June 23, 2024

Archives for July 2009

New Government Regs Will Add Weeks To Mortgage Transactions

Deluge Of Government Regs For Mortgages

The new rules on home appraisals courtesy of the Home Valuation Code of Conduct (HVCC) can sometimes add weeks of delay to a mortgage transaction.    With the mortgage industry still digesting the new regulations of the HVCC, new government laws regarding Regulation Z disclosure requirements promise to potentially add additional weeks of delay to a mortgage transaction.

Effective July 30, 2009 lenders must comply with new rules under the   Truth in Lending Act (TILA) as required under the Mortgage Disclosure Improvement Act (MDIA) which was part of  The Housing and Economic Recovery Act of 2008.

Reg Z Rules Could Add Weeks To Mortgage Process

The new Regulation Z requirements add complex issues to the timing and delivery of disclosure documents to the borrower.  Failure to  adhere to the proper waiting periods for certain disclosure items resets the waiting period requirements.   Many lenders may add their own time restrictions as a safety precaution against violating the new waiting periods and thereby cause additional delay to the mortgage process.

Shown below is a chart summary of triggering events for various waiting periods triggered by different lender actions during the processing of a mortgage transaction.

Waiting Periods and Triggering Events

Triggering Event

Waiting Period Description Timeframe in Business Days
(Business Day is defined as any day except Sunday and Federal Holidays)

Initial Under writing Submission

Initial Truth in Lending Disclosure

Waiting Period — 8 Days

Including the Day of the Initial UW submission, borrowers may close/sign documents on the 9th day.

(1 Day to process, 7 Days for borrower delivery/review enabling closing/signing the next Day.)

Initial Submission

Upfront Fee Collection

Waiting Period  5 Days

Including the Day of the Initial submission, Clients may collect upfront fees on the 6th Day.

(1 Day to process, 1 Day to print and mail and 3 complete Days for borrower delivery/review enabling collection
on the next Day.

Entry and submission of appraisal data

Borrower Appraisal Review

Waiting Period  4 Days

Including the Day appraisal data is submitted, borrowers may close/sign documents on the 5th Day.

1 Day for appraisal day entry 3 Days for borrower delivery/review
enabling closing/signing to occur
on the next Day

Final Loan Submission

QC Hold

Waiting Period 2 Days
(if no risk detected)

requires a 2 Day QC waiting period on all loans.

If the DATA is changed at a later date, then another 2 Day waiting period will be applied.

Request Docs Submission

Final Truth in Lending Disclosure

Waiting Period  7 Days

Including the Day of the Request Docs submission, borrowers may close/sign documents on the 8th Day.

1 Day to process, 3 Days for borrower delivery and 3 Days for borrower review enabling closing/signing to occur on the next Day

If changes at a later date, then another 7 day waiting period will be applied.

The new regulations are meant to allow mortgage customers an easier method to compare rates with different lenders, as well as insure that the customer is properly informed of rates and fees.

The downside of the new regulations are:

  1. Higher compliance costs for lenders which must be passed on to the borrower.
  2. Potentially long delays before a mortgage can be approved and closed which may cause major problems for purchasers with short commitment dates.
  3. Potentially higher rates for consumers who in all probability will need to rate lock for 60 days rather than 30.  The longer rate lock usually results in additional lender fees or higher rates.
  4. One look at the above chart showing waiting period and triggering event time lines indicates the complexity of the new rules, which are certain to cause confusion and frustration for both the lender and the borrower.

For anyone purchasing a home or refinancing, expect the mortgage process to become a potentially grueling two month endeavor.

“Liar Loans” – RIP – October 1, 2009

Liar Loans To Be Prohibited

No income verification and stated income mortgage loans have been available to borrowers for many years.   As originally conceived, a no income verification loan was a sound product, offering highly qualified borrowers the ability to purchase or refinance a home quickly with minimal documentation.  Stated income mortgages are still being offered today to highly qualified borrowers by lenders such as Emigrant Mortgage.

What was once a legitimate mortgage product, however, morphed into the worst type of irresponsible lending during the national housing/mortgage frenzy of the past decade.  “Liar loans” became a product of destruction that allowed millions of totally unqualified people to borrow money who had little or no ability to service the loan.

Due to the mortgage industry’s excesses and irresponsible behavior, the “liar loans” are scheduled for legislative extinction on October 1, 2009.  The new regulations will apply to a newly defined category “of higher-priced mortgages” and the following restrictions will apply:

Prohibit a lender from making a loan without regard to borrowers’ ability to repay the loan from income and assets other than the home’s value.

Require creditors to verify the income and assets they rely upon to determine repayment ability.

The rule’s definition of “higher-priced mortgage loans” will capture virtually all loans in the subprime market, but generally exclude loans in the prime market.  To provide an index, the Federal Reserve Board will publish the “average prime offer rate,” based on a survey currently published by Freddie Mac.  A loan is higher-priced if it is a first-lien mortgage and has an annual percentage rate that is 1.5 percentage points or more above this index…

The new rules take effect on October 1, 2009

No Income Loans To Become Niche Product

The new rules  severely limit the interest rate that can be charged on a stated income prime loan to only 1.5% above the average rate on a prime mortgage.  Given the higher lending risk involved in approving a mortgage without income verification, I would expect that after October 1st, stated income loans will become a niche product, offered by only a few lenders to highly qualified borrowers.

The new rules will make it much more difficult to borrow for those who cannot verify income.   Considering the financial havoc that can result from liar loans, the mortgage industry should welcome the new restrictions which impose proper responsibilities on both lender and borrower.

Mortgage Refinances Drop 11% As Rates Remain Low

Refinances Decline as Rates Stabilize

The latest weekly survey from the Mortgage Bankers Association showed a decrease of 6.3% in mortgage loan applications.   Application volume compared to the previous year increased by 16%.

The interesting aspect of the latest weekly numbers is the decline of 10.9%  in the number of mortgage refinances.  The percentage of refinances to total mortgage applications declined by 2.9% to 53% of total mortgage applications.  With rates hovering at close to all time lows, reduced refinance activity seems to indicate that most borrowers have already taken advantage of the current low mortgage rates.

Have Mortgage Rates Bottomed?

The perfect mortgage borrower can still obtain a rate of around 5% on a thirty year fixed rate mortgage.  In addition, borrowers have had numerous opportunities over the past four years to refinance in the high 4’s or low 5% range.  Unless a borrower is applying for a cash out refinance, there would be little benefit to refinance a mortgage today with a rate of 5.5% or less.

If mortgage rates remain in the low 5% range, expect to see continued declines in the refinance sector of the mortgage market.  In January of this year, the amount of refinances hit a peak of 85% of total mortgage applications as borrowers rushed to take advantage of low rates .

Since it is usually not worth the time and cost of refinancing unless the mortgage rate can be lowered by at least a point, I would not expect to see another mortgage refinance boom unless mortgage rates decline to the low 4% range.  Considering the recent Federal Reserve report which indicates a slower pace of economic decline and an unchanged Fed monetary policy, mortgage rates may have bottomed at this point.

The Fed’s Contribution To Ponzi Schemes

12% Returns – “Guaranteed”

You don’t know whether to laugh or cry every time another Ponzi scheme comes to light.

July 28 (Bloomberg) — The U.S. Securities and Exchange Commission said it halted a $50 million Ponzi scheme near Detroit that raised money for a real-estate investment fund and targeted the elderly.

A federal judge in Michigan agreed to freeze assets after the SEC sued John Bravata, 41, and Richard Trabulsy, 26, claiming they lured more than 400 investors by promising 8 percent to 12 percent annual returns, the agency said today in a statement. Of $50 million raised since May 2006, less than $20.7 million was spent on real estate, the SEC said.

“Investors thought they were investing in a safe and profitable real-estate investment fund, but instead their money was being used to pay for luxury homes, exotic vacations and gambling debts,” said Merri Jo Gillette, director of the SEC’s regional office in Chicago.

The defendants allegedly lured investors by saying the fund offered “safer returns” for individual retirement accounts. More than half the proceeds raised by BBC Equities were conversions from investors’ IRAs, the regulator said.

This should sound very familiar since all Ponzi schemes rely on the same ridiculous promises – very high rates of return with virtually no risk.  The promoters of this latest Ponzi scheme promised returns 1200% higher than what is available on a 2 year treasury note with virtually no risk.  400 hundred “investors” took the bait, apparently believing that 12% returns were available with little risk.

Knowing exactly how many potential investors had to be solicited in order to get 400 to sign up would provide some interesting insights on investor behavior.  Do a significant percentage of individuals fall prey to smooth talking con men promising returns that would normally imply high risk?   As we have seen from the Madoff Ponzi scheme, many wealthy and sophisticated investors succumbed to the lure of high returns with low risk.

Desperate Search For Yield Due To Fed ZIRP Policy

This latest Ponzi scheme may be unique in that the perpetrators targeted the elderly.  Con men have a natural instinct to prey upon the most vulnerable and offer them what they need the most.  Many elderly investors who previously depended on interest income from savings have seen their incomes reduced to virtually zero as the Fed has forced rates at the short end to near zero.

Super low cost funding from saver deposits have resulted in huge lending spread profits for the banks.   A Fed zero interest rate policy (ZIRP) is the silent unpublicized part of the bank bailout.   In this zero sum game, the banks are the winners and the savers the losers.  How many financially prudent savers have been forced by the Fed’s policy of zero rates to take high risks (in search of yield) that has resulted in catastrophic losses?

Savers who must have income to survive have been forced by the Fed to assume more risk with longer maturity and/or riskier asset classes.  Some savers, in their desperate search for yield, have wound up losing everything to Ponzi scheme operators.

For retired savers searching for higher yields and who can tolerate price fluctuations, consider allocating some assets into a diversified selection of blue chip companies that pay dividends.  Here are some companies to consider, with stock symbol and dividend yield listed.

Altria Group                           MO              7.2%
Kraft                                    KFT              4.1%
Merck                                   MRK            5.1%
Home Depot                          HD              3.5%
AT&T                                   T                   6.4%
Philip Morris Intl                  PMI              4.6%

Disclosures:  No Positions

How The Government Encourages “Ruthless Defaulters”

The Delusion of Lenders

The old banking rule of lending only to those who had the capacity to repay was gradually relaxed and then completely abandoned over the past two decades.

New techniques such as loan securitization spread the risk far and wide, theoretically reducing the risk by spreading the risk.    No income verification for mortgage loans became routine since home price appreciation seemed to further diminish the risk – a defaulted mortgage loan could be fully recovered by seizing and selling the collateral.  Risky unsecured credit card lending seemed to have limited risk, as well, since a troubled borrower could simply borrow more to make loan payments that were beyond his income ability.

It all worked fine until it didn’t and economic historians will be debating for decades what went wrong.   The short answer is, of course, that loans extended to those without the ability to repay will eventually default.

The government’s answer to cure defaults by over indebted consumers is to encourage banks to extend more credit to postpone the day of reckoning.  Unfortunately, the government’s “solution” won’t work this time since it is the day of reckoning.

Businesses and the average American consumer have the good sense to realize that borrowing more when they can’t afford the debt payments they have now is total lunacy.  The result is stricter lending by the banks and reduced demand for loans.  Consider the reduction in bank lending taking place:

Loans Shrink as Fear Lingers

Lending continues to slow as bankers and borrowers refrain from taking risks, in a bearish sign for the economy.

The total amount of loans held by 15 large U.S. banks shrank by 2.8% in the second quarter, and more than half of the loan volume in April and May came from refinancing mortgages and renewing credit to businesses, not new loans, an analysis by The Wall Street Journal shows.

The numbers underscore two related trends weighing on the economy. Financial institutions are clamping down on lending to conserve capital as a cushion against mounting loan losses. And loan demand is falling as companies shelve expansion plans and consumers trim spending to ride out the recession.

The slow pace of lending has created political heat for the Obama administration. On Friday, Rep. Spencer Bachus (R., Ala.) pressed Treasury Secretary Timothy Geithner to “tell me why we didn’t really see that multiplier effect” from banks funneling their TARP money into lots of loans.

The disturbing part of the above article is that politicians view tougher lending standards as an economic negative when, in fact,  it is extremely positive.

Bankers, businesses and consumers see the new economic reality and are cutting debt and rebuilding balance sheets –  essential actions for a sound economic recovery.  Those encouraging more lending and borrowing should consider the following chart.

Debt VS Savings

Debt VS Savings

Courtesy: Credit Writedowns

Debt Burdens Double

With income growth declining and debt burdens already intolerable for many,  what rational lender would seek to lend and what rational borrower would seek to borrow?  The debt burden for many has reached levels where default is the only option – more credit would only lead to a larger future loss to a lender.

Growth in debt that is commensurate with growth in income promotes sound economic growth.  Unfortunately the debt burden has expanded far in excess of income growth, with debt to income ratios doubling since the 1980’s.


Household Debt To Income

Courtesy:  continuations.com

Debt Repudiation And Unintended Consequences

Ironically, the biggest impediment to future bank lending is the growing trend of debt repudiation directly sponsored and encouraged by a government concurrently seeking to encourage more lending.

Consumers having trouble paying their debts can now chose from a long list of government programs for debt forgiveness, loan modifications, rate reductions, 125% loan to value mortgages and more programs on the way.  Their is no  longer any shame or embarrassment associated with defaults and bankruptcy.  Defaulting on debt has become a rational choice for many with little repercussions.

How does a banker factor into his risk adjusted lending rate “defaults of convenience”?  The problem of debt repudiation is large and will get larger as described by the New York Times.

When Debtors Decide to Default

Those on the front lines of the debt industry say there is a small but increasingly noticeable group of strapped consumers who, like Ms. Birks, are deciding they will simply stop paying. After loading up on debt eagerly provided by the card companies during the boom times, these people now find themselves trapped in an endless cycle where they are charged interest on interest and fees upon fees while the lenders get government bailouts.

The lending industry term for these people is “ruthless defaulters.” In a miserable economy where paychecks, savings and expectations are all diminished, their numbers will surely grow.

Collectors are noticing a shift not only in ability but in willingness to pay. “With all the bailouts the government is giving everyone, no one has any personal accountability about their own debts,” said Roger Knauf, who runs a trade group of debt-buying firms.

Much of the blame for the excessive debt that consumers took on can be placed on fee crazed bankers who did not properly evaluate risk.  As loan losses continue,  expect bankers to act like bankers again and to continue tightening their lending standards to avoid future defaults.

Lending will remained constrained and intelligent consumers will continue to borrow less and save more – the exact strategy necessary to work off the insane debt binge this country has been on for decades.

Biggest Fool Still Borrowing

Unfortunately, there is still one drunken fool at the party,  relentlessly expanding the borrowing insanity that has put the world on the brink of economic ruin.  Uncle Sam needs to sober up and rethink the flawed theory that unlimited credit equals unlimited wealth.

US Deficits and Debt Increases

US Deficits and Debt Increases

Courtesy: Wikepedia

Time Shares – Another Shattered Dream

Vacation Turns Into Financial Nightmare

Anyone who has vacationed to a tropical resort cannot be blamed for thinking how great it would be to own a piece of paradise.  Those who succumbed to the charms of the omnipresent time share salesmen may now be having deep second thoughts.  Consider the plight of the time share industry:

Major time-share developers, led by Wyndham Worldwide Inc., Marriott International Inc., Starwood Hotels & Resorts Inc. and others, are scaling back their time-share business as investors in time-share loans demand higher interest rates, buyers become more scarce and resales of time shares put downward pressure on prices and demand for new units.

The pullback will reshape some large time-share players. Wyndham, which owns 150 resorts globally and counts 830,000 time-share owners, intends to whittle its time-share business by 40% this year to an annual sales rate of $1.2 billion. That is a big reduction for Wyndham as a whole; its time-share division provided 53% of Wyndham’s revenue last year and 42% of earnings before interest, taxes, depreciation and amortization.

Meanwhile, sales of new time shares have been depressed by a rise in the pool of time shares listed for resale as the foundering economy forces some owners to try to unload their time-share debts and maintenance fees. Carrie Stinchcomb, a sales associate at A Time-share Broker in Orlando, said her office’s listings have increased 30% from last year. However, sales have fallen roughly by half because there are fewer buyers, she said.

Delinquencies on securities backed by time-share loans topped 5% in the first quarter, up from 3% a year earlier, according to Fitch. Starwood, which operates 26 time-share resorts, reported an estimated average default rate of 7.9% at the end of last year on time-share loans it originated.

The hurt that time share developers are feeling may be nothing compared to the plight of those who actually “invested” in time shares.   As an “investment class”, the only apparent rationale for purchasing a time share seemed to be easy financing and the belief that resale prices would increase relentlessly.   Now that values are plunging investors are reflecting on the negative side of time share ownership –  huge upfront sales commissions,  increased yearly maintenance fees, cost of traveling to the timeshare and the cost and complexity of unloading a timeshare in the secondary market.

The default rates on time shares may rise much higher as owners come to grips with the massive price declines that have occurred in time share values.   Many owners may not yet realize the extent to which the value of their investment has declined.  Time shares can often be found on EBay for literally a couple of dollars – eager sellers simply want to dump a unit that carries high yearly maintenance fees.

Here’s a Maui bargain at the Westin in Kaanapali:

STAROPTIONS Westin Kaanapali MAUI Hawaii TIME…

Current Bid: US $17,097.00
Units similar to the one above were being marketed in the 2005 era for $50,000.   Annual maintenance fees are $2,000.

If  you prefer Mexico, here’s another bargain at 92% off the original price.

Playa Del Sol, Los Cabos, Mexico – Buy It Now Price $997, Yearly Maintenance $424
Here is your chance to own a Membership Property (Does Not Expire) at a fraction of the developer price! Studio, One Bathroom (sleeps two),complimentary week! Maintenance fees are billed on odd years only. This club membership allows you to travel to any one of Playa Del Sol’s Resorts. Purchase this exact ownership NOW at a fraction of the original price ($13,500)!! This item is a NO Reserve auction and will be sold to the highest bidder!!

Buying At The Bottom?

Any one trying to sell their time share today is looking at big losses. Those who believe that the Federal Reserve can re-inflate the burst real estate bubble should be buying with both hands.
Disclosures: No positions

Will Mortgage Rates Soar As Fed Programs Wind Down?

Fed Support No Longer Unlimited

There seems to be near unanimous agreement at all levels of government that a recovery in housing prices is essential for economic stabilization and future growth.   The Federal Reserve has supported this effort by driving short term interest rates to near zero and initiating a program to purchase as much as $1.75 trillion in mortgage debt and treasuries.  As of mid year, the Fed had purchased over a half trillion dollars of mortgage-backed securities and housing agency debt in an attempt to keep mortgage rates low.

How much longer will unlimited Fed support for the housing market continue and will mortgage rates increase when Fed support is withdrawn?  The Federal Reserve has indicated that the credit markets have stabilized.  The Federal Reserve’s balance sheet has been shrinking for weeks and is now below the $2 trillion level reached in March.   With financial Armageddon apparently no longer an immediate threat, the Fed also seems to be responding to political pressure to reduce various emergency lending programs.

In response to pointed warnings from foreign creditors about monetizing US debt,  Chairman Bernanke said:

WSJ – “We absolutely will not monetize the debt,” Mr. Bernanke says, using economist-speak that means he won’t let the Fed become the government’s source of cash for deficits. Fed-fueled deficits would be inflationary. Mr. Bernanke says, “we will not abandon price stability.”

In addition, the Fed faces a full assault on its authority from Ron Paul who is attempting to introduce legislation to audit the Fed.  Many other members of Congress have also been critical of the cost and secrecy of Federal Reserve programs and bailouts.

WSJ – As Mr. Bernanke heads to Capitol Hill today for two days of testimony on the economy, the central bank is fending off attacks on many fronts from critics who want to rein in its power and autonomy.

Rallying one charge is Ron Paul, an iconoclastic Texas Republican who wants to abolish the central bank entirely.

Still, Mr. Paul has persuaded nearly two-thirds of the House to co-sponsor a bill requiring far-reaching congressional audits of the Fed. Audits would show “that it’s the Fed that has caused all the mischief” in the U.S. economy, Mr. Paul says.

Mr. Bernanke will face a tough audience in his semiannual report to Congress Tuesday and Wednesday. The Fed “went too far in bailing out companies and exposing taxpayers” to the costs, says Sen. Richard Shelby of Alabama, the senior Republican on the Senate Banking Committee. “They utterly failed the American people as a bank regulator.”

Outlook For Mortgage Rates

With the credit markets stabilized and the Fed under political pressure to reduce its multi trillion dollar financial  commitments, how will mortgage rates respond as the Fed reduces its programs to keep rates low?  Two top rated bond managers at Pimco and American Beacon Advisors have similar opinions.

July 20 (Bloomberg) — Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co., reduced holdings of mortgage debt last month and added to cash and equivalent securities.

Gross cut the $161 billion Total Return Fund’s investment in mortgage bonds to 54 percent of assets, the lowest in almost two years, from 61 percent in May, according to a report on Pimco’s Web site.  Gross trimmed holdings of government-related bonds to 24 percent of assets, the least since February, from 25 percent.

Gross has been selling mortgage-backed securities over the past few months after loading up on them last summer in the midst of the financial crisis, which started with the collapse of the U.S. property market in 2007.

AMERICAN BEACON ADVISORS’ BOND MAVENS, Kirk Brown and Patrick Sporl, have done an admirable job of flying their respective fixed-income funds, AB Treasury Inflation Protected and AB Intermediate Bond, through the credit-market turbulence of the past two years.

He thinks that stagflation — the dreaded combination of a stagnant economy and inflation — is more of a possibility now than at any time since the 1970s.

AB Intermediate Bond, meanwhile, is underweight mortgage-backed securities and overweight corporates.

A reduction of the Fed’s massive intervention in the mortgage market is certain to result in higher mortgage rates, but will not be the disaster that some fear.   The real disaster has already occurred based on the Fed’s past policy of ultra low interest rates to increase lending and inflate housing prices.

Disclosures: No positions

Are The Benefits Of Unrestricted Lending Worth The Costs?

Advanta & CIT – Same Customers Equal Same Results

In early May, when Advanta Corp (ADVNA) announced that it was suspending all new credit card lending, it was speculated that many borrowers would simply stop paying.   The fact that borrowers might default on their debts when Advanta refused to extend new credit says a lot about the crowd that Advanta was lending money to.  Like many overleveraged borrowers, Advanta customers were probably using new loans to make their monthly payments.

May 12 (Bloomberg) –– Advanta Corp., the credit-card issuer for small businesses, may leave 1 million customers scrounging to find new lenders and debt holders facing losses of 35 percent after the company shut down accounts to preserve capital.

“Early amortization has been viewed as a catastrophic event for issuers,” Scott Valentin, an analyst at Friedman Billings Ramsey & Co., said today in a research note. Advanta’s filing said that the charge-off rate for uncollectible loans may increase after accounts are closed. Valentin said that’s likely because “the cards have substantially less utility to cardholders,” cutting the incentive to keep up with payments.

Advanta was the 11th-biggest U.S. credit-card issuer at the end of 2008 with about $5 billion in outstanding balances, and the only major lender focused on small business borrowers, Robertson said.

Advanta Defaults Soar To 57%

Two months later, the nature of Advanta’s high risk lending became obvious when they disclosed that the default rate on their loans had soared to a staggering 57%.  A solid risk customer with sufficient income does not stop paying on his debts merely because he is denied further credit.  Much of Advanta’s lending was made to the highest risk customers and the huge default rate proves it.

July 20 (Bloomberg) — Advanta Corp., the credit-card company that cut off almost 1 million small-business accounts after posting three quarterly losses, said the default rate more than doubled in June from May to 56.95 percent.

Advanta’s charge-off rate dwarfs the national average, which set a record in June when it topped 10.4 percent, according to Fitch Ratings. Bank of America Corp. on July 15 posted the highest June write-offs among the nation’s biggest lenders at 13.86 percent, a rate that includes consumer credit cards.

The ugly picture at Advanta may be on the minds of CIT bondholders since both companies lend to the same customer base of struggling small business owners.   If CIT goes the bankruptcy route and ceases all new lending, will CIT default rates skyrocket as they did at Advanta?  Bondholders are calculating that allowing CIT time to restructure will result in lower losses.

July 20 (Bloomberg) — CIT Group Inc. said bondholders agreed to provide $3 billion in emergency financing, giving the 101-year-old commercial finance company time to devise a recovery plan that averts bankruptcy.

CIT, led by Chief Executive Officer Jeffrey Peek, is receiving a $3 billion secured term loan with a 2 ½-year maturity, the New York-based firm said today. Loan proceeds of $2 billion are available immediately and the rest is expected within 10 days, the company said.

CIT has said bankruptcy would put 760 manufacturing clients at risk of failure and “precipitate a crisis” for as many as 300,000 retailers, according to internal documents.

The Dark Side Of Credit

The question that should be addressed here is how many small business owners where put at the “risk of failure” due to Advanta and CIT extending more credit than their customers could reasonably expect to pay back?   Should public companies be allowed to lend capital to whomever they chose to in a free enterprise system?

Lending without regard to a borrower’s ability to repay may seem initially profitable to the lender and beneficial to the borrower.   The past several years have shown that, in the long run,  excessive over extension of credit leads to financial disaster for the lender, borrower and society in general.   Hopefully, proposed regulatory changes for the financial industry will address this matter.


Disclosures: No positions

CALPERS Pleads Stupidity On Subprime Mortgage Losses

Calpers Blames Rating Agencies For Losses

Fallout from the financial world’s past love affair with subprime mortgages continues as the California Public Employees’ Retirement System (Calpers) announced it is suing the rating agencies.

NEW YORK (Reuters) – Calpers, the biggest U.S. public pension fund, has sued the three largest credit rating agencies for giving perfect grades to securities that later suffered huge subprime mortgage losses.

The California Public Employees’ Retirement System said in a lawsuit filed last week in California Superior Court in San Francisco that it might lose more than $1 billion from structured investment vehicles, or SIVs, that received top grades from Moody’s Investors Service Inc, Standard & Poor’s and Fitch Inc.

By giving these securities their highest ratings, the agencies “made negligent misrepresentations” to the pension fund, Calpers said. Such ratings, which typically accompany investments with almost no risk of loss, “proved to be wildly inaccurate and unreasonably high.

Calpers results for the fiscal year to date as of April 30, 2009 show a loss of 26% and assets of $176 billion.  Calpers assets have declined by a massive $77 billion from $253 billion at 12/31/07.

Calpers return for the 10 year period ended 4/30/2009 was 2.4%, actually a respectable showing compared to the passively managed Vanguard S&P 500 index fund (VFINX) which has declined 2.3% over the past 10 years.

Despite huge losses for the past several years, Calpers has paid out large bonuses.

Calpers, Calstrs award big bonuses despite losses: California’s two biggest public employee pension funds handed out millions of dollars in bonuses last year to their top executives and investment managers, despite losing billions of dollars.

Ailman’s counterpart at the California Public Employees’ Retirement System, Russell Read, received a $208,677 bonus to his $555,360 base pay in August, more than a month after he had resigned from the fund’s top investment job.

Despite continued losses in the market, both funds expect to cut more bonus checks, which they call “incentive awards,” this summer.

Calper’s does not mention that their 10 year investment results could have been higher had Calpers simply invested in bank CDs.  Going forward, Joe Dear, head of Calpers,  is predicting robust future investment returns.  In a recent interview with Barrons, Mr. Dear stated that  “So as a long-term investor, we think the markets are going to produce good returns that will enable us to make our assumed rate of return of 7.75%”.

Apparently Mr. Dear is very confident that the highly paid investment managers at Calpers can achieve investment returns going forward that will be over 3 times better than the past decade.   To achieve returns of almost 8% per year will be remarkable indeed for an economy that many view as being on the verge of a depression.

Fooled by Rating Agencies?

For Calpers to blame the rating agencies for losses suffered on subprime loans seems disingenuous.  The Calpers lawsuit implies that Calpers management did not understand what they were investing in or did not complete the due diligence required of them as stewards of public pension funds.

Calpers money managers have been amply rewarded for outperforming investment benchmarks.   Considering the expertise and experience of Calpers investment managers, none of them came to the conclusion that subprime mortgages were risky?  No one thought that mortgages made to subprime zombies with 550 credit scores and “stated” income would default?   Calpers really thought that subprime mortgages were safe triple A investments just because the rating agencies said so?

Instead of pursuing dubious claims, Calpers management would be better off spending their time figuring out how  to increase investment returns from 2.4% to the lofty 7.75% that is needed to meet future pension obligations.

Disclosures: Position in VFINX