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Sanity Returns to Mortgage Lending – After Trillions In Losses

May 12, 2009 by Leave a Comment

Liar Loans To Become Illegal

Case Closed on Liar Loans

Case Closed on Liar Loans

New legislation passed by the House will outlaw “stated income”  mortgage loans (commonly called liar loans).

WASHINGTON — The House voted Thursday to outlaw “liar loans,” ballooning mortgage payments and other bank practices that lawmakers say preyed on consumers who couldn’t afford their homes.

The proposal, by North Carolina Democratic Reps Brad Miller and Melvin Watt, is one of several that Democrats are pushing to tighten controls on an industry that critics say undermined the economy by underwriting risky loans, then passing them off to investors.

The bill passed 300-114, with many Republicans contending it would limit consumers’ options and restrict credit.

Democrats said it would ban only the most egregious lending practices and wouldn’t keep most people from getting a mortgage they can afford.

Under the bill, banks offering other than traditional fixed-rate mortgages would have to verify a person’s credit history and income and make a “reasonable and good faith determination” that a loan can be repaid. This provision is aimed at eliminating high-risk credit lines that became known as “liar loans” because they required little or no documentation.

Banks also would have to make sure the loan provides a “net tangible benefit” for the consumer.

What Congress is saying is that banks should not lend in a situation where the borrower cannot provide proof of income or has a poor credit history.  Inadequate income and poor credit have always been two factors that imply high risk of  loan default.  In other words, the banks need legislative action to outlaw practices that they should never have  engaged in to begin with.

Niche Lending Gone Astray

Lending to borrowers who cannot provide proof of income and have poor credit has been going on for decades, first by small private “hard equity” lenders and later by (the now defunct) sub prime mortgage lenders such as Countrywide (now part of Bank of America).  Typically, such loans were made at high rates and at low loan to values, reflecting the very high risk of loan default.   Lenders knew the risk and priced accordingly – borrowers knew that not paying back the loan would likely mean the loss of their home which was the collateral for the loan.

Various situations made this type of lending sensible on occasion for both borrowers and lenders.  For example, a homeowner facing a sudden financial emergency could borrow against his home and hope that his situation would improve.  Borrowers who for various legitimate reasons could not verify income, were allowed access to credit.  Small business owners wanting to expand or open a new business could access risk capital that would otherwise not be available.

Unfortunately, Wall Street and the Banking Industry combined forces to turn a small segment of the mortgage industry into a colossal part of their lending operations – greed overrode sound lending and the sowed the seeds for the biggest housing and banking bust in US history.   The legislation to outlaw liar loans should have happened  five years earlier if regulators had been doing their jobs properly.

Some Thoughts on the New Legislation

It is not clear if the legislation outlaws stated income loans only by lending institutions regulated by state or federal agencies.  If private lenders wish to risk their capital without regard to income or credit criteria they should be allowed to do so with informed borrowers.

Banking institutions whose deposits are protected by the FDIC and whose losses are ultimately paid for by the taxpayer should not be allowed to engage in unsound, high risk lending practices.  The very nature of lending without regard to credit or income implies a very high risk loan that should not be backed up by taxpayer funds.

The requirement that there be a “net tangible benefit” to the borrower when engaging in a mortgage transaction is also another sound rule meant to eliminate abuses.  In the past, there were situations in which a borrower could pay closing costs that far exceeded any benefit of cash out or payment reduction.  Does it really make sense to charge a borrower $15,000 in closing costs while the borrower walks away with maybe $5,000 cash and a higher monthly payment?   This type of law is not a restriction on free enterprise – it merely protects the foolish or desperate borrower and prevents some of the egregious lending abuses that have occurred in the past.

Had it not been for the outrageously reckless lending policies engaged in by the banking industry, this new law would not have been necessary.   Although I believe that less  government regulation is usually better, this is one case where it should be welcomed.  Since the lending industry could not properly institute sound lending policies, it is only appropriate that the government  establish guidelines.

A Law That Should Have Never Been Necessary

Consider the message that the House is sending to the banking industry –  loans should not be made to borrowers who cannot afford the loan payment!  The fact that Congress had to pass this type of legislation is an indictment of the banking industry’s judgment and conduct and a reminder of how ongoing absurd situations can be viewed as normal – until the house of cards collapses.

Filed Under: Banking Industry, Congress, Corruption, Mortgages Tagged With: , ,

FHA 203k Program – Financing Uninhabitable Homes

May 1, 2009 by 3 Comments

Good Intentions Gone Astray?

Vacant - Please Destroy

Vacant - Please Destroy

The Federal Housing Administration (FHA) currently provides over one third of all mortgage financing.  One unique mortgage program the FHA offers is the “Rehabilitation Loan Program (203k)”.

The benefits and features of the 203k program according to the FHA are as follows:

Funds for Handyman-Specials and Fixer-Uppers

The purchase of a house that needs repair is often a catch-22 situation, because the bank won’t lend the money to buy the house until the repairs are complete, and the repairs can’t be done until the house has been purchased.

HUD’s 203(k) program can help you overcome this obstacle by enabling you to purchase or refinance a property plus the cost of making the repairs and improvements in one mortgage.

A potential homebuyer locates a fixer-upper and executes a sales contract after doing a feasibility analysis of the property with his/her real estate professional. The contract should state that the buyer is seeking a 203(k) loan and that the contract is contingent on loan approval based on additional required repairs by the FHA or the lender.

If the borrower passes the lender’s credit-worthiness test, the loan closes for an amount that will cover the purchase or refinance cost of the property, the remodeling costs and the allowable closing costs.

An iron clad rule that I have observed is that government programs once enacted never end even after they serve no useful purpose. In a different time, the 203k program made a lot of sense by revitalizing a community. It also allowed a home buyer the opportunity to acquire a property at a low price and through “sweat equity” rehabilitate the property and increase the value of the home.

Does The 203k Program Still Make Sense?

The collapse in home values and the wave of foreclosures require a reassessment of the FHA 203k program due to the huge number of vacant homes in the country.

(Bloomberg) — A record 19 million U.S. homes stood empty at the end of 2008 and homeownership fell to an eight-year low as banks seized homes faster than they could sell them.

The U.S. had 130.8 million housing units in the fourth quarter, including 2.23 million empty homes that were for sale, the Census report said. The vacancy rate was 3.5 percent in urban areas and 2.6 percent in suburbs, the report said.

U.S. banks owned $11.5 billion of homes they seized from delinquent borrowers at the end of the third quarter, according to the Federal Deposit Insurance Corp. in Washington. That’s up from $5.4 billion a year ago.

Many of the vacant homes that the FHA is lending on through the 203k program are currently empty due to the fact that they are uninhabitable (no utilities, gutted interiors, major damage, etc)  and being sold for little more than the value of the land they sit on.   Do we as a nation really need to allocate more of our limited resources to housing when we already have millions of existing vacant homes?  Would it not be more cost effective to tear down the gutted houses and put potential homeowners into a vacant home that needs minimal repairs?

Of course, once the vacant home is rehabilitated via the 203k, there is more than a 1 in 10 chance of the borrower defaulting on the new FHA loan and the home potentially becoming vacant again (See FHA – Ready To Join Fannie and Freddie.)

Filed Under: Banking Industry, FHA, FHA Defaults, Housing Tagged With: , ,

Frugality The New Lifestyle For Many

April 29, 2009 by Leave a Comment

savingsHard Times Bring Back Thrift

Without the aid of easy credit, matching income with expenses has required cutbacks in consumer expenditures and forced price reductions and layoffs by businesses.  Frugality has become the new mantra for many as we can see from the following examples.

Dumped Pets Pay The Price Of Recession –

From fancy cars to foreign holidays, Britons have had to relinquish all sorts of luxuries as the credit crunch takes hold. To this list we can now add pets: 57% more animals were abandoned last year than in 2007, according to figures from the Royal Society for the Prevention of Cruelty to Animals (RSPCA).

The number of abandoned cats rose by half; dogs by nearly a third. Horses, farm animals and exotic pets were also being left to fend for themselves.

Tim Wass, chief officer of the RSPCA inspectorate, said the cause was “everything to do with the economics about owning a pet”, from paying for food to veterinary bills.

In Glum Times, Repair Shops Hum

Economic fears are driving a resurgence for repairmen. When it comes to autos, computers and all kinds of appliances, consumers are more likely to repair what they have, rather than buying a new replacement.

Appliance-repair businesses, too, have seen an uptick in business in recent months, says Michael Donovan … even though the appliances he works on are not very expensive to buy new.

He and other business owners are surprised by the repair work people authorize these days. “Much to my amazement, people are spending $60 on repairing a vacuum that they bought for $100 new,” he said, adding that limiting new purchases is “definitely a factor on everyone’s mind.” Mr. Donovan has even seen a rise in repairs of small home items, such as electric razors.

Cars, however, are the most visible signs of the new frugality, with new-vehicle sales down sharply. Opting to keep cars running, consumers are extending the lives of their vehicles to nearly 10 years on average from eight just two years ago, says the Automotive Services Association, a trade group for repair businesses.

Starbucks Sales Down

Like many retailers in this difficult environment, Starbucks experienced further declines in comparable store sales in both its US and International stores during the quarter. Consolidated comparable store sales declined by 9% for the first quarter of fiscal 2009, with comparable store sales declines of 10% in the US and 3% in International for the period. Management believes that the negative comparable store sales are in large part a result of the ongoing global economic crisis and its effects on consumers’ discretionary spending…

Expect to see continued poor sales at Starbucks as consumers realize that one upscale beverage per work day can amount to over $800 per year.

Falling sales caused by frugality are  forcing businesses to cut costs and slash prices in an attempt to stimulate sales.

Yankees Slash Prices to Fill Costly Seats

Acknowledging their prices were too steep even by Yankees standards, the 26-time world champions announced a plan to fill thousands of empty high-priced seats by reducing prices and giving away much of the unsold inventory.

The Yankees cut season-ticket prices on some of their premium seats by as much as 50% — to $1,250 from $2,500 for some seats and to $650 from $1,000 on others. Customers who purchased such season tickets will receive their choice of a refund or a credit.

Mr. Steinbrenner said the team reviewed its pricing “in light of the economy,” and stated the changes were for the 2009 season only.

Whether or not Mr. Steinbrenner’s optimism is warranted remains to be seen.  I would expect further price cuts in the future as incomes remain weak and demand for premium priced services diminishes further.

Newcomers Challenge Office-Supply Stalwarts

In the grinding recession, companies are finding ways to save even on the cost of the lowly office pen. And that has created an opening for discounters to steal business from the office-supply industry’s big three.

The result: a wave of price-competition that is benefiting lower-cost vendors and encouraging companies to switch suppliers.

Count Me In for Women’s Economic Independence, a New York group that promotes women entrepreneurs, switched its business to Sam’s Club after a review of its Staples invoices. “It turns out we’ll be saving more than $7,000 on an annual basis,”said Nell Merlino, president and chief executive.

Franchise Sales Pull Back During the Recession

Annual applications from franchisers who want to do business in Maryland are down significantly so far this year, says Dale Cantone, an assistant attorney general for the state. First-quarter franchise-registration applications in Maryland fell 16% from a year earlier to 367.

Other states report similar falloffs. For instance, California’s filings from Jan. 1 through its April 20 deadline fell nearly 20% from a year earlier to 769. New York’s first-quarter registrations dropped 22% to 348 — the lowest number in five years.

The fall off in franchise sales is being blamed on a lack of financing.  Hopefully, the real reason is a more rational allocation of capital by lenders.  Does the average American city really need more fast food outlets, real estate firms or home decorators?

Forced Frugality

Have American consumers rejected the notion of  credit fueled economic prosperity or is something else at work?  The reason for the new found frugality correlates to the fundamental economics of adjusting spending to income levels.  Lower income levels, the threat of unemployment, lack of savings and the destruction of stock and real estate values have created a fundamental shift in consumer behavior that is not likely to change in the near future.

Salary Cuts: Ugly, But It Could Be Worse

A growing number of employers are resorting to salary cuts as the recession drags on. This month alone, A.H. Belo Corp., publisher of the Dallas Morning News, and the Atlanta Symphony Orchestra have announced pay reductions of as much as 15%.

At some companies, the cuts affect only executive and senior management levels, but many others are adopting an across-the-board approach or tiered salary reductions. Some companies are imposing permanent cuts, and some are promising to return employees to their full pay — eventually.

A January survey by global outplacement firm Challenger, Gray & Christmas found that of 100 human-resource professionals surveyed, 27.2% reported that their companies have imposed a salary freeze or cut.

Until the current recession, the practice of imposing pay cuts has been “very rare,” says John Challenger, chief executive officer of Challenger, Gray & Christmas, despite recent calls for capping executive salaries and bonuses.

Organizations in dire straits may have no choice but to slash salaries across the board. After being unable to make payroll in mid-March, South Carolina’s Charleston Symphony Orchestra cut the wages of all its staff and employees by 11.4%. Musicians in the orchestra also took a 11.4% hit in the form of unpaid time off.

Entrepreneurs Cut Own Pay To Stay Alive

A number of small-business owners have stopped paying themselves as they struggle to keep their companies afloat.

It’s impossible to know just how many owners are affected. But in a sign of the breadth of the trend, 30% of 727 small-business owners and managers surveyed by American Express Co.’s small-business services division said recently that they were no longer taking a salary. That’s a troubling sign for small businesses, which have created a significant share of the new U.S. jobs in recent years.

It’s not uncommon for owners to give up salaries from time to time to give their companies a temporary lifeline, but business advisers and owners say the prevalence of salary cuts now is unusual even for a recession.

“The situation overall is more dire,” says Jerry Silberman, chief executive of Corporate Turnaround, a debt-restructuring company in Paramus, N.J. Historically, he says, nearly half of his clients weren’t taking a salary when they come through his door. Now, it’s close to two-thirds. And if they do take a salary, it’s often not enough to cover expenses.

The prevalence of pay cuts, something rarely seen before, tells us that this economic downturn is different.  The unanswered questions are how much worse does it get and how long will it last?  Those businesses carrying heavy debts have the lowest chances of surviving as the downside of leverage shows its destructive capacity.

Newly Thrifty Americans Are Slashing Spending More Than The Numbers Show

How much have Americans cut back?
On the face of it, not much. The official data from the Bureau of Economic Analysis say that in February personal spending was down 0.4%, or $40 billion, from the year before. Certainly any drop is bad news, since consumer spendingrarely decreases–but $40 billion out of total spending of $10 trillion doesn’t seem like enough to wreak economic havoc.

A closer look, however, shows that Americans have tightened their belts more sharply than the numbers report. The reason? Official figures for personal spending include a lot of categories, such as Medicare outlays, that are not under the control of households.

After removing these spending categories from the data, let’s call what’s left “pocketbook” spending–the money that consumers actually lay out at retailers and other businesses. By this measure, Americans have cut consumption by $200 billion, or 3.1%, over the past year. This explains why the downturn has hit Main Street hard.

For those American consumers concerned with their financial future, harsh realities are setting in.  The massive structural imbalances caused by decades of stagnant income growth and huge increases in debt levels will not be cured quickly.  Household balance sheets will eventually improve but it will be a slow and painful process for many.  The Age of Frugality is here for the foreseeable future.

Not All Are Suffering

After reviewing the gloomy news above, let’s end on a positive note.  Many Americans are financially secure, by dint of personal effort or privileged positions.  Here are two examples of those in the later category.

CCAGW Opposes Congressional Pay Raise

(Washington, D.C.) – The Council for Citizens Against Government Waste (CCAGW) today urged lawmakers to make their first order of business when they reconvene in the nation’s capitol in January to introduce legislation to freeze congressional salaries at current rates.  All Members of Congress are slated to get an automatic pay raise in January, 2009 unless they vote to block it.  Each rank and file member of Congress is poised to see another $4,700 in his or her paycheck over the next year, an increase of 2.8 percent over their current $169,300 annual salary.

“Members of Congress don’t deserve one additional dime of taxpayer money in 2009,” said CCAGW President Tom Schatz.  “While thousands of Americans are facing layoffs and downsizing, Congress should be mortified to accept a raise.  They failed to pass most of their appropriations bills, the deficit is on pace to reach an unprecedented $1 trillion, and the national debt stands at $10 trillion.  In addition, this Congress has been ethically challenged, plagued with corruption allegations, convictions, and sex scandals.”

The list of monetary benefits (beyond salary) that goes along with being a member of Congress is too long to list, but suffice it to say that most members of Congress will continue to live the “American Dream”.

Money For Nothing-Paul Krugman

On July 15, 2007, The New York Times published an article with the headline “The Richest of the Rich, Proud of a New Gilded Age.” The most prominently featured of the “new titans” was Sanford Weill, the former chairman of Citigroup, (C) who insisted that he and his peers in the financial sector had earned their immense wealth through their contributions to society.

Soon after that article was printed, the financial edifice Mr. Weill took credit for helping to build collapsed, inflicting immense collateral damage in the process. Even if we manage to avoid a repeat of the Great Depression, the world economy will take years to recover from this crisis.

All of which explains why we should be disturbed by an article in Sunday’s Times reporting that pay at investment banks, after dipping last year, is soaring again — right back up to 2007 levels.

One can argue that it’s necessary to rescue Wall Street to protect the economy as a whole — and in fact I agree. But given all that taxpayer money on the line, financial firms should be acting like public utilities, not returning to the practices and paychecks of 2007.

So what’s going on here? Why are paychecks heading for the stratosphere again? Claims that firms have to pay these salaries to retain their best people aren’t plausible: with employment in the financial sector plunging, where are those people going to go?

In 2008, overpaid bankers taking big risks with other people’s money brought the world economy to its knees. The last thing we need is to give them a chance to do it all over again.

Few could argue with Mr. Krugman’s well penned article but will anything change?  With their high powered Washington connections, my bet is that the boys at Citigroup, AIG, Bank of America, et al will continue to do just fine.

More On This Topic

Recession Has Changed Lifestyles

A Reality Check For Economic Optimism

Disclosure

Financial interests in companies mentioned – None

Filed Under: Banking Industry, Congress, Corruption, Deleveraging Tagged With: , ,

Banks And Consumers Say No To More Debt

April 21, 2009 by Leave a Comment

More Debt Rejected As Solution For Debt Crisis

How many times since the current financial crisis began, have we been told by the Government that the key to an economic turnaround is easier credit and more lending? The Federal Reserve and Treasury have supplied virtually unlimited amounts of credit and guarantees to the banking industry to increase lending activity. The government is refusing to allow the return TARP funds, demanding instead that the money be lent out.

There’s just one problem with the government’s attempt to force more borrowing;  consumers don’t want to borrow and banks have few qualified customers.   In a Wall Street Journal report that must be causing fits in Washington, we learn today that the major recipients of TARP funding have dramatically reduced new lending activity.

Bank Lending Keeps Dropping-WSJ

According to a Wall Street Journal analysis of Treasury Department data, the biggest recipients of taxpayer aid made or refinanced 23% less in new loans in February, the latest available data, than in October, the month the Treasury kicked off the Troubled Asset Relief Program.

Banks defend their lending, saying they’re eager to issue new loans, refinance existing ones and modify those in danger of default. Complicating their efforts, bank executives say, is a decline in demand among consumers and businesses.

But excluding mortgage refinancings, consumer lending dropped by about one-third between October and February. Commercial lending slumped by about 40% over that period, the data indicates.

Of the 19 banks, the only ones to originate more loans in February than October were BB&T Corp., a regional bank based in Winston-Salem, N.C.; Wall Street giant Morgan Stanley; and State Street Corp., a Boston-based company that provides financial services mainly to institutions and wealthy individuals.

One of the banks showing the biggest lending decline was J.P. Morgan Chase & Co. In October, the New York bank made or refinanced $61.2 billion in loans. That figure declined 35% to $39.7 billion in February.

J.P. Morgan executives defend their lending levels. In the first quarter, the bank extended about $150 billion in new credit to consumers and businesses, “despite the fact that loan demand has dropped dramatically,” a spokesman said. In March, the spokesman said, J.P. Morgan made $65.5 billion in new loans — slightly more than it made in October.

So Why Aren’t The Banks Making Loans?

Banks are in business to lend money so why the decline in lending activity?  The extension of credit under normal circumstances is vital to economic growth and prosperity.  The reality of the current situation is that the banks (and every other financial institution) have for decades recklessly extended credit without regard to the to the ability of the borrower to service the debt from income.

This financial crisis is different and will not be solved by extending additional credit to over extended borrowers.  The banks and their customers recognize the risk of too much debt while the Government continues to mindlessly encourage more borrowing.

US Consumers Facing Reality

As noted above, a JP Morgan spokesman stated that “loan demand has dropped dramatically”.  The reasons for reduced loan demand are obvious and include the following: declining income, a low savings rate, an already intolerable debt load and a trend towards frugality.  The American consumer has wisely concluded that more debt will only make his financial situation worse.

Debt Levels Soar As Incomes Stagnate

Household Debt Ratio

Median Family Income

The 2nd chart’s blue data curve since 1979 (in 1993 dollars) can be compared to the above chart’s 1970-1978 – showing next to nil growth. The pink data curve from 1979-2007 expresses this in 2007 dollars. This computes real income compound growth for this 37 year period (1970-2007) of a measly 0.26% per year (about $10/month) average, compared to 12 times faster income growth of 3.7% annually in the prior 23 years 1947-1970.

Income growth for the average wage earner has been essentially flat since the early ’80’s.  The early 80’s was also the beginning of the greatest credit expansion in history.  Easy credit growth on a massive scale did not increase real incomes in the past nor will it do so going forward.  The statistics on income will be even more abysmal when updated to 2009,  reflecting salary decreases and an unemployment rate approaching 10%.  The nation does not need more debt but rather more income.

Savings And Home Equity Decline

The false “prosperity” of the past based on credit fueled asset appreciation caused many consumers to believe that saving was no longer necessary.   The  collapse of values in stocks and real estate has now left many consumers with little net worth or liquid savings.

Personal Savings Rate

Owner Home Equity

The American consumers have recognized that borrowed money is not income and that taking on more debt is not the path to prosperity; they  are making the necessary sacrifices to improve their financial future.  The US Government, obsessed with pushing more credit onto over leveraged borrowers, would do well to follow the example of its Citizens.

More on this topic:

What Americans Are Willing To Give Up

French Warn America About Runaway Spending and Stimulus

Filed Under: Banking Industry, Deleveraging Tagged With: , , ,

Banks Move Quickly From Bust To Boom

April 18, 2009 by Leave a Comment

Things Change Quickly

Bank Profits

Only a couple of months ago, the consensus view predicted a collapsing  banking industry that would need to be nationalized.  Banks were viewed as black holes with little chance of becoming profitable.  Fortune Magazine was estimating future write downs of as much as $4 trillion.  Citibank appeared to be on the verge of collapse.  The Treasury hastily put together the Public Private Investment Plan (PPIP) to keep the banking industry solvent by purchasing toxic bank assets.

Then, virtually overnight,  the situation seem to change.  Today’s headlines are filled with stories of banks reporting record profits and attempting to return TARP money that they don’t want or need.   Has every bank in the country suddenly become rock solid?  Let’s examine some aspects of the banking industry’s  “miraculous” turnaround.

Reported Profits Questioned

Wells Fargo’s Profits Look To Good To Be True –

April 16 (Bloomberg) — Wells Fargo & Co. stunned the world last week by proclaiming it had just finished its most profitable quarter ever. This will go down as the moment when lots of investors decided it was safe again to place blind faith in a big bank’s earnings.

What sent Wells shares soaring on April 9 was a three-page press release in which the San Francisco-based bank said it expected to report first-quarter net income of about $3 billion. Wells disclosed few details of what was in that figure. And by pushing the stock up 32 percent that day to $19.61, investors sent a clear message: They didn’t care.

Dig below the surface of Wells’s numbers, though, and there are reasons to be wary. Here are four gimmicks to look out for when the company releases its first-quarter results on April 22:

Gimmick No. 1: Cookie-jar reserves.

Wells’s earnings may have gotten a boost from an accounting maneuver, since banned, that it used last year as part of its $12.5 billion purchase of Wachovia Corp. Specifically, Wells carried over a $7.5 billion loan-loss allowance from Wachovia’s balance sheet onto its own books –

The upshot is that Wells could get by with reduced provisions until the $7.5 billion is used up, boosting net income.

Another quirk: The reserve was related to $352.2 billion of Wachovia loans for which Wells was not forecasting any future credit losses, according to Wells’s annual report.

Gimmick No. 2: Cooked capital.

The most closely watched measure of a bank’s capital these days is a bare-bones metric called tangible common equity.

Measured this way, Wells had $13.5 billion of tangible common equity as of Dec. 31, or 1.1 percent of tangible assets. Yet in a March 6 press release, Wells said its year-end tangible common equity was $36 billion. Wells didn’t say how it arrived at that figure. Nor could I figure out from the disclosures in Wells’s annual report how it got a number so high.

Gimmick No. 3: Otherworldly assets.

Look at Wells’s Dec. 31 balance sheet, and you’ll see a $109.8 billion line item called “other assets.” What’s in that number? For that breakdown, you need to go to a footnote in Wells’s financial statements. And here’s where it gets comical.

The footnote says the largest component was a $44.2 billion bucket that Wells labeled as “other.” Yes, that’s right: The biggest portion of “other assets” was “other.” And what did this include? The disclosure didn’t say. Neither would Bernard.

Talk about a black box. That $44.2 billion is more than Wells’s tangible common equity, even using the bank’s dodgy number. And we don’t have a clue what’s in there.

Gimmick No. 4: Buried losses.

How quickly investors forget. One week before Wells’s earnings news, the FASB caved to pressure by the banking industry and passed new rules that let companies ignore large, long-term losses on the debt securities they own when reporting net income.

Citi Swings to Profit, But Defaults Rack Units

Wall Street Journal –Citigroup Inc. said it earned a quarterly profit for the first time in 18 months, logging a $1.6 billion gain between January and March. But many of the banking company’s businesses continued to deteriorate.

Still, Citi’s bread-and-butter businesses, such as global retail banking and credit cards, suffered from swelling loan defaults.

The (profit) figures also include a $2.4 billion boost from a little-followed accounting adjustment under Financial Accounting Standards Board’s rule 159, which governs how banks value their debt.

Separately, analysts questioned whether Citi was skimping on its ongoing reserves, noting that borrowers defaulted or fell behind on loans at a faster clip than Citigroup socked away money to absorb coming losses.

Bank Bailouts Political Hot Potato

Certainly a lot of unusual items in the reported results, especially the $44 billion of Well’s “other assets” and Citi’s large gains from a questionable accounting change on mark to market.  Since bailing out the banks is highly unpopular with the public, it is easy to conclude that the federal regulators gave the banks extreme latitude in accounting for certain transactions to make reported results look better than they would have.  This accomplishes two things – it takes the bailout issue off the front burner and potentially builds public confidence that the banking industry is not on the edge of collapse.  Whether or not this is just kicking the can down the road remains to be seen.

Liquidity Is Not The Problem

The Feds have literally been force feeding cash into the banking system to stimulate lending.  Banks, having seen enough of the poor results of lending money that cannot be paid back, have concluded that lending more is not the answer.  This can be seen in the massive increase in excess bank reserves that have piled up at the Fed.

Excess Reserves

Excess Reserves

Banks Have Learned Their Lesson On Dealing With The Government

Trapped In Tarp- Forbes

It’s getting itchy under the TARP. Calling funds from the Treasury Department’s Troubled Asset Relief Program a “scarlet letter” for banks, JPMorgan Chase Chief Executive James Dimon said Thursday that his firm is eager to return the $25 billion they’ve received from the government, and will do so as soon as possible.

Many banks are eager to get out from under the government’s thumb. Earlier this week, Goldman Sachs ( GS – news – people ) announced plans to sell $5 billion in new shares to help repay its $10 billion in TARP funds sooner rather than later.

For Dimon, the goal seems to be steering clear entirely of the controversial government programs designed to rehabilitate the banking industry. JPMorgan won’t be participating at all in the Public Private Investment Plan, the Treasury’s program to buy unwanted assets from banks by matching capital from private investors and backing the assets with guarantees.

Dimon wants no part of it. JPMorgan will manage and sell its own assets, he says. “We don’t need” PPIP, he says. “We’re certainly not going to borrow from the federal government, because we’ve learned our lesson about that.”

Lesson For All

The cost of government aid far exceeds the benefits in the judgment of those running the banks.  The bankers now seem more inclined to take their chances rather than tolerate the micro managing of their businesses by the Feds; certainly something to consider for any company contemplating a request for government “help”.

Whether the banking crisis is over is far from certain at this point.  The economy remains weak and loan defaults continue to threaten the profitability of the banking industry.  One thing for certain is that most banks do not want the heavy hand of the government destroying their franchise.  Given the reality of these circumstances, the only banks likely to request TARP funds in the future will be the total basket cases.  Forget the new “stress test” – going forward the Treasury can save time and taxpayer money by simply assuming that any bank weak enough to request aid should be closed down.

Filed Under: Bailout, Banking Industry, Wells Fargo Tagged With: , ,

Some Banks Are Not Amused With 3.875% TARP Mortgages

April 14, 2009 by 1 Comment

TARP Dollars Deployed

It was previously discussed how two banks in Washington State are safedeploying their TARP funds to provide low rate financing for new home buyers.  The program was limited in time and funding allocation as detailed below:

To some extent, this low rate lending program is political theatrics and a public relations effort.   Although the banks in question are offering below market rates, Sterling Savings Bank is only allocating $25 million of its TARP funds to this program after receiving $303 million.  In addition, Sterling is accepting applications for this low rate program only from March 25 to April 15, 2009 and most borrowers will need a 20% down payment to qualify.  The program applies only to new home purchases and not refinances.

Competitors Not Amused With Low Rate Offer

Well run banks that did not request or need TARP funds would seem to be at a competitive disadvantage when trying to match the generous (although limited) offer from Sterling and Banner Bank.  One large bank that is a competitor was definitely not amused.  Here is the response sent to a customer who is refinancing and asked why her bank could not provide the same low rates that Sterling and Banner were offering.

The TARP funds we borrowed are a big topic here, everything is pointing to “XBank” giving the money back. The regulations are changing all the time and the Bank believes it might be in our best interest to simply return it as we are in good financial position.

The deals with Sterling and Banner if you read into them are for newly constructed home purchases, each bank has a list of homes to choose from.

They are doing this because most of the money they lent to these builders is not being paid back, so to avoid bank losses they are trying to help the builders sell the homes. These are very limited programs and they are only for people purchasing new construction homes that the bank owns, essentially banks are selling their foreclosures with special financing.

There are always two sides to every story but with the entry of the Feds into the banking industry, things will become ever more complicated for everyone.

By the way, good luck to “XBank” in trying to return the TARP funds.  The Feds are making it very difficult for the banks and investment houses to return taxpayer money that they now say they don’t want or need.  Here are some insights into  Goldman Sachs’ efforts to return TARP money.

Goldman Sachs’ Mad Dash To Repay The TARP Cash, Jr DeputyAccountant

I maintain my opinion that Goldman Sachs, America’s top economic terrorists, have an in at both the Treasury and the New York Fed (should this really come as that much of a shock?) and have therefore been tipped off that something wicked this way comes for TARP recipient banks. Why else would they be so suddenly compelled to return the TARP cash they never really wanted in the first place?

The official line is that Goldman’s “regulator” the Fed fears how it will look if GS is first through the TARP repayment gate – what the f***? Don’t we want this money back? If the banks which took the money in the first place, either by choice or by force (?), are now bragging about profitability (despite insolvency in many cases – a denial which will eventually come out in the wash as it always does) then shouldn’t the taxpayer report profitability along with them by getting our God damn TARP money back which should have never gone to any of the Street thieves in the first place?!

Only in Bizarro World would a broken country falling further down the debt spiral by the day actually turn away money from the very robbers who snatched it in the first place.

Filed Under: Banking Industry, Mortgages Tagged With: ,

Second Mortgage Investors Facing 100% Losses

April 10, 2009 by 1 Comment

Extinguished

Risky Lending

Second mortgage liens have always been considered risky lending.  Investors in second mortgages are about to find out that the risk was higher than anticipated.

WASHINGTON, April 6 (Reuters) – The U.S. Treasury will soon finalize details on a plan to extinguish and modify second-lien mortgages as part of its overall housing program, a senior Treasury official said on Monday.

The second liens — home equity loans that were often written in tandem with a primary mortgage during the housing boom years — have been an obstacle to refinancing and modifying loans to make them more affordable.

The official, speaking to reporters on condition of anonymity, said assistance would be provided and also guidelines that “comprise a clear path for the reduction of second lien debt.”

He said these range from extinguishing them to keeping them in place as a part of mortgage modifications done under a $75 billion program the Obama administration is implementing to make failing mortgages affordable to home owners.

Under the “old rules” obtaining a second mortgage was not easy.  There were tough restrictions on loan to value levels and the borrower needed sterling credit.   Investors are now discovering why the old rules made sense as they face total losses on second mortgages approved during the lending boom.

Mortgages Secured By Negative Equity

During the peak years of the housing boom it was common for second mortgage lenders to allow borrowing up to 100% of a home’s value.   As housing prices cratered over the past three years, the collateral backing these high risk second mortgages was vaporized leaving lenders  with an essentially unsecured note.

It has become somewhat of an open industry secret that second mortgage investors  do not even bother trying to foreclose or collect since recovery would be minimal.   The second mortgage lien remains on title, however, preventing homeowners from selling or refinancing unless they can come to a settlement with the second mortgage lender.

It now appears that most of the underwater second mortgage investors will be forced to recognize a 100% loss of investment based on legislative decree.

Many Losers, Some Winners

The end result of the second mortgage easy lending fiasco is a total loss for many second mortgage investors.  Most of the companies that specialized in second mortgage lending are no longer in business.  Many future applicants looking for a second mortgage loan will be out of luck as lenders abandon second mortgage lending.

Every disaster, however, seems to have some winners. Those homeowners who borrowed to the max and used second mortgage money for cars, furniture or exotic vacations and such are no doubt smiling at the prospect of having their debt extinguished.

Filed Under: Banking Industry, Deleveraging, loan modification, Second mortgages Tagged With: ,

Banks Offering 3.875% Fixed Rate Mortgages

April 8, 2009 by Leave a Comment

3.875%

TARP Dollars Deployed

Two Washington State banks are now offering 30 year fixed rate mortgages at 3.875%.

SPOKANE, Wash. — Spokane-based Sterling Savings Bank and Walla Walla-based Banner Bank are offering mortgages at interest rates below 4 percent to stimulate sales and help builders move homes.

Bank officials said the low rates benefit buyers and builders, and demonstrate the banks are putting federal government bailout money to work in the Northwest.

Banner received $124 million from the federal Troubled Asset Relief Program, or TARP, while Sterling collected $303 million.

Sterling is working with Golf Savings Bank, its mortgage lending subsidiary, to offer qualified borrowers either a 3.875 percent fixed mortgage rate or a 3 percent lender contribution, up to $20,000.

Golf Executive Vice President Donn Costa said the program helps reduce the inventory of unoccupied homes and firms up prices in markets where sales activity have been slow.

Sterling has set aside $25 million of its federal bailout money to the program, which has allowed it to do 10 times more loan volume than it would have without that money, Costa said.

Expect Mortgage Rates To Continue To Decline

To some extent, this low rate lending program is political theatrics and a public relations effort.   Although the banks in question are offering below market rates, Sterling Savings Bank is only allocating $25 million of its TARP funds to this program after receiving $303 million.  In addition, Sterling is accepting applications for this low rate program only from March 25 to April 15, 2009 and most borrowers will need a 20% down payment to qualify.  The program applies only to new home purchases and not refinances.

Nonetheless, expect to see more offers of low mortgage rates for the following reasons:

-The government is actively pushing  banks to lend TARP funds.

-Both the Federal Reserve and Congress are convinced that reviving the housing market is key to economic stabilization and recovery and will supply the banks with whatever amount of funds is necessary to achieve this goal.

-Continued purchases of mortgage backed securities by the Federal Reserve  (theoretically), will keep mortgage rates low.

-Banks are currently parking massive amounts of excess reserves in low yielding treasury securities.  At some point, especially if the housing market appears to be stabilizing,  funds should start flowing  from treasuries into mortgages. This asset reallocation  would be highly profitable for the banks, given the wide spread between cost of funds and mortgage yields.

In the long term, free market forces will ultimately determine the level of mortgage rates and housing prices.  In the short term,  I would view any  chance to refinance in the mid 3% range as the opportunity of a lifetime.

Filed Under: Banking Industry, Housing, Interest Rates, Mortgages Tagged With:

Markets Plunging On Geithner’s Remarks

March 30, 2009 by 2 Comments

bearGeithner Does It Again

The Treasury Secretary said Sunday that some banks will need large amounts of financial aid.  Geithner’s comments seemed to imply that his recently announced rescue plan for the banking industry is only a first step and that additional government funds will be needed.  Markets responded with a massive selloff in Asia and the Dow futures are down heading into Monday morning.

Bloomberg: “Some banks are going to need some large amounts of assistance,” Geithner said yesterday on the ABC News program “This Week.” The terms of a $500 billion public-private program to aid banks “cannot change” for investors or they’ll lose confidence in the plan, he said on NBC’s “Meet the Press.”

The Obama administration is pursuing the most costly rescue of the U.S. financial system in history while facing taxpayer concerns the aid is bailing out Wall Street firms that took excessive risks. After allocating about 80 percent of $700 billion in aid approved by Congress, administration officials want to keep open the option of seeking more.

Geithner said the Treasury has about $135 billion left in a financial-stability fund while declining to say whether he will request additional money.

“If we get to that point, we’ll go to the Congress and make the strongest case possible and help them understand why this will be cheaper over the long run to move aggressively,” he told ABC News.

Most members of Congress probably wouldn’t support a request for new bailout funds because they aren’t clear about how the government used the $700 billion authorized in the first legislation, McCain said.

“We still don’t have the transparency and oversight,” McCain said on “Meet the Press.” He said his biggest concern is that the cost of stemming the financial crisis will worsen annual deficits projected to exceed $1 trillion for many years.

“What I am most worried about is laying the debt on future generations of Americans,” he said.

Private Investor Participation Is A Sham

It seems clear that there is dwindling public support for further massive bailouts of Wall Street and the banking industry.  Geithner’s plan of bailing out the banking industry with a “public/private” partnership is an attempt to deceive the public about the true extent of the cost of the bank bailout.

Taxpayer backed loans will be used to fund most of the asset purchases under the so called Public-Private Investment Program (PPIP).  Private investors can lose no more than their initial investment but can potentially earn huge returns if the assets purchased recover in value.  Geithner is offering these generous returns to lure in potential private investors who will be deceptively portrayed as the risk takers in the bank bailout, when in fact, the taxpayers are the ones at risk.

“We’re all mad here” – Lewis Carroll, Alice in Wonderland

Geithner’s solutions to solving the banking and financial crisis is increasing being viewed by many as something straight out of Alice In Wonderland.

Banks need to show more willingness to take risks and restore lending to businesses in order for the U.S. economy to recover from the recession, Geithner said.

“To get out of this we need banks to take a chance on businesses, to take risks again,” he said.

Banks did not become insolvent because they made too few loans or took too few risks.  The banking crisis was caused by too much lending to unqualified borrowers who are now defaulting.  Proposing to lend more to those already carrying an intolerable debt burden is sheer madness.   The President of the European Union, Czech prime minister Topolanek, called the bailouts and stimulus plans “a way to hell”.  The Emperor has no clothes and people are starting to notice.

The United States has been pushing other nations to imitate our borrowing and spending rampage with little success.  In fact, opposition to the American “solution” has become so vocal that this topic has been taken off the table by the Obama administration for the upcoming Group of 20 economic summit.

WASHINGTON — U.S. officials preparing for the Group of 20 economic summit on Thursday in London are playing down fiscal-stimulus targets and focusing on objectives such as new rules for tax havens and coordination of financial regulation.

European opposition to additional spending to stimulate economies has grown sharper over the past weeks. Obama administration officials have opted to back off the public spat.

Avoid All Pain At All Costs

A recession is the solution to curing economic excesses.  Recessions bring economic pain but lay the groundwork for a fundamental economic recovery by reallocating capital to healthy enterprises.  Attempting to paper over inevitable economic corrections with oceans of debt and spending only serves to further destabilize any recovery.   Economic policy makers did not see this financial disaster coming and their “solutions” have made the problem worse.

Rolfe Winkler, Option ARMageddon, makes a clear assessment of the current crisis.

The problem isn’t falling asset prices, it’s not rising foreclosures, it’s too much debt.

And yet American policy-makers appear convinced that more debt can rescue an economy already drowning in it. If we can just keep the leverage party going, all will be well. $787 billion to fund “stimulus,” another $9 trillion committed to guarantee bad debts, 0% interest rates and quantitative easing to drive more lending, new off balance sheet vehicles to hide from the public the toxic assets they’ve absorbed. All of it to be funded with debt, most of it the responsibility of taxpayers.

If I may offer just one reason this will all fail: rising interest rates. Interest rates need only revert to their historical median in order to hammer asset values, and balance sheets, into oblivion.

Picture it if you will: the economy stabilizes, money flows out of Treasurys, which drives interest rates back to normal. Asset values that had appeared to stabilize fall again. More writedowns ensue, more balance sheets turn up insolvent. The debt deflation conflagration ignites again, burning up what’s left of the economy.

If our experience to date has taught us anything it should be that kicking losses up to bigger balance sheets solves nothing. Losses have to be taken. The balance sheets on which they reside will end up insolvent. Why compound our problems by piling up more debt and concentrating all of it on the public’s balance sheet? Is American arrogance so great that we believe our Treasury and our currency will survive the trillions of $ worth of losses and stimulus we’ve already agreed to fund?

At the end of the day, flushing more debt through the system is the only lever policy-makers know how to pull. Lower interest rates, quantitative easing, deficit spending, it’s all the same. It’s all borrowing against future income. Each time we bump up against recession, we borrow a bit more to keep the economy going. With garden variety recessions, this can work. Everyone wants the good times to continue, so no one demands debts be paid back. Creditors accept more IOUs and economic “growth” continues apace. If it sounds like Bernie Madoff’s Ponzi scheme, that’s because it is.

But at a certain point, Ponzis get too big. There simply aren’t enough new investors to pay off older ones. In the aggregate, the same is true for Western economies. Their debt loads are now so huge, they are simply unpayable.

Economic Summit

The Group of 20 economic summit will accomplish nothing.  They have decided in advance to eliminate debate on the major issue – whether more debt will solve our debt problems.   The Czech prime minister should be the main speaker at this summit and our Treasury Secretary should be put in the front row.  It is a time for fiscal austerity – not more reckless borrowing.

Filed Under: Bailout, Banking Industry, Geithner, PPIP, printing money Tagged With: , , ,