The Mortgage Bankers Association is reporting that nearly one in ten households with mortgages are at least one payment behind.  That is a record, my friends. And it certainly means we cannot believe house prices have permanently stabilized.

The New York Times says:

The delinquency figure, and a corresponding rise in the number of those losing their homes to foreclosure, was expected to be bad. Nevertheless, the figures underlined the level of stress on a large segment of the country, a situation that could snuff out the modest recovery in home prices over the last few months and impede any economic rebound.

Unless foreclosure modification efforts begin succeeding on a permanent basis — which many analysts say they think is unlikely — millions more foreclosed homes will come to market.

Translation: there are a lot writedowns in residential real estate still coming. This is one reason bank credit is not going up significantly despite zero interest rates. Remember when I wrote about “extend and pretend?” This is the kind of thing that is holding up bank balance sheets. The article I wrote in October on short sales in North County San Diego highlights the issues involved. But at some point banks will have to take the hit (unless house prices magically go up to near previous levels – what everyone except renters wants).

Ivy Zelman has the same sinking feeling I do here; we don’t think house prices are necessarily heading up permanently. She even throws in a mixed metaphor to get her point across. She says:

I’ve been pretty bearish on this big ugly pig stuck in the python and this cements my view that home prices are going back down.

Look, the fake recovery is now in full swing.  But I expect the recovery to hit a brick wall by 2011, if not earlier. While the proximate cause of my concern is the likelihood of increased taxes and/or reduced spending by the Obama Administration, it is jobs that concern me. See Calculated Risk’s post showing the correlation between unemployment and mortgage delinquency and you see the connection. The fact is we have a record number of foreclosures and that is a direct result of rising unemployment. Unemployed people don’t have any money, so they don’t pay mortgages. It’s as simple as that.

The interesting bit about the New York Times article was this:

The number of loans insured by the Federal Housing Administration that are at least one month past due rose to 14.4 percent in the third quarter, from 12.9 percent last year. An additional 3.3 percent of F.H.A. loans are in foreclosure.

The fact is the F.H.A is the next Fannie Mae. If you’re looking and wondering where the next bailout will be, take a good look at the F.H.A. Not only is this agency guaranteeing hugely delinquent loans, but the Economic Stimulus Act of 2008 doubled the maximum loan that it could insure to $729,750 in order to cover jumbo mortgages common in cities like New York, San Francisco or D.C.. The purpose was to give liquidity to the frozen jumbo market in high-cost cities.  However, the net effect is that the F.H.A was expanding at exactly the time when loan quality was falling. There will be significantly more losses as delinquencies mount.

To make matters worse, the F.H.A. has an abysmally low 0.53% insurance reserve ratio – that’s the lowest ever. Yes, this ratio includes expected future losses, but you don’t have to be a rocket scientist to know any downside wipes these guys out. And that means more taxpayer money will be forthcoming.

Is this a pretty picture? No. But, is this what is going to happen? Of course it is.  So when the bailouts come because the foreclosures begin again in earnest and politicians start saying, “who could have known?” you will have every right to be disgusted.

Related posts:

• UK home prices fall in June
• A Home Price Firewall
• Can I borrow the full amount and an extra 25% too?
• Foreclosures hit a record in April
• Extend and pretend and the growing divide between delinquencies and foreclosures

I have written extensively about how I believe the bank bailouts were the worst of all possible solutions – fixes that perpetuate too big to fail, moral hazard and crony capitalism.  That ship has sailed, but the questions still linger – in large part because the fix has not trickled down to common folk to better their lot.  Rising unemployment is but one demonstration of this.

Arnold Kling writes a post that goes beyond banking to AIG, mortgages and Fannie and Freddie. He offers real world solutions that don’t require creating special resolution authority, buying toxic assets or orchestrating bailouts.  While there would certainly be costs to these solutions as well, they would be far less than what we are paying now.

The interesting bit is he proposed them in the moment when the bailouts were ongoing. Don’t let anyone tell you that there weren’t other options available because there were in spades.

1. Existing Mortgages and home owners.

Actual policy: attempts to implement loan modification programs

My policy: pay the moving expenses of homeowners who default on their mortgages. But do not interfere with the foreclosure process.

2. Mortgage Markets

Actual policy: keep Freddie Mac and Fannie Mae going, and we now have 90 percent of mortgage loans made by federal agencies.

My policy: Limit Freddie Mac and Fannie Mae to their existing book of mortgage loans (I wrote this in September of 2008) and not allow them to purchase any new mortgages. Let banks take up the slack in mortgage lending.

3. AIG

Actual policy: creditors bailed out 100 percent.

My policy: Send in a "stern sheriff" to protect the liquid assets of AIG from creditors making "collateral calls." I was thinking of a government-suggested mediator, perhaps a former bankruptcy judge. If the parties did not like it, they could go to court. But my guess is that the parties would have preferred a mediated solution.

4. Big banks

Actual policy: bailouts of nearly all of them

My policy: Triage. Shut down the ones that have clearly failed, using FDIC procedures. Those that are clearly solvent should be allowed to proceed. Those that are neither clearly failed nor clearly solvent should be given forbearance, but with tight supervision to ensure that they do not use this forbearance to expand their risk-taking. Again, this was what I advocated in September of 2008.

Why proposals of this sort were not followed is the subject of much debate.

Source

Was TARP Necessary? – Arnold Kling

Related posts:

• Fannie, Freddie to get $15 Billion from U.S. government
• Federal takeover of GSEs now in the works
• A quick note on corporate bankruptcy and bailouts
• Treasury to Consider Further Measures to Halt Housing Slide
• Dean Baker: I saw this scenario in 2002

Credit Suisse has a note out urging caution on Citigroup shares due to regulatory hurdles.  Their logic bears noting as it can be useful for other U.S.-based banks.

On Monday the CS analysts met with Citi management, who were somewhat cautious. The CS note indicates that regulatory changes in the U.S. are likely to mandate higher capital ratios and this necessarily will constrain returns on capital, not just at Citigroup but elsewhere in banking.

Another question involved deferred tax assets (DTAs), which I brought up last week. Citi said only $13 billion of the $38 billion in DTAs were counted against Tier 1 capital, meaning any writedowns to capital will have much less affect on Tier 1 capital. About $14 billion in DTAs were related to Citi’s burgeoning loan loss reserves; so the tax losses have not yet been triggered. This may give Citi time to earn money in order to use the DTAs. Again, the key with Citi’s DTAs has to do with how much it earns going forward. If it does not earn enough money, the deferred assets will have to be written down.

In general, banks are now entering a less favourable regulatory environment.  Moreover, in March, many bank stocks were trading below tangible book for the first time since 1990, at the height of the last major credit crunch in the U.S.. After a more than doubling in bank stocks from March lows, this is no longer the case and it will be harder to beat now elevated earnings estimates.

Meredith Whitney has said she expects the large cap bank stocks to underperform due to some of these hurdles and sees a relative value play in regionals.  However, a lot of CRE and loan construction exposure remains at regionals and the continued seizure of 3 or 4 banks every week by the FDIC points to distress.

I continue to believe upside in bank shares is limited all around.

Related posts:

• How well capitalized is Citigroup?
• How is Citi going to deal with $38 billion in deferred tax assets?
• The Citigroup Bailout: a blogosphere post-mortem
• Citigroup and Redecard: shedding international assets
• Rubin resigns from Citigroup

Is this propaganda? I just received this e-mail from the FDIC’s consumer news with the title above. Personally, I never doubted that unbrokered deposits under $250,000 are safe at U.S. depositary institutions. But, the natural sceptic in me doesn’t like to see someone reaffirm what I thought I already knew.

As bank failures are in the news, the Federal Deposit Insurance Corporation is helping consumers understand why, as Chairman Sheila C. Bair has said, "there’s no safer place in the world for their checking, savings or retirement money." The Fall 2009 issue of FDIC Consumer News gives facts and figures explaining the agency’s financial resources run deep and that insured deposits are fully protected.

"Depositors should understand that the chances of their bank failing are low, and even if their bank does fail, depositors have nothing to worry about," said Chairman Bair. "The FDIC fully guarantees their insured deposits and provides them with seamless access to their money. For the insured depositor, a bank failure is a non-event."

The newsletter gives these reasons why consumers can trust the ironclad protection of FDIC insurance:

• By law, federal deposit insurance is backed by "the full faith and credit of the United States government." It means that the financial resources of the U.S. government protect federally insured depositors. "In short," said Chairman Bair, "we cannot run out of money."
• If needed, the FDIC can quickly borrow money from the U.S. Treasury. However, Chairman Bair has stressed that the FDIC expects to continue to collect premiums from the banking industry to pay for banking industry problems — without borrowing from U.S. taxpayers.
• Federal law also requires that all insured deposits be paid "as soon as possible." If a bank fails, the FDIC has always paid every penny of insured deposits, up to the insurance limit, including principal and any accrued interest through the date of the closing. In most cases, the FDIC provides access to accounts on the next business day by arranging with a healthy institution to assume the insured deposits. .

According to Chairman Bair, the bottom line for consumers is this: "No insured depositor has ever lost a penny of insured deposits — and none ever will. The FDIC was created specifically for times like these. Our resources are strong. Your insured deposits are absolutely safe."

A related article reminds consumers that the basic maximum insurance amount under current law is $250,000 through year-end 2013, but that, as always, customers may qualify for much more protection at the same bank depending on the types and ownership of their accounts. The same article highlights FDIC resources that can help answer consumers’ questions about deposit insurance coverage.

Also in this issue are tips for paying with plastic. One article helps consumers understand the potential benefits and concerns when choosing and using debit cards versus credit cards. Another article examines prepaid cards, which have evolved from gift cards sold by individual retailers to multi-purpose, "reloadable" cards that can be used to pay for purchases and access cash at ATMs around the world.

Another article offers five things to know about safe deposit boxes and home safes. Among the tips: Bank safe deposit boxes are good choices to store originals of key documents, such as birth certificates and property deeds, but probably not for anything someone might need to access quickly on a night, weekend or holiday. Also, people are better off stashing their cash in a bank deposit account than in a home safe or a safe deposit box, where the money can’t earn interest and won’t be protected by FDIC insurance.

The goal of FDIC Consumer News is to deliver timely, reliable and innovative tips and information about financial matters, free of charge. The latest issue can be read or printed atwww.fdic.gov/consumers/consumer/news/cnfall09. To find current and past issues, including special editions, visit www.fdic.gov/consumernews or request paper copies by contacting the FDIC’s Public Information Center toll-free at 1-877-275-3342, by e-mail to publicinfo@fdic.gov, or by writing to the FDIC Public Information Center, 3501 North Fairfax Drive, Room E-1002, Arlington, VA 22226.

There are two ways to subscribe to the quarterly FDIC Consumer News. To receive an e-mail about each new issue with links to stories, go to www.fdic.gov/about/subscriptions/index.html. To receive the newsletter in the mail, free of charge, contact the Public Information Center as listed above.

Source

No Safer Place in the World for Your Money – FDIC

Related posts:

• Westsound Bank seized by FDIC
• SunTrust Bank receives insured deposits of Omni National Bank
• FDIC Friday Night Special: Lincolnwood
• FDIC shuts down Haven Trust and Sanderson State
• FDIC moves in at Great Basin Bank

Orion Bank, Naples, Florida

As of October 31, 2009, Orion Bank had total assets of $2.7 billion and total deposits of approximately $2.1 billion. The FDIC accepted a 1.5 percent discount from IBERIABANK on the deposits of the failed bank. In addition to assuming all of the deposits of the failed bank, IBERIABANK agreed to purchase $2.4 billion of the failed bank’s assets. The FDIC retained the remaining assets for later disposition.

The FDIC and IBERIABANK entered into a loss-share transaction on approximately $1.9 billion of Orion Bank’s assets. IBERIABANK will share in the losses on the asset pools covered under the loss-share agreement.

Century Bank, Federal Savings Bank, Sarasota, Florida

As of October 31, 2009, Century Bank, FSB had total assets of $728 million and total deposits of approximately $631 million. The FDIC accepted a 1.5 percent discount on the deposits of the failed bank from IBERIABANK. In addition to assuming all of the deposits of the failed bank, IBERIABANK agreed to purchase $706 million of the failed bank’s assets. The FDIC retained the remaining assets for later disposition.

The FDIC and IBERIABANK entered into a loss-share transaction on approximately $656 million of Century Bank, FSB’s assets. IBERIABANK will share in the losses on the asset pools covered under the loss-share agreement.

Pacific Coast National Bank, San Clemente, California

As of August 31, 2009, Pacific Coast National Bank had total assets of $134.4 million and total deposits of approximately $130.9 million. Sunwest Bank did not pay a premium to assume all of the deposits of Pacific Coast National Bank. In addition to assuming all of the deposits of the failed bank, Sunwest Bank agreed to purchase essentially all of the assets.

Related posts:

• Seven banks seized by FDIC
• FDIC shutters five more banks
• FDIC moves in at Great Basin Bank
• FDIC Friday Night Special: San Joaquin Bank, Bakersfield, California
• FDIC Bank seizures 56 and 57

The Jamie Dimon piece in today’s Washington Post is a must-read. Dimon, head of behemoth JPMorgan Chase makes the best case for not breaking up large too-big-to-fail financial institutions. His idea: set up a robust resolution process and let reckless lenders fail regardless of size.

Now, back in September, I attended a meeting at the Clinton Global Initiative where both Americans Sheila Bair and Jamie Dimon and British bank executive Peter Sands gave their ideas on the too big to fail idea. They all agreed that too big to fail must end. But, while Bair was arguing for shifting the balance of power toward smaller, community banks, Dimon was arguing, as he does in the Post, to keep large organizations intact.

Reviewing the exchanges, I wrote:

What I found interesting was the general agreement between Dimon, Sands and Bair that regulatory reform to date has been a bust…  the conversation made clear that Bair, Dimon and Sands all felt that the first and most important bit of financial reform must be to set up a resolution process in order to deal with too-big-to-fail institutions. Let me characterize Dimon and Bair’s remarks below.

Jamie Dimon. It is clear that Dimon believes JPMorgan Chase was never in any real jeopardy during the financial crisis. He spoke on several occasions about the lack of a resolution crisis to deal with large firms without mentioning any names, but clearly intimating that other beleaguered institutions like Citi and BofA were saved by this. He said that the financial crisis should not be used as an excuse to break up large institutions (like his) because the crisis was the result of bad lending as in any other crisis. He said, smaller imprudent lenders are being liquidated systematically by the FDIC. The only reason larger companies did not face liquidation is because no resolution mechanism was or still is in place to deal with them…

He said the present reform proposals are not heading in the right direction and used an analogy saying, “If we had a problem with our legal department, I would tell the guys to fix the legal department. If the government had the same problem, it would create a second new legal department.”  Over-regulation is not the answer. Smart regulation is.

Sheila Bair. Bair was in stunning agreement with Dimon on the core issues. She too said the first priority of any financial regulation must be to put a resolution mechanism in place to deal with too-big-to-fail institutions. She rejected the concept of the Federal Reserve as the main financial regulator, something even Ben Bernanke is now rejecting. But, she disagreed with Dimon. Instead she felt that the financial system had veered excessively into derivatives and other complicated financial products and that this was a major contributor to the financial collapse. She advocated regulating these and increasing the focus on traditional banking products typical in community banking. It was clear from these remarks that she favors community banks over too-big-to-fail institutions.

Both points of view make sense. Dimon is obviously advocating from the position of an interested party. Nevertheless, he does make good arguments. Note that he says management should be fired. Shareholders should be wiped out. Unsecured creditors should, if necessary, be wiped out too. This is a big deal.

Here are excerpts of what he had to say (bolding added).  The link to the full article is at the bottom.

Our company, J.P. Morgan Chase, employs more than 220,000 people, serves well over 100 million customers, lends hundreds of millions of dollars each day and has operations in nearly 100 countries. And if some unforeseen circumstance should put this firm at risk of collapse, I believe we should be allowed to fail…

But ending the era of "too big to fail" does not mean that we must somehow cap the size of financial-services firms. Scale can create value for shareholders; for consumers, who are beneficiaries of better products, delivered more quickly and at less cost; for the businesses that are our customers; and for the economy as a whole. Artificially limiting the size of an institution, regardless of the business implications, does not make sense…

Creating the structures to allow for the orderly failure of a large financial institution starts with giving regulators the authority to facilitate failures when they occur. Under such a system, a failed bank’s shareholders should lose their value; unsecured creditors should be at risk and, if necessary, wiped out. A regulator should be able to terminate management and boards and liquidate assets… We can learn here from how the Federal Deposit Insurance Corp. closes banks…

…It also requires effective international cooperation, as the implications of a major financial institution’s failure are global. This is challenging but worth doing…

As we have seen clearly over the last several years, financial institutions, including those not considered "too big," can pose serious risks for our markets because of their interconnectivity. A cap on the size of an institution will not prevent that risk. Properly structured resolution authority, however, can help halt the spread of one company’s failure to another and to the broader economy…

To understand the harm of artificially capping the size of financial institutions, consider that some of America’s largest companies, which employ millions of Americans, operate around the world. These global enterprises need financial-services partners in China, India, Brazil, South Africa and Russia…

…a fragmented banking system cannot always provide the level of service, breadth of products and speed of execution that clients often need. Capping the size of American banks won’t eliminate the needs of big businesses; it will force them to turn to foreign banks that won’t face the same restrictions.

Source

No more ‘too big to fail’ – Jamie Dimon, Washington Post

Disclosure: I have no financial interest in any financial services companies. Further, I have said previously that I do not favor re-imposing Glass-Steagall as a magic bullet solution given that most financial carnage over the past twenty-five years has originated in the regulated commercial bank sector. Like Dimon and Bair, I see a robust regulatory regime as critical. On the other hand, I am generally in favor of reducing bank size, unlike Dimon.

Related posts:

• The failure to address the looming too-big-to-fail issue
• Jamie Dimon on the economy
• Jamie Dimon: ‘we don’t need’ your money
• Quote of the day: “Jamie is always hanging around the hoop”
• Jamie Dimon: “If You Are Not Fearful, You Are Crazy”

Bond insurer Ambac Financial has warned bankruptcy is a distinct possibility, sending its shares plummeting more than 30% today.

What is intriguing about this pending bankruptcy is how this company escaped bankruptcy in 2008, was downgraded continually in 2009, yet just reported billions in profit 5 days ago. Now it warns of bankruptcy? 

This story also is related to municipal bonds.

Rewind to July of last year and Ambac was headed to zero fast after having been downgraded by S&P the month before. Basically, their business model of using a AAA rating to guarantee bonds (a sort of credit default insurance) was rendered non-viable by the credit crunch.

But in November, Ambac was able to forestall the inevitable. On November 19th, MarketWatch reported:

Ambac said late Wednesday that it commuted, or tore up, roughly $3.5 billion worth of guarantees on complex mortgage-related vehicles known as collateralized debt obligations. The company’s main bond insurance unit paid counterparties $1 billion in cash to settle the contracts.

The deal will improve the capital position of the bond insurance unit for rating agencies, Ambac said.

Later the insurance subsidiary eliminated its dividend to the parent company.

When the company rejected an unsolicited offer by Warren Buffett to reinsure $800 billion in municipal bonds insured by Ambac and MBIA in December, this was generally seen as a sign of strength. But, the company was holding on by a thread.

Then came the potential for a big bailout in March. MarketWatch again:

Life and bond insurers soared after the announcement Monday that they will be eligible to participate in the Treasury Department’s Public Private Partnership Investment Program.

Bond insurer Ambac Financial Group is one that will investigate Treasury’s offer to backstop a market for securities it holds in its investments, said Ambac spokeswoman Vandana Sharma.

The public-private program will use $75 billion to $100 billion in money from the Troubled Asset Relief Program called TARP to generate $500 billion in purchasing power to buy legacy assets held by investors, with a government backstop encouraging private sector investors to purchase the assets.

"A broad array of investors are expected to participate in the Legacy Loans Program," the Treasury said in a fact sheet it provided Monday. "The participation of individual investors, pension plans, insurance companies and other long-term investors is particularly encouraged."

Up to now, insurers such as Ambac have unsuccessfully lobbied for inclusion in government programs that have offered capital to help make up for losses tied to mortgage loans.

Ambac did not get TARP money.  All the while, the two companies MBIA and Ambac continued to be downgraded by the ratings agencies – dead men walking.

But just five days ago, Housing Wire reported the following:

Bond insurer Ambac Financial Group posted net income of $2.2bn, or $7.58 per share, in Q309, compared with a net loss of $2.4bn in the year-ago quarter.

Quarterly results were impacted by unrealized mark-to-market gains in the New York City-based financial services and insurance firm’s credit derivatives portfolio and gains from Q309 reinsurance cancellations.

The firm experienced a positive $2.1bn change in fair value of credit derivatives, driven by the adjustment made under Financial Accounting Standard (FAS) 157 relating to Ambac’s widening credit spread…

“We continue to make progress in de-risking the balance sheet via negotiated reinsurance buy-backs, CDO of ABS commutations, settlements related to defaulted RMBS transactions as well as expanded analysis of expected recoveries relating to RMBS representation and warranty breaches,” said president and CEO David Wallis.

Nice, right?  Well, now they could be filing for bankruptcy.

The muni connection comes from the fact that Ambac was a large guarantor in the municipal bond market. Witness this ill-timed article from Fortune in February 2008:

Forget what you may have read in the newspaper about state budget problems or bond insurer meltdowns. This is a perfect time to be buying municipal bonds. The economy is slowing, the Federal Reserve is poised for more interest rate cuts (boosting bond prices), and a Democratic win in November would probably lead to higher taxes on the rich, thereby enhancing munis’ tax advantages. Throw in munis’ microscopic default rates, and you’ve got an ideal landing spot for investors weary of the stock market roller coaster…

As we said, the default rate on munis is minuscule, especially for GOs, water-and-sewer revenue bonds, and the other plain-vanilla offerings that make up the majority of the muni market. Even triple-B-rated munis – the lowest rung of investment grade – have a default rate of only 0.06 percent…

Over the years, this incongruity has fueled the growth of Ambac (ABK), MBIA (MBI) and other bond insurance companies. By selling states and cities insurance that turns triple-B and single-A bond issues into triple-A’s – reducing government borrowing costs in the process – the bond insurers manage to pocket much of the extra yield that would otherwise go to investors. Best of all, bond insurers rarely had to pay claims, certainly not on the plain-vanilla GOs and water-and-sewer bonds. "In my opinion," says Paul Disdier, who oversees the municipal bond fund division at Dreyfus, "the worst thing to happen to the muni market is the spread of bond insurance."

I’m sure you know that the spread is actually not the worst thing here. It’s that risk was being underpriced. That’s why Ambac is hitting the wall. And so it is again.

By the way, the Fed and the Treasury are on record as being leery of guaranteeing anything in the municipal bond market. So, with Ambac crumbling and no Federal government backstop, there is no safety net for bad investments in munis. Caveat Emptor.

Update: To be clear – Ambac Financial, the parent entity is filing for bankruptcy. But Ambac Assurance, which is the insurance subsidiary is not. Nevertheless, Ambac Assurance still has a Caa2/CC rating and we should anticipate it will be soon to be out of business.

Update 2: see the following Bloomberg article for detailed information on the potential bankruptcy filing and associated market action: Ambac, MBIA Tumble as Losses May Overwhelm Bond Insurers.

Related posts:

• MBIA and Ambac sued by LA
• MBIA, Ambac, $1 Trillion of Debt, Lose S&P AAA Rating
• Ambac is going to zero fast
• The coming collapse of the municipal bond market
• AIG: looking to raise $20 billion

Of the five, United Commercial is pretty darn big ($11.2 billion in assets)

United Commercial Bank
San Francisco, CA

As of October 23, 2009, United Commercial Bank had total assets of $11.2 billion and total deposits of approximately $7.5 billion. East West Bank paid the FDIC a premium of 1.1 percent for the right to assume all of the deposits of United Commercial Bank. In addition to assuming all of the deposits of the failed bank, East West Bank agreed to purchase approximately $10.2 billion in assets of the failed bank. As part of the purchase and assumption agreement, the FDIC transferred to East West Bank all qualified financial contracts to which United Commercial Bank was a party and those contracts remain in full force and effect.

The FDIC and East West Bank entered into a loss-share transaction on approximately $7.7 billion of United Commercial Bank’s assets.

Gateway Bank of St. Louis
St. Louis, MO

As of September 25, 2009, Gateway Bank of St. Louis had total assets of $27.7 million and total deposits of approximately $27.9 million. Central Bank of Kansas City did not pay the FDIC a premium for the deposits of Gateway Bank of St. Louis. In addition to assuming all of the deposits of the failed bank, Central Bank of Kansas City agreed to purchase essentially all of the assets.

Prosperan Bank
Oakdale, MN

As of August 31, 2009, Prosperan Bank had total assets of $199.5 million and total deposits of approximately $175.6 million. Alerus Financial, N.A. will pay the FDIC a premium of 1.02 percent to assume all of the deposits of Prosperan Bank. In addition to assuming all of the deposits of the failed bank, Alerus Financial, N.A. agreed to purchase approximately $173.9 million of the failed bank’s assets.

The FDIC and Alerus Financial, N.A. entered into a loss-share transaction on approximately $173.9 million of Prosperan Bank’s assets

Home Federal Savings Bank
Detroit, MI

As of September 24, 2009, Home Federal Savings Bank had total assets of $14.9 million and total deposits of approximately $12.8 million. Liberty Bank and Trust Company did not pay a premium to assume all of the deposits of Home Federal Savings Bank. In addition to assuming all of the deposits of the failed bank, Liberty Bank and Trust Company agreed to purchase essentially all of the assets.

United Security Bank
Sparta, GA

As of September 14, 2009, United Security Bank had total assets of $157 million and total deposits of approximately $150 million. Ameris Bank will pay the FDIC a premium of 0.36 percent to assume all of the deposits of United Security Bank. In addition to assuming all of the deposits of the failed bank, Ameris Bank agreed to purchase essentially all of the assets.

The FDIC and Ameris Bank entered into a loss-share transaction on approximately $123 million of United Security Bank’s assets.

Related posts:

• Seven banks seized by FDIC
• Three more FDIC bank seizures
• Five banks seized in FDIC Friday night special
• FDIC Friday Night Special: San Joaquin Bank, Bakersfield, California
• FDIC moves in at Great Basin Bank

Why aren’t more municipal bonds being downgraded by the ratings agencies Fitch, Moody’s and S&P?  If you look at sovereign debt in revenue-constrained countries like Greece, Portugal or Ireland, the ratings agencies are issuing warnings. 

But, states and municipalities are suffering from the same revenue constraints. Tax revenues have plunged. Governments have shut down services to save cash. And they have cut staff. There are dozens of articles in the national press daily detailing the difficulties municipalities, cities and states are having.

You wouldn’t know that if you looked at the charts of some of the major municipal bond funds. Take a look at Nuveen Municipal Value Fund (NUV) for example.  It bottomed in December last year. Now, 11 months later it is up 31%. How about BlackRock’s MuniHoldings Insured Investment Fund (MFL). It bottomed in December as well. But is up over 70% since then. Pretty nice return. But, I don’t think it can last.

California’s summer struggles made it is the poster child of the distress in the finances of US states and municipalities. But, there are many states, cities and municipalities on the brink. That’s why I found the excerpt from the post “The Coming Collapse of the Municipal Bond Market” at Phillip Greenspun’s blog over at Harvard Law School interesting. Note the highlighted sections

A money manager friend showed me an interesting research report by Frederick J. Sheehan titled “Dark Vision: The Coming Collapse of the Municipal Bond Market. This is a product of weedenco.com and available only to subscribers, but I will summarize it here.

Sheehan starts off by noting that a lack of panic by the ratings and government agencies does not indicate health for a financial market. He cites the fact that the Fed did not anticipate how bad the subprime collapse was likely to be and obviously the Moody’s and Standard and Poor’s ratings were ridiculous.

Sheehan notes that “spending is rising and revenue is collapsing” for all levels of government. Pension fund losses will require governments to double their contributions to pension plans (see my blog posting on public employee pensions). Spending is rising, e.g., in New York City from an average of $65,401 in compensation per public employee in 2000 to $106,743 in 2009. The number of full-time employees in NYC grew as well, despite falling school enrollment. The number of state and local government workers grew from 4 million in 1955 to 20 million in 2008 (5x growth, against less than 2X growth in U.S. population). Those workers receive an average of 43 percent more pay and benefits than a private sector worker.

Municipalities dealt with the separation between taxes and expenses by borrowing. In the mid-1990s, states and cities were retiring as much debt as they were incurring. During the 2000s, though, they borrowed about $150 billion per year in aggregate, peaking at $215 billion in 2007 by which time $2.7 trillion in debt was outstanding, more than two years’ worth of tax receipts.

Barring some sort of miraculous boom in the economy and pension fund investment returns, state and local governments are headed for insolvency and default. This means that valuing a municipal bond becomes a matter for a legal expert rather than an accountant. Even for the legal expert, it is apparently tough to predict what will happen. Let’s start with the Wikipedia article on Chapter 9 bankruptcy: “Previous to the creation of Chapter 9 bankruptcy the only remedy when a municipality was unable to pay its creditors was for the creditors to pursue an action of mandamus, and compel the municipality to raise taxes. During the Great Depression this approach proved impossible so in 1934 the Bankruptcy Act was amended to extend to municipalities.”

Without bankruptcy protection, a city that couldn’t pay bondholders would be forced to raise taxes until it could. This happened to West Palm Beach, Florida in the Depression and property tax rates rose to 42.5 percent of assessed value. Potentially bondholders might demand that the city hand over real estate to satisfy its debts. With bankruptcy protection, it is unclear what happens. Vallejo, California went bankrupt 18 months ago and their obligations have not yet been resolved (story). If courts allow municipalities to walk away from debt they’ll have every incentive to declare bankruptcy and start afresh. There are no shareholders in a municipality to wipe out and therefore the only negative consequence of a bankruptcy filing would possibly be having to pay higher interest rates for future borrowing. If on the other hand, governments are not allowed to walk away from many of their obligations, they will simply run out of cash. Are bondholders senior to pension obligations or not? It may be up to the individual judge. This is “uncharted territory for investors” as my money manager put it (he does not buy U.S. muni bonds).

Municipal bonds are still perceived as almost risk-free by most investors and consequently offer a low yield, according to Sheehan. He points out that if the municipalities don’t default, the investor gets only a slightly better return than in Treasuries. Why take the risk if you’re not getting paid for it?

This ends my summary of Sheehan’s report. My own opinion is that the main lesson of subprime is that an investor cannot rely on the ratings agencies or the government to protect his or her interests.  The never-employed guy in Cleveland with the house in a crummy neighborhood and no down payment? The risk that he would never make a payment should have been apparent to any investor who dug underneath the asset-backed security. Similarly, an investor in muni bonds can look at the municipality. Does the state have a shrinking population, high public employee salaries, and a big pension obligation overhang from when the population was larger? They probably will eventually default. And if an insurance company was dumb enough to insure the bonds, they’ll probably be bankrupt too.

If you’re waiting until the ratings agencies give you a heads up, thinking this will happen before these problems get reflected in lower muni bond prices, you better think again.

Related posts:

• Chanos says dump munis as distress mounts and ratings attacked
• State and local government weighed down by housing
• Ambac may file bankruptcy soon
• MBIA and Ambac sued by LA
• State and local governments: budget cuts likely

I have said on a number of occasions that a sovereign nation that issues debt in its own fiat currency cannot default involuntarily.  The case most people point to as a counterfactual is Russia in 1998.  I mentioned Russia in a recent post:

Countries that have gone bust, Russia, Mexico, and Argentina were borrowing in foreign currency because of interest rate differentials. No sovereign nation which prints and issues debt in its own fiat currency can ever involuntarily be made insolvent.

I was on a trading desk that was dealing in synthetic GKOs before Russia defaulted in 1998, so I remember the incident quite clearly. Russia’s was not an involuntary default by a country which issues debt in its own fiat currency. Russia was a perfect example of a voluntary default due to huge foreign currency debt and foreign exchange reserve losses (see Wikipedia for a pretty accurate and thorough account on the events of the 1998 Russian financial crisis).

Marshall Auerback summed it up well in an email to me as we discussed this case in view of his post refuting chatter about Japan defaulting. Not the underlined words.

Russia didn’t have to default.  As a point of logic, the concept of ability to pay being inherently revenue constrained is not applicable to the issuer of a currency. Any such constraints are necessarily self-imposed (including various ‘no overdraft’ legislation in some countries for the Treasury at the Central Bank). The issuer can always make payment of its currency by crediting the appropriate account or by issuing actual paper currency if demanded by the counter party.

An extreme example is Russia in August 1998. The rouble was convertible into $US at the Russian Central Bank at the rate of 6.45 roubles per $US. The Russian government, desirous of maintaining this fixed exchange rate policy, was limited in its willingness to pay by its holdings of $US reserves, since even at very high interest rates holders of roubles desired to exchange them for $US at the Russian Central Bank. Facing declining $US reserves, and unable to obtain additional reserves in international markets, convertibility was suspended around mid August, and the Russian Central Bank has no choice but to allow the rouble to float.

All throughout this process, the Russian Government had the ability to pay in roubles. However, due to its choice of fixing the exchange rate at level above ‘market levels’ it was not, in mid August, willing to make payments in roubles. In fact, even after floating the rouble, when payment could have been made without losing reserves, the Russian Government, which included the Treasury and Central Bank, continued to be unwilling to make payments in roubles when due, both domestically and internationally. It defaulted on rouble payment by choice, as it always possessed the ability to pay simply by crediting the appropriate accounts with roubles at the Central Bank.

Why Russia made this choice is the subject of much debate. However, there is no debate over the fact that Russia had the ability to meet its notional rouble obligations but was unwilling to pay and instead chose to default.

Russia defaulted voluntarily, an event which the geniuses at Long-Term Capital Management failed to model correctly. Moreover, the immediate stress on Russia was not the rouble-denominated debt but the mountain of foreign currency obligations via an unrealistic currency peg which were draining reserves. Similar events unfolded in Argentina a few years later as their currency board crumbled and the Peso was devalued by three-quarters.

Again, the point is that a government can always make good on its own fiat currency obligations if it chooses to do so. The real question is why a country might voluntarily default on its own currency debt or involuntarily on foreign currency debt.  The answer usually has to do with taxes.  In Argentina and Russia, the government was unable to prove that its taxation policies were benefitting its citizens, creating rampant tax evasion, especially in the monied classes. Capital flight took form as many dodged taxes. Capital flight eventually turns into currency revulsion which creates the pre-conditions for depression, as Latvia, Estonia and Lithuania learned most recently.

The relationship these examples from the Baltics, Argentina and Russia have with Japan and the United States is taxes. When taxes seem unfair or excessive, the citizens evade taxes and eventually revolt; you end up with a situation like Russia circa 1998, Argentina circa 2002 or Zimbabwe circa 2007.

Related posts:

• Russia devalues currency again as foreign reserves plummet
• Latvia – the insanity continues
• The Age of the Fiat Currency: A 38-year experiment in inflation
• Argentina faces potential collapse
• Russia cuts Europe off completely from its gas

CIT has the approval of debtholders to file a prepackaged bankruptcy. This comes via Business Wire:

CIT Group Inc. (NYSE: CIT), a leading provider of financing to small businesses and middle market companies, today announced that, with the overwhelming support of its debtholders, the Board of Directors voted to proceed with the prepackaged plan of reorganization for CIT Group Inc. and a subsidiary that will restructure the Company’s debt and streamline its capital structure.

Importantly, none of CIT’s operating subsidiaries, including CIT Bank, a Utah state bank, will be included in the filings. As a result, all operating entities are expected to continue normal operations during the pendency of the cases.

All classes voted to accept the prepackaged plan and all were substantially in excess of the required thresholds for a successful vote. Approximately 85% of the Company’s eligible debt participated in the solicitation, and nearly 90% of those participating supported the prepackaged plan of reorganization.

Similarly, approximately 90% of the number of debtholders voting, both large and small, cast affirmative votes for the prepackaged plan. The conditions for consummating the exchange offers were not met.

Accordingly, CIT’s Board of Directors approved the Company to proceed with the voluntary filings for CIT Group Inc. and CIT Group Funding Company of Delaware LLC with the U.S. Bankruptcy Court for the Southern District of New York (“the Court”).

Due to the overwhelming and broad support from its debtholders, the Company is asking the Court for a quick confirmation of the approved prepackaged plan. Under the plan, CIT expects to reduce total debt by approximately $10 billion, significantly reduce its liquidity needs over the next three years, enhance its capital ratios and accelerate its return to profitability.

“The decision to proceed with our plan of reorganization will allow CIT to continue to provide funding to our small business and middle market customers, two sectors that remain vitally important to the U.S. economy,” said Jeffrey M. Peek, Chairman and CEO. “We are enormously appreciative of the extraordinary support we have received from our many constituencies. This market-based solution allows CIT to enter into the reorganization process well-prepared and positioned for a swift emergence. I want to thank our customers for their support and express my gratitude to our employees whose dedication and hard work are crucial to the future of CIT. We also acknowledge our constructive working relationship with our regulators and look forward to their continued guidance as we move through this process.”

For more than 100 years, CIT has provided much needed capital to small business and middle market customers. These two sectors play a vital role in the U.S. economy and in overall employment and job creation, representing more than 90 million employees.

Related posts:

• Obama Team considering a pre-pack Auto bankruptcy
• GM gets the green light on its section 363 bankruptcy
• The case of the dissident Chrysler bondholders
• Is the GM section 363 bankruptcy plan really a stealth re-organization plan?
• CIT: $3 Billion Credit Facility and Recap Plan

Annaly Capital Management’s blog has a good piece up on foreclosures, inspired by yesterday’s Case-Shiller data (hat tip Scott). If you missed it, The S&P/Case-Shiller index showed a pretty steep 1.2% month-on-month increase in U.S. house prices in its latest figures (for August 2009). This is the fourth consecutive month of increases, signaling to some that residential real estate prices have bottomed (see my post on Case-Shiller here).

Not so fast. First, we need to see this trend hold through the winter months after incentives have dissipated and after the summer selling season is less of a factor driving sales.  But, there’s something more ominous lurking in the data, and Annaly points this out. It’s the growing gap between delinquencies and foreclosures.

The S&P/Case-Shiller Home Price Index grew 1.2% month-over-month, and expanded for the third month in a row, according to data released this morning.  It would appear that the housing recovery is upon us.  To maintain this sunny outlook, we advise readers to please stop their analysis of the health of the housing market right there.  For braver souls, LPS (a provider of data and services to mortgage lenders and servicers) releases its Monthly Mortgage Monitor in the middle of every month.  The growing disparity between delinquencies and foreclosure starts is in focus in the chart below, from October’s release.

As the graph illustrates, delinquencies are rising, but foreclosure starts are not.  As of September 2009, 90+deterioration more than doubled actual foreclosure starts.  LPS has dubbed this “shadow foreclosure inventory.”  Higher unemployment begets delinquencies and defaults, but foreclosures aren’t flowing through due to modification efforts and various moratoria.  Depending on the success of programs like HAMP, more than a few of these loans are still destined for foreclosure.

This is the result of what is known as extend and pretend because a rolling loan gathers no moss or credit writedowns, but does gather fee income.  On the one hand, a lot of home owners are finding it difficult to get loan modification terms. But, on the other hand, mortgage delinquencies have more than doubled since the recession began, so the absolute number getting modifications has risen. The question is not so much whether enough modifications are being done, but rather under which circumstances are lenders modifying loans.

The Annaly data and graph above suggest that lenders are actually modifying a decent number of mortgages that fall delinquent – so much so that foreclosure statistics understate the overall distress in the housing market. So, this is a little bit of damned if you do, damned if you don’t as far as banks are concerned. On the one hand, they are getting pilloried for not modifying loans. Yet, on the other hand, in modifying loans they can be accused of “delay and pray” tactics in order to avoid writedowns. Both accusations seem fair given the enormous increase in foreclosures. Nevertheless, you can understand the dilemma. If you want a real-life story about how extend and pretend works in practice, see my post, “Short Sales in North County: “Feeding Frenzy” as banks pretend and extend.”

These cases are where the shadow inventory everyone keeps talking about comes from: houses that have not been foreclosed but where delinquencies show an increased probability of foreclosure, especially in a weak economic environment.

For banks looking to husband capital, it makes sense to extend and pretend where one thinks there is a reasonable chance that this will result in fewer loan losses. But, at the same time, given the securitized nature of the mortgage market, it is mortgage servicers which have an increased measure of control in loan modifications. And their incentives do not appear to align with those of the mortgagees. Time will tell how all of this impacts house prices.

Source

Who Knows What Evil Lurks In The Hearts of Men? – Annaly Salvos

Related posts:

• Prime Foreclosures greater than subprime
• Ivy Zelman: “Home prices are going back down”
• Case-Shiller: House prices up for second month
• Subprime, Alt-A Delinquencies Rise
• Consumer loan delinquencies paint bleak picture

Remember the iconic Depression-era movie “Mr. Smith Goes to Washington, in which Jimmy Stewart plays the wholesome young man in Washington out to do good? Well, Mr. Smith could just as easily have been your friendly banker at Washington Mutual. Unfortunately, Mr. Smith lost his way and turned predatory lender – and that’s the subject of the second part of a Seattle Times expose on the rise and fall of WaMu.

I posted yesterday on part one, which you should definitely read to get a sense of how WaMu culture changed. Now comes part two – also a must-read.

The lead-in says it all:

For decades, Washington Mutual lived up to its image as a staid, straight-laced Seattle institution. Its motto: "The Friend of the Family."

By the time WaMu made history last year as the nation’s biggest bank failure, it bore no resemblance to this homey image.

What few people knew was that bank executives crafted a radical new business strategy in 2003 that was intended to boost profits. The new WaMu used huge sales commissions and misleading marketing to hawk risky and overpriced loans to borrowers.

In short, WaMu became one of the nation’s biggest predatory lenders.

 

Here are a two quotes from the article:

• WaMu lured borrowers with a very low interest rate of about 1 percent. But this "teaser" rate was good only for one month. After that, the option ARM could have far higher interest rates than conventional 30-year fixed-rate loans. With each minimum payment, unpaid interest piled up. Once the debt grew too large, WaMu canceled the minimum-payment option. You could suddenly get a new bill for two or three times what you had been paying.
• "I always felt like I worked for a really honest industry that cared for the borrowers they dealt with," she said. The corporate culture changed to: "We just want to do the most we can to make money for the bank."
• The 1 percent interest rate Houk thought he was getting was only good for the first month. It had reset to 7.4 percent, nearly 3 percentage points above his previous WaMu loan. This was buried in the fine print in a sheaf of legal documents he had signed. "Who in their right mind would give up a 4.6 percent loan?" Houk said. "I felt totally duped."

The overall gist of the article (in conjunction with the previous one) is of a company whose CEO was obsessed with the share price as validation of success.  As a result, the company morphed from an institution worthy of Mr. Smith to just another profit-oriented bank. 

The key changes came in crisis after profits were devastated by the recession of 2001 and the jobless recovery afterwards. WaMu was forced into huge layoffs.

It is often said true character is shown in crisis and at WaMu it would be no different.  Instead of accepting a temporarily lower share price and reduced earnings from its bread and butter mortgage products, WaMu went all-in, wading into sub-prime and option-ARM products which were not its mainstay. That is when the predatory lending began, ultimately setting the firm up for failure.

More here.

WaMu: Hometown bank turned predatory – Seattle Times

Related posts:

• Anecdotes on reckless lending at WaMu from the Seattle Times
• WaMu on the brink of disaster: has agreement with regulators
• JP Morgan Chase buys WaMu out
• Is the new affordable FHFA loan program predatory lending?
• How refinancing helps the likes of Bank of America and Wells Fargo

Three years ago, MetLife agreed to sell the community of Stuyvesant Town (Peter Cooper Village) to Tishman Speyer and BlackRock for the exorbitant sum of $5.4 billion at the top the market. That deal has now gone completely pear-shaped and bankruptcy is expected soon in another bizarre chapter in the history of one of the most iconic 20th century planned communities in America.

Brief History of Stuyvesant Town

Stuyvesant Town was born in controversy. The Stuyvesant Town Wikipedia entry gives a fairly even-handed description of the events surrounding its development (more history found in the NYTimes article from 2006 second in the links at the bottom).

Due to a housing crisis building since the Depression, Stuyvesant Town was already being planned as a post-war housing project in 1942-43, some years before the war’s end. Provision was made that the rental applications of veterans would have selection priority.

Stuyvesant Town was controversial from the beginning. It was championed by Parks Commissioner Robert Moses, who, at the behest of Mayor La Guardia, sought "to induce insurance companies and savings banks to enter the field of large-scale slum clearance" (Moses, Letter to The New York Times, June 3, 1943). It was enabled by various state laws and amendments which permitted private companies to enter what was previously a public field of action. The new public-private partnership, and the contract entered between the city and the developer, the Metropolitan Life Insurance Company, were the source of much debate.

Among the issues at stake were use of the power of eminent domain for private purposes; the reversion of public streets and land, such as public school property, to private ownership; the 25-year tax exemption granted by the contract; and the rights of the company to discriminate in selecting tenants.

When the $50 million Stuyvesant Town plan was approved by the City Planning Commission on May 20, 1943 by a five to one vote, discrimination against African Americans was already a significant topic of debate.

Let’s call this redlining. Just as an addendum to this factoid on the ignoble beginnings, I should also add that Robert Moses  used his coercive power as Triborough head on slum clearances throughout New York City to make way for progress in the form of roads, bridges, and development (see the eponymous mid-70s book, “The Power Broker” for more – a true testament to coercive power in an advanced democracy). Another notable slum clearance of a similar nature was the Park West Village which went up in the Bloomingdale District of Manhattan just west of Central Park. Thousands were displaced in these actions and while Stuyvesant Town is a notable architectural achievement, Park West Village is not a wonder of post-War architectural design.

The bubble and the end of rent control

But Stuyvesant Town eventually thrived and developed a vibrant community of renters. When Tishman Speyer and BlackRock took over the days of below-market rents were over as the companies needed to get market prices to finance the enormous debt used to purchase Peter Cooper Village. See last year’s NYTimes article “Renters Forced Out of Stuyvesant Town” for more. However, this move was blocked on Thursday in court and now the New York Times is reporting that Stuyvesant Town is about to go bust.

Despite all the wailing and celebrating by opposing parties, it may be years before landlords and tenants in New York City know the full impact of a decision by the state’s highest court on Thursday that the owners of two major residential complexes improperly charged market-rate rents for thousands of apartments.

The New York Court of Appeals ruled that the owners of Stuyvesant Town and Peter Cooper Village, adjoining complexes in Manhattan with 11,227 apartments, improperly raised rents and deregulated 4,400 apartments while receiving special tax breaks from the city.

Landlords immediately criticized the decision, saying its impact would throw thousands of building owners who did the same thing into financial distress. At the same time, tenants looked forward to rent rebates going back years and damages worth tens of thousands of dollars.

But lawyers on both sides of the issue said on Friday that it could take years of litigation to determine if the owners of Stuyvesant Town and other landlords must repay tenants for years of rent overcharges, or simply adhere to the court’s decision from now on.

By that time, this property will be bust because there is no way this top of the market purchase is affordable with rent control and under anything but the the best of economic circumstances. All of the top of the market mistakes are eventually going to come a cropper. Consider this in that vein.

Other Sources

The Upscaling of Stuyvesant Town – NYTimes, 28 Jan 2001

Megadeal: Inside a New York Real Estate Coup – NYTimes, 31 Dec 2006

Big Landlord Found to Have Wrongly Raised Rents – NYTimes, 6 Mar 2009

Related posts:

• Circuit City as canary in the coalmine for commercial real estate
• Manhattan real estate now getting decimated
• Banks can do ‘You Walk Away’ too
• Looking for a bottom in Manhattan real estate
• Muncipalities can tear up contracts

The Seattle Times has a must-read piece on Washington Mutual today which reveals a lot of the fine detail on how the company was run and what led to its demise (hat tip calculated Risk).

As with many of the other busted financial giants like Northern Rock and Lehman Brothers, indications that something was amiss were apparent long before their ultimate demise.  However, in an environment of easy money and lax regulatory standards those signs were overlooked as share prices kept rising.

Here are a few of the verbatim quotes from the article which I found most telling.

• In its headlong pursuit of growth, WaMu systematically dismantled or weakened the internal controls meant to prevent the bank from taking on too much risk
• WaMu’s riskiest loans raked in money from high fees, but because the bank skimped on making sure borrowers could repay them, they eventually failed at disastrously high rates.
• WaMu’s subprime home loans failed at the highest rates in nation. Foreclosure rates for subprime loans made from 2005 to 2007 — the peak of the boom — were calamitous. In the 10 hardest-hit cities, more than a third of WaMu subprime loans went into foreclosure.
• By the summer of 2004, nearly 60 percent of the loans WaMu was making were the riskiest sort — option ARMs, subprime mortgages and home-equity loans.
• Talk to people who worked with Killinger, and the same phrases and adjectives keep coming up. Ambitious. Quick study. Smartest guy in the room. And always, always optimistic. "He’s a cockeyed optimist to the nth degree," one former associate said. "He always thought he could get out of whatever trouble he was in." But Killinger also is repeatedly described as avoiding confrontation and uninterested in the nuts-and-bolts details of WaMu’s business.
• And even more than most chief executives, insiders say, Killinger was focused on WaMu’s stock price as the company’s — and his — primary gauge of success. "Kerry’s view of himself was tied to a constant increase in the stock price," Chapman said. "He was fixated on it."

This article is the first of two parts. The link to the article is below. It is a good read and documents fairly extensively how all-encompassing the originate-to-sell model of securitization was at WaMu and how this relaxed internal controls and risk management, leading to its demise. What tipped me off to what was happening was the change in Washington Mutual’s lending profile as it rushed headlong into option ARMs. The whole episode is rather sad because WaMu was a great company with an amazing brand. And from most anecdotes I hear, Killinger was a brilliant man as well.

But, smarts are not enough when you are taking on too much risk, thinking you have somehow magically hedged yourself against those risks. No, you do not have to dance, if the music is playing. Given the bubbles now building again and the likelihood of a nasty end to this particular episode as well, this is something that bears remembering.

Source

Reckless strategies doomed WaMu – Seattle Times

See also “A Giant Downfall” from Portfolio.com last month. It documents WaMu’s last days and demonstrates that WaMu was the subject of a bank run – the major reason it was seized by regulators.

Related posts:

• WaMu: Mr. Smith goes to Washington and turns predatory
• WaMu on the brink of disaster: has agreement with regulators
• AIG down; Lehman and WaMu looking to be sold
• JP Morgan Chase buys WaMu out
• Consolidation through merger over bankruptcy

This is probably my fourth post on the tangled web woven by securitization, which puts a considerable distance between home owners and mortgagees which own a mortgage.  The issue is causing huge problems in bankruptcy and foreclosure in courts around the U.S. 

This morning, Gretchen Morgenson has another good piece out describing how a judge nixed all claims by mortgagee which refused to modify a home owner’s mortgage.

The debtors’ revolt is on.

For decades, when troubled homeowners and banks battled over delinquent mortgages, it wasn’t a contest. Homes went into foreclosure, and lenders took control of the property.

On top of that, courts rubber-stamped the array of foreclosure charges that lenders heaped onto borrowers and took banks at their word when the lenders said they owned the mortgage notes underlying troubled properties.

In other words, with lenders in the driver’s seat, borrowers were run over, more often than not…

But some judges are starting to scrutinize the rules-don’t-matter methods used by lenders and their lawyers in the recent foreclosure wave. On occasion, lenders are even getting slapped around a bit.

One surprising smackdown occurred on Oct. 9 in federal bankruptcy court in the Southern District of New York. Ruling that a lender, PHH Mortgage, hadn’t proved its claim to a delinquent borrower’s home in White Plains, Judge Robert D. Drain wiped out a $461,263 mortgage debt on the property. That’s right: the mortgage debt disappeared, via a court order.

I see this as a watershed case in jurisprudence surrounding mortgage-related bankruptcies and foreclosures.  The reason this is huge is that it echoes the case in Kansas I have written about in two previous posts:

• “Why mortgages aren’t modified and what a ruling stopping foreclosures means”
• “What are the legal rights of lenders and homeowners in foreclosure?”)

At issue is the question of what legal rights do lenders or their agents have in foreclosure in the new byzantine world of securitized mortgages.  In the New York case the judge nixed the entire claim as the mortgagee could not prove it had legal claim to the mortgage note. With the mortgagee unable to show ownership, the homeowner might even be able to stay in his home mortgage-free, Morgenson attests. That’s huge – and we should definitely expect an appeal.

In the Kansas case, MERS, a mortgage registrar, and a second-mortgage mortgagee were not informed of the homeowners bankruptcy and disposition of assets and claims before judgment was made. Nevertheless, the district court, the appeals court AND the Kansas supreme court all upheld the original summary judgment arguing that MERS was not contingently necessary.  While I would expect this case to be appealed because of the precedent it could set, I don’t see how it can be overturned after affirmation in every court – that is except through a politicization of the verdict.

Notice how PHH and MERS, the two lender agents in each cases, are not the actual owners of the mortgages. They are the servicers of the mortgages. This is why these cases have a lot to do with securitization

See also: How much money is Wells Fargo really making? for how some of this affects earnings at money center banks.

Morgenson had another article of merit on this topic last week. See her piece The Mortgage Machine Backfires.  This could get interesting.

Related posts:

• What are the legal rights of lenders and homeowners in foreclosure?
• Why mortgages aren’t modified and what a ruling stopping foreclosures means
• Citi agrees to do cramdowns
• Almost all biggest subprime lenders have received bailout money
• What would an alternative to bailouts have looked like?

This is good. H/T Michael Panzner.

Related posts:

• TurboTax: targetting ads to Obama’s team problems
• Michael Panzner: regional banks in trouble
• Darwin: Very gradual change we can believe in
• Hedge Funds
• GM gets the green light on its section 363 bankruptcy

A sign that the commercial real estate (CRE) market continues to cause headaches comes this weekend in the form of news of Capmark Financial’s imminent demise. Capmark is one of America’s largest commercial property lenders with about $10 billion in assets.

The New York Times’ Dealbook reports:

The Capmark Financial Group, the big commercial real estate finance company cobbled together from pieces of GMAC, may file for bankruptcy as soon as this weekend, a person briefed on the matter told DealBook on Saturday.

If that happens, the move would be unsurprising: Capmark warned last month that it might seek Chapter 11 protection after it reported a $1.62 billion quarterly loss.

Last month, the company agreed to sell its mortgage loan and servicing business to Warren E. Buffett’s Berkshire Hathaway and Leucadia National for as much as $490 million. That agreement carried a 60-day expiration date, or around Nov. 2 — unless Capmark filed for bankruptcy, which would give it another 60 days to complete the sale.

The company is only the latest to fall victim to continued trouble in the commercial real estate market, which many analysts have said will continue to deteriorate. Many small banks have collapsed this year under the weight of commercial loans.

Kohlberg Kravis Roberts, Goldman Sachs Capital Partners, Five Mile Capital and Dune Capital bought GMAC’s commercial real estate businesses in 2006 for about $1.5 billion, with GMAC retaining a 25 percent stake in the operation. K.K.R. has already written down the value of its Capmark investment to zero.

With the closure of seven small banks that brought the total this year to 106, this weekend shows a financial industry still under enormous strain. Commercial property, where Capmark was busy, is the area of greatest concern.  This is one reason the Federal Reserve Bank of New York has received $2.12 billion in requests for government loans in October to purchase legacy commercial mortgage-backed securities (CMBS) under the TALF program.

Related posts:

• Commercial property hits the front page
• Commercial Real Estate bust
• Frankfurt property market in freefall
• GMAC has been nationalized
• Six Flags: setting the record straight on bankruptcy

This is the biggest weekend for FDIC seizures yet. Seven banks have been shut down.

Below is the list of banks.

Partners Bank, Naples, Florida (Stonegate assumes assets)

• As of September 30, 2009, Partners Bank had total assets of $65.5 million and total deposits of approximately $64.9 million. Stonegate Bank did not pay the FDIC a premium for the deposits of Partners Bank. In addition to assuming all of the deposits of the failed bank, Stonegate Bank agreed to purchase essentially all of the assets.

American United Bank, Lawrenceville, Georgia (Ameris Bank assumes assets)

• As of August 11, 2009, American United Bank had total assets of $111 million and total deposits of approximately $101 million. Ameris Bank will pay the FDIC a premium of 1.02 percent to assume all of the deposits of American United Bank. In addition to assuming all of the deposits of the failed bank, Ameris Bank agreed to purchase essentially all of the assets.

  The FDIC and Ameris Bank entered into a loss-share transaction on approximately $92 million of American United Bank’s assets. Ameris Bank will share in the losses on the asset pools covered under the loss-share agreement.

Hillcrest Bank Florida, Naples (Stonegate Bank assumes these assets too)

• As of October 1, 2009 , Hillcrest Bank Florida had total assets of $83 million and total deposits of approximately $84 million. Stonegate Bank will pay the FDIC a premium of 0.50 percent to assume all of the deposits of Hillcrest Bank Florida. In addition to assuming all of the deposits of the failed bank, Stonegate Bank agreed to purchase $28 million of the failed bank’s assets. The FDIC will retain the remaining assets for later disposition.

Bank of Elmwood, Racine, Wisconsin (Tri Citi National Bank assumes assets)

• As of September 30, 2009, Bank of Elmwood had total assets of $327.4 million and total deposits of approximately $273.2 million. Tri City National Bank did not pay the FDIC a premium for the deposits of Bank of Elmwood. In addition to assuming all of the deposits of the failed bank, Tri City National Bank agreed to purchase essentially all of the assets.

Flagship National Bank, Bradenton, Florida (First Federal Bank of Florida assumes assets)

• As of August 31, 2009, Flagship National Bank had total assets of $190 million and total deposits of approximately $175 million. First Federal Bank of Florida did not pay the FDIC a premium for the deposits of Flagship National Bank. In addition to assuming all of the deposits of the failed bank, First Federal Bank of Florida agreed to purchase essentially all of the assets.

  The FDIC and First Federal Bank of Florida entered into a loss-share transaction on approximately $130 million of Flagship National Bank’s assets. First Federal Bank of Florida will share in the losses on the asset pools covered under the loss-share agreement

Riverview Community Bank, Otsego, Minnesota (Central, Bank, Stillwater, MN assumes assets)

• As of August 31, 2009, Riverview Community Bank had total assets of $108 million and total deposits of approximately $80 million. Central Bank did not pay the FDIC a premium to assume all of the deposits of Riverview Community Bank. In addition to assuming all of the deposits of the failed bank, Central Bank agreed to purchase essentially all of the assets.

The FDIC and Central Bank entered into a loss-share transaction on approximately $75 million of Riverview Community Bank’s assets. Central Bank will share in the losses on the assets covered under the loss-share agreement.

First Dupage Bank, Westmont, Illinois (First Midwest Bank assumes assets)

As of July 31, 2009, First Dupage Bank had total assets of $279 million and total deposits of approximately $254 million. First Midwest Bank will pay the FDIC a premium of 0.75 percent to assume all of the deposits of First Dupage Bank. In addition to assuming all of the deposits of the failed bank, First Midwest Bank agreed to purchase essentially all of the assets.

The FDIC and First Midwest Bank entered into a loss-share transaction on approximately $247 million of First Dupage Bank’s assets. First Midwest Bank will share in the losses on the asset pools covered under the loss-share agreement.

Related posts:

• Three more FDIC bank seizures
• FDIC shutters five more banks
• Five banks seized in FDIC Friday night special
• FDIC Friday Night Special: San Joaquin Bank, Bakersfield, California
• FDIC Friday Night Special: First National Bank of Anthony

After I published the recent story on the case against servicing agent MERS in the Kansas Supreme court, I noticed a lot of chatter about some mortgage servicing line items in Wells Fargo’s earnings report. So I wanted to quote a few blurbs from the Kansas Appeals Court and Supreme Court decisions as background for another post on future mortgage service revenue streams in banking.

The Appeals Court case had a narrow focus as to whether MERS was a ‘necessary party’ in this particular foreclosure case. The finding was that MERS was not. The Kansas Supreme court agreed that MERS was not “contingently necessary.” They went further in concluding that the fact that MERS neither possessed the promissory note or had authority to assign it may mean it cannot file suit.

However, because this is not a comprehensive judgment as to MERS’ role as nominee, clarification is needed. Given the number of foreclosures in the US, I expect this case is going to the Supreme Court.

Here are the facts.

Landmark National Bank v. Boyd A. Kessler summary

My summary of the case is as follows:

A homeowner based in Kansas came into economic difficulty, causing him to fall behind on his mortgage and file for bankruptcy on 13 April 2006. While he could have exempted his house in discharging his personal liabilities in bankruptcy, the homeowner opted instead to surrender the house.

Three months after he filed, on 27 Jul 2006, the bank with his primary mortgage decided to foreclose. It did not inform MERS (the central repository which tracks changes in mortgage ownership and servicing rights). Nor did it inform the bank holding the secondary mortgage.

On 6 September 2006, the district court then entered a default judgment and ordered a sale on 29 September 2006. Notice of the sale went out into newspapers and a couple picked up this foreclosed property on the cheap on 14 November 2006. So far, so good.

Except that very day, a full seven after the bankruptcy filing, the secondary bank filed a petition to set aside the district court opinion, arguing that MERS was a “contingently necessary party.” It wanted the money it was owed. And on 16 January 2007, MERS joined the bank in filing.  By 1 February 2007, the district court denied the petition to vacate the original default judgment.

The case was appealed to both the Kansas Appeals and Kansas Supreme Courts

Here are some of the issues:

• Is MERS as a mortgage servicing registry a “contingently necessary party” in this particular or any bankruptcy involving a property in its database?
• In what instances can MERS act as a nominee for the mortgagees in court to enforce a foreclosure?
• If MERS can act as a nominee, does MERS have to produce the original mortgage promissory note in order to foreclose?
• If MERS can act as a nominee, can a homeowner sue MERS or the mortgage servicing agent for the original lenders’ alleged predatory lending?
• Is the mortgage servicing agent a nominee or agent of the mortgagee or even a principal? If so, what are the obligations of the servicing agent to help affect a mortgage loan modification?

All of these questions arise because of the convoluted process we have for mortgages as a result of the mortgage-backed security market.  These questions have only become acute because the rise in foreclosures has made them a serious issue.

Excerpts from the Kansas Appeals Court decision

• A party is not contingently necessary in a mortgage-foreclosure lawsuit when that party is called the mortgagee in a mortgage but is not the lender, has no right to the repayment of the underlying debt, and has no role in handling mortgage payments.
• In a mortgage-foreclosure lawsuit, a district court does not abuse its discretion when it denies a motion to intervene that is filed by an unrecorded mortgage holder or its agent after the mortgage has been foreclosed and the property has been sold
• What is MERS’s interest? MERS claims that it holds the title to the second mortgage, not the real estate. So it does, but only as a nominee. In terms of the roles that we’ve discussed in the mortgage business, MERS holds the mortgage but without rights to the debt. The district court found that MERS was merely an agent for the principal player, Millennia. While MERS objects to its characterization as an agent, it’s a fair one.
• MERS had no right to the underlying debt repayment secured by the mortgage; MERS did not even act as the servicing agent to receive the payments and remit them to the lender. MERS’s right to act to enforce the mortgage was strictly limited: if "necessary to comply with law or custom," MERS could foreclose the mortgage or enter a release of the mortgage. MERS certainly could not act at odds to its principal, the lender. Its role fits the classic definition of an agent: one "’authorized by another to act for him, or intrusted with another’s business.’" In re Tax Appeal of Scholastic Book Clubs, Inc., 260 Kan. 528, 534, 920 P.2d 947 (1996) (quoting Black’s Law Dictionary 85 [4th ed. 1968]).
• Kansas law does require through K.S.A. 58-2309a that a mortgage holder promptly release a mortgage when the debt has been paid; MERS could be required as a matter of law to file a mortgage release after a borrower proved that the debt had been paid. Other than that, however, it is hard to conceive of another act that MERS—instead of the lender—would be required to take by law or custom.
• We do not attempt in this opinion to comprehensively determine all of the rights or duties of MERS as a nominee mortgagee. As the mortgage suggests may be done when "necessary to comply with law or custom," courts elsewhere have found that MERS may in some cases bring foreclosure suits in its own name.

Excerpts from the Kansas Supreme Court decision

• K.S.A. 60-219(a) defines which parties are to be joined in an action as necessary for just adjudication:

  "A person is contingently necessary if (1) complete relief cannot be accorded in his absence among those already parties, or (2) he claims an interest relating to the property or transaction which is the subject of the action and he is so situated that the disposition of the action in his absence may (i) as a practical matter substantially impair or impede his ability to protect that interest or (ii) leave any of the persons already parties subject to a substantial risk of incurring double, multiple, or otherwise inconsistent obligations by reason of his claimed interest."

• The relationship that MERS has to Sovereign is more akin to that of a straw man than to a party possessing all the rights given a buyer. A mortgagee and a lender have intertwined rights that defy a clear separation of interests, especially when such a purported separation relies on ambiguous contractual language. The law generally understands that a mortgagee is not distinct from a lender: a mortgagee is "[o]ne to whom property is mortgaged: the mortgage creditor, or lender." Black’s Law Dictionary 1034 (8th ed. 2004). By statute, assignment of the mortgage carries with it the assignment of the debt. K.S.A. 58-2323. Although MERS asserts that, under some situations, the mortgage document purports to give it the same rights as the lender, the document consistently refers only to rights of the lender, including rights to receive notice of litigation, to collect payments, and to enforce the debt obligation. The document consistently limits MERS to acting "solely" as the nominee of the lender.
• The Missouri court found that, because MERS was not the original holder of the promissory note and because the record contained no evidence that the original holder of the note authorized MERS to transfer the note, the language of the assignment purporting to transfer the promissory note was ineffective. "MERS never held the promissory note, thus its assignment of the deed of trust to Ocwen separate from the note had no force."
• "MERS does not take applications, underwrite loans, make decisions on whether to extend credit, collect mortgage payments, hold escrows for taxes and insurance, or provide any loan servicing functions whatsoever. MERS merely tracks the ownership of the lien and is paid for its services through membership fees charged to its members. MERS does not receive compensation from consumers." 270 Neb. at 534.

My reading of these statements is that MERS is a nominee and not much more. This should limit its ability to act on behalf of a mortgagee in foreclosure.  How much and in what ways due process is at stake has yet to be decided in the courts, the reason I expect this case to receive a look from the Supreme Court.

Sources

Landmark National Bank v. Boyd A. Kessler, Kan 2009, No. 98,489 – Kansas Courts Documents

See my post “Why mortgages aren’t modified and what a ruling stopping foreclosures means” for the Appeals Court decision.

Related posts:

• Wow, judges now nixing lenders’ foreclosure claims entirely in court
• Why mortgages aren’t modified and what a ruling stopping foreclosures means
• Habeas Corpus and the Supreme Court
• Why pro-choice Dems have nothing to like about John McCain
• Chrysler dissident lenders lose fight and disband

In August, the Kansas Supreme Court issued a ruling against a mortgage tracking service which may prove very costly to banks in foreclosure, leading to massive writedowns. It could be a life saver for many trapped in the foreclosure process. The case goes to the core of the functioning of massive markets in securitization and derivatives and has wide-ranging importance.

The service, MERS (Mortgage Electronic Registration System), is a privately-owned registry set up in 1997 by Fannie Mae, Freddie Mac and several large banks including JPMorgan Chase, Citigroup and Bank of America. In foreclosure, MERS is often the party which files on behalf of the lenders behind the mortgage against homeowners. The Kansas ruling effectively blocks MERS from bringing legal action on the lenders’ behalf in certain foreclosure situations, potentially putting the kibosh on  MERS’ legal authority on the more than 60 million mortgages it holds and subjecting the lenders to huge losses.

This is a complicated but important case I want to break down for you below.

Securitization at fault

The crux of the case has to do with mortgage-backed securities and the process of securitization. In a bygone era, almost all mortgages were held as loans on the books of the originating banks.  In this case, if a mortgage went past due, it was a matter to be worked out between an individual homeowner and an individual mortgage holder.

However, when the mortgage-backed securities (MBS) market took off, mortgages were sliced and diced into tranches and packaged into securities and sold on to investors.  These same securities were then sliced and diced and packaged with other securities into collateralized debt obligations (CDOs). CDOs were often then sliced and diced further still into CDOs-squared – that is CDOs of CDOs.

Often times, the underlying mortgages in these instruments were high-risk, sub-prime mortgages. But the ratings agencies could still give them AAA ratings, which made them eligible for investment by risk-averse investors like teachers’ pension funds or municipalities. So, these securities were then sold on to investors around the world into remote places like small towns in Norway and banks in Germany. However, when the housing market fell, the value of these securities plummeted; and they fell much more than the house prices as the securities are derivatives and leveraged against the value of the underlying asset. The result was a financial crisis of epic proportions.

Making matters more complicated for the homeowner, the originating lender is often not the servicing agent of a mortgage. Payment from the homeowner and to investors who are the ultimate owners of the security is handled by a mortgage servicer who collects a fee for its work.

What this has meant is that there is considerable distance between a homeowner and a mortgage holder, such that in the event of foreclosure, it is not a matter of picking up the telephone and calling Mr. Smith at the local Bank. Often times, there is a byzantine web of originating bank, mortgage holder (if loan is sold), mortgage servicer, MBS pooling/securitizing agent, and investors. Needless to say, the average person doesn’t have a clue as to who to call in order to get relief to avoid foreclosure. The obvious port of call is the mortgage servicer, who is the one party with whom a homeowner has ongoing contact.

Mortgage Servicer

Below is a research report written by the National Consumer Law Center just this past month on why consumers in jeopardy of suffering foreclosure cannot get loans modified.

It starts:

The country is in the midst of a foreclosure crisis of unprecedented proportions. Millions of families have lost their homes and millions more are expected to lose their homes in the next few years. With home values plummeting and layoffs common, homeowners are crumbling under the weight of mortgages that were often only marginally affordable when made.

One commonsense solution to the foreclosure crisis is to modify the loan terms. Lenders routinely lament their losses in foreclosure. Foreclosures cost everyone—the homeowner, the lender, the community—money. Yet foreclosures continue to outstrip loan modifications. Why?

Once a mortgage loan is made, in most cases the original lender does not have further ongoing contact with the homeowner. Instead, the original lender, or the investment trust to which the loan is sold, hires a servicer to collect monthly payments. It is the servicer that either answers the borrower’s plea for a modification or launches a foreclosure. Servicers spend millions of dollars advertising their concern for the plight of homeowners and their willingness to make deals. Yet the experience of many homeowners and their advocates is that servicers—not the mortgage owners—are often the barrier to making a loan modification.

See the problem?  This is exactly why loan modifications are not happening in large enough numbers.  This goes to incentives – mortgage servicers are not incentivized to make modifications. In fact the incentives go the other way – foreclosure.

Servicers have four main sources of income, listed in descending order of importance:

• The monthly servicing fee, a fixed percentage of the unpaid principal balance of the loans in the pool;
• Fees charged borrowers in default, including late fees and “process management fees”;
• Float income, or interest income from the time between when the servicer collects the payment from the borrower and when it turns the payment over to the mortgage owner; and
• Income from investment interests in the pool of mortgage loans that the servicer is servicing.

Overall, these sources of income give servicers little incentive to offer sustainable loan modifications, and some incentive to push loans into foreclosure. The monthly fee that the servicer receives based on a percentage of the outstanding principal of the loans in the pool provides some incentive to servicers to keep loans in the pool rather than foreclosing on them, but also provides a significant disincentive to offer principal reductions or other loan modifications that are sustainable on the long term. In fact, this fee gives servicers an incentive to increase the loan principal by adding delinquent amounts and junk fees. Then the servicer receives a higher monthly fee for a while, until the loan finally fails. Fees that servicers charge borrowers in default reward servicers for getting and keeping a borrower in default. As they grow, these fees make a modification less and less feasible. The servicer may have to waive them to make a loan modification feasible but is almost always assured of collecting them if a foreclosure goes through. The other two sources of servicer income are less significant.

If servicers’ income gives no incentive to modify and some incentive to foreclose, through increased fees, what about servicers’ expenditures? Servicers’ largest expenses are the costs of financing the advances they are required to make to investors of the principal and interest payments on nonperforming loans. Once a loan is modified or the home foreclosed on and sold, the requirement to make advances stops. Servicers will only want to modify if doing so stops the clock on advances sooner than a foreclosure would.

Worse, under the rules promulgated by the credit rating agencies and bond insurers, servicers are delayed in recovering the advances when they do a modification, but not when they foreclose. Servicers lose no money from foreclosures because they recover all of their expenses when a loan is foreclosed, before any of the investors get paid. The rules for recovery of expenses in a  modification are much less clear and somewhat less generous.

In addition, performing large numbers of loan modifications would cost servicers upfront money in fixed overhead costs, including staffing and physical infrastructure, plus out-of-pocket expenses such as property valuation and credit reports as well as financing costs. On the other hand, servicers lose no money from foreclosures.

This is a very important document for anyone looking to do a loan modification. I strongly suggest you read it, download it and act upon it.

By the way, the largest servicers are:

• Bank of America: $2.1 trillion, up from $530 billion a year earlier (via its acquisition of Countrywide – this is WHY bank of America bought Countrywide)
• Wells Fargo: $1.8 trillion, up from $1.5 trillion a year earlier
• JPMorgan Chase: $1.5 trillion, up from $795 billion a year ago (thanks in large part to its acquisition of Washington Mutual)
• CitiMortgage (a division of Citigroup): $792 billion, down from $799 billion a year earlier. Citi is hurting i everywhere)
• ResCap: $391 billion, down from $449 billion in the first quarter of 2008.

As you can see, consolidation has meant the big are getting bigger. Despite a recession, servicing fees are increasing, not decreasing.

You should DEFINITELY read my post “How refinancing helps the likes of Bank of America and Wells Fargo” because this demonstrates why these banks are going to rack up monster fees in mortgage servicing.

Landmark National Bank v. Boyd A. Kessler, Kan 2009, No. 98,489

That brings us to the Kansas case. According to the Kansas City Business Journal, the case can be summarized as follows:

A Ford County man went into bankruptcy in 2006. He had taken out two mortgages on the same property, one to Landmark National Bank and one to Millennia Mortgage Corp. Landmark foreclosed on its mortgage. Millennia had sold its mortgage, which eventually landed at Sovereign Bank, though that transaction never was recorded in Ford County.

Neither MERS nor Sovereign received notice when Landmark filed its foreclosure. That’s because the notice went to Millennia, still registered in Ford County, which is like telling someone that a stranger’s car is about to be towed.

Landmark won a default judgment, essentially wiping out Sovereign’s mortgage. MERS and Sovereign sued to set aside the judgment, arguing that MERS should have received notice. They lost at trial and on appeal.

Supreme Court justices had a difficult time accepting what MERS was and why it would be entitled to receive notice of a foreclosure when it was not a lender and had no stake in the property behind the mortgage. In addition, the court found, the original mortgage required notice only to the lender, not MERS.

This case was decided on 28 August 2009 in favor of the homeowner Boyd Kessler (Document and link below). The issue was predatory lending.  But there was more wrong here. MERS does facilitate liquidity in the MBS market, but it does a lot of other things that could harm consumers

• MERS also acts as a “corporate shield,” protecting lenders from legal action in cases of predatory lending.
• MERS can foreclose even though it is not the financial party with interest
• Because MERS is a distant intermediary, foreclosure can proceed without even producing an original mortgage note
• With MERS in control, consumers cannot access publicly available information to adequately determine who the holders of their note are.

If MERS is blocked from filing suit in many cases, there will be large losses accumulating at the holders of these notes. Expect to hear more about this very important case.

Landmark Bank v. Kessler, Kansas Appeals Court (MERS), 2008

Sources

Landmark National Bank v. Boyd A. Kessler, Kan 2009, No. 98,489 – Kansas Courts Documents

Why Servicers Foreclose When They Should Modify and Other Puzzles of Servicer Behavior (pdf) – National Consumer Law Center

The Mortgage Machine Backfires – Gretchen Morgenson, NY Times

The Next Financial Crisis Hits Wall Street, as Judges Start Nixing Foreclosures – Counterpunch

60 Million Fatally Flawed Mortgages – The Classic Liberal

Landmark Decision Promises Massive Relief for Homeowners and Trouble for Banks – Peace Options

Related posts:

• What are the legal rights of lenders and homeowners in foreclosure?
• Wow, judges now nixing lenders’ foreclosure claims entirely in court
• How refinancing helps the likes of Bank of America and Wells Fargo
• McCain repackages bailout proposal and labels it his own
• Subprime good, prime bad

Jim the Realtor is back with a bunch of foreclosures, REOs and short sales on the market in North County San Diego.  Some of these places look pretty nice.  In this particular video, the property is in Carmel Valley and on the market for $1.249 million. It is interesting for a couple of reasons.

The guy in the house has been on the foreclosure roles for a long time.  Apparently, he ran up loans 15% over the original amount, which suggests he may have been using the house price as an ATM when prices were going up. But now he is making partial payments to avoid being foreclosed.  The interesting thing is that by making a partial payment, the owner can get off the foreclosure roles and stay in his home.. until he misses another payment, which in this case has happened several times.

This is called “extend and pretend” otherwise known as “delay and pray.” Banks love this because they don’t have to write down the value of the loan immediately and the owner is looking for an exit strategy that doesn’t put him out on the street. It’s all good, right?

Obviously, the inventory levels would be a lot higher if short sales like these were foreclosed.

Another interesting factoid is that this place got multiple offers over list – and we’re talking cash buyers here. Jim’s prospective buyer came in with 50% down as well – and lost.  Jim calls this a “feeding frenzy.”

Clearly, record-low interest rates are doing the trick to reflate house prices in San Diego, a canary in the coalmine for the rest of the country (they led on the way up the first time and on the way down). This reflation is exactly why you delay and pray. For this particular seller it worked out as well as it could.

Related posts:

• Extend and pretend and the growing divide between delinquencies and foreclosures
• Cruising foreclosures, REO and short sales with Jim the Realtor
• Banks can do ‘You Walk Away’ too
• Manhattan Q2 Apartment Sales down 22%
• Case-Shiller Index: Less bad, but three markets cut in half

From the FDIC:

San Joaquin Bank, Bakersfield, California, was closed today by the California Department of Financial Institutions, which appointed the Federal Deposit Insurance Corporation (FDIC) as receiver. To protect the depositors, the FDIC entered into a purchase and assumption agreement with Citizens Business Bank, Ontario, California, to assume all of the deposits of San Joaquin Bank…

As of September 29, 2009, San Joaquin Bank had total assets of $775 million and total deposits of approximately $631 million. Citizens Business Bank did not pay the FDIC a premium for the deposits of San Joaquin Bank. In addition to assuming all of the deposits of the failed bank, Citizens Business Bank agreed to purchase essentially all of the assets.

The FDIC and Citizens Business Bank entered into a loss-share transaction on approximately $683 million of San Joaquin Bank’s assets. Citizens Business Bank will share in the losses on the asset pools covered under the loss-share agreement. The loss-share arrangement is projected to maximize returns on the assets covered by keeping them in the private sector. The agreement also is expected to minimize disruptions for loan customers.

This is the 99th failure this year.

Related articles

Fed Gives Calif’s San Joaquin Bank Deadline To Shape Up – NASDAQ, 5 Oct 2009

San Joaquin Bank reassures customers ahead of deadline – Bakersfield.com, 14 Oct 2009

San Joaquin Bank keeps mum through deadline – Bakersfield.com, 15 Oct 2009

Related posts:

• FDIC Friday Night Special: First National Bank of Anthony
• Five banks seized in FDIC Friday night special
• Three more FDIC bank seizures
• FDIC Friday Night Special: American Sterling Bank
• FDIC moves in at Great Basin Bank

In speaking to the Council of Foreign Relations, Greenspan said what I have heard many other credible financial experts say, namely that financial institutions which are ‘too big to fail’ (TBTF) are simply too big.

Is this Alan Greenspan talking?  I am astonished that the man we have called bubble-blower in chief is willing to repudiate the notion of too big to fail.  I applaud him.

Here is how Bloomberg quotes Greenspan:

“If they’re too big to fail, they’re too big,” Greenspan said today. “In 1911 we broke up Standard Oil — so what happened? The individual parts became more valuable than the whole. Maybe that’s what we need to do.”

At one point, no bank was considered too big to fail, Greenspan said. That changed after the Treasury Department under then-Secretary Hank Paulson effectively nationalized Fannie Mae and Freddie Mac, and the Treasury and Fed bailed out Bear Stearns Cos. and American International Group Inc.

“It’s going to be very difficult to repair their credibility on that because when push came to shove, they didn’t stand up,” Greenspan said.

Fed officials have suggested imposing a tax or requiring higher capital ratios on larger banks to ensure the firms’ safety and reduce some of the competitive advantage from the implied subsidy. Greenspan said that won’t work.

“I don’t think merely raising the fees or capital on large institutions or taxing them is enough,” Greenspan said. “I think they’ll absorb that, they’ll work with that, and it’s totally inefficient and they’ll still be using the savings.”

Greenspan’s comments put him on the record as more desirous of change than the Obama Administration. The Wall Street Journal accurately characterizes the Obama Administrations big regulatory proposal on TBTF institutions thusly:

The Obama-Summers-Geithner solution — in case you haven’t studied the administration’s white paper — in Summers’ words:

• Raise capital requirements
• Eliminate a system where financial institutions can choose who regulates them
• Impose rigorous standards and supervision to protect the economy and investors
• Establish resolution authority to ensure that no financial institution is too big to fail
• Create a unified, independent agency to protect the American consumer from fraud and abuse and ensure that people get the clear information they need about loans and other financial products.

This is a good start and I certainly like their thinking on establishing a resolution procedure for TBTF institutions. But, of course, nothing in the Obama-Summers-Geithner solution advocates the break-up of TBTF institutions. Perhaps this is because the Bush and Obama Administrations have redefined what it means to be too big to fail. 

Bill Black, who has some experience in these matters, took on this issue in a recent post on the University of Missouri-KC economics blog. He says:

The Obama administration is continuing the Bush administration policy of refusing to comply with the Prompt Corrective Action (PCA) law (see here and here). Both administrations twisted a deeply flawed doctrine – “too big to fail” – into a policy enshrining crony capitalism.

Historically, “too big to fail” was a misnomer – large, insolvent banks and S&Ls were placed in receivership and their “risk capital” (shareholders and subordinated debtholders) received nothing. That treatment is fair, minimizes the costs to the taxpayers, and minimizes “moral hazard.” “Too big to fail” meant only that they were not placed in liquidating receiverships (akin to a Chapter 7 “liquidating” bankruptcy). In this crisis, however, regulators have twisted the term into immunity. Massive insolvent banks are not placed in receivership, their senior managers are left in place, and the taxpayers secretly subsidize their risk capital. This policy is indefensible. It is also unlawful. It violates the Prompt Corrective Action law. If it is continued it will cause future crises and recurrent scandals.

I hope this solution sounds familiar because it is precisely the resolution process I advocate in my post “More on greed, regulation, Lehman and the financial industry." The point is the one Greenspan makes, namely that:

Failure is an integral part, a necessary part of a market system… If you start focusing on those who should be shrinking, it undermines growing standards of living and can even bring them down.

Let’s see what we get from Obama on this issue now that even Alan Greenspan has decided to speak out.

Related posts:

• UK: Darling confirms government to break up too big to fail banks
• How to downsize the US financial sector
• The failure to address the looming too-big-to-fail issue
• Jamie Dimon makes the best case for not breaking up banks
• Rosner: Financial Stability Act “single worst not-yet passed piece of legislation”

Starwood Capital Group gets the assets in a consortium with TPG capital, Perry Capital and WLR LeFrak (another Wilbur Ross company – this guy is cleaning up in the FDIC private equity bonanza).

Here’s the press release:

The Federal Deposit Insurance Corporation (FDIC) has signed a bid confirmation letter to sell a 40 percent equity interest in a limited liability company (LLC) created to hold assets of Corus Bank, NA, Chicago, Illinois, to a consortium managed by Starwood Capital Group (Starwood) that also includes TPG Capital, Perry Capital and WLR LeFrak.

The sale was conducted on a competitive bid basis, and the best and final offers were received on Wednesday, September 30, 2009. A total of eight bidders submitted bids to purchase an ownership interest in the LLC, to which the FDIC as Receiver of Corus will convey a portfolio of predominantly performing and non-performing construction loans and real estate owned (REO) assets with an unpaid principal balance of approximately $4.5 billion. The FDIC initially will hold a 60 percent equity interest in the LLC.

The bid received from the consortium was determined to be the offer that would result in the greatest return for the receivership of all competing bids. Corus Bank failed on September 11, 2009, and the FDIC immediately entered into a purchase and assumption agreement with MB Financial Bank, National Association, Chicago, Illinois, to assume all of the deposits of the institution and approximately $3 billion of the assets, comprised mainly of cash and marketable securities. This transaction completes the sale of the majority of the remaining assets of Corus Bank.

The expected closing date is in mid-October, consistent with the timeline previously provided by the FDIC.

Corus was the big fish amongst a trio of failed banks which went bust on 11 September 2009 (see my links post). At the time, only $3 billion of the assets were disposed of via MB Financial.  The FDIC was forced to hold the other $4 billion in assets for later disposition.  The Starwood-TPG-Wilbur Ross trio came away with the assets.

Wilbur Ross was also involved in the giveaway known as BankUnited (see my post “BankUnited goes bust and is replaced by BankUnited”). Back in August, I called this and other Private Equity transactions the socialization of losses.

Imagine you are Sheila Bair.  You have shuttered 80-odd institutions this year and you realize that 150, 200, maybe 300 more institutions could fail still.  No way on earth does your organization have the manpower to deal with this avalanche of bank failures without sloughing the assets off on willing buyers.  How do you entice those buyers? In a word, price.

It’s what is known as a sweetheart deal.  There were a number of bidders for Guaranty including US Bank, and a private-equity consortium led by Gerald Ford which included Blackstone, Carlyle and TPG.  Yet, the deal went to BBVA in a loss-share agreement that caps their exposure at 20%?  I ‘d like to get in on a deal like that.  If you are a private equity buyer, you’re probably chomping at the bit for more deals like this.

And this will continue to be an inevitability for an FDIC short of cash. If you are a large private equity company, you are probably going to be making a shed load of cash very soon.

Related posts:

• BankUnited goes bust and is replaced by BankUnited
• FDIC list of problem banks
• Georgia bank fails with $1.1 billion in assets
• Fifth Third takes on assets of Freedom Bank
• Seven more bank failures brings total to 64