Mortgaged Future

The Fed’s Contribution To Ponzi Schemes

July 29, 2009 by admin Leave a Comment

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

Filed Under: Federal Reserve, Fraud, Interest Rates, Saving Money Tagged With: Fed policy crushes the prudent saver, savers forced to take higher risks, savers only group not bailed out

How The Government Encourages “Ruthless Defaulters”

July 28, 2009 by admin Leave a Comment

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

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

Courtesy: Wikepedia

Filed Under: Deleveraging, Government spending, loan modification Tagged With: defaults lead to tighter lending, US promotes debt repudiation, why not default?

Time Shares – Another Shattered Dream

July 23, 2009 by admin 1 Comment

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

Filed Under: Deleveraging, Federal Reserve, Too Good To Be True, Uncategorized Tagged With: great vacation - bad investment as timeshares sink, time shares tank in value, time to buy time shares?

Will Mortgage Rates Soar As Fed Programs Wind Down?

July 21, 2009 by admin Leave a Comment

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

Filed Under: Bernanke, Congress, Federal Reserve, Housing, Mortgages Tagged With: FED power facing criticism, mortgage rates to increase

Are The Benefits Of Unrestricted Lending Worth The Costs?

July 21, 2009 by admin 1 Comment

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.

advna

Disclosures: No positions

Filed Under: Advanta ADVNA, CIT Tagged With: ADVNA And CIT -similar customer base, How much customer pain did Advanta cause?, the dark side of leverage

CALPERS Pleads Stupidity On Subprime Mortgage Losses

July 20, 2009 by admin Leave a Comment

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

Filed Under: CALPERS, Too Good To Be True Tagged With: Calpers - they said subprime was safe, Calpers poor bet with subprime loans

Feds To CIT – “Your Loan Application Has Been Denied”

July 16, 2009 by admin Leave a Comment

CIT Solution Is Bankruptcy – Not Bailout

A CIT spokesman said late today that “There is no appreciable likelihood of additional government support being provided over the near term”. Taxpayers had previously supplied a massive $2.3 billion dollars in loans under the TARP program late last year. The large TARP infusion did little to turn around CIT which has reported losses for the past two years of over $3.4 billion.

CIT has $60 billion in finance loans and leases outstanding, an amount that is a mere rounding error in a $14 trillion US economy. CIT does not represent a systemic risk to the US financial system. The large amount of losses reported by CIT over the past two years suggest that loan approvals were given to risky enterprises. CIT would not be losing money and on the verge of bankruptcy if their lending policies had properly accounted for risk.

The weak economy certainly contributed to CIT’s losses, but they could have been mitigated by better risk management. As a private lender, CIT has the right to lend based on whatever standards they chose. As a private lender, they also bear the responsibility of loss.

The American taxpayer should not be stuck with the cost of bailing out every failed business enterprise. There already is a solution for poorly run companies – the solution is known as bankruptcy. The US Treasury can join other creditors in bankruptcy court – cutting your losses is often the best option.

CIT aggressively expanded its loan portfolio over the past fives years by almost 100% to $60 billion. CIT attempted to rein in its lending as the recession deepened, but the losses continued. Increased losses resulted in a dramatic reduction of new lending activity over the past year. CIT has effectively shut down new lending to small businesses for over a year now. Customers that qualify for financing have gone elsewhere.

CIT -courtesy WSJ

For small businesses, CIT is already failing.

“In order to service its debt and meet obligations, [CIT] has been cutting back on new originations,” explains David Chiaverini, research analyst at BMO Capital Markets.

CIT CEO Jeffrey Peek said in November that his company was “the bridge between Wall Street and Main Street,” and “one of the few significant sources of liquidity for small and mid-sized businesses who are struggling to survive.” But by then, CIT was already burning down its bridge, turning away many of the small businesses that had come to rely on the company.

BMO Capital Markets’ Chiaverini sees bankruptcy as CIT’s most likely next step.

“The best case for CIT is to get its liquidity issues resolved — bankruptcy could actually get things back to normal on the lending front,” he says. “If it does go into bankruptcy, I think what will happen is unsecured debt holders will convert their debt into equity and it will emerge stronger without the overhang of debt coming due. Then, it can start lending again.”

CIT’s role in small business financing will be hard to fill, but for many companies, the damage is already happening. Saving CIT would only help Main Street businesses if the company became healthy enough to resume making loans.

FDIC Rejects CIT Loan Guarantee Request

Sheila Bair, FDIC Chairman, had previously expressed deep reservations about allowing CIT to access the Temporary Loan Guarantee Program (TLGP) due to CIT’s weak financial condition. Due to the financial crisis, the FDIC was called upon to provide guarantees to bank issued debt under the TLGP. This type of massive “mission creep” imperils the primary purpose of the FDIC which is to protect depositor funds. The FDIC Deposit Insurance Fund (DIF) is nearly depleted. Sheila Bair made the right call and so did the Federal Government. Let the owners and creditors of CIT assume the risk of loss – not the US taxpayer.

“Cutting Your Losses”

cit-chart

Disclosures: No positions

More on this topic: Treasury Bets U.S. Financial System Can Weather CIT Collapse

Filed Under: Bailout, CIT, Deleveraging, FDIC, Problem banks Tagged With: CIT solution is bankruptcy - not bailour, FDIC makes right decision with CIT

Payday Lenders – Predators or Saviors?

July 14, 2009 by admin 2 Comments

Payday Lenders Serve The Financially Inept

One of the fastest growing lending businesses in the country has been “payday lending”. Without the hassle of a credit check or application, a payday lender will give an employee a cash advance to carry him over to his next paycheck. There has been huge consumer demand for payday loans as reflected by the growth of payday storefronts to 25,000 today from zero in 1990. Convenient locations and quick easy cash entice consumers to take a one week loan on a $300 paycheck for a $50 fee.

Payday lenders argue that the credit losses, overhead costs and the complexity of administering millions of small loans require them to charge high fees to stay in business. When Pennsylvania capped interest based fees on payday loans, the payday lenders disappeared from the State.

Responsible Lending.org has characterized payday lending as predatory and forcing borrowers into a vicious cycle where each loan is paid off with another loan resulting in huge fees to the borrower. Effective annual interest rates can exceed 800%.

A full three quarters of loan volume of the payday lending industry is generated by borrowers who, after meeting the short-term due date of the loan, must re-borrow before their next pay period

Repeat borrowing of what is marketed as a short-term loan of a few hundred dollars has long been documented, but this report verifies for the first time how quickly most payday lending customers must turn around and re-borrow after paying off their previous loan.

Payday lenders generate loan volume by making a payday loan due in full on payday and charging a sizeable fee—now nearly $60 for an average $350 loan. This virtually guarantees that low-income customers will experience a shortfall before their next paycheck and need to come right back in the store to take a new loan. This churning accounts for 76 percent of total loan volume, and for $20 billion of the industry’s $27 billion in annual loan originations.

Payday lenders argue that they are lenders of last resort and provide vital credit that cannot be obtained elsewhere. If payday lenders cease operating, how would those who had relied on the payday loan get by?

North Carolina provides an example of how consumers fared after payday lending was closed in 2006. Here are the results of a study done by the Center for Community Capital:

Researchers concluded that the absence of storefront payday lending had no significant impact on the availability of credit for households in North Carolina. The vast majority of households surveyed reported being unaffected by the end of payday lending. Households reported using an array of options to manage financial shortfalls, and few are impacted by the absence of a single option – in this case, payday lending.

More than twice as many former payday borrowers reported that the absence of payday lending has had a positive rather than negative effect on their household.

Payday borrowers gave first-hand accounts of how payday loans are easy to get into but a struggle to get out of.

Nearly nine out of ten households surveyed think that payday lending is a bad thing.

As was the case with aggressive no income and sub prime mortgage lending, many people will borrow money despite onerous fees and high rates. Financially desperate consumers giving up 15% of their next paycheck to have money a week early are clearly not helping their financial situation. The government cannot prevent people from making foolish financial decisions, but in the case of payday lending, tougher regulation seems necessary to protect the financially inept.

Ironically, despite the high fees charged by payday lenders, it turns out that investors fared no better than the payday borrowers. Earnings have generally been trending downwards and stock prices have declined significantly. New State or Federal fee restrictions on the payday lending industry would crush loan growth and profits. Investors in QCCO and AEA are likely to face continued disappointing returns.

qcco

aea

Disclosures: No positions.

Filed Under: Interest Rates, Payday lenders, Regulatory Reform, Saving Money Tagged With: payday borrowers financially foolish, Payday lenders - predators or saviors?

High Risk Mortgage Lending Still Being Promoted By GSEs

July 13, 2009 by admin Leave a Comment

Sufficient Income Key To Sound Home Ownership

In an effort to prevent delinquent home owners from losing their homes to foreclosure, the Department of the Treasury recently issued guidelines to lenders. Under the Making Home Affordable mortgage modification program, the Treasury stated that the mortgage loans for at risk home owners should be modified to result in a front end debt ratio of 31%. A front end debt ratio is the percentage of gross monthly income that is spent on housing costs, typically principal, interest, taxes and insurance.

Historically, a front end debt ratio of around 31% was considered to be an affordable portion of a borrowers gross income to allocate to housing. A housing debt ratio in this range allowed the borrower sufficient remaining income to cover other living costs and debt payments.

DEPARTMENT OF THE TREASURY
Office of the Comptroller of the Currency, Joint Statement of June 23, 2009

On March 4, 2009, Treasury announced guidelines under the Program to promote sustainable loan modifications for homeowners at risk of losing their homes due to foreclosure.

Under the Program, Treasury will partner with lenders and loan servicers to offer at-risk homeowners loan modifications under which the homeowners may obtain more affordable monthly mortgage payments.

The Program guidelines require the lender to first reduce payments on eligible first-lien loans to an amount representing no greater than a 38 percent initial front-end debt-to-income ratio.6 Treasury then will match further reductions in monthly payments with the lender dollar-for-dollar to achieve a 31 percent front-end debt-to-income ratio. Borrowers whose back-end debt-to-income ratio exceeds 55 percent must agree to work with a foreclosure prevention counselor approved by the Department of Housing and Urban Development.

The OCC guidelines corresponded to comments by the Secretary of HUD, Shaun Donovan, who had previously supported lowering the debt ratios of at risk homeowners to 31%. In response to the question as to why so many home owners re default after having a mortgaged modified, Mr. Donovan stated the obvious – if a mortgage payment was excessive compared to income, default was much more likely.

What it showed was that where there’s actually a reduction in payments, there’s long-term success for those homeowners. People do much better when you lower payments and make them affordable than these other so-called modifications, which actually keep payments the same or increase them.

So I saw it, and in fact, if you look at the report, some of the language in it directly supports the way that we’re setting up our plan to create a standard that is truly affordable for borrowers. 31 percent debt-to-income ratio is the right standard. It’s widely accepted, and if we can get to that level, as we do in our plan, we believe that that sets us up, based on the results of the study, for long-term success for homeowners.

Someone Should Tell The GSEs

The HUD Secretary’s comments make sense and reflect previous sound underwriting guidelines that existing prior to the housing lending mania of the bubble years. If mortgage lenders had not abandoned traditional income requirements, borrowers would not have been approved at debt ratios that virtually guaranteed future defaults. The Treasury and HUD are promoting sound lending policies when they recommend a conservative debt ratio.

The problem is that some one forgot to tell Fannie Mae (FNM), Freddie Mac (FRE) and especially the FHA what HUD and the OCC have proposed as a safe debt ratio. (See Why Does The FHA Approve Loans That Borrowers Cannot Afford.) We now have the absurdity of lenders being required (at taxpayer expense) to modify mortgages to a 31% debt ratio while it is extremely common to see new mortgages being approved at debt ratios of 50% or higher. When a borrower is paying out half of pre tax income for housing expenses, there is usually barely enough left for other debt payments, living expenses, home repairs, etc. A reduction in income, a major unexpected home repair bill or any other unexpected expense can be enough to tip the borrower into default. Yet, the automated underwriting systems of Fannie, Freddie and the FHA are routinely approving risky mortgage loans at debt ratios far in excess of 31%.

The government’s obsession with increasing housing sales and refinances has resulted in a bizarro world situation. Mortgages are being approved with unaffordable payments, the borrower falls behind and then the payments are modified lower under the Making Home Affordable program. It’s not surprising that the Federal Reserve has had to become the buyer of last resort of mortgage backed securities – who else would want to buy them?