Published in the Courier News, Tuesday, October 14, 2008
Subprime mortgage rescue fund: Safety net or disincentive?
By LISA G. RYAN • GANNETT STATE BUREAU • October 14, 2008
TRENTON —A plan to create an estimated $40 million trust fund to help New Jersey residents who have subprime mortgages avoid losing their homes is instead creating a growing controversy.
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Nonprofit housing groups are championing the New Jersey Homeownership Preservation Act as a safety net for homeowners struggling to pay mortgages they can no longer afford, but mortgage lenders are criticizing it as a costly, knee-jerk government reaction that will dissuade lending institutions from doing business in New Jersey.
"Not everybody is going to be able to renegotiate their mortgage and stay in their home. But we want to help as many people as we can," said Staci Berger, advocacy and policy director at the Housing and Community Development Network of New Jersey, which supports the bill.
"The process being suggested is too costly and too onerous, and it could stop businesses from lending in New Jersey," cautioned E. Robert Levy, executive director of the Mortgage Bankers Association of New Jersey.
The bill is one of 19 economy-related measures that moved forward last week during the Assembly's much publicized session on the global financial crisis. The full Assembly could vote on the bill later this month.
It calls for the state to assess a $2,000 fee on any mortgage lender that forecloses on homeowners who have a subprime mortgage. The money collected would go into a trust fund run by the New Jersey Housing and Mortgage Finance Agency, which would distribute it first to nonprofit groups qualified to counsel people facing foreclosure. Remaining money would provide homeowners facing foreclosure with emergency assistance loans and help buy and convert foreclosed homes into affordable housing.
The bill would also require lenders to offer homeowners with subprime mortgages a six-month hold to give them time to renegotiate their loans.
There were more than 134,000 subprime mortgages in New Jersey as of June 30, and 32.5 percent of them were in foreclosure or close to it, according to the Mortgage Bankers Association National Delinquency Survey.
The state's housing and mortgage agency estimates another 10,000 to 20,000 subprime loans will fall into these categories over the next two years if the situation continues unabated. It projects the trust fund would receive between $20 million and $40 million by 2010.
"I don't think the individuals who were trying to secure these loans thought that at some point they were going to lose their jobs to the degree that jobs have been lost, that the values of their homes were going to decrease to the point that they are less than the money that they owe," said Assembly Majority Leader Bonnie Watson Coleman, D-Mercer, before the Assembly Budget Committee last week.
Since March, Watson Coleman and Sen. Ronald Rice, D-Essex, have been leading the effort to get the bill approved in the Legislature and adopted into law. The lawmakers told the budget committee that many homeowners now facing hardship were preyed upon by unscrupulous lenders.
But Assemblyman Declan O'Scanlon Jr., R-Monmouth, who opposes the bill, fears it would give mortgage companies, which are now facing their own problems in the credit market, another disincentive to lend to qualified New Jersey consumers.
The lending institutions could also pass the $2,000 state fee along to their customers, said Assemblywoman Alison Littell McHose, R-Sussex, who criticized the program's estimated $675,000 in startup and staffing costs as too high for financially strapped New Jersey.
"For the amount of money this bill could generate, I think it has a lot of holes in it," McHose said.
SKEPTICS: For more criticisms of the bill from lawmakers, who wonder who'd benefit financially and who'd shoulder the load, visit the Gannett State Bureau's new Capitol Quickies blog at http://blogs.app.com/capitolquickies
Lisa G. Ryan: lgryan@gannett.com
Online story here. Archived here.
(Note: Online stories may be taken down by their publisher after a period of time or made available for a fee. Links posted here is from the original online publication of this piece.)
(In accordance with Title 17 U.S.C. Section 107, this material is distributed without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes. Plainfield Today, Plainfield Stuff and Clippings have no affiliation whatsoever with the originator of these articles nor are Plainfield Today, Plainfield Stuff or Clippings endorsed or sponsored by the originator.)
Showing posts with label Mortgages. Show all posts
Showing posts with label Mortgages. Show all posts
Thursday, October 30, 2008
Wednesday, January 09, 2008
Real Estate- NY Times - Baltimore sues bank over subprime mortgage fees
Published in the NY Times, Tuesday, January 8, 2008
Baltimore is suing bank over foreclosure crisis
By GRETCHEN MORGENSON
Baltimore’s mayor and City Council are suing Wells Fargo Bank, contending that its lending practices discriminated against black borrowers and led to a wave of foreclosures that has reduced city tax revenues and increased its costs.
The recent surge in homeowner defaults nationwide, generated by lax lending practices during the real estate boom, has officials bracing for a range of problems that often accompany foreclosures. Some municipalities, including Cleveland and Buffalo, are trying to make lenders responsible for abandoned properties to ward off crimes like arson, drug use and prostitution.
But the civil suit that officials in Baltimore are filing in United States District Court may presage another type of litigation against lenders by municipalities facing shortfalls in their budgets.
In the suit, Mayor Sheila Dixon joined with the City Council to ask that the court bar Wells Fargo from charging higher fees to black borrowers. Many of these borrowers paid more under the bank’s subprime lending program, designed for less creditworthy consumers, and are more likely to default on their loans.
In 2006, Wells Fargo made high-cost loans, with an interest rate at least three percentage points above a federal benchmark, to 65 percent of its black customers in Baltimore and to only 15 percent of its white customers in the area, according to the lawsuit. Similarly, refinancings to black borrowers were more likely to be higher cost than to white ones and to carry prepayment penalties.
The complaint requests unspecified damages to cover the diminished property tax revenues and higher costs that the city said it had incurred. Additional costs include those for fire and police protection in hard-hit neighborhoods and expenditures to buy and rehabilitate vacant properties.
Kevin Waetke, a Wells Fargo spokesman, rejected the contention that race was a factor in the bank’s pricing of mortgage loans. “We do not tolerate illegal discrimination against or unfair treatment of any consumer,” Mr. Waetke said. “Our loan pricing is based on credit risk. We are committed to serving all customers fairly — our continued growth depends on it.”
But Suzanne Sangree, chief solicitor for the Baltimore City Law Department, said: “This wave of foreclosures in minority neighborhoods really threatens to undermine the tremendous progress the city has made in developing distressed neighborhoods and moving the city ahead economically. Wells Fargo could do a lot, as well as other banks that have engaged in similar practices, to help to curb the flood of foreclosures that the city is experiencing now.”
Among the practices cited by the city, Wells Fargo allowed mortgage brokers to charge higher commissions when they put borrowers in loans with higher interest rates than the customers qualified for based on their credit profiles. The bank also failed to underwrite mortgage loans to traditional criteria, the suit said, setting up the borrowers for default. Such practices were common at many lenders during the boom.
Now, Baltimore is a city in a foreclosure crisis, according to the complaint. Citing figures from the Maryland Department of Housing and Community Development, the suit said foreclosure-related events in the city, including notices of default, foreclosure sales and lenders’ purchases of foreclosed properties, rose more than five times between the first and second quarters of 2007.
Wells Fargo has been the largest or second-largest provider of mortgage loans to Baltimore borrowers since 2004, according to the lawsuit. From 2004 through 2006, Wells Fargo made at least 1,285 mortgage loans a year to area residents with a total value of more than $600 million. Wells Fargo now has the largest number of foreclosures in Baltimore of any lender, the suit stated.
Half of the Wells Fargo foreclosures in 2006 occurred in census tracts with populations that were more than 80 percent black, the suit said. Meanwhile, only 16 percent of the foreclosures were found in tracts with populations that are 20 percent or less black. Figures for 2007 were similar, the city said.
John P. Relman, a lawyer at Relman & Dane in Washington, represents the City of Baltimore in its case against Wells Fargo. “Foreclosures have a more profound effect in minority communities because they are closest to the line of distressed neighborhoods in many cities,” Mr. Relman said. “That causes big problems for the cities, not just the lost income from taxes but also the long-term social costs. Programs are going to be needed to stabilize the communities to be rebuilt.”
The Baltimore complaint cited a 2005 study showing that foreclosures required more municipal services and higher costs. The study, commissioned by the Homeownership Preservation Foundation of Minneapolis, identified 26 different costs incurred by government agencies responding to foreclosures in Chicago and in Cook County, Ill., in 2003 and 2004. The analysis concluded that total costs reached $34,199 for each foreclosure.
Online story here. Archived here.
(Note: Online stories may be taken down by their publisher after a period of time or made available for a fee. Links posted here is from the original online publication of this piece.)
(In accordance with Title 17 U.S.C. Section 107, this material is distributed without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes. Plainfield Today, Plainfield Stuff and Clippings have no affiliation whatsoever with the originator of these articles nor are Plainfield Today, Plainfield Stuff or Clippings endorsed or sponsored by the originator.)
Baltimore is suing bank over foreclosure crisis
By GRETCHEN MORGENSON
Baltimore’s mayor and City Council are suing Wells Fargo Bank, contending that its lending practices discriminated against black borrowers and led to a wave of foreclosures that has reduced city tax revenues and increased its costs.
The recent surge in homeowner defaults nationwide, generated by lax lending practices during the real estate boom, has officials bracing for a range of problems that often accompany foreclosures. Some municipalities, including Cleveland and Buffalo, are trying to make lenders responsible for abandoned properties to ward off crimes like arson, drug use and prostitution.
But the civil suit that officials in Baltimore are filing in United States District Court may presage another type of litigation against lenders by municipalities facing shortfalls in their budgets.
In the suit, Mayor Sheila Dixon joined with the City Council to ask that the court bar Wells Fargo from charging higher fees to black borrowers. Many of these borrowers paid more under the bank’s subprime lending program, designed for less creditworthy consumers, and are more likely to default on their loans.
In 2006, Wells Fargo made high-cost loans, with an interest rate at least three percentage points above a federal benchmark, to 65 percent of its black customers in Baltimore and to only 15 percent of its white customers in the area, according to the lawsuit. Similarly, refinancings to black borrowers were more likely to be higher cost than to white ones and to carry prepayment penalties.
The complaint requests unspecified damages to cover the diminished property tax revenues and higher costs that the city said it had incurred. Additional costs include those for fire and police protection in hard-hit neighborhoods and expenditures to buy and rehabilitate vacant properties.
Kevin Waetke, a Wells Fargo spokesman, rejected the contention that race was a factor in the bank’s pricing of mortgage loans. “We do not tolerate illegal discrimination against or unfair treatment of any consumer,” Mr. Waetke said. “Our loan pricing is based on credit risk. We are committed to serving all customers fairly — our continued growth depends on it.”
But Suzanne Sangree, chief solicitor for the Baltimore City Law Department, said: “This wave of foreclosures in minority neighborhoods really threatens to undermine the tremendous progress the city has made in developing distressed neighborhoods and moving the city ahead economically. Wells Fargo could do a lot, as well as other banks that have engaged in similar practices, to help to curb the flood of foreclosures that the city is experiencing now.”
Among the practices cited by the city, Wells Fargo allowed mortgage brokers to charge higher commissions when they put borrowers in loans with higher interest rates than the customers qualified for based on their credit profiles. The bank also failed to underwrite mortgage loans to traditional criteria, the suit said, setting up the borrowers for default. Such practices were common at many lenders during the boom.
Now, Baltimore is a city in a foreclosure crisis, according to the complaint. Citing figures from the Maryland Department of Housing and Community Development, the suit said foreclosure-related events in the city, including notices of default, foreclosure sales and lenders’ purchases of foreclosed properties, rose more than five times between the first and second quarters of 2007.
Wells Fargo has been the largest or second-largest provider of mortgage loans to Baltimore borrowers since 2004, according to the lawsuit. From 2004 through 2006, Wells Fargo made at least 1,285 mortgage loans a year to area residents with a total value of more than $600 million. Wells Fargo now has the largest number of foreclosures in Baltimore of any lender, the suit stated.
Half of the Wells Fargo foreclosures in 2006 occurred in census tracts with populations that were more than 80 percent black, the suit said. Meanwhile, only 16 percent of the foreclosures were found in tracts with populations that are 20 percent or less black. Figures for 2007 were similar, the city said.
John P. Relman, a lawyer at Relman & Dane in Washington, represents the City of Baltimore in its case against Wells Fargo. “Foreclosures have a more profound effect in minority communities because they are closest to the line of distressed neighborhoods in many cities,” Mr. Relman said. “That causes big problems for the cities, not just the lost income from taxes but also the long-term social costs. Programs are going to be needed to stabilize the communities to be rebuilt.”
The Baltimore complaint cited a 2005 study showing that foreclosures required more municipal services and higher costs. The study, commissioned by the Homeownership Preservation Foundation of Minneapolis, identified 26 different costs incurred by government agencies responding to foreclosures in Chicago and in Cook County, Ill., in 2003 and 2004. The analysis concluded that total costs reached $34,199 for each foreclosure.
Online story here. Archived here.
(Note: Online stories may be taken down by their publisher after a period of time or made available for a fee. Links posted here is from the original online publication of this piece.)
(In accordance with Title 17 U.S.C. Section 107, this material is distributed without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes. Plainfield Today, Plainfield Stuff and Clippings have no affiliation whatsoever with the originator of these articles nor are Plainfield Today, Plainfield Stuff or Clippings endorsed or sponsored by the originator.)
Friday, September 21, 2007
Mortgages - TT - Subprime crisis testimony by DOBI
Published in the Times of Trenton, Tuesday, September 18, 2007
Mortgage crisis puts scores in foreclosure, senators told
BY TOM HESTER
Star-Ledger Staff
At least 8,000 of the 143,898 New Jersey borrowers who opted for subprime mortgages went into foreclosure in the first half of this year, state Division of Banking officials said yesterday.
Testifying before the Senate Community and Urban Affairs Committee in Trenton, state officials and lenders said another 11,000 of those borrowers are up to three months behind on their mortgage payments.
"I want to be clear that here in New Jersey this is a real threat to homeowners and to the economy," state Banking Director Terry McEwen said of the widening subprime mortgage crisis.
Of the 15,426 first-time foreclosures filed in New Jersey in the first six months of this year, 53 percent involve borrowers with adjustable rate mortgages. Nationally, the figure is 37 percent for the same period.
Black and Hispanic borrowers, who hold 41 percent of subprime loans, have been hardest hit.
In Newark, 12.7 percent of subprime mortgage holders are more than three months delinquent in their payments. In Camden, it's 10.9 percent; Edison 10.5 percent; and Trenton 9.5 percent. By contrast, of all of the 1.24 million mortgage loans of all types in New Jersey, 1.23 percent are in foreclosure.
The Senate Community and Urban Affairs Committee asked banking officials, lenders and government activists to Trenton to discuss potential ways to ease the problem and bail out at least some of the borrowers.
"If anyone in this room believes that the worst is over in the subprime mortgage fiasco -- you are very, very wrong," said Phyllis Salowe-Kaye, director of New Jersey Citizen Action. "A tsunami of interest rate hikes on thousands of loans is headed our way and we had better be prepared for the disaster and heartache that lies ahead for many communities and homeowners in New Jersey."
Officials said the 8,000 subprime borrowers in foreclosure and the thousands more expected to join them are people with both good and bad credit who took out mortgage loans with adjustable rates that start out with low interest then bump up to a higher rate after a few years. The result is some homeowners took out bigger loans than they could afford, hoping a rising housing market would let them refinance later on. Instead, the housing market statewide and nationally has stalled and home prices are falling.
Lenders, state officials and citizen activists told the committee the borrowers were often low- or moderate-income people who did not do their homework as they prepared to seek mortgages and were misled by unscrupulous lenders.
Jerry Keelen, director of Single Family Programs with the state Housing and Mortgage Finance Agency, said his agency is preparing to offer $30 million to help bail out subprime borrowers, but he told senators he expects it will aid no more than 200 of the 1,600 borrowers who have already contacted the state seeking help.
Sen. Ronald Rice (D-Essex), the committee chairman, told Keelan to go slow in passing out the aid, saying senators are attempting to get a handle on the crisis and determine what legislation may be necessary to help solve it.
With lenders mainly controlled by federal statutes, speakers told the committee that guidance and public education on finding and managing a mortgage and avoiding foreclosure may be the best help the state can provide.
"It is worth noting that a big challenge in this area is informing delinquent borrowers that they have workout options -- and they must talk to their lender early," said Jeffrey Markowitz, a vice president with Freddie Mac, a federal-government mortgage provider. "Delinquent borrowers who work with our lenders on a workout plan are 80 percent more likely to avoid foreclosure than those who do not work with a lender."
Markowitz said a 2005 Freddie Mac survey found 61 percent of delinquent borrowers did not know there are workout options, "and significant percentages of those borrowers did not return lender phone calls out of embarrassment or a lack of faith that anything can be done to help them."
The Federal Housing Administration will provide information on home ownership, mortgages and dealing with lenders on Sept. 29, from 9:30 a.m. to 2 p.m., at Essex County College, 303 University Ave., Newark. People can register by calling 1-800-CALLFHA.
A "Homeowners Guide to Subprime" is available in English and Spanish at the state Department of Insurance and Banking Web site: www.njdobi.org.
Online story here. Archived here.
(Note: Online stories may be taken down by their publisher after a period of time or made available for a fee. Links posted here is from the original online publication of this piece.)
(In accordance with Title 17 U.S.C. Section 107, this material is distributed without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes. Plainfield Today, Plainfield Stuff and Clippings have no affiliation whatsoever with the originator of these articles nor are Plainfield Today, Plainfield Stuff or Clippings endorsed or sponsored by the originator.)
Mortgage crisis puts scores in foreclosure, senators told
BY TOM HESTER
Star-Ledger Staff
At least 8,000 of the 143,898 New Jersey borrowers who opted for subprime mortgages went into foreclosure in the first half of this year, state Division of Banking officials said yesterday.
Testifying before the Senate Community and Urban Affairs Committee in Trenton, state officials and lenders said another 11,000 of those borrowers are up to three months behind on their mortgage payments.
"I want to be clear that here in New Jersey this is a real threat to homeowners and to the economy," state Banking Director Terry McEwen said of the widening subprime mortgage crisis.
Of the 15,426 first-time foreclosures filed in New Jersey in the first six months of this year, 53 percent involve borrowers with adjustable rate mortgages. Nationally, the figure is 37 percent for the same period.
Black and Hispanic borrowers, who hold 41 percent of subprime loans, have been hardest hit.
In Newark, 12.7 percent of subprime mortgage holders are more than three months delinquent in their payments. In Camden, it's 10.9 percent; Edison 10.5 percent; and Trenton 9.5 percent. By contrast, of all of the 1.24 million mortgage loans of all types in New Jersey, 1.23 percent are in foreclosure.
The Senate Community and Urban Affairs Committee asked banking officials, lenders and government activists to Trenton to discuss potential ways to ease the problem and bail out at least some of the borrowers.
"If anyone in this room believes that the worst is over in the subprime mortgage fiasco -- you are very, very wrong," said Phyllis Salowe-Kaye, director of New Jersey Citizen Action. "A tsunami of interest rate hikes on thousands of loans is headed our way and we had better be prepared for the disaster and heartache that lies ahead for many communities and homeowners in New Jersey."
Officials said the 8,000 subprime borrowers in foreclosure and the thousands more expected to join them are people with both good and bad credit who took out mortgage loans with adjustable rates that start out with low interest then bump up to a higher rate after a few years. The result is some homeowners took out bigger loans than they could afford, hoping a rising housing market would let them refinance later on. Instead, the housing market statewide and nationally has stalled and home prices are falling.
Lenders, state officials and citizen activists told the committee the borrowers were often low- or moderate-income people who did not do their homework as they prepared to seek mortgages and were misled by unscrupulous lenders.
Jerry Keelen, director of Single Family Programs with the state Housing and Mortgage Finance Agency, said his agency is preparing to offer $30 million to help bail out subprime borrowers, but he told senators he expects it will aid no more than 200 of the 1,600 borrowers who have already contacted the state seeking help.
Sen. Ronald Rice (D-Essex), the committee chairman, told Keelan to go slow in passing out the aid, saying senators are attempting to get a handle on the crisis and determine what legislation may be necessary to help solve it.
With lenders mainly controlled by federal statutes, speakers told the committee that guidance and public education on finding and managing a mortgage and avoiding foreclosure may be the best help the state can provide.
"It is worth noting that a big challenge in this area is informing delinquent borrowers that they have workout options -- and they must talk to their lender early," said Jeffrey Markowitz, a vice president with Freddie Mac, a federal-government mortgage provider. "Delinquent borrowers who work with our lenders on a workout plan are 80 percent more likely to avoid foreclosure than those who do not work with a lender."
Markowitz said a 2005 Freddie Mac survey found 61 percent of delinquent borrowers did not know there are workout options, "and significant percentages of those borrowers did not return lender phone calls out of embarrassment or a lack of faith that anything can be done to help them."
The Federal Housing Administration will provide information on home ownership, mortgages and dealing with lenders on Sept. 29, from 9:30 a.m. to 2 p.m., at Essex County College, 303 University Ave., Newark. People can register by calling 1-800-CALLFHA.
A "Homeowners Guide to Subprime" is available in English and Spanish at the state Department of Insurance and Banking Web site: www.njdobi.org.
Online story here. Archived here.
(Note: Online stories may be taken down by their publisher after a period of time or made available for a fee. Links posted here is from the original online publication of this piece.)
(In accordance with Title 17 U.S.C. Section 107, this material is distributed without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes. Plainfield Today, Plainfield Stuff and Clippings have no affiliation whatsoever with the originator of these articles nor are Plainfield Today, Plainfield Stuff or Clippings endorsed or sponsored by the originator.)
Friday, August 31, 2007
Market Crisis of 2007 - NY Times - Primer on CDOs and Credit Derivatives
Published in the New York Times, Friday, August 31, 2007
News Analysis
Why a U.S. Subprime Mortgage Crisis Is Felt Around the World
By JENNY ANDERSON and HEATHER TIMMONS
The evening entertainment for roughly 500 financial executives at the Deutsche Bank global derivatives conference last month in Barcelona did not come cheap — the Rolling Stones reportedly were paid more than $5 million.
“The best part is, it’s coming out of your bonuses,” Mick Jagger joked to the crowd.
The hosts of the conference could well afford it. After all, the business of creating new finance vehicles like derivatives and structured products has exploded in recent years. And at the time of the conference, there remained a mostly rosy view of such instruments, because of their ability to help businesses and investors spread out risk.
But the global financial turmoil — set off by problems with subprime mortgages — has prompted a backlash in some quarters against such financial engineering.
More broadly, it has led to a better understanding of the downside of spreading risk so well — it can be felt in all corners of the world, unsettling hedge funds, banks and stock markets as far away as Australia, Thailand and Germany. In effect, reducing risk on a global scale appears to have increased it for some players.
“The market appears to be finding it harder to truly understand the inherent and underlying risks involved,” said Chris Rexworthy, who was a regulator with the Financial Services Authority in Britain for 10 years before moving recently to the private sector.
The backlash is particularly sharp abroad, in countries that were surprised to find that problems with United States homeowners could be felt so keenly in their home markets. Foreign politicians and regulators are seeking a role in the oversight of American markets, banks and rating agencies. The head of the Council of Economic Analysis in France has called for complex securities to be scrutinized before banks are authorized to buy them.
In the United States, regulators appear to think that the new and often unregulated investment vehicles — which have shrunk the world and speeded up business in much the same way as the Internet — are not all inherently flawed.
This opinion is captured in an analogy offered by Peter Douglas, the founder of GFIA, a hedge fund research firm in Singapore. He likens using derivatives to power tools. If you know how to use them, he said, they are exponentially better and faster for building a house, compared with using hammers, screwdrivers and handsaws.
If you don’t, “you could drill a hole in your head," he said.
Funds and banks around the world have taken hits because they purchased bonds, or risk related to bonds, backed by bad home loans, often bundled into financial instruments called collateralized debt obligations, or C.D.O.’s.
The losses have often surprised the investors, and in some cases the funds and the executives of the banks, who were unaware of the extent of their risks.
The crisis extended as far as the $2.2 trillion money market that finances the day-to-day operations of businesses, as investors wondered whether the underlying assets were sound. “It’s amazing how much ignorance and fear are out there,” said Kevin Davis, a professor of finance at the University of Melbourne.
The confusion about these products lies in part in their complexity. Structured products are pooled assets that have been sliced and diced into ever more smaller, more specialized pieces.
They offered investors higher returns at a time when traditional fixed income, or debt-related products, were producing low returns.
As low interest rates fueled a lending boom to borrowers with weak credit, banks looked for new ways to package those loans, so they could sell more. A central building block to offset the risk was asset-backed securities, which are bonds backed by pools of mortgages or other income-producing assets, like student loans, auto loans, and credit card receivables.
Banks and other financial institutions pooled those asset-backed securities into new units, dividing them up again and issuing securities against them, creating collateralized debt obligations.
The idea took off, with new combinations that were further removed from the original asset. New creations included C.D.O.’s of C.D.O.’s, called C.D.O.-squared. There is even a C.D.O.-cubed.
According to JPMorgan, there are about $1.5 trillion in global collateralized debt obligations, and about $500 billion to $600 billion in structured-finance C.D.O.’s, referring to those made up of bonds backed by subprime mortgages, slightly safer mortgages and commercial mortgage backed securities.
Many of the products have proved to be highly problematic as the underlying assets — the subprime mortgages — have gone bust, revealing dangerous amounts of leverage in the securities that few people could value. As a result, they have become like a potent computer virus, leaving many people fearful that they too will be affected.
“A lot of risk in the subprime asset-backed market is embedded in, and amplified by, C.D.O.’s,” said Rod Dubitsky, head of asset-backed research at Credit Suisse.
Weaknesses in the system were laid bare, including ratings that did not accurately reflect risk and faulty assumptions on how diversified pools with multiple layers of leverage would react.
That in turn spooked investors in other markets, who started selling anything they thought might be risky, from stocks to loans, and in some cases putting their money into cash.
The combination of a subprime shock, “untested financial innovation and leverage has led to a confidence crisis,” said Pierre Cailleteau, Moody’s Investors Service chief economist in London.
The advent of radically more complex structured products coincided with another trend in finance: the explosion of credit derivatives, financial tools that enabled institutions like banks and hedge funds to try to hedge exposure to the huge credit market, like loans to corporations.
“Credit derivatives are the fastest-growing part of any bank,” says Derek Smith, head of flow credit trading at Deutsche Bank. He cited 80 percent growth in 2007 for his firm and average annual growth of about 40 percent for the industry.
Blythe Masters, a veteran of the credit derivatives revolution and the head of global derivatives at JPMorgan Chase, added, “There has been a wall of money coming at the credit markets in the past five years.”
Credit default swaps (what are widely known as a credit derivatives) allow two parties to exchange the credit risk of an issuer, such as a company. For example, if an investor buys a credit default swap on General Motors, called buying protection, he or she makes money when the credit weakens and makes a lot of money if G.M. goes bankrupt.
In the meantime, the seller of protection makes a fee from the buyer and profits if the company’s credit improves.
Credit derivatives radically shifted the financial landscape for two reasons: they allowed banks to hedge some of their exposure to the huge loans they give corporations, and they have allowed investors to bet against, or short credit, as a hedge and to speculate.
For banks, shedding exposure to the credit risk of companies, or governments, or individuals, means not having to reserve as much capital for potential losses. That frees up capital to make even more loans — to homeowners, institutional investors, corporations or hedge funds.
The banks found a perfect partner in hedge funds, lightly regulated pools of capital with high fees that were looking for better returns. Insurance companies and pension funds also sought the higher returns, called yield, as interest rates hit historically low rates.
“Fundamentally, having 100 or 1,000 people with a slice of the risk is better than a bank holding 100 percent of the risk,” said Robert G. Pickel, chief executive of the International Swaps and Derivatives Association.
As the market for C.D.O.’s backed by structured products choked in recent weeks, the overall credit derivatives market has performed well, say some industry participants.
“Credit derivatives have done a good job at doing exactly what they should do: they have accurately and immediately reflected the markets’ pricing of risk throughout this crisis,” Ms. Masters said. But there has been a lot of pain. Investors purchasing derivatives are making a bet that the underlying stock or bond or loan is going to rise or fall, but they do not own it. Because buying a derivative requires much less capital than buying the loan or bond it is derived from, banks and traders can buy more of them than they could loans or bonds. That can translate into huge gains — or, in times of stress, outsize losses.
Some institutions are not parsing what products are riskier than others, but rather they are rushing for the door. First State Investments in Singapore has slashed its holdings in all Asian financial firms in recent weeks.
At this point “it doesn’t really matter what their exposure is” to subprime products through derivatives, said Alistair Thompson, the deputy head of Asia-Pacific equities at First State. “What concerns us is the sentiment” in the market, he said.
The surprises are certainly not over: there were whispers among investors in Australia this week that some local funds were still turning up unexpected subprime exposure because of credit derivatives, weeks after the problems first surfaced.
While that happens, markets are sure to remain skittish.
“Liquidity can just be turned off, and essentially it is a confidence game,” Mr. Thompson said.
Link to online story here. Archived here.
(In accordance with Title 17 U.S.C. Section 107, this material is distributed without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes. Plainfield Today, Plainfield Stuff and Clippings have no affiliation whatsoever with the originator of these articles nor are Plainfield Today, Plainfield Stuff or Clippings endorsed or sponsored by the originator.)
News Analysis
Why a U.S. Subprime Mortgage Crisis Is Felt Around the World
By JENNY ANDERSON and HEATHER TIMMONS
The evening entertainment for roughly 500 financial executives at the Deutsche Bank global derivatives conference last month in Barcelona did not come cheap — the Rolling Stones reportedly were paid more than $5 million.
“The best part is, it’s coming out of your bonuses,” Mick Jagger joked to the crowd.
The hosts of the conference could well afford it. After all, the business of creating new finance vehicles like derivatives and structured products has exploded in recent years. And at the time of the conference, there remained a mostly rosy view of such instruments, because of their ability to help businesses and investors spread out risk.
But the global financial turmoil — set off by problems with subprime mortgages — has prompted a backlash in some quarters against such financial engineering.
More broadly, it has led to a better understanding of the downside of spreading risk so well — it can be felt in all corners of the world, unsettling hedge funds, banks and stock markets as far away as Australia, Thailand and Germany. In effect, reducing risk on a global scale appears to have increased it for some players.
“The market appears to be finding it harder to truly understand the inherent and underlying risks involved,” said Chris Rexworthy, who was a regulator with the Financial Services Authority in Britain for 10 years before moving recently to the private sector.
The backlash is particularly sharp abroad, in countries that were surprised to find that problems with United States homeowners could be felt so keenly in their home markets. Foreign politicians and regulators are seeking a role in the oversight of American markets, banks and rating agencies. The head of the Council of Economic Analysis in France has called for complex securities to be scrutinized before banks are authorized to buy them.
In the United States, regulators appear to think that the new and often unregulated investment vehicles — which have shrunk the world and speeded up business in much the same way as the Internet — are not all inherently flawed.
This opinion is captured in an analogy offered by Peter Douglas, the founder of GFIA, a hedge fund research firm in Singapore. He likens using derivatives to power tools. If you know how to use them, he said, they are exponentially better and faster for building a house, compared with using hammers, screwdrivers and handsaws.
If you don’t, “you could drill a hole in your head," he said.
Funds and banks around the world have taken hits because they purchased bonds, or risk related to bonds, backed by bad home loans, often bundled into financial instruments called collateralized debt obligations, or C.D.O.’s.
The losses have often surprised the investors, and in some cases the funds and the executives of the banks, who were unaware of the extent of their risks.
The crisis extended as far as the $2.2 trillion money market that finances the day-to-day operations of businesses, as investors wondered whether the underlying assets were sound. “It’s amazing how much ignorance and fear are out there,” said Kevin Davis, a professor of finance at the University of Melbourne.
The confusion about these products lies in part in their complexity. Structured products are pooled assets that have been sliced and diced into ever more smaller, more specialized pieces.
They offered investors higher returns at a time when traditional fixed income, or debt-related products, were producing low returns.
As low interest rates fueled a lending boom to borrowers with weak credit, banks looked for new ways to package those loans, so they could sell more. A central building block to offset the risk was asset-backed securities, which are bonds backed by pools of mortgages or other income-producing assets, like student loans, auto loans, and credit card receivables.
Banks and other financial institutions pooled those asset-backed securities into new units, dividing them up again and issuing securities against them, creating collateralized debt obligations.
The idea took off, with new combinations that were further removed from the original asset. New creations included C.D.O.’s of C.D.O.’s, called C.D.O.-squared. There is even a C.D.O.-cubed.
According to JPMorgan, there are about $1.5 trillion in global collateralized debt obligations, and about $500 billion to $600 billion in structured-finance C.D.O.’s, referring to those made up of bonds backed by subprime mortgages, slightly safer mortgages and commercial mortgage backed securities.
Many of the products have proved to be highly problematic as the underlying assets — the subprime mortgages — have gone bust, revealing dangerous amounts of leverage in the securities that few people could value. As a result, they have become like a potent computer virus, leaving many people fearful that they too will be affected.
“A lot of risk in the subprime asset-backed market is embedded in, and amplified by, C.D.O.’s,” said Rod Dubitsky, head of asset-backed research at Credit Suisse.
Weaknesses in the system were laid bare, including ratings that did not accurately reflect risk and faulty assumptions on how diversified pools with multiple layers of leverage would react.
That in turn spooked investors in other markets, who started selling anything they thought might be risky, from stocks to loans, and in some cases putting their money into cash.
The combination of a subprime shock, “untested financial innovation and leverage has led to a confidence crisis,” said Pierre Cailleteau, Moody’s Investors Service chief economist in London.
The advent of radically more complex structured products coincided with another trend in finance: the explosion of credit derivatives, financial tools that enabled institutions like banks and hedge funds to try to hedge exposure to the huge credit market, like loans to corporations.
“Credit derivatives are the fastest-growing part of any bank,” says Derek Smith, head of flow credit trading at Deutsche Bank. He cited 80 percent growth in 2007 for his firm and average annual growth of about 40 percent for the industry.
Blythe Masters, a veteran of the credit derivatives revolution and the head of global derivatives at JPMorgan Chase, added, “There has been a wall of money coming at the credit markets in the past five years.”
Credit default swaps (what are widely known as a credit derivatives) allow two parties to exchange the credit risk of an issuer, such as a company. For example, if an investor buys a credit default swap on General Motors, called buying protection, he or she makes money when the credit weakens and makes a lot of money if G.M. goes bankrupt.
In the meantime, the seller of protection makes a fee from the buyer and profits if the company’s credit improves.
Credit derivatives radically shifted the financial landscape for two reasons: they allowed banks to hedge some of their exposure to the huge loans they give corporations, and they have allowed investors to bet against, or short credit, as a hedge and to speculate.
For banks, shedding exposure to the credit risk of companies, or governments, or individuals, means not having to reserve as much capital for potential losses. That frees up capital to make even more loans — to homeowners, institutional investors, corporations or hedge funds.
The banks found a perfect partner in hedge funds, lightly regulated pools of capital with high fees that were looking for better returns. Insurance companies and pension funds also sought the higher returns, called yield, as interest rates hit historically low rates.
“Fundamentally, having 100 or 1,000 people with a slice of the risk is better than a bank holding 100 percent of the risk,” said Robert G. Pickel, chief executive of the International Swaps and Derivatives Association.
As the market for C.D.O.’s backed by structured products choked in recent weeks, the overall credit derivatives market has performed well, say some industry participants.
“Credit derivatives have done a good job at doing exactly what they should do: they have accurately and immediately reflected the markets’ pricing of risk throughout this crisis,” Ms. Masters said. But there has been a lot of pain. Investors purchasing derivatives are making a bet that the underlying stock or bond or loan is going to rise or fall, but they do not own it. Because buying a derivative requires much less capital than buying the loan or bond it is derived from, banks and traders can buy more of them than they could loans or bonds. That can translate into huge gains — or, in times of stress, outsize losses.
Some institutions are not parsing what products are riskier than others, but rather they are rushing for the door. First State Investments in Singapore has slashed its holdings in all Asian financial firms in recent weeks.
At this point “it doesn’t really matter what their exposure is” to subprime products through derivatives, said Alistair Thompson, the deputy head of Asia-Pacific equities at First State. “What concerns us is the sentiment” in the market, he said.
The surprises are certainly not over: there were whispers among investors in Australia this week that some local funds were still turning up unexpected subprime exposure because of credit derivatives, weeks after the problems first surfaced.
While that happens, markets are sure to remain skittish.
“Liquidity can just be turned off, and essentially it is a confidence game,” Mr. Thompson said.
Link to online story here. Archived here.
(In accordance with Title 17 U.S.C. Section 107, this material is distributed without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes. Plainfield Today, Plainfield Stuff and Clippings have no affiliation whatsoever with the originator of these articles nor are Plainfield Today, Plainfield Stuff or Clippings endorsed or sponsored by the originator.)
Thursday, August 30, 2007
Market Crisis of 2007 - Economist - Policy: What would Bagehot do?
Published in The Economist, Thursday, August 16, 2007
Economics focus
What would Bagehot do?
Should central banks act as buyers of last resort?
Aug 16th 2007
From The Economist print edition
HOWEVER much marble they lay in their foyers, banks have typically been brittle institutions. They borrow short (collecting deposits or short-term loans that might have to be repaid quickly) and lend long (making loans that cannot easily be converted into cash at anything close to their value to the bank).
A bank is solvent if its assets are worth more than the money it owes to its depositors and creditors. As long as its depositors believe that their money is safe, their faith is rewarded. But even a solvent bank can be broken by a bank run. If depositors fear that others will withdraw their money, making claims on the bank's reserves of cash, nobody will want to be last in line. Since a bank cannot redeem more than a fraction of its deposits at any one time, the depositors' rush to escape with their money paradoxically ensures that some of them will lose it.
The damage may not stop there. A run on one bank can shake faith in another, if only because depositors have no reliable way to distinguish between sound and unsound institutions. As the banking system comes under threat, the supply of credit to businesses and households will be interrupted. And since cheques and other payments are often drawn on bank accounts, the payments system can come under strain.
In “Lombard Street”, his 1873 account of the money markets, Walter Bagehot urged the Bank of England to stave off such panics by lending “quickly, freely and readily”, at a penalty rate of interest, to any bank that can offer “good securities” as collateral. When this newspaper laid out these principles in September 1866, they were described by a director of the Bank of England as “the most mischievous doctrine ever broached in the monetary or banking world in this country”.
But as Bagehot pointed out, by lending liberally, central banks make it less likely that their money will be needed. By demanding good collateral, the central bank can try to distinguish insolvent banks from illiquid ones; and by charging a penalty rate of interest, it ensures that it is truly the lender of last resort.
Bagehot's mischievous doctrine is now conventional wisdom among central banks, as last week's events dramatically demonstrated. First the European Central Bank and then the Federal Reserve intervened liberally, lending against good collateral. They departed from Bagehot only in not charging a penalty rate.
Bank architecture has moved on since Bagehot's day: neo-classical columns giving way to glass atriums. Their position in the financial architecture has also changed. Companies that would once have turned to a bank for an overdraft or a loan now sell paper or bonds to the market. Home mortgages are now bundled into securities and sold on.
But as the past few weeks have shown, the financial system remains brittle. Hedge funds, for example, have ventured into thinly traded securities, such as collateralised-debt obligations (CDOs), that nowadays are easy to dispose of only in the mathematical models they use to value them. On the other side of the balance sheet, the funds have short-term financing from multiple sources. If a fund starts to show losses, its backers may lose faith in its trades. But even if they believe it will eventually make money, they might grow nervous about the fund's other backers. Just like a nervous depositor eyeing the queues in front of a bank, one hedge-fund creditor may demand its collateral before everyone else grabs theirs. If, to muster collateral, a fund is forced to sell assets into a falling market, a profitable trade can quickly become unprofitable. In this way, seasons of alarm “beget the calamities they dread,” as Bagehot put it.
Should anyone else care? Some of the buyers of CDOs are big enough that their failure can hit the banks that sponsor or finance them. It could also cause the credit markets to seize up, interrupting the provision of finance to the economy. What would Bagehot do in such circumstances? Making it cheaper for banks to lend to each other is a rather indirect method of intervention. The Fed's rate cuts in the autumn of 1998, as Long-Term Capital Management, a big hedge fund, neared collapse, allowed banks to pick up the pieces as the capital markets came unstuck. But such tactics might not always do the trick.
The new mischief-makers
Willem Buiter of the London School of Economics and Anne Sibert of Birkbeck College, London, have advocated their own mischievous doctrine*. They think central banks should become “market-makers of last resort”, setting a price for securities that can no longer be sold on “orderly” markets because distress sales are pushing prices far below their fundamental value.
The central bank could make a market in CDOs, say, either by accepting them as collateral or by buying them outright. In either case, it would have to make up its mind about the underlying risk of such instruments and an appropriate penalty price. If it gets its calculations wrong, the central bank may lose money and face. But, the two authors say, preserving financial stability is more important than “covering the central bank's posterior”.
The bigger danger is that the central bank might make the next crisis more likely if it goes too far to protect investors' posteriors in this one. After all, they should anticipate that a security might not be easy to trade. But they won't deal with this “liquidity risk” if they can rely on the central bank to create a liquid market in whatever security has got them into trouble.
Banks, in return for the protection offered by a lender of last resort and by deposit insurance, accept restrictions on how far they can extend themselves. Mr Buiter thinks that hedge funds should not enjoy the protection of a central bank until they too are willing to accept analogous restrictions. In the meantime, perhaps they should lay more marble in their foyers.
* maverecon.blogspot.com/2007/08/central-bank-as-market-maker-of-last.html
Link to online story here. Archived here.
(Note: Online stories may be taken down by their publisher after a period of time or made available for a fee. Links posted here is from the original online publication of this piece.)
(In accordance with Title 17 U.S.C. Section 107, this material is distributed without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes. Plainfield Today, Plainfield Stuff and Clippings have no affiliation whatsoever with the originator of these articles nor are Plainfield Today, Plainfield Stuff or Clippings endorsed or sponsored by the originator.)
Economics focus
What would Bagehot do?
Should central banks act as buyers of last resort?
Aug 16th 2007
From The Economist print edition
HOWEVER much marble they lay in their foyers, banks have typically been brittle institutions. They borrow short (collecting deposits or short-term loans that might have to be repaid quickly) and lend long (making loans that cannot easily be converted into cash at anything close to their value to the bank).
A bank is solvent if its assets are worth more than the money it owes to its depositors and creditors. As long as its depositors believe that their money is safe, their faith is rewarded. But even a solvent bank can be broken by a bank run. If depositors fear that others will withdraw their money, making claims on the bank's reserves of cash, nobody will want to be last in line. Since a bank cannot redeem more than a fraction of its deposits at any one time, the depositors' rush to escape with their money paradoxically ensures that some of them will lose it.
The damage may not stop there. A run on one bank can shake faith in another, if only because depositors have no reliable way to distinguish between sound and unsound institutions. As the banking system comes under threat, the supply of credit to businesses and households will be interrupted. And since cheques and other payments are often drawn on bank accounts, the payments system can come under strain.
In “Lombard Street”, his 1873 account of the money markets, Walter Bagehot urged the Bank of England to stave off such panics by lending “quickly, freely and readily”, at a penalty rate of interest, to any bank that can offer “good securities” as collateral. When this newspaper laid out these principles in September 1866, they were described by a director of the Bank of England as “the most mischievous doctrine ever broached in the monetary or banking world in this country”.
But as Bagehot pointed out, by lending liberally, central banks make it less likely that their money will be needed. By demanding good collateral, the central bank can try to distinguish insolvent banks from illiquid ones; and by charging a penalty rate of interest, it ensures that it is truly the lender of last resort.
Bagehot's mischievous doctrine is now conventional wisdom among central banks, as last week's events dramatically demonstrated. First the European Central Bank and then the Federal Reserve intervened liberally, lending against good collateral. They departed from Bagehot only in not charging a penalty rate.
Bank architecture has moved on since Bagehot's day: neo-classical columns giving way to glass atriums. Their position in the financial architecture has also changed. Companies that would once have turned to a bank for an overdraft or a loan now sell paper or bonds to the market. Home mortgages are now bundled into securities and sold on.
But as the past few weeks have shown, the financial system remains brittle. Hedge funds, for example, have ventured into thinly traded securities, such as collateralised-debt obligations (CDOs), that nowadays are easy to dispose of only in the mathematical models they use to value them. On the other side of the balance sheet, the funds have short-term financing from multiple sources. If a fund starts to show losses, its backers may lose faith in its trades. But even if they believe it will eventually make money, they might grow nervous about the fund's other backers. Just like a nervous depositor eyeing the queues in front of a bank, one hedge-fund creditor may demand its collateral before everyone else grabs theirs. If, to muster collateral, a fund is forced to sell assets into a falling market, a profitable trade can quickly become unprofitable. In this way, seasons of alarm “beget the calamities they dread,” as Bagehot put it.
Should anyone else care? Some of the buyers of CDOs are big enough that their failure can hit the banks that sponsor or finance them. It could also cause the credit markets to seize up, interrupting the provision of finance to the economy. What would Bagehot do in such circumstances? Making it cheaper for banks to lend to each other is a rather indirect method of intervention. The Fed's rate cuts in the autumn of 1998, as Long-Term Capital Management, a big hedge fund, neared collapse, allowed banks to pick up the pieces as the capital markets came unstuck. But such tactics might not always do the trick.
The new mischief-makers
Willem Buiter of the London School of Economics and Anne Sibert of Birkbeck College, London, have advocated their own mischievous doctrine*. They think central banks should become “market-makers of last resort”, setting a price for securities that can no longer be sold on “orderly” markets because distress sales are pushing prices far below their fundamental value.
The central bank could make a market in CDOs, say, either by accepting them as collateral or by buying them outright. In either case, it would have to make up its mind about the underlying risk of such instruments and an appropriate penalty price. If it gets its calculations wrong, the central bank may lose money and face. But, the two authors say, preserving financial stability is more important than “covering the central bank's posterior”.
The bigger danger is that the central bank might make the next crisis more likely if it goes too far to protect investors' posteriors in this one. After all, they should anticipate that a security might not be easy to trade. But they won't deal with this “liquidity risk” if they can rely on the central bank to create a liquid market in whatever security has got them into trouble.
Banks, in return for the protection offered by a lender of last resort and by deposit insurance, accept restrictions on how far they can extend themselves. Mr Buiter thinks that hedge funds should not enjoy the protection of a central bank until they too are willing to accept analogous restrictions. In the meantime, perhaps they should lay more marble in their foyers.
* maverecon.blogspot.com/2007/08/central-bank-as-market-maker-of-last.html
Link to online story here. Archived here.
(Note: Online stories may be taken down by their publisher after a period of time or made available for a fee. Links posted here is from the original online publication of this piece.)
(In accordance with Title 17 U.S.C. Section 107, this material is distributed without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes. Plainfield Today, Plainfield Stuff and Clippings have no affiliation whatsoever with the originator of these articles nor are Plainfield Today, Plainfield Stuff or Clippings endorsed or sponsored by the originator.)
Market Crisis of 2007 - Economist - Risk: Surviving the markets
Published in The Economist, Thursday, August 16, 2007
Risk and the new financial order
Surviving the markets
The new financial order is undergoing its harshest test.
It will not be pretty, but it is necessary
Aug 16th 2007
From The Economist print edition
THE lifeguards had been scanning the horizon for an oil-price shock, a bankrupt buy-out or a terrorist attack. But when the big wave struck last week it surprised them by coming from inside the financial system and threatening to swamp an unlikely shore, the money markets where banks lend to each other to help cover their daily operations. Investors have been asking for years if the frantic innovation in finance, especially the securitisation of just about every form of debt into a tradable asset, was a way to spread risk efficiently, or whether this left the financial system prone to rare—but cataclysmic—failures. It looks as if investors are about to find out.
Over the past week central banks have lent tens of billions of dollars to restore confidence to the markets (see article). But it is already clear that this mess is about more than a bit of rash mortgage lending to Americans who were in the habit of falling behind with their monthly payments. Hedge funds and private-equity firms, kings of the boom, are nursing big losses. Debt markets that once handed out cash to all comers are tight or closed altogether. In almost every asset market, investors are scurrying to reprice risk—which mostly means to reduce it.
The gravest and most immediate threat is to the banking system. For the time being, banks no longer trust other banks enough to lend them money except on onerous terms; equally worryingly, they lack confidence that other banks will trust them if they want to borrow. It is alarming when the very outfits that exist to supply the economy with credit start to hoard it from each other. At best this tightens monetary policy; at worst, a shortage of cash will cripple the payments system and cause runs on otherwise solvent banks and businesses that cannot rapidly raise funds.
Underneath all the new technology and the fancy derivatives with strange acronyms is a dilemma as old as banking itself. Anyone who thinks that lending has been too loose—and many bankers do—should welcome a purge: better now than later when the imbalances would be bigger and the economy probably weaker. But if good banks fail and money for good companies dries up, the purge will wreak huge and wasteful damage on healthy parts of the economy. How likely is that?
Fear of the deep
Financial crises are always about the way people do business, and not just the deals they have struck. Yet this one goes deeper than most. The spreading panic has shown up weaknesses in some of the foundations of modern finance. The past 20 years have created untold wealth. As securities and markets have steadily taken the place of old-style bank managers, the number of potential investors has grown and the cost of capital has fallen. Much good has come of that.
But there is a price that is only now becoming apparent. Because lenders expected to be able to sell on the risk of default to someone else, they lent too easily. After all, they would not have to pick up the pieces. In theory, that risk should have been borne by the people best able to carry it. But with everybody having sold on the risk to everyone else—and the risk often being carved up, repackaged and sold again—nobody is sure where the losses are. The fear is that some risks ended up with those who least understood what they were getting into, and fear is a potent force in this disintermediated world. In the interbank market, every counterparty was potentially vulnerable. Even small amounts of bad credit can drive out good.
In theory, ratings agencies and mathematical models help investors price the risk they are taking on, even if the securities they are buying are scarcely traded. Yet when some supposedly good-quality assets proved to be worth little, people lost faith in the models and the ratings. Across the board, investors had failed to take account of how fast and how far asset prices fall when everyone wants to sell at the same time. Hard-to-sell long-term securities had been bought with short-lived debt, which left borrowers vulnerable to a change in sentiment every time the debt fell due. It does nothing to restore confidence when the biggest model-driven hedge funds had to get in new money. The people at Goldman Sachs lost a packet when something happened that their computers told them should occur only once every 100 millennia.
Reassess, reprice and then rebound
The retreat to a new level of risk was never going to be orderly or free of casualties. Neither should it be. Bankers and investors need to suffer precisely because the methods of modern finance have been found wanting. It sounds Darwinian, but the brutal demonstration that you pay for your sins is what leads the system to evolve. Markets learn from their mistakes. Only fear will spur investors to price risks better and get them to put more effort into monitoring their counterparties.
If these lessons are to sink in, central bankers must stand back—as, by and large, they have done. Every intervention now will be taken as a sign of what the regulators will do next time. If they bail out banks that have mispriced risk, the mispricing will continue. And when the central banks do step in, it should not be to save the financiers. The cost of intervention is warranted only to save the rest of the economy from the financiers' folly. By that test, central banks were right to lend money to the banks in recent days, because it ensured that a liquidity crisis did not become a solvency crisis. They may yet have to take over a failed bank, though only if that is needed to stop a run. It is still far too soon to cut interest rates.
Because this crisis taps so deeply into the newly devised structures of finance, anyone who says the worst is definitely over is either a fool or someone with a position to protect. As risk has become bewilderingly dispersed, so too has information. Nobody yet knows who will bear what losses from mortgages—because nobody can be sure what those loans are really worth. Nobody knows if tighter lending standards will oblige borrowers to raise more capital, triggering more sales in stockmarkets and more pain. Nobody knows how messy the inevitable bankruptcies will turn out to be. What markets need now is time to piece that information back together. Time before the next wave strikes.
Link to online story here. Archived here.
(Note: Online stories may be taken down by their publisher after a period of time or made available for a fee. Links posted here is from the original online publication of this piece.)
(In accordance with Title 17 U.S.C. Section 107, this material is distributed without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes. Plainfield Today, Plainfield Stuff and Clippings have no affiliation whatsoever with the originator of these articles nor are Plainfield Today, Plainfield Stuff or Clippings endorsed or sponsored by the originator.)
Risk and the new financial order
Surviving the markets
The new financial order is undergoing its harshest test.
It will not be pretty, but it is necessary
Aug 16th 2007
From The Economist print edition
THE lifeguards had been scanning the horizon for an oil-price shock, a bankrupt buy-out or a terrorist attack. But when the big wave struck last week it surprised them by coming from inside the financial system and threatening to swamp an unlikely shore, the money markets where banks lend to each other to help cover their daily operations. Investors have been asking for years if the frantic innovation in finance, especially the securitisation of just about every form of debt into a tradable asset, was a way to spread risk efficiently, or whether this left the financial system prone to rare—but cataclysmic—failures. It looks as if investors are about to find out.
Over the past week central banks have lent tens of billions of dollars to restore confidence to the markets (see article). But it is already clear that this mess is about more than a bit of rash mortgage lending to Americans who were in the habit of falling behind with their monthly payments. Hedge funds and private-equity firms, kings of the boom, are nursing big losses. Debt markets that once handed out cash to all comers are tight or closed altogether. In almost every asset market, investors are scurrying to reprice risk—which mostly means to reduce it.
The gravest and most immediate threat is to the banking system. For the time being, banks no longer trust other banks enough to lend them money except on onerous terms; equally worryingly, they lack confidence that other banks will trust them if they want to borrow. It is alarming when the very outfits that exist to supply the economy with credit start to hoard it from each other. At best this tightens monetary policy; at worst, a shortage of cash will cripple the payments system and cause runs on otherwise solvent banks and businesses that cannot rapidly raise funds.
Underneath all the new technology and the fancy derivatives with strange acronyms is a dilemma as old as banking itself. Anyone who thinks that lending has been too loose—and many bankers do—should welcome a purge: better now than later when the imbalances would be bigger and the economy probably weaker. But if good banks fail and money for good companies dries up, the purge will wreak huge and wasteful damage on healthy parts of the economy. How likely is that?
Fear of the deep
Financial crises are always about the way people do business, and not just the deals they have struck. Yet this one goes deeper than most. The spreading panic has shown up weaknesses in some of the foundations of modern finance. The past 20 years have created untold wealth. As securities and markets have steadily taken the place of old-style bank managers, the number of potential investors has grown and the cost of capital has fallen. Much good has come of that.
But there is a price that is only now becoming apparent. Because lenders expected to be able to sell on the risk of default to someone else, they lent too easily. After all, they would not have to pick up the pieces. In theory, that risk should have been borne by the people best able to carry it. But with everybody having sold on the risk to everyone else—and the risk often being carved up, repackaged and sold again—nobody is sure where the losses are. The fear is that some risks ended up with those who least understood what they were getting into, and fear is a potent force in this disintermediated world. In the interbank market, every counterparty was potentially vulnerable. Even small amounts of bad credit can drive out good.
In theory, ratings agencies and mathematical models help investors price the risk they are taking on, even if the securities they are buying are scarcely traded. Yet when some supposedly good-quality assets proved to be worth little, people lost faith in the models and the ratings. Across the board, investors had failed to take account of how fast and how far asset prices fall when everyone wants to sell at the same time. Hard-to-sell long-term securities had been bought with short-lived debt, which left borrowers vulnerable to a change in sentiment every time the debt fell due. It does nothing to restore confidence when the biggest model-driven hedge funds had to get in new money. The people at Goldman Sachs lost a packet when something happened that their computers told them should occur only once every 100 millennia.
Reassess, reprice and then rebound
The retreat to a new level of risk was never going to be orderly or free of casualties. Neither should it be. Bankers and investors need to suffer precisely because the methods of modern finance have been found wanting. It sounds Darwinian, but the brutal demonstration that you pay for your sins is what leads the system to evolve. Markets learn from their mistakes. Only fear will spur investors to price risks better and get them to put more effort into monitoring their counterparties.
If these lessons are to sink in, central bankers must stand back—as, by and large, they have done. Every intervention now will be taken as a sign of what the regulators will do next time. If they bail out banks that have mispriced risk, the mispricing will continue. And when the central banks do step in, it should not be to save the financiers. The cost of intervention is warranted only to save the rest of the economy from the financiers' folly. By that test, central banks were right to lend money to the banks in recent days, because it ensured that a liquidity crisis did not become a solvency crisis. They may yet have to take over a failed bank, though only if that is needed to stop a run. It is still far too soon to cut interest rates.
Because this crisis taps so deeply into the newly devised structures of finance, anyone who says the worst is definitely over is either a fool or someone with a position to protect. As risk has become bewilderingly dispersed, so too has information. Nobody yet knows who will bear what losses from mortgages—because nobody can be sure what those loans are really worth. Nobody knows if tighter lending standards will oblige borrowers to raise more capital, triggering more sales in stockmarkets and more pain. Nobody knows how messy the inevitable bankruptcies will turn out to be. What markets need now is time to piece that information back together. Time before the next wave strikes.
Link to online story here. Archived here.
(Note: Online stories may be taken down by their publisher after a period of time or made available for a fee. Links posted here is from the original online publication of this piece.)
(In accordance with Title 17 U.S.C. Section 107, this material is distributed without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes. Plainfield Today, Plainfield Stuff and Clippings have no affiliation whatsoever with the originator of these articles nor are Plainfield Today, Plainfield Stuff or Clippings endorsed or sponsored by the originator.)
Market Crisis of 2007 - NY Times - OpEd: Fed's Subprime Solution
Published in the New York Times, Sunday, August 26, 2007
Op-Ed Contributor
The Fed’s Subprime Solution
By JAMES GRANT
THE subprime mortgage crisis of 2007 is, in fact, a credit crisis — a worldwide disruption in lending and borrowing. It is only the latest in a long succession of such disturbances. Who’s to blame? The human race, first and foremost. Well-intended public policy, second. And Wall Street, third — if only for taking what generations of policy makers have so unwisely handed it.
Possibly, one lender and one borrower could do business together without harm to themselves or to the economy around them. But masses of lenders and borrowers invariably seem to come to grief, as they have today — not only in mortgages but also in a variety of other debt instruments. First, they overdo it until the signs of excess become too obvious to ignore. Then, with contrite and fearful hearts, they proceed to underdo it. Such is the “credit cycle,” the eternal migration of lenders and borrowers between the extreme points of accommodation and stringency.
Significantly, such cycles have occurred in every institutional, monetary and regulatory setting. No need for a central bank, or for newfangled mortgage securities, or for the proliferation of hedge funds to foment a panic — there have been plenty of dislocations without any of the modern-day improvements.
Late in the 1880s, long before the institution of the Federal Reserve, Eastern savers and Western borrowers teamed up to inflate the value of cropland in the Great Plains. Gimmicky mortgages — pay interest and only interest for the first two years! — and loose talk of a new era in rainfall beguiled the borrowers. High yields on Western mortgages enticed the lenders. But the climate of Kansas and Nebraska reverted to parched, and the drought-stricken debtors trudged back East or to the West Coast in wagons emblazoned, “In God we trusted, in Kansas we busted.” To the creditors went the farms.
Every crackup is the same, yet every one is different. Today’s troubles are unusual not because the losses have been felt so far from the corner of Broad and Wall, or because our lenders are unprecedentedly reckless. The panics of the second half of the 19th century were trans-Atlantic affairs, while the debt abuses of the 1920s anticipated the most dubious lending practices of 2006. Our crisis will go down in history for different reasons.
One is the sheer size of the debt in which people have belatedly lost faith. The issuance of one kind of mortgage-backed structure — collateralized debt obligations — alone runs to $1 trillion. The shocking fragility of recently issued debt is another singular feature of the 2007 downturn — alarming numbers of defaults despite high employment and reasonably strong economic growth. Hundreds of billions of dollars of mortgage-backed securities would, by now, have had to be recalled if Wall Street did business as Detroit does.
Benjamin Graham and David L. Dodd, in the 1940 edition of their seminal volume “Security Analysis,” held that the acid test of a bond or a mortgage issuer is its ability to discharge its financial obligations “under conditions of depression rather than prosperity.” Today’s mortgage market can’t seem to weather prosperity.
A third remarkable aspect of the summer’s troubles is the speed with which the world’s central banks have felt it necessary to intervene. Bear in mind that when the Federal Reserve cut its discount rate on Aug. 17 — a move intended to restore confidence and restart the machinery of lending and borrowing — the Dow Jones industrial average had fallen just 8.25 percent from its record high. The Fed has so far refused to reduce the federal funds rate, the main interest rate it fixes, but it has all but begged the banks to avail themselves of the dollars they need through the slightly unconventional means of borrowing at the discount window — that is, from the Fed itself.
What could account for the weakness of our credit markets? Why does the Fed feel the need to intervene at the drop of a market? The reasons have to do with an idea set firmly in place in the 1930s and expanded at every crisis up to the present. This is the notion that, while the risks inherent in the business of lending and borrowing should be finally borne by the public, the profits of that line of work should mainly accrue to the lenders and borrowers.
It has not been lost on our Wall Street titans that the government is the reliable first responder to scenes of financial distress, or that there will always be enough paper dollars to go around to assist the very largest financial institutions. In the aftermath of the failure of Long-Term Capital Management, the genius-directed hedge fund that came a cropper in 1998, the Fed — under Alan Greenspan — delivered three quick reductions in the federal funds rate. Thus fortified, lenders and borrowers, speculators and investors, resumed their manic buying of technology stocks. That bubble burst in March 2000.
Understandably, it’s only the selling kind of panic to which the government dispatches its rescue apparatus. Few object to riots on the upside. But bull markets, too, go to extremes. People get carried away, prices go too high and economic resources go where they shouldn’t. Bear markets are nature’s way of returning to the rule of reason.
But the regulatory history of the past decade is the story of governmental encroachment on the bears’ habitat. Under Mr. Greenspan, the Fed set its face against falling prices everywhere. As it intervened to save the financial markets in 1998, so it printed money in 2002 and 2003 to rescue the economy. From what? From the peril of everyday lower prices — “deflation,” the economists styled it. In this mission, at least, the Fed succeeded. Prices, especially housing prices, soared. Knowing that the Fed would do its best to engineer rising prices, people responded rationally. They borrowed lots of money at the Fed’s ultralow interest rates.
Now comes the bill for that binge and, with it, cries for even greater federal oversight and protection. Ben S. Bernanke, Mr. Greenspan’s successor at the Fed (and his loyal supporter during the antideflation hysteria), is said to be resisting the demand for broadly lower interest rates. Maybe he is seeing the light that capitalism without financial failure is not capitalism at all, but a kind of socialism for the rich.
In any case, to all of us, rich and poor alike, the Fed owes a pledge that it will do what it can and not do what it can’t. High on the list of things that no human agency can, or should, attempt is manipulating prices to achieve a more stable and prosperous economy. Jiggling its interest rate, the Fed can impose the appearance of stability today, but only at the cost of instability tomorrow. By the looks of things, tomorrow is upon us already.
A century ago, on the eve of the Panic of 1907, the president of the National City Bank of New York, James Stillman, prepared for the troubles he saw coming. “If by able and judicious management,” he briefed his staff, “we have money to help our dealers when trust companies have [failed], we will have all the business we want for many years.” The panic came and his bank, today called Citigroup, emerged more profitable than ever.
Last month, Stillman’s corporate descendant, Chuck Prince, chief executive of Citigroup, dismissed fears about an early end to the postmillennial debt frolics. “When the music stops,” he told The Financial Times, “in terms of liquidity, things will get complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.”
What a difference a century makes.
James Grant, the editor of Grant’s Interest Rate Observer, is the author of “Money of the Mind.”
Permalink to online story here. Archived here.
(Note: Online stories may be taken down by their publisher after a period of time or made available for a fee. Links posted here is from the original online publication of this piece.)
(In accordance with Title 17 U.S.C. Section 107, this material is distributed without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes. Plainfield Today, Plainfield Stuff and Clippings have no affiliation whatsoever with the originator of these articles nor are Plainfield Today, Plainfield Stuff or Clippings endorsed or sponsored by the originator.)
Op-Ed Contributor
The Fed’s Subprime Solution
By JAMES GRANT
THE subprime mortgage crisis of 2007 is, in fact, a credit crisis — a worldwide disruption in lending and borrowing. It is only the latest in a long succession of such disturbances. Who’s to blame? The human race, first and foremost. Well-intended public policy, second. And Wall Street, third — if only for taking what generations of policy makers have so unwisely handed it.
Possibly, one lender and one borrower could do business together without harm to themselves or to the economy around them. But masses of lenders and borrowers invariably seem to come to grief, as they have today — not only in mortgages but also in a variety of other debt instruments. First, they overdo it until the signs of excess become too obvious to ignore. Then, with contrite and fearful hearts, they proceed to underdo it. Such is the “credit cycle,” the eternal migration of lenders and borrowers between the extreme points of accommodation and stringency.
Significantly, such cycles have occurred in every institutional, monetary and regulatory setting. No need for a central bank, or for newfangled mortgage securities, or for the proliferation of hedge funds to foment a panic — there have been plenty of dislocations without any of the modern-day improvements.
Late in the 1880s, long before the institution of the Federal Reserve, Eastern savers and Western borrowers teamed up to inflate the value of cropland in the Great Plains. Gimmicky mortgages — pay interest and only interest for the first two years! — and loose talk of a new era in rainfall beguiled the borrowers. High yields on Western mortgages enticed the lenders. But the climate of Kansas and Nebraska reverted to parched, and the drought-stricken debtors trudged back East or to the West Coast in wagons emblazoned, “In God we trusted, in Kansas we busted.” To the creditors went the farms.
Every crackup is the same, yet every one is different. Today’s troubles are unusual not because the losses have been felt so far from the corner of Broad and Wall, or because our lenders are unprecedentedly reckless. The panics of the second half of the 19th century were trans-Atlantic affairs, while the debt abuses of the 1920s anticipated the most dubious lending practices of 2006. Our crisis will go down in history for different reasons.
One is the sheer size of the debt in which people have belatedly lost faith. The issuance of one kind of mortgage-backed structure — collateralized debt obligations — alone runs to $1 trillion. The shocking fragility of recently issued debt is another singular feature of the 2007 downturn — alarming numbers of defaults despite high employment and reasonably strong economic growth. Hundreds of billions of dollars of mortgage-backed securities would, by now, have had to be recalled if Wall Street did business as Detroit does.
Benjamin Graham and David L. Dodd, in the 1940 edition of their seminal volume “Security Analysis,” held that the acid test of a bond or a mortgage issuer is its ability to discharge its financial obligations “under conditions of depression rather than prosperity.” Today’s mortgage market can’t seem to weather prosperity.
A third remarkable aspect of the summer’s troubles is the speed with which the world’s central banks have felt it necessary to intervene. Bear in mind that when the Federal Reserve cut its discount rate on Aug. 17 — a move intended to restore confidence and restart the machinery of lending and borrowing — the Dow Jones industrial average had fallen just 8.25 percent from its record high. The Fed has so far refused to reduce the federal funds rate, the main interest rate it fixes, but it has all but begged the banks to avail themselves of the dollars they need through the slightly unconventional means of borrowing at the discount window — that is, from the Fed itself.
What could account for the weakness of our credit markets? Why does the Fed feel the need to intervene at the drop of a market? The reasons have to do with an idea set firmly in place in the 1930s and expanded at every crisis up to the present. This is the notion that, while the risks inherent in the business of lending and borrowing should be finally borne by the public, the profits of that line of work should mainly accrue to the lenders and borrowers.
It has not been lost on our Wall Street titans that the government is the reliable first responder to scenes of financial distress, or that there will always be enough paper dollars to go around to assist the very largest financial institutions. In the aftermath of the failure of Long-Term Capital Management, the genius-directed hedge fund that came a cropper in 1998, the Fed — under Alan Greenspan — delivered three quick reductions in the federal funds rate. Thus fortified, lenders and borrowers, speculators and investors, resumed their manic buying of technology stocks. That bubble burst in March 2000.
Understandably, it’s only the selling kind of panic to which the government dispatches its rescue apparatus. Few object to riots on the upside. But bull markets, too, go to extremes. People get carried away, prices go too high and economic resources go where they shouldn’t. Bear markets are nature’s way of returning to the rule of reason.
But the regulatory history of the past decade is the story of governmental encroachment on the bears’ habitat. Under Mr. Greenspan, the Fed set its face against falling prices everywhere. As it intervened to save the financial markets in 1998, so it printed money in 2002 and 2003 to rescue the economy. From what? From the peril of everyday lower prices — “deflation,” the economists styled it. In this mission, at least, the Fed succeeded. Prices, especially housing prices, soared. Knowing that the Fed would do its best to engineer rising prices, people responded rationally. They borrowed lots of money at the Fed’s ultralow interest rates.
Now comes the bill for that binge and, with it, cries for even greater federal oversight and protection. Ben S. Bernanke, Mr. Greenspan’s successor at the Fed (and his loyal supporter during the antideflation hysteria), is said to be resisting the demand for broadly lower interest rates. Maybe he is seeing the light that capitalism without financial failure is not capitalism at all, but a kind of socialism for the rich.
In any case, to all of us, rich and poor alike, the Fed owes a pledge that it will do what it can and not do what it can’t. High on the list of things that no human agency can, or should, attempt is manipulating prices to achieve a more stable and prosperous economy. Jiggling its interest rate, the Fed can impose the appearance of stability today, but only at the cost of instability tomorrow. By the looks of things, tomorrow is upon us already.
A century ago, on the eve of the Panic of 1907, the president of the National City Bank of New York, James Stillman, prepared for the troubles he saw coming. “If by able and judicious management,” he briefed his staff, “we have money to help our dealers when trust companies have [failed], we will have all the business we want for many years.” The panic came and his bank, today called Citigroup, emerged more profitable than ever.
Last month, Stillman’s corporate descendant, Chuck Prince, chief executive of Citigroup, dismissed fears about an early end to the postmillennial debt frolics. “When the music stops,” he told The Financial Times, “in terms of liquidity, things will get complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.”
What a difference a century makes.
James Grant, the editor of Grant’s Interest Rate Observer, is the author of “Money of the Mind.”
Permalink to online story here. Archived here.
(Note: Online stories may be taken down by their publisher after a period of time or made available for a fee. Links posted here is from the original online publication of this piece.)
(In accordance with Title 17 U.S.C. Section 107, this material is distributed without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes. Plainfield Today, Plainfield Stuff and Clippings have no affiliation whatsoever with the originator of these articles nor are Plainfield Today, Plainfield Stuff or Clippings endorsed or sponsored by the originator.)
Thursday, August 16, 2007
Mortgage Fraud - Financial Times - Payback Time
Published in the Financial Times [London], Thursday, August 9, 2007
[Mortgage Fraud]
Payback time
By Brooke Masters and Saskia Scholtes
At the height of the US subprime lending boom, taking out a mortgage could not have been easier. Low credit score and history of bankruptcy? No problem. Income too low to qualify for a mortgage? Inflate what you earn on a "stated income" loan. Nervous that your lender might check up on your "stated income"? Visit www.verifyemployment.net.
For a $55 fee, the operators of this small California company will help you get a loan by employing you as an "independent contractor". They provide payslips as "proof" of income and, for an additional $25, they also man the telephones to give you a glowing reference should your lender need it.
But perhaps the most absurd aspect of the US subprime mortgage market in recent years is that lenders became so generous with credit provision for out-of-pocket borrowers that very few checks were ever made.
That left the system extraordinarily vulnerable to widespread fraud, a possibility that federal and state prosecutors across the US have begun to look into. With the subprime crisis expected to cost investors between $50bn (£24bn, €36bn) and $100bn, according to the US Federal Reserve, these investigations could transform it from a market correction to a full-blown national scandal.
At the root of the subprime problem was easy credit: lenders and their brokers were often rewarded for generating new mortgages on the basis of volume, without being directly exposed to the consequences of borrowers defaulting. During several years of strong capital markets and strong investor appetite for high-yielding securities, lenders became accustomed to easily selling the risky home loans they made to Wall Street banks. The banks in turn packaged them into securities and sold them to investors around the globe.
Such ease of mortgage funding allowed thousands of borrowers to get away with fraudulently mis-stating their incomes, often with the encouragement of their brokers. More ambitious fraudsters appear to have taken out multiple mortgages and walked away with the cash.
Karen Gelernt, a partner at law firm Cadwalader, Wickersham & Taft, says: "The difficulty is getting a handle on the size of the problem, because there is no real mechanism for reporting fraud for most originators in this market. In fact, they had every incentive not to report."
Fraud has been detected up and down the financing chain: just as borrowers have lied to get better rates and larger loans, mortgage brokers and loan officers have lied to borrowers about the terms of their loans and may also have lied to the banks about the qualifications of the borrowers. Appraisers, likewise, have lied about the value of the properties involved.
"The recent rapid expansion of the subprime market was clearly accompanied by deterioration in underwriting standards and, in some cases, by abusive lending practices and outright fraud," Ben Bernanke, Fed chairman, recently told lawmakers. With mortgage rates rising and house prices falling, subprime borrowers have been defaulting at record rates.
The fallout is working its way up from the retail level - forcing people out of their homes and lenders into bankruptcy. Investment banks have lost revenue as investors back away from mortgage securities and a handful of high-profile hedge funds have collapsed - most notably two highly leveraged funds managed by Bear Stearns. The crisis has contributed to turmoil in financial markets in recent weeks and could threaten the health of the US economy as lenders tighten access to credit, putting a drag on consumer spending.
For some, this rapid and dramatic unravelling of the subprime lending industry has echoes of the costly savings and loans crisis of the early 1980s - a meltdown that also had its origins in financial market innovation and inadequate oversight, and which many cite as a contributing factor in the 1990-91 economic recession. That crisis ended with a federal bail-out of $150bn and a handful of high-profile convictions for fraud.
This time around, the major losers have been hedge funds, which in theory are limited to wealthy investors. But some analysts believe the pain could spread - many pension funds and college endowments have turned to hedge funds to heat up their returns and some, including Harvard University, are starting to get their fingers burned. Harvard is estimated to have lost $350m of the $550m it invested in a hedge fund run by Jeffrey Larson, a former Harvard money manager, that collapsed recently as a result of positions related to the subprime market.
If the losses trickle down and end up hurting small investors, pressure may grow for a public bail-out. Rumours swept the market earlier this week that Fannie Mae and Freddie Mac, the government-backed mortgage agencies, might get the authority to make sweeping purchases of underpriced mortgage securities.
"The US mortgage landscape has become a top-of-mind political talking point, and we would not be surprised to see the usual 'flow like mud' legislative process fast-tracked with respect to items offering relief to the -troubled mortgage market," says Louise Purtle, strategist at -CreditSights, a research firm.
Most fraud in subprime lending appears to have been so-called "fraud for purchase" - lying about income so as to win a mortgage approval. In reviewing a sample of "no doc" loans that relied on borrowers' statements, the Mortgage Asset Research Institute recently found that almost all would-be home owners had exaggerated their income, with almost 60 per cent inflating it by more than 50 per cent.
These fraudulent borrowers are often difficult to uncover, says Ms Gelernt, because they often stretch to meet their minimum payments for some time before they eventually default. The time lag between initial fraud and default also makes a conviction hard to obtain, she adds, while mortgage investors also have little chance of recovering their losses from individual borrowers in these circumstances.
Many of the originators to blame for poor quality control standards may not be held to account either - with several such lenders already in bankruptcy. "There's a real problem in finding fraud after the fact because the money is already out the door and you won't get the recovery," says Ms Gelernt.
Loose lending standards also facilitated fraud for profit. US prosecutors around the country have broken up at least a dozen mortgage fraud rings and more cases are expected.
In one New York case, the FBI charged 26 people who used stolen identities, invented purchasers and inflated appraisals to obtain subprime loans on more than $200m of property. In an Ohio case, 49 per cent of the mortgages processed by a -single broker never made even a first payment.
The fate of a series of North Carolina neighbourhoods built by Beazer Homes may offer a foretaste of the looming problem. Low income home-buyers around Charlotte have sued the builder alleging that its lending arm steered them into mortgages they could not afford, leading to widespread foreclosures.
The homeowners allege that sales agents misrepresented their personal data, including assets and income, to help them qualify for government-insured mortgages starting in 2002. By the beginning of this year, 10 Beazer subdivisions in Charlotte had foreclosure rates of 20 per cent or higher, compared with 3 per cent state-wide, according to a local newspaper analysis.
The FBI is probing Beazer for possible fraud and the US Housing and Urban Development is examining whether its sales practices violated government-insured mortgage rules. Beazer has defended its sales practices and says it has a "commitment to managing and conducting business in an honest, ethical and lawful manner". In June it announced that it had fired its chief accounting officer for allegedly attempting to destroy documents. The company's shares have lost 75 per cent of their value since the probes began.
Several state attorneys-general are also on the trail. Andrew Cuomo of New York state made headlines this spring with a series of subpoenas to property appraisal companies and has said publicly that he is probing the entire industry. Sources familiar with the office's work say the investigation is still at a relatively early stage.
Marc Dann, the Ohio attorney- general, is looking further up the funding chain. He has been outspoken in his criticism of the role the financial services industry may have played in the large numbers of foreclosures in his state. "There's a whole series of people that knew or should have known that there was fraud in the acquisition of these mortgages," Mr Dann told the Financial Times. "We're looking at ways to hold everybody who aided and abetted that fraud."
Mr Dann's office is looking at brokers, appraisers, rating agencies and securitisers and plans to use several legal methods to hold bad actors accountable. The Ohio attorney-general not only has criminal enforcement powers, but also represents the third-largest set of public pensions in the country and can thus file civil lawsuits on behalf of investors.
"But for the mechanism of packaging these loans, the fraud never would have existed," Mr Dann says. "We're following this trail from homeowner to bondholder." He says his investigation could take six months to a year to bear fruit.
The Securities and Exchange Commission, for its part, is investigating whether Bear Stearns and other hedge fund managers were forthright about disclosing the rapidly declining value of their holdings.
Many of the mortgage-related securities bought by the hedge funds are rarely traded and difficult to value accurately. They are often valued in portfolios according to complex mathematical models because real market prices are not available, making it possible to disguise underperformance if models are not updated.
The SEC has not brought a case in the area so far, but current and former regulators note that it has previously won settlements from several mutual funds and banks that failed to revise the prices of illiquid assets during a falling market.
Private securities lawyers are also starting to file securities fraud lawsuits on behalf of investors who have lost out because of the subprime meltdown.
Jake Zamansky, a lawyer who negotiated an early settlement from Merrill Lynch in the scandal over skewed investment bank research, has filed an arbitration claim against Bear Stearns alleging the firm misled investors about its exposure to the mortgage-backed securities market.
The class action law firm of Bernstein Litowitz is also preparing a claim against Bear Stearns, alleging the firm made material mis-statements in the offering documents for its now defunct hedge funds.
"This was simply about a hedge fund strategy that failed," said a Bear Stearns spokesman. "We plan on defending ourselves vigorously against the allegations in these complaints."
Other hedge funds may also come under political or legal pressure over their role in the loan crisis.
Richard Carnell, a professor at Fordham law school, says it may be possible to hold the investment banks that securitised the mortgages at least partially responsible in the case of a major collapse of the market. "There are two things you can object to in the securitisers' conduct: failing to disclose material facts about the credit quality of the mortgages; and you can also criticise them for acting as an enabler for someone they know is a bad actor," he says.
But putting together a case will not be easy because the hedge funds and other investors who bought such securities are presumed to be sophisticated about financial matters. This means it will be harder for them to prove they were not properly warned about the risks involved.
In the case of the Bear Stearns funds, investors may face new hurdles to recovering any money through US lawsuits. Though the funds operated mostly in New York, they were incorporated in the Cayman Islands and that is where they have filed for bankruptcy. In what could be a test case for international bankruptcy laws, the liquidators have applied to the US courts asking them to block US lawsuits during the liquidation process.
Bear Stearns said in a statement: "Because the two funds are incorporated in the Cayman Islands, the funds' boards filed for liquidation there . . . The return to creditors and investors will be based on the underlying assets and liabilities of the funds not on the location of the filing."
Even if the US lawsuits do go forward, a case pending before the Supreme Court could also prove crucial to investors who hope to make a case that hedge funds and rating agencies enabled widespread fraud.
In Stoneridge Investment Partners v Scientific Atlanta, the court is considering whether investors can recover from firms - including accountants, lawyers and bankers - that help a public company commit fraud by participating in a "scheme to defraud". If the high court rules against "scheme liability", investors who lost money in the subprime market will have very few places to turn to try to get some of it back.
William Poole of the Federal Reserve Bank of St. Louis thinks that this may be what investors who lose money on subprime-linked securities deserve for not looking at them closely enough.
Criticising Wall Street underwriting standards recently, he said: "The punishment has been meted out to those who have done misdeeds and made bad judgments. We are getting good evidence that the companies and hedge funds that are being hit are the ones who deserve it.''
Online story here. Archived here.
(Note: Online stories may be taken down by their publisher after a period of time or made available for a fee. Links posted here is from the original online publication of this piece.)
(In accordance with Title 17 U.S.C. Section 107, this material is distributed without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes. Plainfield Today, Plainfield Stuff and Clippings have no affiliation whatsoever with the originator of these articles nor are Plainfield Today, Plainfield Stuff or Clippings endorsed or sponsored by the originator.)
[Mortgage Fraud]
Payback time
By Brooke Masters and Saskia Scholtes
At the height of the US subprime lending boom, taking out a mortgage could not have been easier. Low credit score and history of bankruptcy? No problem. Income too low to qualify for a mortgage? Inflate what you earn on a "stated income" loan. Nervous that your lender might check up on your "stated income"? Visit www.verifyemployment.net.
For a $55 fee, the operators of this small California company will help you get a loan by employing you as an "independent contractor". They provide payslips as "proof" of income and, for an additional $25, they also man the telephones to give you a glowing reference should your lender need it.
But perhaps the most absurd aspect of the US subprime mortgage market in recent years is that lenders became so generous with credit provision for out-of-pocket borrowers that very few checks were ever made.
That left the system extraordinarily vulnerable to widespread fraud, a possibility that federal and state prosecutors across the US have begun to look into. With the subprime crisis expected to cost investors between $50bn (£24bn, €36bn) and $100bn, according to the US Federal Reserve, these investigations could transform it from a market correction to a full-blown national scandal.
At the root of the subprime problem was easy credit: lenders and their brokers were often rewarded for generating new mortgages on the basis of volume, without being directly exposed to the consequences of borrowers defaulting. During several years of strong capital markets and strong investor appetite for high-yielding securities, lenders became accustomed to easily selling the risky home loans they made to Wall Street banks. The banks in turn packaged them into securities and sold them to investors around the globe.
Such ease of mortgage funding allowed thousands of borrowers to get away with fraudulently mis-stating their incomes, often with the encouragement of their brokers. More ambitious fraudsters appear to have taken out multiple mortgages and walked away with the cash.
Karen Gelernt, a partner at law firm Cadwalader, Wickersham & Taft, says: "The difficulty is getting a handle on the size of the problem, because there is no real mechanism for reporting fraud for most originators in this market. In fact, they had every incentive not to report."
Fraud has been detected up and down the financing chain: just as borrowers have lied to get better rates and larger loans, mortgage brokers and loan officers have lied to borrowers about the terms of their loans and may also have lied to the banks about the qualifications of the borrowers. Appraisers, likewise, have lied about the value of the properties involved.
"The recent rapid expansion of the subprime market was clearly accompanied by deterioration in underwriting standards and, in some cases, by abusive lending practices and outright fraud," Ben Bernanke, Fed chairman, recently told lawmakers. With mortgage rates rising and house prices falling, subprime borrowers have been defaulting at record rates.
The fallout is working its way up from the retail level - forcing people out of their homes and lenders into bankruptcy. Investment banks have lost revenue as investors back away from mortgage securities and a handful of high-profile hedge funds have collapsed - most notably two highly leveraged funds managed by Bear Stearns. The crisis has contributed to turmoil in financial markets in recent weeks and could threaten the health of the US economy as lenders tighten access to credit, putting a drag on consumer spending.
For some, this rapid and dramatic unravelling of the subprime lending industry has echoes of the costly savings and loans crisis of the early 1980s - a meltdown that also had its origins in financial market innovation and inadequate oversight, and which many cite as a contributing factor in the 1990-91 economic recession. That crisis ended with a federal bail-out of $150bn and a handful of high-profile convictions for fraud.
This time around, the major losers have been hedge funds, which in theory are limited to wealthy investors. But some analysts believe the pain could spread - many pension funds and college endowments have turned to hedge funds to heat up their returns and some, including Harvard University, are starting to get their fingers burned. Harvard is estimated to have lost $350m of the $550m it invested in a hedge fund run by Jeffrey Larson, a former Harvard money manager, that collapsed recently as a result of positions related to the subprime market.
If the losses trickle down and end up hurting small investors, pressure may grow for a public bail-out. Rumours swept the market earlier this week that Fannie Mae and Freddie Mac, the government-backed mortgage agencies, might get the authority to make sweeping purchases of underpriced mortgage securities.
"The US mortgage landscape has become a top-of-mind political talking point, and we would not be surprised to see the usual 'flow like mud' legislative process fast-tracked with respect to items offering relief to the -troubled mortgage market," says Louise Purtle, strategist at -CreditSights, a research firm.
Most fraud in subprime lending appears to have been so-called "fraud for purchase" - lying about income so as to win a mortgage approval. In reviewing a sample of "no doc" loans that relied on borrowers' statements, the Mortgage Asset Research Institute recently found that almost all would-be home owners had exaggerated their income, with almost 60 per cent inflating it by more than 50 per cent.
These fraudulent borrowers are often difficult to uncover, says Ms Gelernt, because they often stretch to meet their minimum payments for some time before they eventually default. The time lag between initial fraud and default also makes a conviction hard to obtain, she adds, while mortgage investors also have little chance of recovering their losses from individual borrowers in these circumstances.
Many of the originators to blame for poor quality control standards may not be held to account either - with several such lenders already in bankruptcy. "There's a real problem in finding fraud after the fact because the money is already out the door and you won't get the recovery," says Ms Gelernt.
Loose lending standards also facilitated fraud for profit. US prosecutors around the country have broken up at least a dozen mortgage fraud rings and more cases are expected.
In one New York case, the FBI charged 26 people who used stolen identities, invented purchasers and inflated appraisals to obtain subprime loans on more than $200m of property. In an Ohio case, 49 per cent of the mortgages processed by a -single broker never made even a first payment.
The fate of a series of North Carolina neighbourhoods built by Beazer Homes may offer a foretaste of the looming problem. Low income home-buyers around Charlotte have sued the builder alleging that its lending arm steered them into mortgages they could not afford, leading to widespread foreclosures.
The homeowners allege that sales agents misrepresented their personal data, including assets and income, to help them qualify for government-insured mortgages starting in 2002. By the beginning of this year, 10 Beazer subdivisions in Charlotte had foreclosure rates of 20 per cent or higher, compared with 3 per cent state-wide, according to a local newspaper analysis.
The FBI is probing Beazer for possible fraud and the US Housing and Urban Development is examining whether its sales practices violated government-insured mortgage rules. Beazer has defended its sales practices and says it has a "commitment to managing and conducting business in an honest, ethical and lawful manner". In June it announced that it had fired its chief accounting officer for allegedly attempting to destroy documents. The company's shares have lost 75 per cent of their value since the probes began.
Several state attorneys-general are also on the trail. Andrew Cuomo of New York state made headlines this spring with a series of subpoenas to property appraisal companies and has said publicly that he is probing the entire industry. Sources familiar with the office's work say the investigation is still at a relatively early stage.
Marc Dann, the Ohio attorney- general, is looking further up the funding chain. He has been outspoken in his criticism of the role the financial services industry may have played in the large numbers of foreclosures in his state. "There's a whole series of people that knew or should have known that there was fraud in the acquisition of these mortgages," Mr Dann told the Financial Times. "We're looking at ways to hold everybody who aided and abetted that fraud."
Mr Dann's office is looking at brokers, appraisers, rating agencies and securitisers and plans to use several legal methods to hold bad actors accountable. The Ohio attorney-general not only has criminal enforcement powers, but also represents the third-largest set of public pensions in the country and can thus file civil lawsuits on behalf of investors.
"But for the mechanism of packaging these loans, the fraud never would have existed," Mr Dann says. "We're following this trail from homeowner to bondholder." He says his investigation could take six months to a year to bear fruit.
The Securities and Exchange Commission, for its part, is investigating whether Bear Stearns and other hedge fund managers were forthright about disclosing the rapidly declining value of their holdings.
Many of the mortgage-related securities bought by the hedge funds are rarely traded and difficult to value accurately. They are often valued in portfolios according to complex mathematical models because real market prices are not available, making it possible to disguise underperformance if models are not updated.
The SEC has not brought a case in the area so far, but current and former regulators note that it has previously won settlements from several mutual funds and banks that failed to revise the prices of illiquid assets during a falling market.
Private securities lawyers are also starting to file securities fraud lawsuits on behalf of investors who have lost out because of the subprime meltdown.
Jake Zamansky, a lawyer who negotiated an early settlement from Merrill Lynch in the scandal over skewed investment bank research, has filed an arbitration claim against Bear Stearns alleging the firm misled investors about its exposure to the mortgage-backed securities market.
The class action law firm of Bernstein Litowitz is also preparing a claim against Bear Stearns, alleging the firm made material mis-statements in the offering documents for its now defunct hedge funds.
"This was simply about a hedge fund strategy that failed," said a Bear Stearns spokesman. "We plan on defending ourselves vigorously against the allegations in these complaints."
Other hedge funds may also come under political or legal pressure over their role in the loan crisis.
Richard Carnell, a professor at Fordham law school, says it may be possible to hold the investment banks that securitised the mortgages at least partially responsible in the case of a major collapse of the market. "There are two things you can object to in the securitisers' conduct: failing to disclose material facts about the credit quality of the mortgages; and you can also criticise them for acting as an enabler for someone they know is a bad actor," he says.
But putting together a case will not be easy because the hedge funds and other investors who bought such securities are presumed to be sophisticated about financial matters. This means it will be harder for them to prove they were not properly warned about the risks involved.
In the case of the Bear Stearns funds, investors may face new hurdles to recovering any money through US lawsuits. Though the funds operated mostly in New York, they were incorporated in the Cayman Islands and that is where they have filed for bankruptcy. In what could be a test case for international bankruptcy laws, the liquidators have applied to the US courts asking them to block US lawsuits during the liquidation process.
Bear Stearns said in a statement: "Because the two funds are incorporated in the Cayman Islands, the funds' boards filed for liquidation there . . . The return to creditors and investors will be based on the underlying assets and liabilities of the funds not on the location of the filing."
Even if the US lawsuits do go forward, a case pending before the Supreme Court could also prove crucial to investors who hope to make a case that hedge funds and rating agencies enabled widespread fraud.
In Stoneridge Investment Partners v Scientific Atlanta, the court is considering whether investors can recover from firms - including accountants, lawyers and bankers - that help a public company commit fraud by participating in a "scheme to defraud". If the high court rules against "scheme liability", investors who lost money in the subprime market will have very few places to turn to try to get some of it back.
William Poole of the Federal Reserve Bank of St. Louis thinks that this may be what investors who lose money on subprime-linked securities deserve for not looking at them closely enough.
Criticising Wall Street underwriting standards recently, he said: "The punishment has been meted out to those who have done misdeeds and made bad judgments. We are getting good evidence that the companies and hedge funds that are being hit are the ones who deserve it.''
Online story here. Archived here.
(Note: Online stories may be taken down by their publisher after a period of time or made available for a fee. Links posted here is from the original online publication of this piece.)
(In accordance with Title 17 U.S.C. Section 107, this material is distributed without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes. Plainfield Today, Plainfield Stuff and Clippings have no affiliation whatsoever with the originator of these articles nor are Plainfield Today, Plainfield Stuff or Clippings endorsed or sponsored by the originator.)
Monday, August 06, 2007
Mortgages - NYTimes - Adjustable Rate Resets 2007-09
Published in the New York Times, Wednesday, August 1, 2007
Economic Scene
Keep Your Eyes on Adjustable-Rate Mortgages
By DAVID LEONHARDT
Two years ago, when the housing market was roaring along, I called a mortgage broker on the West Coast and asked for some help. I told him that I wanted to interview some recent home buyers who had taken out an adjustable-rate mortgage — one of the big drivers of the boom — and he was nice enough to pass along a short list of names.
One of the buyers was a business consultant in her 40s. She told me about her charming new house and the fact that she expected it to be a good investment, even if it had cost a bit more than she wanted to spend. Then I asked about her adjustable-rate mortgage.
“I don’t have an adjustable rate,” she said.
Confused, I called the broker again to see what was going on. A little while later, I got a sheepish e-mail message from him explaining that her loan did, in fact, have an adjustable rate. She just hadn’t realized it.
Now, I think this was an honest misunderstanding in which the broker believed that he had explained the terms of the loans more clearly than he had. And the mortgage ended up being a good one for the buyer anyway: she recently decided to move to a new area and sold the house before her rate jumped.
But the fact that this confusion could have occurred neatly captures the ridiculous state of the home buying business in 2005 and 2006. The fallout is going to last a long time. House prices will need years to work off their irrational values, more people are going to lose their homes and Wall Street can probably look forward to some more nasty surprises.
In fact, the mortgage meltdown has arrived at something of a turning point. So far, most of the loans gone bad were among the worst of the worst. Some were based on outright fraud, either by the lender or the borrower. In many cases, buyers were never going to be able to make their monthly payments and were instead banking on a rapid appreciation in home values.
But the pool of people falling behind on their house payments is starting to widen beyond this initial group, and adjustable-rate mortgages are the main reason. Starting in the spring of 2005, these mortgages began to get a lot more popular, largely because regular mortgages no longer allowed many buyers to afford the house they wanted.
They turned instead to a mortgage that had an artificially low interest rate for an initial period, before resetting to a higher rate. When the higher rate kicks in, the monthly mortgage bill typically jumps by hundreds of dollars. The initial period often lasted two years, and two plus 2005 equals right about now.
The peak month for the resetting of mortgages will come this October, according to Credit Suisse, when more than $50 billion in mortgages will switch to a new rate for the first time. The level will remain above $30 billion a month through September 2008. In all, the interest rates on about $1 trillion worth of mortgages, or 12 percent of the nation’s total, will reset for the first time this year or next. A couple of years ago, by comparison, only a marginal amount of mortgage debt — a few billion dollars — was resetting each month.
So all the carnage in the mortgage market thus far has come even before the bulk of mortgages have reset. “The worst is not over in the subprime mortgage market,” analysts at JPMorgan recently wrote to the firm’s clients. “The reason for our pessimism is that loans originated in late 2005 and all of 2006, the period that saw peak origination volumes and sharply decreased underwriting quality, are only now starting to reset in large numbers.”
It isn’t hard to figure out what will happen when buyers who were already stretching to afford a house are faced with suddenly higher payments. Many will manage. They will cut back on other spending, or they will refinance their mortgage and get a new one they can afford. Others, like the buyer I interviewed two years ago, probably planned all along on selling their homes after a few years. For them, the artificially low initial rate was a no-lose proposition.
But there are also likely to be a shocking number of people who lose their homes. From 1994 to 2005, some 3.2 million households were able to buy homes thanks to subprime mortgages or other such loans, according to an analysis by Moody’s Economy.com. About 1.7 million of them will probably lose their homes to foreclosure when all is said and done. More than half of the homeownership gains from subprime mortgages will be erased.
The flood of those homes onto the market will further depress house prices. So will the newfound conservatism of mortgage lenders, which will make it harder for tomorrow’s buyers to get a mortgage. (Thank goodness.) The S.& P./Case-Shiller index of home prices covering 10 major cities has fallen about 3 percent since its peak last summer. Two or three years from now, JPMorgan predicts, the index will have fallen 15 to 20 percent. Adjusting for inflation, the decline will be worse.
The big unknown is whether the housing bust will cause a recession or a bear market. Most people who have looked closely at the mortgage market argue that the answer is no and that the damage will be contained. Subprime loans still make up a distinct minority of the mortgage market. Over all, only 3.4 percent of mortgage holders are currently behind on their payments. And as Victoria Averbukh, a former mortgage analyst at Deutsche Bank now teaching at Cornell, points out, “The housing market is still a limited portion of the U.S. economy.” Consumer spending has slowed recently, but is still fairly strong. Corporate balance sheets and the job market seem fine.
Rationally, the argument for optimism is pretty compelling: the economy’s strengths do look big enough to overcome its weaknesses. Yet even many of the optimists confess to an uncomfortable amount of uncertainty. There has never been a real estate bubble like the one of the last decade. So it’s impossible to know what the bust will bring, especially when there are still so many mortgages that are about to get a lot more expensive.
E-mail: Leonhardt@nytimes.com
nb: Chart filed under 'meta'
Permalink to online story.
(In accordance with Title 17 U.S.C. Section 107, this material is distributed without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes. Plainfield Today, Plainfield Stuff and Clippings have no affiliation whatsoever with the originator of these articles nor are Plainfield Today, Plainfield Stuff or Clippings endorsed or sponsored by the originator.)
Economic Scene
Keep Your Eyes on Adjustable-Rate Mortgages
By DAVID LEONHARDT
Two years ago, when the housing market was roaring along, I called a mortgage broker on the West Coast and asked for some help. I told him that I wanted to interview some recent home buyers who had taken out an adjustable-rate mortgage — one of the big drivers of the boom — and he was nice enough to pass along a short list of names.
One of the buyers was a business consultant in her 40s. She told me about her charming new house and the fact that she expected it to be a good investment, even if it had cost a bit more than she wanted to spend. Then I asked about her adjustable-rate mortgage.
“I don’t have an adjustable rate,” she said.
Confused, I called the broker again to see what was going on. A little while later, I got a sheepish e-mail message from him explaining that her loan did, in fact, have an adjustable rate. She just hadn’t realized it.
Now, I think this was an honest misunderstanding in which the broker believed that he had explained the terms of the loans more clearly than he had. And the mortgage ended up being a good one for the buyer anyway: she recently decided to move to a new area and sold the house before her rate jumped.
But the fact that this confusion could have occurred neatly captures the ridiculous state of the home buying business in 2005 and 2006. The fallout is going to last a long time. House prices will need years to work off their irrational values, more people are going to lose their homes and Wall Street can probably look forward to some more nasty surprises.
In fact, the mortgage meltdown has arrived at something of a turning point. So far, most of the loans gone bad were among the worst of the worst. Some were based on outright fraud, either by the lender or the borrower. In many cases, buyers were never going to be able to make their monthly payments and were instead banking on a rapid appreciation in home values.
But the pool of people falling behind on their house payments is starting to widen beyond this initial group, and adjustable-rate mortgages are the main reason. Starting in the spring of 2005, these mortgages began to get a lot more popular, largely because regular mortgages no longer allowed many buyers to afford the house they wanted.
They turned instead to a mortgage that had an artificially low interest rate for an initial period, before resetting to a higher rate. When the higher rate kicks in, the monthly mortgage bill typically jumps by hundreds of dollars. The initial period often lasted two years, and two plus 2005 equals right about now.
The peak month for the resetting of mortgages will come this October, according to Credit Suisse, when more than $50 billion in mortgages will switch to a new rate for the first time. The level will remain above $30 billion a month through September 2008. In all, the interest rates on about $1 trillion worth of mortgages, or 12 percent of the nation’s total, will reset for the first time this year or next. A couple of years ago, by comparison, only a marginal amount of mortgage debt — a few billion dollars — was resetting each month.
So all the carnage in the mortgage market thus far has come even before the bulk of mortgages have reset. “The worst is not over in the subprime mortgage market,” analysts at JPMorgan recently wrote to the firm’s clients. “The reason for our pessimism is that loans originated in late 2005 and all of 2006, the period that saw peak origination volumes and sharply decreased underwriting quality, are only now starting to reset in large numbers.”
It isn’t hard to figure out what will happen when buyers who were already stretching to afford a house are faced with suddenly higher payments. Many will manage. They will cut back on other spending, or they will refinance their mortgage and get a new one they can afford. Others, like the buyer I interviewed two years ago, probably planned all along on selling their homes after a few years. For them, the artificially low initial rate was a no-lose proposition.
But there are also likely to be a shocking number of people who lose their homes. From 1994 to 2005, some 3.2 million households were able to buy homes thanks to subprime mortgages or other such loans, according to an analysis by Moody’s Economy.com. About 1.7 million of them will probably lose their homes to foreclosure when all is said and done. More than half of the homeownership gains from subprime mortgages will be erased.
The flood of those homes onto the market will further depress house prices. So will the newfound conservatism of mortgage lenders, which will make it harder for tomorrow’s buyers to get a mortgage. (Thank goodness.) The S.& P./Case-Shiller index of home prices covering 10 major cities has fallen about 3 percent since its peak last summer. Two or three years from now, JPMorgan predicts, the index will have fallen 15 to 20 percent. Adjusting for inflation, the decline will be worse.
The big unknown is whether the housing bust will cause a recession or a bear market. Most people who have looked closely at the mortgage market argue that the answer is no and that the damage will be contained. Subprime loans still make up a distinct minority of the mortgage market. Over all, only 3.4 percent of mortgage holders are currently behind on their payments. And as Victoria Averbukh, a former mortgage analyst at Deutsche Bank now teaching at Cornell, points out, “The housing market is still a limited portion of the U.S. economy.” Consumer spending has slowed recently, but is still fairly strong. Corporate balance sheets and the job market seem fine.
Rationally, the argument for optimism is pretty compelling: the economy’s strengths do look big enough to overcome its weaknesses. Yet even many of the optimists confess to an uncomfortable amount of uncertainty. There has never been a real estate bubble like the one of the last decade. So it’s impossible to know what the bust will bring, especially when there are still so many mortgages that are about to get a lot more expensive.
E-mail: Leonhardt@nytimes.com
nb: Chart filed under 'meta'
Permalink to online story.
(In accordance with Title 17 U.S.C. Section 107, this material is distributed without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes. Plainfield Today, Plainfield Stuff and Clippings have no affiliation whatsoever with the originator of these articles nor are Plainfield Today, Plainfield Stuff or Clippings endorsed or sponsored by the originator.)
Saturday, July 21, 2007
Mortgage Brokers - Herald News - NJ May Set Broker Rules
Published in the Herald News [Paterson], Friday, July 20, 2007
New Jersey may home in on broker rules
By HEATHER HADDON
HERALD NEWS
A consortium of 26 states took steps earlier this week to protect future homeowners from getting saddled with the risky mortgages that have left thousands of New Jersey residents on the brink of losing their properties.
But some housing experts say the guidelines provide too little, too late. That, and New Jersey wasn't among the states who initially signed on.
"I was disappointed," said James Bednar, of Clifton, who runs a real estate blog about North Jersey. "I had thoroughly expected New Jersey to be on that list."
State banking authorities say it's just a matter of time before New Jersey signs on. Regardless, housing advocates argue that no single set of recommendations can erase the damage done by loose lending standards to homeowners, pension holders and the economy.
On Tuesday, a group of banking regulators agreed to extend new guidelines for federal mortgage brokers to ones charted on the state level -- where many experts say the riskiest loans come from.
The guidelines would require brokers ensure that borrowers can afford a loan at its maximum monthly rate, not just an artificially low "teaser" amount. Brokers would also face new restrictions in issuing loans without income verification, which became a commonly abused practice in recent years.
"Hopefully, this will get more of the unscrupulous players out of the industry," said John Allison, a member of the Conference of State Bank Supervisors from Mississippi.
Unscrupulous brokers have already done extensive damage. On Wednesday, Federal Reserve Board Chairman Ben Bernanke devoted half of his assessment of the American economy to the negative impact of the mortgage and housing markets.
The bad news continued on Wednesday when Bear Sterns, the fifth-largest securities firm in the United States, announced that two of its mortgage investment funds had little or no value left. Pension funds, including in New Jersey, commonly invest in these types of funds. Now, angry shareholders have begun suing over their worthless investments.
The fallout reminds Bender of the junk bond fiasco of the 1980s.
"It's already caused a lot of suffering. Now, it's going mess up the economy," he said.
Homeowners struggling to hang on are in the eye of the storm. New Jersey ranked ninth in the nation for the number of loans in jeopardy of default in May, according to Bargain Network, a company that tracks the industry. In the past three months, more than 12,000 loans went into default in New Jersey, a 25 percent increase from the beginning of this year.
Not all loan defaults turn into foreclosures. But those have been on the rise as well.
In Passaic County, foreclosures are projected to rise by 22 percent this year, an analysis of county Sheriff's Department statistics shows.
Tighter standards for who can receive a loan would have prevented much of the hardship, according to Melissa Totaro, a West Orange lawyer who previously worked for the Passaic County Legal Aid Society.
"It's just a matter of common sense," Totaro said. "Any guidelines are better than just trusting the market."
Last year, risky loans like these constituted 20 percent of the mortgage market. Most went to low-income borrowers, people with bad credit or those who had personal debt to refinance.
Jacqueline McCormack, spokeswoman for the New York State Banking Department, said that signing onto the guidelines was a no-brainer because they mirror federal ones. "This needs immediate attention," McCormack said.
But New Jersey regulators opted to ruminate longer on the standards. "We wanted to make sure we understand them before we sign on," said Marshall McKnight, a spokesman for the state Division of Banking and Insurance.
McKnight said he couldn't estimate exactly when the state would make a decision, but it should be soon.
The guidelines will give regulators more ammunition to crack down on mortgage brokers that bilk homeowners into a loan they can't afford. But they don't outlaw the practice cold.
"One would hope (the guidelines) will be followed. But they don't have teeth," said Henry Wolfe of Legal Services of New Jersey.
Totaro, the lawyer, said that any measure helps.
"It's too late for people who are in foreclosure," she said. "It's not too late to stop this craziness and help people in the future."
Link to online story.
(In accordance with Title 17 U.S.C. Section 107, this material is distributed without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes. Plainfield Today, Plainfield Stuff and Clippings have no affiliation whatsoever with the originator of these articles nor are Plainfield Today, Plainfield Stuff or Clippings endorsed or sponsored by the originator.)
New Jersey may home in on broker rules
By HEATHER HADDON
HERALD NEWS
A consortium of 26 states took steps earlier this week to protect future homeowners from getting saddled with the risky mortgages that have left thousands of New Jersey residents on the brink of losing their properties.
But some housing experts say the guidelines provide too little, too late. That, and New Jersey wasn't among the states who initially signed on.
"I was disappointed," said James Bednar, of Clifton, who runs a real estate blog about North Jersey. "I had thoroughly expected New Jersey to be on that list."
State banking authorities say it's just a matter of time before New Jersey signs on. Regardless, housing advocates argue that no single set of recommendations can erase the damage done by loose lending standards to homeowners, pension holders and the economy.
On Tuesday, a group of banking regulators agreed to extend new guidelines for federal mortgage brokers to ones charted on the state level -- where many experts say the riskiest loans come from.
The guidelines would require brokers ensure that borrowers can afford a loan at its maximum monthly rate, not just an artificially low "teaser" amount. Brokers would also face new restrictions in issuing loans without income verification, which became a commonly abused practice in recent years.
"Hopefully, this will get more of the unscrupulous players out of the industry," said John Allison, a member of the Conference of State Bank Supervisors from Mississippi.
Unscrupulous brokers have already done extensive damage. On Wednesday, Federal Reserve Board Chairman Ben Bernanke devoted half of his assessment of the American economy to the negative impact of the mortgage and housing markets.
The bad news continued on Wednesday when Bear Sterns, the fifth-largest securities firm in the United States, announced that two of its mortgage investment funds had little or no value left. Pension funds, including in New Jersey, commonly invest in these types of funds. Now, angry shareholders have begun suing over their worthless investments.
The fallout reminds Bender of the junk bond fiasco of the 1980s.
"It's already caused a lot of suffering. Now, it's going mess up the economy," he said.
Homeowners struggling to hang on are in the eye of the storm. New Jersey ranked ninth in the nation for the number of loans in jeopardy of default in May, according to Bargain Network, a company that tracks the industry. In the past three months, more than 12,000 loans went into default in New Jersey, a 25 percent increase from the beginning of this year.
Not all loan defaults turn into foreclosures. But those have been on the rise as well.
In Passaic County, foreclosures are projected to rise by 22 percent this year, an analysis of county Sheriff's Department statistics shows.
Tighter standards for who can receive a loan would have prevented much of the hardship, according to Melissa Totaro, a West Orange lawyer who previously worked for the Passaic County Legal Aid Society.
"It's just a matter of common sense," Totaro said. "Any guidelines are better than just trusting the market."
Last year, risky loans like these constituted 20 percent of the mortgage market. Most went to low-income borrowers, people with bad credit or those who had personal debt to refinance.
Jacqueline McCormack, spokeswoman for the New York State Banking Department, said that signing onto the guidelines was a no-brainer because they mirror federal ones. "This needs immediate attention," McCormack said.
But New Jersey regulators opted to ruminate longer on the standards. "We wanted to make sure we understand them before we sign on," said Marshall McKnight, a spokesman for the state Division of Banking and Insurance.
McKnight said he couldn't estimate exactly when the state would make a decision, but it should be soon.
The guidelines will give regulators more ammunition to crack down on mortgage brokers that bilk homeowners into a loan they can't afford. But they don't outlaw the practice cold.
"One would hope (the guidelines) will be followed. But they don't have teeth," said Henry Wolfe of Legal Services of New Jersey.
Totaro, the lawyer, said that any measure helps.
"It's too late for people who are in foreclosure," she said. "It's not too late to stop this craziness and help people in the future."
LENDING GUIDELINES
• A consortium of banking regulators proposed new standards for state mortgage brokers earlier this week. New Jersey has yet to sign but is expected to do so. Here's some of what regulators recommend that brokers do:
• Ensure that a borrower has sufficient income to pay the loan at the highest interest rate, not just an initial teaser offer.
• If income isn't verified, limit loans to specific circumstances, such as when someone anticipates earning additional income.
• Explain possible risks for suddenly increasing payments in a company's advertisements.
• Stop giving predatory loans, or face investigation from regulators.
Source: Statement on Subprime Mortgage Lending
Link to online story.
(In accordance with Title 17 U.S.C. Section 107, this material is distributed without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes. Plainfield Today, Plainfield Stuff and Clippings have no affiliation whatsoever with the originator of these articles nor are Plainfield Today, Plainfield Stuff or Clippings endorsed or sponsored by the originator.)
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