around watching CNN, where the correspondents read the NYT for ideas. Talk about inbreeding!) 

The gist of the story is that the administration's Home Affordable Mortgage Program, or HAMP as it is known by insiders, activists and housing counselors (who claim that HAMP paperwork requirements keeps them on a treadmill like a bunch of hamsters!) is now "hitting its stride" and, according to the NYT article quoting our tax-cheating Treasury Secretary "Turbotax" Tim Geithner, "unaffordable mortgages are now being modified at a pace faster than homes are being sold in foreclosure proceedings."

(What is it with tax cheats in the Democrat ranks these days? Geithner, Daschle, and now Charlie Rangel not only has four rent-controlled apartments in Harlem to which he is not "legally entitled," he can't seem to remember a half million dollars in income! These Democrats cheat more on Uncle Sam than Republicans pols (Sanford, Ensign, etc.) cheat on their wives . . . .) 

Talk about obfuscating! What the heck does Geithner's statement really mean? According to Loan Processing Services report for Sep 2009, more than 600,000 borrowers--not a typo--600,000 became delinquent on their mortgages for the first time during September, rising from previous months and signaling that the U.S. residential real estate market continues to deteriorate at an increasing rate. In that same report, LPS reports that delinquent mortgages hit a new record high of 9.06% and foreclosures hit a new record high of 3.04% for a combined new high of 12.10%. For a dose of reality, go to www.lpsvcs.com and download their report; it is truly frightening for the uninitiated who have been drinking too much Kool-Aid from the media. (Hot stock tip: wait for the Mortgage Bankers Association to release the Q3 results from their National Delinquency Survey, which follows LPS with a lag but is much more widely covered in the media. Look for a three-figure drop in the Dow following its release, much like last Thursday's drop in anticipation of the bad employment report.)

The number of foreclosure sales, as cited by Geithner has been stunted by various foreclosure moratoria around the country, which serve only to distort foreclosure statistics but have no real effect of the market or doing anything more than delaying the inevitable for homes that are at the last stage of the foreclosure process--sheriff's sale. These moratoria also have slowed the entry of delinquent mortgages into the foreclosure process, creating a massive backlog of mortgage loans that are delinquent more than 90 days and often more than 180 and even 270 days. LPS refers to this as the "shadow foreclosure inventory." LPS also reports that new foreclosures during September fell to the lowest level since January. Green shoots, anyone? (Read the rest of the report!) 

Compounding this problem is the fact that banks are supposed to "mark to market" these loans when they go into the foreclosure process, leading many lenders to put off this "unpleasant" task for as along as possible. Other concerns are liabilities that hit the lender when a mortgage goes into foreclosure, such as fines for unkempt lawns, "green" pools, etc. These factors also are contributing to the growing "shadow foreclosure inventory."

At least the flack who wrote Treasury's press release had the decency to write "new modifications are being issued at a faster rate than new homeowners are becoming eligible." Well, thank goodness for that! According to the detailed report referenced in the press release, just over 100,000 "trial mods" were issued during September, implying that less than 100,000 new homeowners became eligible. Hmm. 600,000 newly delinquent homeowners, but, apparently, fewer than one in six are "eligible" for mods. I'm sure that the "one in six" will be so happy. The remaining 500,000 will have to join the 785,000 workers who reported to the BLS that they had lost their jobs during September (look at the household survey, not the establishment survey.) in looking for "green shoots" elsewhere.

Oh, those "lucky" ones, who got the trial mods? Those mods predominantly consist of longer maturities and lower interest rates, but rarely include principal reduction, without which delinquency recidivism is reported to be more than 50% during the six months following modification. Look for the lucky ones to be re-entering the whole delinquency/foreclosure process sometime during 2010. This truly is starting to look like a repeat of the Japanese "lost decade" of the 1990s which followed their banking meltdown in the early 1990s.

What happened to the "transparency" that we were promised by this new administration? Why can't they simply be honest with the numbers? The housing crisis is bad and getting worse. Admit it. Come up with a plan to deal with it. Stop lying to us.

Joe Wilson, where are you when we need you? (Not Valerie Plame's Joe Wilson, South Carolina's.)

Oh yeah, that was the "health insurance crisis" not the "housing crisis."

Well, can I take this opportunity to say "YOU LIE, MR. GEITHNER!"

Oh, yeah.

He already admitted that he did that to the IRS. And got away with it.

So why would he listen to me . . . ?

Posted by m1rac01 at 08:46 PM | Permalink | Comments (13) | TrackBacks (0)

This morning at 8:30 a.m. EDT, just as it does on each first friday of a new month, the Bureau of Labor Statistics released its monthly employment report entitled "The Employment Situation," for the previous month, in this case, for September 2009.

As always, the employment report summarizes the results from two surveys--the Household Survey (HS), from which the headline unemployment rate comes, and the Establishment Survey (ES), from which the headline employment number comes. From the ES, the headline jobs number was a decline of 263,000, larger than consensus estimate, which was 175,000 or less, and much larger than the decline of 213,000 reported for August. From the HS, the headline unemployment number was 9.8%, up 214,000 from the 14.93 million unemployed reported for August and up from 6.2% in September 2008.

In other words, the employment situation continues to deteriorate, not improve, in spite of the $787 billion Stimulus Package, the $700 billion TARP, the $1.6 trillion deficit for the fiscal year 2009, which ended two days ago on September 30, the $1 trillion increase in the Fed's balance sheet and the fall of the Fed's target interest rate from 5.0% essentially to zero.

Why didn't the unemployment rate rise even more? To understand, we need to delve deeper into the report. Not widely known is the fact that the HS also provides an employment number, albeit one measured with greater error than the one from the ES. That said, this second employment number can be very informative, especially if it is widely different from the headline ES jobs number. This is because the HS employment number reflects self employment and employment at smaller and newer establishments not covered by the ES. In September, the HS employment number fell by 785,000 jobs, or more than three times the 263,000 decline in the ES number.

How is this possible when unemployment rose by only 214,000? It is possible because the remaining (785,000 - 214,000 =) 571,000 formerly employed persons left the labor force. In other words, they gave up. Remember, to be unemployed, one has to have actively looked for work during the previous four weeks. If you lose your job and give up, you're not "unemployed," you're "out of the labor force."

For this reason, the BLS also reports broader measures of unemployment in Table A12. U-6 is the broadest of these measures, including officially unemployed plus discouraged workers, plus those employed part time for economic reasons, plus marginally attached workers. This measure rose to 26.2 million, or 17.0% of the civilian labor force in September, up from 16.8% in August and 11.2% in September 2008. Also, the number of long-term unemployed (jobless for 27 weeks or more) rose by 450K to 5.4 million.

Among men, the unemployment rate rose to 10.3%, up from 10.1% in August, while, among women, the unemployment rate rose to 7.8%, up from 7.6% in August. This recession discriminates against men.

The BLS also revised its employment numbers for July (down 28,000) and August (up 15,000) as establishments that missed the original survey deadlines are counted when then eventually report. The July revision was on top of a downward revision of 29,000 announced last month.

Another statistic reported in the employment report is the length of the average workweek (in hours). This number fell by 0.1 hour to 33.0. Were the average workweek to return to its 33.6 hour level of a year ago, this would be the equivalent of hiring 2.75 million new full-time workers. The implication is that employers are much more likely to increase the average workweek for existing employees before they rehire laid-off workers, so that unemployment is likely to remain high even when the economy eventually begins to recover.

Also released today by the BLS is another report on benchmark revisions to the ES jobs numbers. This report contains preliminary revisions to the monthly ES numbers released each month. Each year, the BLS benchmarks employment estimates using state unemployment insurance tax records filed by virtually all employers. Usually, these revisions are up or down no more than two-tenths of one percent, but, this year, they are likely to be three times as large. The preliminary revision for March 2009 shows that the BLS "over-estimated" employment by 824,000 workers.

These sobering numbers are more than a "lagging indicator," as dismissive politicians and pundits refer to the unemployment rate. They are a continuing reminder that it is far too early to declare "mission accomplished" in dealing with the ongoing financial crisis. Until the BLS reports that the number of jobs is growing instead of declining, we remain in a real recession, even if Bernanke, Goolsbee and other members of the adminstration have declared that we are now in "technical recovery."

Posted by m1rac01 at 10:35 AM | Permalink | Comments (1) | TrackBacks (0)