Home-Account.com

By Kristen Koh

It shocks me how little media pundits know about what is really going on when it comes to the mortgage crisis. The PPIP program (Private Public Investment Partnership–buying toxic assets) WILL loosen consumer lending and is NOT stupid.

The banks have TWICE the cash (capital) they had last year, even though they are accused of being insolvent today whereas they were flying high last year this time. The moolah is sitting in their accounts at the Fed earning 0.25 percent.  They are paying 5 percent on TARP money, and earning only 0.25 percent on it.  So are Jamie Dimon and Ken Lewis dumb?  NO.  They are TERRIFIED that bank regulators gone wild will seize their banks for not having enough collateral to back the declining value of their investment portfolios which include these toxic (or maybe not so toxic) assets.

Right now there is no market for these securities. They are absolutely frozen except for a few fire sales from liquidating funds and manipulation tactics from bad hedge funds. On top of this, onerous application of mark to market rules that came into effect in mid 2007 at the market peak are greatly exaggerating balance sheet crises for the banks.

What does this mean?  Let’s say that you bought an investment property for $1 million and it generates $50,000 in annual net rental income. You have a mortgage on the property for $700,000.  A comparable property sells under duress for $200,000 in an illiquid market and regulators tell you that your property is now worth $200,000 even though if you ran a Discounted Cash Flow analysis on the rental income stream, you’d get $1 million as an asset value.

You argue that even if rents fell 30 percent, which is a possibility under a Depression scenario, your property is worth at least $700,000.  But the regulator says, no, it’s worth $200,000 due to mark to market rules and you are now in violation of rules due to your mortgage ($700k) being higher than your asset value ($200k) so they seize your building since you are unable to come up with the $500,000 difference.

They sell your building for nothing and you are bankrupt.  Does this sound right?  Of course not!  This is why mark to market rules are stupid when the market is hyper-cyclical (artificially inflates values during bull markets and artificially deflates values during bear markets).

That is what is going on with the banks right now.  The market says their asset backed bond portfolios are worth 20 cents on the dollar and the banks are saying they are worth at least 70 cents (albeit on the books at probably 90+ cents), maybe more when held to maturity.  The 50 cent spread was the reason why then Treasury Secretary Hank Paulson (my former boss at Goldman) couldn’t make the first TARP effort work.  You can’t force the banks to dump their assets below what they are worth and investors are too scared to pay what they are worth.

That is until now since the PPIP program enables incredible leverage with Fed money so that it will be hard NOT to make money on these investments.  You put in $1, the government puts in $7 ($1 equity, $6 debt), and you are allowed to keep 50% of the profits.

So, you say, that the example above would never happen because the comparable building would never sell for $200,000.  Well that’s where hedge fund shenanigans come into play.

Let’s say I wanted to make some money manipulating the markets.  I would short shares in the big banks.  I would then find some illiquid asset-backed bonds that I know many of the banks owned.  I would find some desperate seller who just got a margin call and buy a tiny piece of his holding ($1000 worth) and print a price on the tape that showed that I bought the bond at 20 cents on the dollar.  Then I would tell everybody how the banks are holding their bond portfolios at 70 cents on the dollar (after 30 percent writedowns) and they are really just worth 20 cents.  I would point to the tape that showed my purchase (a price point I forced on very small volume).  I would go on CNBC and talk about how the banks have negative equity and will be seized by the regulators a la Lehman, Bear, Wachovia, Wamu, etc, and talk about how Ken Lewis is a liar just as was the case with Dick Fuld before Lehman went down in flames. Everyone will panic, and I’ll be able to cover my bank shorts 50 percent lower.  This is why Bank of America is trading at $7 instead of $15: hedge funds gone wild.

Regulations are WAY behind the many ways the market can be manipulated.  Don’t get me started about naked short selling, the elimination of the uptick rule, and the proliferation of the triple short bear ETFs that skirt existing margin rules.  The only people talking about how these confidence/market shattering conditions don’t matter are short sellers upset that they may have to stop taking candy from babies.

This is why it is important that the government is tweaking the application of mark to market rules. Congressman Paul Kanjorski (D-PA and chairman of the House Financial Service Committee) basically told Finanial Accounting Stadards Board (FASB) chairman Robert Herz that if the FASB doesn’t figure it out, Congress will legislate mark to market changes making the FASB irrelevant.

This is also why it is important to create incentives for vultures to buy the “toxic” bank assets (PPIP) at closer to 70 cents on the dollar so the banks will actually sell them.  Until those sales happen the banks will hoard capital to avoid what they fear – being seized by regulators.    Until then they will not lend in volume even though they have huge cash reserves being poorly deployed.

With the exception of Goldman Sachs and Morgan Stanley, the banks are holding their “toxic assets” at probably 90 cents on the dollar saying that they plan to hold these assets to maturity.  FASB rules allow assets in hold-to-maturity investment accounts to be valued differently than those in trading portfolios which have to be marked to market daily.   This makes sense,  yes, but banks have to mark down their portfolios at sale which is keeping them from selling at today’s irrationally depressed prices.  .

Now here is the important part.  The write-down from 90 cents to 70 cents can probably be absorbed by the operating profits of the banks given time.  It’s a good business to borrow at 0 percent and lend at 10 percent A write-down to 50 cents or less probably makes the banks truly insolvent which is keeping them from trying to sell these assets.  This uncertainty is what motivates banks to hoard cash.  There is $831 billion in cash on the balance sheets of these banks (held with the Fed earning 0.25 percent). So all the TARP money is right back where it came from, just under the ownership of the banks rather than the Fed.

That money is sitting there doing nothing while businesses are starving from the lack of credit.

Remember it’s not the quantity of money but the velocity of money that will get us going.

So what is the risk to the PPIP program?  The banks may refuse to dump assets at the prices these hedge funds are willing to pay.  This would give us a standoff where the velocity of money stays at very low levels.  That’s what happened in Japan where the market fell for ten years and real estate prices have been going down for 20.

We don’t want to be Japan.

Kristen Koh is chief financial officer of Home-Account. She personally owns bank ETFs and call options on those ETFs.

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When is a hedge not a hedge? When it is hedging an Alt-A or Sub-prime mortgage, according to Democrats who are proposing that lenders not be allowed to substantially shift repayment risk from such exotic loans.

The legislation proposed this week in the U.S. House of Representatives would prohibit lenders from “directly or indirectly” hedging or transferring a minimum retained credit risk on most nontraditional mortgages, including some loans that have adjustable interest rates or require little documentation of a borrower’s income. The bill, introduced yesterday, is being sponsored by Representatives Barney Frank of Massachusetts, and Melvin Watt and Brad Miller of North Carolina.

The bill is designed to curb “predatory” lending and encourage the use of traditional 30-year, fixed-rate loans. “The growth of exotic, non-traditional mortgages was a major factor in the current housing and foreclosure crisis,” Frank, Watt and Miller said in a statement.

Alt-A loans were primarily sold to borrowers who wanted atypical terms such as proof-of-income waivers, investment- property collateral or delayed principal repayment, without enough positive compensating attributes. Subprime loans were made to people with poor or limited credit histories.

About 20 percent of Alt-A mortgages securitized with bonds not backed by Fannie Mae, Freddie Mac or the federal government are at least 60 days past due, in foreclosure or already seized. The Alt-A market expanded to $400 billion in 2006 from $55 billion in 2001, according to newsletter Inside Mortgage Finance.
The legislation would make permanent rules that prohibit lending to borrowers who don’t have a “reasonable ability” to repay. It also restricts so-called yield spread premiums, which are upfront commissions paid to mortgage brokers when a loan is closed. The legislation builds on a measure Frank said lacked political support last year to pass.

“We don’t know whether this would work for individual mortgage lenders” that rely on warehouse lines of credit — a form of interim financing — to fund the loans they originate, said Francis Creighton, the chief lobbyist for the Mortgage Bankers Association in Washington. For smaller independent mortgage firms, it may be difficult to repay those credit lines if they cannot sell off 100 percent of the loan, Creighton said.

“The political climate has changed,” Miller said in the statement. “The foreclosure crisis has wreaked havoc on middle- class families and our economy as a whole.”

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Mortgage rates have hit all-time lows according to Bankrate.com, which announced this week that it’s latest survey pegs the average 30-year fixed mortgage rate at 5.19 percent with an average of 0.42 discount and origination points.

The average 15-year fixed rate mortgage retreated to 4.80 percent and the average jumbo 30-year fixed rate fell to 6.66 percent. Adjustable rate mortgages were lower also, with the average 1-year ARM pulling back to 5.30 percent and the 5/1 ARM slipping to 5.21 percent.

Mortgage rates fell lower than ever recorded in the 24 years of Bankrate’s survey, eclipsing the previous low of 5.28 percent seen this January and in June 2003. The last time mortgage rates were recorded lower than this was December 1956, according to the National Bureau of Economic Research. Jumbo mortgage rates benefited as well, with rates now at the lowest level since May 2007, prior to the onset of the credit crunch. The catalyst for the decline in rates was the Federal Reserve’s March 18 announcement of stepped up mortgage debt purchases and an initiative to buy Treasury securities.

Mortgage rates have dropped substantially over the past five months. The average 30-year fixed mortgage rate in late October was 6.77 percent, meaning a $200,000 loan would have carried a monthly payment of $1,299.86. With the average rate now at 5.19 percent, the monthly payment for the same size loan would be $1,096.99, a savings of more than $200 per month for a homeowner refinancing now.

Bankrate’s national weekly mortgage survey is conducted each Wednesday from data provided by the top 10 banks and thrifts in the top 10 markets.

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New economic numbers released by the government yesterday suggest that if the recession isn’t getting better at least it isn’t getting worse, either. Retail sales have held steady recently. And there are signs that the housing market is stabilizing.

The number of newly issued residential building permits, which offers a glimpse of construction activity in coming months, ticked up 3 percent in February from January. Existing-home sales were up 5.1 percent, according to industry data released this week. And yesterday, government data showed that sales of new single-family homes increased 4.7 percent, the first increase in that market in seven months. Median sale prices of those homes, however, were down 18 percent over a year ago.

The positive signs in the housing market are particularly encouraging. It was the housing bust that led the nation into recession, and for months analysts have said that a recovery in the market will be key to leading the nation out of recession.

Analysts said buyers are being enticed back into the market by plummeting home prices, along with historically low mortgage rates and an $8,000 tax credit for first-time home buyers in the stimulus package.

“There are some pieces of information that reconfirm that we are very near the bottom. . . . I want to see a couple more before I am confident that this truly the bottom,” said David Crowe, chief economist for the National Association of Home Builders.

Forecasters, for their part, stress that even after the worst is over, the economy will be fragile for some time. Recovery is expected to be weak, especially in the housing market, because there’s so much excess inventory. Consumers are still deeply in debt, unemployment is still on the rise, and countries around the world remain mired in recession, crippling demand for U.S. goods.

“Businesses have a ways to catch up to weak demand over last six months, so business spending will be extremely weak. . . . Exports will fall further as the global economy falls,” said Scott Anderson, an economist with Wells Fargo. “But this increases the odds the economy will start growing at the end of this year.”

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March 26, 2009 — At a hearing before the House of Representatives’ Financial Services Committee, U. S Treasury Secretary Timothy Geithner is asked Congress to grant the Treasury Department sweeping authority over a range of financial institutions previously beyond the reach of bank regulators, including insurance companies and hedge funds, and possibly even the finance divisions of major U.S. corporations.

Geithner outlined parts of the administration’s ideas for regulatory reform during several public appearances this week, including testimony before the same House panel Tuesday.

Broadly speaking, the administration is looking for powers similar to those held by the Federal Deposit Insurance Corp. in its handling of bank failures. This would allow the government to take over non-bank financial institutions, sell their assets and renegotiate contracts with employees and counterparties.

The government wants to create a regulatory structure that will prevent the failure of some large firms from exposing the entire financial system to too much risk. Officials have said that if such regulation were in place, the government would not have needed to continue funneling money into American International Group, which has soaked up $170 billion in taxpayer money as the government props it up.

“Destabilizing dangers can come from financial institutions besides banks,” Geithner warned in a speech at the Council of Foreign Relations Wednesday. “Our plan will give the government the tools to limit the risk taking at firms that could set off cascading damage.”

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