Global Financial Crisis (Was: Subprime Meltdown)

[xilman]

Originally Posted by R.D. Silverman

The solution should be obvious. Let the market correct itself. This will take time. It will also mean allowing companies to fail. There is no quick fix.


We also need some laws prohibiting these kinds of things in the
future. We should not allow:

(1) A mortgage without at least some downpayment.
(2) Variable rate mortgages.
(3) Making the fixed interest rate depend on the amount of downpayment.

The UK housing market has had variable-rate mortgages for many decades. Until quite recently, variable rates were the norm. My mortgage is variable rate, though it has only a few more months to run (you can tell I'm getting old ...).

The UK experience very strongly suggests that variable rate mortgages are no real problem and I'm curious to find out why you regard them with such abhorrence that you'd have the government forbid them. In particular, the proposal appears inconsistent with your advice that the market shoud be self-correcting.


Paul

[S485122]

Originally Posted by xilman

The UK experience very strongly suggests that variable rate mortgages are no real problem and I'm curious to find out why you regard them with such abhorrence that you'd have the government forbid them. In particular, the proposal appears inconsistent with your advice that the market shoud be self-correcting.

I think M. Silverman refers to variable rates where, for the first few years the rate is much below the market rate or even 0, and after that the rate is much above to compensate. This kind of mortgage does not exist in Europe AFAIK.

Jacob

[ewmayer]

Originally Posted by S485122

I think M. Silverman refers to variable rates where, for the first few years the rate is much below the market rate or even 0, and after that the rate is much above to compensate. This kind of mortgage does not exist in Europe AFAIK.

Yes - while ARMs have also been available here in the U.S. for long before the current crisis, the sheer number and outrageousness of the creative-financing ARMs which proliferated in the past decade is responsible for the current "abhorrence." We had a spate of teaser-rate ARMs [what Jacob refers to, the bulk of which have yet to reset to the "true" rate], negative-amortization loans, reverse mortgages [many of which were scams to rip off seniors], the "stated-income" or so-called "liar loans" [where the mortgage issuers often encouraged the signers to lie in the greatly-upward direction, since they got paid based on the total loan volume, and had zero incentive to care whether the folks taking out the loans had a hope in hell of ever repaying them].

In short, here "ARM" is currently a euphemism for "creative irresponsible Ponzi financing scheme by which homebuyers are encouraged to buy way more house than they could ever possibly afford under any reasonable repayment and debt-to-income standard." One of the reasons I rag on ex-Fed-chair Greenspan so much is that these practices exploded on his watch, he knew about it, and rather than doing the slightest thing to rein in the mania [oversight of loan practices falls directly under the Fed's mandate], he in fact did quite the opposite, and went out of his way to promote the supposed magic of ARMs - all while fixed rates were in fact quite low. In other words, he not only ignored the growing rot, he actively abetted it.

[ewmayer]

Despite the differing specific financial vehicles used to blow the housing bubbles in the U.S. and UK [and Ireland, and Spain, and Canada, and Australia, and China, and...], the underlying problem is the same: large numbers of people who bought way more house than they could afford. Seem the UK at least is attempting much the same "cure" as the U.S.:

BofE foolishly Follows Fed's Footsteps

The UK Council of Mortgage Lenders pleads Bank of England must act on mortgage market:

The Bank of England came under further pressure to act quickly on the mortgage crisis today, as the Council of Mortgage Lenders reported that mortgage lending tumbled 17pc in March.

The trade body for lenders warned of "rapidly worsening market conditions" as banks and building societies await government intervention to ease the reluctance between banks to lend money in the wake of the credit crunch.

Michael Coogan, director general of the CML, said: "Early action is needed if we are to be able to maintain a market in which UK borrowers continue to be able to access mortgage funds at reasonable prices."

My Comment: Where was the Council of Mortgage Clowns hiding when the bubble was being created? And who gets to determine "reasonable prices"? Perhaps mortgage rates were too reasonable, too long. What needs to happen is for housing prices to crash. The sooner home prices become affordable the better off everyone will be.

The trillion-dollar mortgage time bomb: Risks are rising that Fannie Mae and Freddie Mac may need a government bailout that could cost far more than previous rescues.

NEW YORK (CNNMoney.com) -- Among the nightmares lurking around the corner for the already battered housing and credit markets would be a meltdown at mortgage financing giants Fannie Mae and Freddie Mac.

Although few are predicting an imminent need for a bailout just yet, credit rating agency Standard & Poor's recently placed an estimated price tag on this worst case scenario -- $420 billion to $1.1 trillion of taxpayer's money.

This dwarfs how much it cost to help banks during the savings and loan crisis of the late 1980's and early 1990's. That cost taxpayers about $250 billion in today's dollars.

S&P added that saving Fannie (FNM) and Freddie (FRE) might cost so much that the federal government's AAA credit rating, the top possible rating, might even be at risk. If that was lost, then all federal government borrowing would become more expensive.

Gee, whodathunk that allowing Fannie and Freddie to load up on hundreds of billions of dollars' worth of CrapLoans generated in huge-bubble markets like Florida, Nevada and California might somehow put them at risk? Like Ben Bernanke, I fail to see the connection ... can't we just print money to give them, if they get into trouble? Hey, it worked for Weimar way back in '23...

But seriously, if S&P - quite possibly the most blinkered, in-bed-with-the-companies-it-rates of the Big 3 ratings agencies [although it's very nearly a dead heat with Moody's] - says you're in trouble, you better really pay attention. The irony of course being that much of the very same "risky" mortgage debt currently being fobbed off on Fannie and Freddie not long ago was labeled "AAA - super duper!" by S&P and Moody's. Funny how "not getting paid to rate security X" seems to affect the resulting rating of security X, isn't it?

[ewmayer]

Getting back to the issue of ARMs, there's an interesting connection between the LIBOR [interbank loan] rate which I commented on last week and ARMs, namely that many ARMs' rates are pegged to the LIBOR - that is, pegged to the average loan rate banks *report*, not the one they are actually paying - the reason so many banks are lying about their true borrowing costs is that they are desperate to cover up the true extent of their financial woes - if it cost them a few billions as year in lost ARM-loan proceeds, they apparently judged that to be preferable to a share-price collapse or a run on the bank. What that means is that as banks are slowly forced to come clean about their true lending rates, many ARMholders will experience the double-whammy of a reset to a higher non-teaser rate, which is raised further by the rising of underlying LIBOR index - from today's Wall Street Journal:

Libor's Rise May Sock Many Borrowers

A sharp and unexpected rise in a widely used interest rate is threatening to add billions of dollars to the interest bills of homeowners, companies and other borrowers around the world.

The London interbank offered rate jumped for the second straight day Friday -- two days after the British Bankers' Association, which oversees the calculation of the interest rate, said it was investigating the borrowing rates that banks had been providing to it.

The BBA started its review amid growing concerns among bankers that their rivals weren't reporting their true high borrowing costs, for fear of signaling to the market they were desperate for cash. John Ewan, a manager of the Libor system at the BBA, said Friday the association continues to believe in the accuracy of the Libor system.

Libor is one of the world's most important financial indicators. It serves as a benchmark for $900 billion in subprime mortgage loans that adjust -- typically every six months -- according to its movements. Companies globally have nearly $9 trillion in debt with interest payments pegged to Libor, according to data provider Dealogic.

If sustained, the past week's rise of Libor could add roughly $18 billion in annual interest costs on that corporate debt, or about $100 to the monthly payment on a $500,000 adjustable-rate mortgage loan.

Article is mostly on point, though I've no clue where they got that the rise was "unexpected" - the banks cheating on their numbers-reporting got caught out, suddenly we had an "unexpected" rise in the reported numbers ... duh.

Now, a $100-a-month increase may not sound like much, but for already-overstretched consumers, it's not peanuts. Also, since the underreporting issue came to light, the LIBOR has ticked up only a few tenths of a % - there is every chance it will continue to go even higher, as more banks feel an "unexpected" urge to stop lying in their reporting, and scrutiny of the numbers continues to increase. If it gets anywhere close to 4%, the impact on both residential and commercial real estate will be huge.

[R.D. Silverman]

Originally Posted by ewmayer

Highly recommend the WSJ article mentioned above - it's an appalling yet oddly fascinating chronicle of the type of irresponsible, borderline insane corporate risk-taking behavior which the Bush/Greenspan laissez-faire credit, [no-]regulatory and market policies have fostered .

It isn't just government policy.

As long as corporate executives are paid as they are today, [garnering
enormous bonuses for short-term gain while taking huge long-term risks
that damage a company] this behavior will continue. As long as these
executives can take such risks without consequence to themselves,
why should they give a sh*t what happens?? We need to (somehow)
make them criminally responsible for their misdeeds.

These senior executives are employees, not owners of the company,
yet they act as if they are owners. Indeed, they are free to exercize
authority without responsibility -- a sure recipe for disaster. Their
behavior is a fraud perpetrated on the stockholders.

Until laws are changed or (fantasy land!!) boards decide to show some sanity,
this will continue. Corporate boards allow this kind of train wreck because
corporate executives sit on each other's boards. Perhaps we should
ban corporate officers from ANY company from sitting on ANY board????

Consider the annual stockholder meeting of any public U.S. corporation.
Are stockholders even allowed to put forth and vote on a resolution that
limits salaries? After all, the stockholders are the real owners.

I have a strong personal resentment towards corporate execs who earn
millions even while their company is going belly up. It is CRAZY.

[R.D. Silverman]

Originally Posted by R.D. Silverman

It isn't just government policy.

As long as corporate executives are paid as they are today, [garnering
enormous bonuses for short-term gain while taking huge long-term risks
that damage a company] this behavior will continue. As long as these
executives can take such risks without consequence to themselves,
why should they give a sh*t what happens?? We need to (somehow)
make them criminally responsible for their misdeeds.

These senior executives are employees, not owners of the company,
yet they act as if they are owners. Indeed, they are free to exercize
authority without responsibility -- a sure recipe for disaster. Their
behavior is a fraud perpetrated on the stockholders.

Until laws are changed or (fantasy land!!) boards decide to show some sanity,
this will continue. Corporate boards allow this kind of train wreck because
corporate executives sit on each other's boards. Perhaps we should
ban corporate officers from ANY company from sitting on ANY board????

Consider the annual stockholder meeting of any public U.S. corporation.
Are stockholders even allowed to put forth and vote on a resolution that
limits salaries? After all, the stockholders are the real owners.

I have a strong personal resentment towards corporate execs who earn
millions even while their company is going belly up. It is CRAZY.

I have a terrific idea! (aka, A Modest Proposal)

Currently, senior execs get paid huge bonuses. They claim it is necessary
to attract talent and as a reward for good stewardship of a company.

However, if they are entitled to such compensation when a company does
well, then they must be held accountable when a company does poorly.

Therefore it is proposed:

(1) Anytime a corporate layoff occurs, no employee may be laid off until
the person they report to has been laid off before them.

(2) If a company later hires back any laid-off employee, then noone may
be hired back before someone else who reported to them.

(3) Any severance package must be applied uniformly to all employees.

This will force layoffs to happen "from the top down".

[R.D. Silverman]

Originally Posted by R.D. Silverman

I have a terrific idea! (aka, A Modest Proposal)

Currently, senior execs get paid huge bonuses. They claim it is necessary
to attract talent and as a reward for good stewardship of a company.

However, if they are entitled to such compensation when a company does
well, then they must be held accountable when a company does poorly.

Therefore it is proposed:

(1) Anytime a corporate layoff occurs, no employee may be laid off until
the person they report to has been laid off before them.

(2) If a company later hires back any laid-off employee, then noone may
be hired back before someone else who reported to them.

(3) Any severance package must be applied uniformly to all employees.

This will force layoffs to happen "from the top down".

Another "modest proposal".

Do not allow mortgage lenders to sell their mortgages to someone else.
This will mean that the primary lender takes the risk, rather than just
taking a cut and then dumping the risk onto someone else. This will
certainly make them more cautious!

[ewmayer]

Originally Posted by R.D. Silverman

Another "modest proposal".

Do not allow mortgage lenders to sell their mortgages to someone else.
This will mean that the primary lender takes the risk, rather than just
taking a cut and then dumping the risk onto someone else. This will
certainly make them more cautious!

While I think your "Management Pay and Hiring/Firing" proposal has a snowball's chance in hell of ever getting implemented - big biz has too powerful a lobby in the corridors of Washington - the mortgage-related one is laudable. In fact, the idea of "loan issuers having a stake in whether the loan gets repaid" used to be something called "standard practice." But that was stodgy old-fashioned finance, carrying huge rocks with a hole drilled in the center on long poles around when payment was due, that sort of thing.

On to today's news:

Some of the interesting lesser-known places of the world in which the credit crunch is wreaking havoc:

Iceland, a Tiny Dynamo, Loses Steam: Little could have prepared Iceland for the reversal of fortune it has suffered in the last few months. The country’s long economic boom has ended in a painful bust, with a collapsing currency, rising inflation, double-digit interest rates and predictions of its first recession since 1992 ... To many Icelanders, their country is the victim of foreign speculators, circling like sharks smelling blood. To outside investors, Iceland is the victim of its own excesses.


Bank of America to exit risky mortgages: Charlotte, N.C.-based bank to end subprime, mortgages with long resets, and other non-traditional loans as it closes Countrywide purchase.

LOL ... First BofA pays way too much for Countrywide - the king of the "non-traditional" CrapMortgouge - then after blowing a huge wad of equity on that, they turn around and nix Countrywide's one-trick-pony revenue model. Yeah, that's a clear sign that BofA's top execs really know what they're doing ... sure to inspire massive confidence amongst shareholders.


Interesting new book out from onetime Nixon-strategist-turned-politcal-analyst [and author of the 2006 bestseller American Theocracy] Kevin Phillips:

Bad Money: Reckless Finance, Failed Politics and the Global Crisis of American Capitalism

Editorial Reviews

In American Theocracy, Kevin Phillips warned us of the perilous interaction of debt, financial recklessness, and the increasing cost of scarce oil. The current housing and mortgage debacle is proof once more of Phillips’s prescience, and only the first harbinger of a national crisis. In Bad Money, Phillips describes the consequences of our misguided economic policies, our mounting debt, our collapsing housing market, our threatened oil, and the end of American domination of world markets. America’s current challenges (and failures) run striking parallels to the decline of previous leading world economic powers—especially the Dutch and British. Global overreach, worn-out politics, excessive debt, and exhausted energy regimes are all chilling signals that the United States is crumbling as the world superpower.

“Bad money” refers to a new phenomenon in wayward megafinance—the emergence of a U.S. economy that is globally dependent and dominated by hubris-driven financial services. Also “bad” are the risk miscalculations and strategic abuses of new multitrillion-dollar products such as asset-backed securities and the lure of buccaneering vehicles like hedge funds. Finally, the U.S. dollar has been turned into bad money as it has weakened and become vulnerable to the world’s other currencies. In all these ways, “bad” finance has failed the American people and pointed U.S. capitalism toward a global crisis. Bad Money is the perfect follow- up to Phillips’s last book, whose dire warnings are now proving frighteningly accurate.

[ewmayer]

NYT Magazine piece on the AAA failure of the ratings agencies:

NYT Magazine | Triple-A Failure

In 1996, Thomas Friedman, the New York Times columnist, remarked on “The NewsHour With Jim Lehrer” that there were two superpowers in the world — the United States and Moody’s bond-rating service — and it was sometimes unclear which was more powerful. Moody’s was then a private company that rated corporate bonds, but it was, already, spreading its wings into the exotic business of rating securities backed by pools of residential mortgages.

Obscure and dry-seeming as it was, this business offered a certain magic. The magic consisted of turning risky mortgages into investments that would be suitable for investors who would know nothing about the underlying loans. To get why this is impressive, you have to think about all that determines whether a mortgage is safe. Who owns the property? What is his or her income? Bundle hundreds of mortgages into a single security and the questions multiply; no investor could begin to answer them. But suppose the security had a rating. If it were rated triple-A by a firm like Moody’s, then the investor could forget about the underlying mortgages. He wouldn’t need to know what properties were in the pool, only that the pool was triple-A — it was just as safe, in theory, as other triple-A securities.

Over the last decade, Moody’s and its two principal competitors, Standard & Poor’s and Fitch, played this game to perfection — putting what amounted to gold seals on mortgage securities that investors swept up with increasing élan. For the rating agencies, this business was extremely lucrative. Their profits surged, Moody’s in particular: it went public, saw its stock increase sixfold and its earnings grow by 900 percent.

By providing the mortgage industry with an entree to Wall Street, the agencies also transformed what had been among the sleepiest corners of finance. No longer did mortgage banks have to wait 10 or 20 or 30 years to get their money back from homeowners. Now they sold their loans into securitized pools and — their capital thus replenished — wrote new loans at a much quicker pace.
[Full Story]

...And of course lost all interest in seeing that the resulting loans ever got repaid. I do believe this would be a prime example of the [of course non-existent, because deemed preposterous by Greenspan and cohorts] "moral hazard" which entered the burgeoning market at that point. [Or would have entered, were it not so obviously preposterous as to be non-existent - thank you, Greenspan cohort Alice Rivkin].

[ewmayer]

More juicy tidbits from the NYT Magazine article on Moody`s megamoney "let`s call the sow`s ear a silk purse" racket:

Moody’s did not have access to the individual loan files, much less did it communicate with the borrowers or try to verify the information they provided in their loan applications. “We aren’t loan officers,” Claire Robinson, a 20-year veteran who is in charge of asset-backed finance for Moody’s, told me. “Our expertise is as statisticians on an aggregate basis. We want to know, of 1,000 individuals, based on historical performance, what percent will pay their loans?”

Ah, the old "vee vere chust following der orders, ja?" defense - apply historical performance fudge factors to loan practices having no historical precedent. Don`t even do due diligence on *one* of these subprime pools, to get a clue as to whether the mortgage companies are being on the level. "Don`t ask, don`t tell, everyone wins except the poor slob who buys this crap - they`re screwed, of course, but hey, no one forced to buy this junk, right?"

Moody`s assigned an analyst to evaluate the package, subject to review by a committee. The investment bank provided an enormous spreadsheet chock with data on the borrowers` credit histories and much else that might, at very least, have given Moody`s pause.

...had they bothered to do anything but rubber-stamp it and collect their hefty fee for doing so, that is.

Three-quarters of the borrowers had adjustable-rate mortgages, or ARMs — “teaser” loans on which the interest rate could be raised in short order. Since subprime borrowers cannot afford higher rates, they would need to refinance soon. This is a classic sign of a bubble — lending on the belief, or the hope, that new money will bail out the old.

Where I come from, we have a different name for it: "Ponzi scheme."

Moody’s learned that almost half of these borrowers — 43 percent — did not provide written verification of their incomes. The data also showed that 12 percent of the mortgages were for properties in Southern California, including a half-percent in a single ZIP code, in Riverside. That suggested a risky degree of concentration.

Or would have, had Moody`s given a rat`s ass about anything other than "when can we get paid for rating this garbage?"

On the plus side, Moody’s noted, 94 percent of those borrowers with adjustable-rate loans said their mortgages were for primary residences. “That was a comfort feeling,” Robinson said. Historically, people have been slow to abandon their primary homes. When you get into a crunch, she added, “You’ll give up your ski chalet first.”

So nearly half of them lied about their income, but you believe the rest of what they said? And who cares if it`s their primary residence? If they have no income, they can`t afford it whether they live in it or not. I sometimes get a warm fuzzy feeling too, but try not to confuse the genuine article with warm fuzzy I get from peeing down my leg after way too much beer.

In the frenetic, deal-happy climate of 2006, the Moody’s analyst had only a single day to process the credit data from the bank. The analyst wasn’t evaluating the mortgages but, rather, the bonds issued by the investment vehicle created to house them. A so-called special-purpose vehicle — a ghost corporation with no people or furniture and no assets either until the deal was struck — would purchase the mortgages. Thereafter, monthly payments from the homeowners would go to the S.P.V. The S.P.V. would finance itself by selling bonds.

Where I come from, we have a different name for it: A "shell corporation", a standard feature of fraudulent-investment and money-laundering schemes. But perhaps we`re just cycnical where I come from.

The question for Moody’s was whether the inflow of mortgage checks would cover the outgoing payments to bondholders. From the investment bank’s point of view, the key to the deal was obtaining a triple-A rating — without which the deal wouldn’t be profitable. That a vehicle backed by subprime mortgages could borrow at triple-A rates seems like a trick of finance. “People say, ‘How can you create triple-A out of B-rated paper?’ ” notes Arturo Cifuentes, a former Moody’s credit analyst who now designs credit instruments. It may seem like a scam, but it’s not.

Yes it is.

The secret sauce is that the S.P.V. would float 12 classes of bonds, from triple-A to a lowly Ba1. The highest-rated bonds would have first priority on the cash received from mortgage holders until they were fully paid, then the next tier of bonds, then the next and so on. The bonds at the bottom of the pile got the highest interest rate, but if homeowners defaulted, they would absorb the first losses.

Again, call me cynical, but I get a rather distinct non-comfort feeling from description of investment vehicles involving the words "secret sauce."

It was this segregation of payments that protected the bonds at the top of the structure and enabled Moody’s to classify them as triple-A. Imagine a seaside condo beset by flooding: just as the penthouse will not get wet until the lower floors are thoroughly soaked, so the triple-A bonds would not lose a dime unless the lower credits were wiped out.

...Except that a buyer of such a seaside condo would not expect to pay penthouse prices for the whole building - like I said, a scam.

Structured finance, of which this deal is typical, is both clever and useful; in the housing industry it has greatly expanded the pool of credit. But in extreme conditions, it can fail. The old-fashioned corner banker used his instincts, as well as his pencil, to apportion credit; modern finance is formulaic. However elegant its models, forecasting the behavior of 2,393 mortgage holders is an uncertain business.

"Useful" for whom and for what purposes, one wants to know. And of course forecasting is an uncertain business ... especially so when the would-be forecaster does zero due diligence and displays willful ignorance of the most-relevant aspects of the mortgage holders` finances at every step.

Moody’s used statistical models to assess C.D.O.’s; it relied on historical patterns of default. This assumed that the past would remain relevant in an era in which the mortgage industry was morphing into a wildly speculative business. The complexity of C.D.O.’s undermined the process as well. Jamie Dimon, the chief executive of JPMorgan Chase, which recently scooped up the mortally wounded Bear Stearns, says, “There was a large failure of common sense” by rating agencies and also by banks like his. “Very complex securities shouldn’t have been rated as if they were easy-to-value bonds.”

Of course, rampant greed didn`t factor into any of this. The old "mistakes were made - we`re so sorry [that we got caught]" ploy.

Government responded. The Securities and Exchange Commission, faced with the question of how to measure the capital of broker-dealers, decided to penalize brokers for holding bonds that were less than investment-grade (the term applies to Moody’s 10 top grades). This prompted a question: investment grade according to whom? The S.E.C. opted to create a new category of officially designated rating agencies, and grandfathered the big three — S.&P., Moody’s and Fitch. In effect, the government outsourced its regulatory function to three for-profit companies.

Typical ... S.E.C. gives these outfits special status which virtually guarantees massive steady profits, while completely ignoring the massive conflict of interest resulting from the "special designee" ratingshouses being paid by the companies whose bonds they rate. That must've been a fun 6-martini lunch for the folks who came up with that one.

More later ... just a little too close to gagging in disgust at the moment.