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FDIC Steps Up

February 26, 2010

Since I wrote and posted the piece that follows, Barry Ritholz at The Big Picture blog has also posted a thoughtful note on this titled “Underwater Homeowners:  Demand Principal Reductions.”  Commenting on the FDIC move described in my post below, Ritholz notes

It only requires basic math skills for all parties to recognize that it is in the banks interest to avoid foreclosures. Underwater borrower with this knowledge — and the cojones — should let the bank know they understand simple math: Foreclosures = 50% bank loss.

They can then “engage in an arm’s length, Wall Street style negotiation.” Not precisely a threat, but simply laying out clearly what the mortgagee’s options are.

He finishes up by observing that, 

My guesstimate is that of the 5 million probable future foreclosures, this mod would be applicable to about 20% of them. Note that a recent report from the Office of the Comptroller of the Currency implies that banks have figured this out: In Q3 of 2009, 13% of loan mods included a principal reduction, up from 10% in Q2 ‘09.

Of course, if Congress didn’t force FASB tio eliminate mark-to-market on holdings, the banks wouldn’t be able to, Japanese style, wait the whole mess out over the next decade or two.

As others have noted, this is how commercial borrowers and lenders negotiate all the time. Somehow, our concerns about the “moral hazards” of renegotiated debt seem to apply only to individual owners, and not the big boys and girls who play chicken with each others’ money all the time.  Some of you who have commented on my earlier posts about principal reduction have strongly supported such bilateral negotiations, but decried the notion of government paying for some or all of a reduction.  

Seems like Ritholz agrees with you.

Balance of Power

In reality, individual borrowers are not like Tishman Speyer or other commercial borrowers who have real loan officers with whom they deal and whose liabilities jeopardize the lender as much as themselves.  

In the real world of mortgage modifications, borrowers are still reduced to trying to break through 800 customer service numbers where they are likely to speak to a different staff person every time they call.  Documents are still provided by fax, sometimes to overseas fax centers.  

Trying to negotiate even a HAMP loan mod is proving to be difficult enough for individual borrowers.  A bare-knuckled negotiation with the lender to force a cram-down seems out of Everyman’s reach.

This imbalance of power and influence between the borrowers and the debt holders in the securitized system that we are living with is one of the root problems in getting to a swift resolution.  The lenders hold most, if not all, of the cards.  Individual borrowers on their own have scant power to negotiate, and servicers have small incentives to accommodate them with radical moves like principal reductions.

Hence, having the government step in on behalf of these borrowers seems to me to be an ideal use of government of, by and for the people.  

As proposed back in March, 2009 in recommendations to incoming HUD Secretary Shaun S. Donovan, government bulk purchases of the mortgage assets behind private label securities at discounts that reflect reality as Ritholz has described would enable it to follow with an orderly disposal of the assets with tools that could include steep writedowns reflective of the discount.

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Once again, as it has so many times in this crisis, the FDIC has stepped up and announced it will launch a pilot effort to test ways to reduce principal amounts for overwhelmed and underwater borrowers.  

Under Chair Sheila Bair, the FDIC has been a strong and sometimes lonely voice for consumers’ interests and practical solutions.  She’s proof that the phrase “bipartisan policy making” is not always a euphemism for “food fight.”

According to the Feb. 26 Washington Post,

Under the FDIC program, borrowers would be eligible for a reduction in their mortgage balances if they kept up their payments on the mortgage over a long period. The performance of those borrowers would be compared with borrowers given more traditional mortgage relief packages, such as those that cut the interest rate on loans.

“We’re thinking about it in terms of earned principal forgiveness. If you stay current on your mortgage, you would earn a principal reduction. It would only be for loans significantly underwater,” said FDIC Chairman Sheila C. Bair. 

This comes a week after the Obama Administration announced a $1.5 billion pilot funding program to encourage innovation in the five states with the steepest housing price declines—California, Arizona, Nevada, Florida and Michigan.  This was a welcome initiative, as well.  But the amounts available will make only a slight difference in these beleaguered state economies, take months to get up and running with the gauntlet of submissions and approvals it includes, and take years to provide any useful data that could move them from state to national approaches.  Not reasons to stop, but reasons that it falls far short of what needs to be done.

As I’ve noted in other blogs here, principal reductions are emerging as perhaps the only reliable way of modifying mortgages for long term success. The FDIC initiative is a welcome break in the logjam that is keeping so many borrowers from getting a break that can help them keep their homes and keep paying on at least some of what they owe.  

Telling it Straight

February 25, 2010

If you have a credit card, or have been paying attention to the news lately, you know that Congress last year passed important legislation curbing abuses in the credit card industry.  Responding to consumer complaints about arbitrary fees, interest rate increases on existing balances, and other income generating tactics banks have rolled out in recent years, Congress banned these and other practices in the Credit Card Accountability, Responsibility and Disclosure (CARD) Act of 2009.  

As usual, leave it to The Daily Show to completely capture just how outrageous life in our times has become.

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How Much Does it Take?

February 25, 2010

Bloomberg News reports that new documents obtained by Rep. Darrell Issa (R-CA) suggest that Goldman Sachs was the underwriter of some of the most toxic securities against which it then bought credit default swaps from ill-fated American Insurance Group (AIG) at the height of the Wall Street subprime feeding frenzy.  

As the article states it, 

The public can now see for the first time how poorly the securities performed, with losses exceeding 75 percent of their notional value in some cases. Compounding this, the document and Bloomberg data demonstrate that the banks that bought the swaps from AIG are mostly the same firms that underwrote the CDOs in the first place.

Goldman presumably did not contact the buyers of the notes they underwrote to warn them of their own bet against them.  The cynical transfer of risk to the customer is bad enough.  The profit-taking on their misfortune adds insult to injury.

This article, first reported on Bloomberg’s website and in the April issue of its magazine, was then followed by revelations that Goldman helped the Greek government expand its borrowing capacity by using off-balance sheet transactions that essentially hid the extent of their indebtedness.  According to the Feb. 25, 2010 New York Times, 

In 2000 and 2001, Goldman helped Athens quietly borrow billions by creating derivatives that essentially transformed loans into currency trades that did not have to be disclosed under European rules. The instruments, called currency swaps, helped Greece stay within the limits on deficit spending that were crucial to Greece joining the euro, the common European currency now used by 16 countries.

According to Bloomberg on Feb. 17, 2010, Goldman later was part of underwriting $15 billion in bonds sold by the Greek government after helping the Greeks hide the full extent of their indebtedness with the currency swap.  

No mention was made of the swap in sales documents for the securities in at least six of the 10 sales the bank arranged for Greece since the transaction, according to a review of the prospectuses by Bloomberg. The New York-based firm helped Greece raise $1 billion of off-balance-sheet funding in 2002 through the swap, which European Union regulators said they knew nothing about until recent days.

Failing to disclose the swap may have allowed Goldman, a co-lead manager on many of the sales, other underwriters and Greece to get a better price for the securities, said Bill Blain, co-head of fixed income at Matrix Corporate Capital LLP, a London-based broker and fund manager.

“The price of bonds should reflect the reality of Greece’s finances,” Blain said. “If a bank was selling them to investors on the basis of publicly available information, and they were aware that information was incorrect, then investors have been fooled.”

Astoundingly, even in the face of this continuing cascade of evidence of Wall Street’s amoral “take the money and run” attitude, the US Senate remains mired in negotiations to bring forth a financial reform package that could address these and other depradations.  What is it going to take to get us off the dime on this?

More Pitchforks?

February 06, 2010

When the mortgage crisis first started unfolding, I remember reading in a number of articles how Goldman Sachs had been more clever than other firms in avoiding heavy exposures to subprime mortgage bonds.  In fact, at least one article pointed out that Goldman had been betting against the subprime securities market for its own accounts, even while still trading the bonds for customers.  

When Goldman's counterparty AIG faltered, the U.S. Government stepped in to back up its insurance contracts on bonds.  The firm itself had traded directly on the parent company's legendary AAA status.  But it turned out they did not have nearly enough capital to cover all the bets they'd made.  Like a bookie who's taken the wrong side of too many "sure things," AIG was busted and American taxpayers ended up having to bail them out.  Among the biggest winners in this game?  Goldman Sachs, who received an estimated $12 billion in taxpayer money funnelled through AIG to make good on their contracts. 

Today's New York Times extends the debate about Goldman's role in the market's unraveling, outlining in a lengthy article how Goldman resisted AIG's attempts to pay less than full value on the contracts, arguing that the securities they'd guaranteed were worth more than Goldman claimed.

Perhaps the commission headed by former California Treasurer Philip Angelides will get to the bottom of who did what to whom.  For now, it seems safe to say that the behavior that seemed so smart two years ago may prove to have been too smart by half when re-examined in the wake of the worst financial crisis in more than 70 years.

Zombies In The House

February 03, 2010

Just when you thought it was starting to be safe again outside, analysts are beginning to tote up the costs facing banks and others from buy-back demands from insurers and Fannie Mae and Freddie Mac.  

With losses still mounting from failing home loans, more and more scrutiny is being applied to the underlying loans and their documentation and underwriting.  When Fannie or Freddie securitize or buy a loan, they require sellers to warrant that they have followed all the guidelines required by the companies.  When bond insurers or mortgage insurers write policies on mortgages or bonds backed by them, they do the same.

With billions at stake, it’s not surprising that these lenders are going over files with a fine-toothed comb, looking for any opportunity to force the originator to make good on their promise to buy back faulty loans.  A recent Housing Wire article calls this a “$10 billion problem.”  Best quote is from Chris Whelan, Managing Director at Institutional Risk Analytics:

“The wave of loan repurchase demands on securitization sponsors is the next area of fun in the zombie dance party, namely the part where different zombies start to eat each other.”