Oct. 15, 2009: Yet ANOTHER Bail-Out for the Big Banks!
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 . . . .
