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

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

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

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

A number of new films have been produced chronicling the misadventures in America’s residential property markets and financial system.  One such story is American Casino. 

I have yet to see the film.  However, below is a clip from the filmmakers Andrew and Leslie Cockburn on one unforeseen consequence of the recent financial crisis. Abandoned homes in newer California sub-divisions are a breeding ground for mosquitoes, increasing the threat of West Nile virus.

Related posts:

• Foreclosures hit a record in April
• Cruising foreclosures, REO and short sales with Jim the Realtor
• The Housing Bubble and Bailout
• WHO: Swine Flu Pandemic is imminent
• First Swine Flu death in Texas (video)

Spain has been a laggard in the search for improving economic fundamentals.  The news coming out of Spain has been dreadful from employment to house prices to mortgages and banking. But the first ray of hope appeared yesterday when it was reported that late payments on loans granted by banks, savings banks and cooperatives fell for the first time in two years.

According to the numbers released by the Bank of Spain the delinquency rate for June 2009 stood at 4.488%, down from May’s 4.563% and the first fall since July 2007.  Mind you, the rate of delinquency is still at levels not seen since 1996.  But this is the first countertrend in the upward march of financial distress for Spanish mortgage holders.

Nevertheless, the news was not all good yesterday.  Edward Hugh reported the same day that twenty percent of Spanish mortgages are now considered high risk.

According to an article which appeared in the Spanish newspaper Expansion this morning, one in five Spanish mortgages is now considered as being high risk and liable to become “non performing”.

The mortgages at greatest risk are naturally those contracted after 2005 where the loan to valuation was over 80% of the total. In 2006 and 2007, according to data from the bank of Spain, LtVs were over 80% in 17.7% of the mortgages granted, since prices are now heading back towards the 2005 level, we can easily conclude that something in the region of one in five Spanish mortgages are now high risk.

Prior to 2006, the main source of data comes from a study by Genworth Financial, who show that loans with +80% LtV rose from 12.2% in 1996 to 26.4% in 2005 (see chart below which comes from Expansion). These loans were especially popular between 2003 and 2006, but then started to decline as the decision of the ECB to raise interest rates made the likelihood of a price correction rise sharply.

It is the Spanish savings banks, the cajas, which are most affected by delinquency and high risk loans. See my April post “Spain’s savings banks may have 40 billion in writedowns.” The big Spanish banks are in a much better capital position.  Just today, it was leaked that BBVA is expected to win a government-run auction for the troubled American lender Guaranty Financial. The FDIC had set a deadline for today for bids.

Both BBVA and Santander have used the credit crisis as an opportunity to strengthen their position internationally. Santander previously bought Sovereign Bancorp in the US and Alliance and Leicester in the UK.  For some time now, BBVA has been making a tactical expansion into the Sun Belt markets in the US, an area with a large Spanish-speaking population.  Obviously, the purchase of Guaranty fits into that strategy.

Santander has a market capitalization of over 80 billion Euros (nearly $120 billion) while BBVA has a market cap over 40 billion Euros (nearly $60 billion). By comparison, only Goldman Sachs, Wells Fargo, JPMorgan Chase and Bank of America are bigger in the U.S., a country with six times the population of Spain. So, these are very international banks of enormous size, well regarded in the capital markets.

So while Spain is a country still beset with problems, especially in the banking sector, there is an extreme dichotomy between the fortunes of the international big banks and the domestic savings banks.

Source

La morosidad del crédito baja en junio por primera vez en casi dos años – Finanzas

Related posts:

• Spain’s savings banks may have 40 billion in writedowns
• Banco Santander is very confident
• Spain’s BBVA making a push in the US
• Sovereign Bancorp: Santander looking to buy regional bank
• Guaranty is bankrupt: BBVA gets its FDIC-seized assets

Fannie Mae has the luxury of marking its accounts more accurately because they have no fear of being nationalized or going bust since they already have hit the wall.  So, when we read the latest quarterly results from Fannie Mae, we are not just seeing a glimpse of Fannie’s reckless financing, but of the American financial system as a whole.

From Fannie Mae’s Q2 press release (note the emphasis added):

Fannie Mae… reported a loss of $14.8 billion, or ($2.67) per diluted share, in the second quarter of 2009, compared with a loss of $23.2 billion, or ($4.09) per diluted share, in the first quarter of 2009. Second-quarter results were driven primarily by $18.8 billion of credit-related expenses, reflecting the ongoing impact of adverse conditions in the housing market, as well as the economic recession and rising unemployment. Credit-related expenses were partially offset by fair value gains. The company also reported a substantial decrease in impairment losses on investment securities, which was due in part to the adoption of new accounting guidance…

Combined loss reserves were $55.1 billion on June 30, 2009, up from $41.7 billion on March 31, 2009, and $24.8 billion on December 31, 2008. The combined loss reserves were 1.80 percent of our guaranty book of business on June 30, 2009, compared with 1.38 percent on March 31, 2009, and 0.83 percent on December 31, 2008.

Translation: we lost over $40 billion and our loss reserve rate has more than doubled in 6 months.  We are a financial bottomless pit.

How about this statement on page three:

Total nonperforming loans in our guaranty book of business were $171.0 billion on June 30, 2009, compared with $144.9 billion on March 31, 2009, and $119.2 billion on December 31, 2008.

That’s $171.0 billion in NPLs, not million.  Breathtaking.  Needless to say, Fannie has its hands out for more taxpayer money – $10.7 billion to cover their net worth deficit from this quarter alone to be exact.

But, the reported net worth deficit of $10.6 billion does not represent figures according to fair value. That is covered on page six (emphasis added):

Our estimated fair value net asset deficit was $102.0 billion as of June 30, 2009, compared with $110.3 billion as of March 31, 2009.

Is Fannie far worse off than, say, Citi or BofA, or are they reporting their numbers somewhat closer to mark-to-market? The scale of the losses seem astronomical.

More here.

Related posts:

• Question: How is Fannie Mae a AAA company?
• BofA carrying loans on books for $44 billion above fair value
• Gateway Financial and Midwest Banc have one-third of capital in Fannie and Freddie Preferreds
• Everyone’s talking about Fannie and Freddie
• RBS reports a record loss of 24 billion pounds

If you haven’t seen any of Jim the Realtor’s videos over at Calculated Risk, you are not getting a feel for what’s happening in residential real estate in America.  The guy really gives the whole housing problem in California a look you wouldn’t have unless you were a real estate agent living it. His videos do have a certain twisted voyeuristic appeal to them.

In the videos below, Jim cruises around looking for REO properties.  All of this stuff is ‘shadow’ inventory, meaning it’s not really on the market.  There aren’t any for sale signs in the front yards. You can only imagine the shattered lives behind these videos. It gives you a good idea of how much more inventory is out on the market and the distress that creates for people selling. In the first video, Jim does say there isn’t a ton of shadow inventory yet, though.  He works in North San Diego County.

Since foreclosures are flooding the market in places like California, it pays to do your homework because some of these houses are being unloaded by the banks for ridiculous prices.

Just in case you don’t know what an REO is, here’s a great primer from the bloggers at roost.com:

Real estate owned or REO is a class of property owned by a lender, typically a bank, after an unsuccessful sale at a foreclosure auction.^[1] A bank will typically set the opening bid at a foreclosure auction for at least the outstanding loan amount. If there are no bidders that are interested, then the bank will legally repossess the property. As soon as the bank repossesses the property, it is listed on their books as REO – Real Estate Owned – and is categorized as an asset (non-performing).

As soon as a property goes into a distressed status (the borrower/home owner misses mortgage payments) the bank will want to determine the amount of equity that the property has. A popular method to determine the equity is to obtain a Broker Price Opinion BPO or order an appraisal. Based on the amount of equity that is determined from the BPO, the bank will decide to try for a short sale or to allow it to go through the foreclosure process. If the bank is able to sell the property through a short sale or at a foreclosure auction, then the property will not become a REO property.

After repossession and the property becomes classified as REO, the bank will go through the process of trying to sell the property on its own. It will remove some of the liens and other expenses on the home and try to resell it to the public, either through future auctions or direct marketing through a real estate broker (REALTOR). Generally speaking, bank REO properties are in poor shape in terms of repairs and maintenance; however, real estate investors will often go after these properties as banks are not in the business of owning homes and so, in some cases, the low price can more than compensate for the condition of the property.

Once a property is REO, the bank or lender will try to get rid of the property by either selling it directly themselves or through an established broker. Many larger banks such as Bank of America and Wells Fargo have REO/asset management departments that will field bids and offers, oversee upkeep and handle sales. The majority of REO properties that are on the open market are listed in MLS by the broker/REALTOR that performed the BPO.

And now for the clips.

Shadow REO Tor 1

I should mention that all the data for these houses is right there on the Internet.  Here’s the page at Zillow.com for the 2nd house from the previous video and here again on Redfin.com.  It’s pretty amazing how much reconnaissance you can do without even leaving your home.  Scary, actually.

Here’s video 2. Shadow REO Tour 2

Shadow REO Tour 3

Shadow REO Tour 4.

Related posts:

• Existing home sales add to the parade of bullish data
• Short Sales in North County: “Feeding Frenzy” as banks pretend and extend
• Manhattan Q2 Apartment Sales down 22%
• Banks can do ‘You Walk Away’ too
• Baker-Samwick trial balloon floated by Obama

I supported a proposal to help foreclosed homeowners by Dean Baker and Andrew Samwick back in June (see “Why not protect the homeowner?”).  Apparently, the Obama Administration likes this proposal and is floating a trial balloon via Treasury Assistant Secretary Herb Allison (hat tip Marshall Auerback).

A top Treasury Department official told a Senate panel yesterday that the government is considering a proposal to allow homeowners to stay in their home as renters after a foreclosure.

If enacted, the plan would attempt to address the glut of vacant properties in neighborhoods across the country, helping drag down home values. It would be yet another acknowledgment by the Obama administration that some borrowers cannot be saved from foreclosure despite government and industry efforts.

"It’s certainly an idea we’re thinking about," Herbert M. Allison, assistant secretary for financial stability, told the Senate Banking Committee. A Treasury spokeswoman said that the proposal was being studied but that no decision had been made.

Felix Salmon has been talking a lot about this proposal (see his recent posts here, here and here) and whether it is a viable plan.  I believe it is.  It certainly reduces housing inventory on the market. But, even more importantly, it prevents unwanted evictions in a period of economic distress.

Some find fault with the proposal. According to the Washington Post, a similar program launched by Freddie Mac has had few takers, suggesting the benefits of such a program could be meagre.  Moreover, lenders probably want to become landlords with tenants even less than they want to become residential real estate moguls. However, there is nothing in the proposals preventing lenders from selling foreclosed properties.  They merely protect former homeowners from a precipitous eviction.

I would actually like to see this proposal include renters of foreclosed homes as there have been a number of cases of foreclosed owners renting out their property without properly informing the new tenants of the pending foreclosure. The tenants are then evicted in short measure with nowhere to go. A video of evictions in Las Vegas below including an immediate eviction of rental tenants at about 6:00.

Related posts:

• Wow, judges now nixing lenders’ foreclosure claims entirely in court
• Treasury Considers Plan to Halt Home Price Slide
• McCain repackages bailout proposal and labels it his own
• Why not protect the homeowner?
• Treasury to Consider Further Measures to Halt Housing Slide

I got a tip from a friend Andrew about a sale of assets by Wells Fargo (WFC) which raises a number of interesting questions.  He sent me the following 14 July article from the Milwaukee Business Journal.

Wells Fargo sold $600 million in mostly non-performing subprime loans to Irvine, Calif.-based Arch Bay Capital, National Mortgage News reported, citing sources familiar with the sale.

The industry publication said the loans sold for 35 cents on the dollar, about double what most hedge funds were offering.

Most of the subprime loans San Francisco-based Wells Fargo (NYSE: WFC) sold were originated by once-high flying Accredited Home Loans and NovaStar Financial, both of which originated subprime loans in the Milwaukee area.

No one involved in the recent sale is talking on the record, which may be a key reason lenders will look to private transactions to unload bad assets rather than turn to a government-sponsored program, National Mortgage News said.

Now, this transaction has not received a lot of coverage.  But the OC Register’s Matthew Padilla covered it as well as the buyer Arch Bay is based there. And they ask some interesting question based on the piece from the original source, National Mortgage News.

National Mortgage News reports Wells Fargo recently sold $600 million in distressed subprime loans to Irvine-based Arch Bay Capital.

Paul Muolo of NMN says the loans were originally funded by two mid-sized subprime lenders: Accredited Home Loans and NovaStar Financial.

Arch Bay co-founder Steven Davis declined to comment on the purported sale to his firm, referring calls to his partner Shawn Miller who serves as Arch Bay’s CEO. Mr. Davis didn’t deny that the sale took place but he wouldn’t confirm it either. Mr. Miller could not be reached for comment.

Meanwhile, one question the sale raises is this: How exactly did the publicly traded Wells wind up with so many crummy non-prime loans from these once highflying firms? Answer: I don’t know and Wells isn’t talking. A company spokesman said the bank’s corporate policy is to not discuss its loan auctions.
…
The nice thing about the private non-performing loan market is that none of these messy details have to see the light of day, including the price paid. One banker told me that the 35 cents on the dollar that Arch Bay reportedly paid was twice what some hedge fund bidders were offering.

I have calls into Wells and Arch Bay and will update the post if and when I hear back.

Does such a sizable deal signal we really don’t need PPIP? Or, looking at it another way, if paying 35 cents on the dollar is a high bid, then I don’t see how PPIP could help banks’ books.

The last question is a good one, but I have others.  Here is what I wonder:

• Why does Wells have this exposure to Milwaukee-based loans to begin with?  If these were part of an MBS, the loan pool would be more dispersed. Were they out buying NovaStar and Accredited Home loans back in 2007 when these companies’ subprime operations went to the wall?  (See my list of bank writedown news by lender for the 2007 events at NovaStar and Accredited Home.)
• Do they even own these loans or are they the ‘asset manager?’  They could be selling on behalf of a third party.  But, as they are not talking, we have to assume this is their own exposure.
• How much more Midwestern exposure does Wells have?  I have to assume they bought these loans to hold on their books if these are not part of a broader MBS pool.  I know they have operations in the Midwest because of Norwest. But, the fact that they probably bought loans outright to hold on their books would suggest that they have a lot of exposure in the Midwest.
• As The OC Register says: is 35 cents a high bid?  That would suggest massive writedowns waiting to be taken on other assets of  similar quality in the Midwest. Think Ohio and Michigan.  Where are these assets marked on the books?  At 35 cents, higher, or lower?  I’m betting much higher. Will we learn more in the WFC Q2 conference call next Wednesday on 22 July?
• Who else is doing deals like this?  And does that mean they are bypassing the PPIP program because they can do these deals privately?

Finally, as the OC Register suggests, a 35 cents on the dollar bid means huge writedowns that banks do not want to take – especially banks still on government TARP life support like WFC.  To me, this explains very well why the PPIP program was a failure: if banks can sell distressed assets quietly over time to private bidders, they might be able to delay taking writedowns.  But, the price discovery involved in the PPIP program would be a blood bath for banks already capital-constrained.  This is why the program has failed.

Related posts:

• Wells profit forecast is a clear bullish sign
• Creditors paid in full? No – try 6 cents on the dollar
• Quality financials are out there
• Wells Fargo to buy Wachovia
• Regionals are exposed to credit crisis

This comes via the Nationwide website:

As a responsible lender which aims to support its borrowers Nationwide has responded to market conditions and made an option available which enables some existing customers in negative equity to move home. This is not available to new customers. The maximum LTV for existing customers taking a new deal at Nationwide remains at 95%.

Nationwide remains a very prudent and cautious lender with a track record of low arrears, low possessions and has a low LTV (loan-to-value) mortgage book. As the borrower is required to put down a deposit of at least 5%, under this scheme, the LTV and the risk to Nationwide will reduce as a result of the transaction.

Nationwide introduced this option on 10 June 2009 for existing customers only in the following particular circumstances:

• they are in negative equity
• they need to move home
• they meet our strict lending criteria and
• they have a good credit record.

The Society does not anticipate, and has not seen, a great demand for this service.

Borrowers in these unique circumstances are simply able to transfer part of their existing negative equity with them when they need to move home – as illustrated below the actual value of the negative equity and the LTV will reduce in all circumstances.

The maximum LTV available is 95% on the new property plus the remaining negative equity amount carried forward from the current property. The customer will need to pay a 5% deposit on the new property from their own funds, for example:

Current property value	£200,000	New property value	£250,000
Current mortgage	-£220,000	5% deposit required	-£12,500
Negative equity amount	=£20,000	Negative equity carried forward	+£20,000
Current LTV	110%	New mortgage	=£257,500
		New LTV	103%
		New negative equity amount	£7,500

Both the main loan and the associated negative equity top-up are restricted to three and five year fixed rate products to protect the customer from potential payment shock over the short term and are only available on a repayment basis.

Rates available on the main loan match those available to existing customers not in a negative equity situation who are moving home with a 95% LTV and are currently:

• main loan up to 95% LTV: 6.73% (3 year fixed) and 7.48% (5 year fixed)
• top-up loan covering 100-125% LTV: 7.23% (3 year fixed) and 7.98% (5 year fixed).

Andy McQueen, director of mortgages at Nationwide said: “Nationwide is a responsible lender and our negative equity policy is an appropriate and prudent response to market conditions and demonstrates our continued commitment to supporting our customers.”

Related posts:

• Nationwide brings back 125% LTV mortgages
• Home Equity Lines Pulled
• Nationwide looking to buy targets in UK mortgage market
• Nationwide: British home prices now higher than a year ago
• Nationwide: U.K. house prices down 16.6%

The Nationwide, the world’s largest building society, is now bringing back the dreaded 125% mortgage.  While the lender claims these mortgages are a “niche product” designed for customers of Nationwide in negative equity, the Financial Services Authority (FSA) is looking to ban this type of lending.

From the BBC:

It will only be available to existing customers in negative equity who want to move house.

Negative equity means that the value of someone’s home is less than the amount they owe on their mortgage.

Nationwide said the deal was a very "niche offer" and that not everyone in negative equity would qualify.

The Financial Services Authority is considering limiting mortgage loans to 100% of a property’s value.

‘No more risk’

The Nationwide only offers new customers mortgages worth 85% of the value of the home they want to buy.

Under its new arrangement, borrowers would take out a loan for 95% of the value of their new house at a fixed rate of 6.73% for three years or 7.48% for five years.

They would then be able to add on the negative equity from their old home, up to another 30% of the value of the new property, at a higher fixed rate of 7.23% for three years or 7.98% for five years.

Now, this is a different product than the one being sponsored by the U.S. government ( see posts on that here and here). In the U.S., the 125% mortgage only applies to the refinancing of mortgages of existing properties.  Here, the Nationwide is offering to fund 95% of the new house purchase, plus up to 30% negative equity from a previous residence.

While I am sceptical about the rationale for this product, it is quite innovative. First, the negative equity portion carries a higher rate than the 95% mortgage.  Moreover, loan exposure for Nationwide probably won’t increase because these deals are for existing customers.  And, Nationwide seems to have found a way to get more house transactions in a climate where prices have been declining.

To my mind, the 125% product offered by this building society shows how innovative the financial services industry can be in any investing or economic climate.  However, products like these operate on the fringe of what should be considered prudent. I see it as further evidence that the financial services industry needs strong oversight to prevent lenders from taking on too much risk and creating the kind of financial crises we have experienced.

Related articles
Nationwide offers 125pc mortgage to home owners trapped in negative equity – The Telegraph
Nationwide brings back 125% mortgage – The Guardian

Related posts:

• Nationwide: guidance on its 125% LTV product
• Home Equity Lines Pulled
• Nationwide: U.K. house prices down 17.6% in year to Februay
• Nationwide: UK house prices rise for fourth month
• Nationwide: U.K. house prices resume their descent

Let’s say you’re an American named Maria living in Southern California.  The year is 2006.  You make $45,000 and your husband David makes another $40,000.  You have two children aged six and four and your two-bedroom apartment is getting too small.  So you decide to consider buying a house.  Eventually, you and your husband find a new home. Now, granted you know nothing about mortgage finance.  But, your guy at New Century Financial hooks you up and with the help of a teaser-rate adjustable rate-mortgage you are able to afford the home.  In the end, you shop around and get another bank you consider more reputable to match New Century’s terms. Sale Price $390,000.  As you have no money down and roll up some fees into the mortgage, the final mortgage price is $390,000 with a second piggy back mortgage of $10,000 for a grand total of $400,000 of debt.

Fast forward to 2009. The economy is in tatters but you and your husband have your jobs. You’re doing alright. And, as it turns out, you have picked wisely by buying the smallest house on the block in a really up-and-coming neighborhood.  The only problem is that house prices in your metro area are down 40%.  Your house, while down less, is still down 20% and is only worth $320,000. This is a big worry because your mortgage was a 3-year ARM and the rate is about to go way up.

Enter the federal government’s “Making Home Affordable” plan.  Just the other day HUD Secretary Shaun Donovan announced that mortgages owned or guaranteed by Freddie Mac and Fannie Mae can be refinanced up to – get this – 125% loan-to-value.  That means, you can take out a refinance loan on your house now valued at $320,000 for up to $400,000. Bingo!  That’s exactly what you need to keep your house.  Do you do it?

Debtor’s Prison

If you do go ahead, we might as well stick you in the King’s Bench because you are about to find yourself in debtor’s prison.  The Blog Seattle Bubble has this nailed (with some nifty charts to boot):

Let’s take a look at some hypothetical home borrowers who currently owe $400,000 in various mortgages with difficult terms or high rates, and whose home is presently worth $320,000. They jump on the new FHFA Home Affordable Refinance Program and refinance into a single 30-year fixed-rate loan at a 5.75% interest rate with a 125% loan-to-value ratio…

With the home value appreciation tweaked to a slightly less rosy scenario, it takes 17 years before our couple can break even selling their house.

Nice, huh?  Their comment on this is dead on:

If the goal of this new 125% loan-to-value program is to financially imprison people in their current homes for a decade or more, then it looks like it could be a rousing success. However, I’m not sure how many currently struggling home borrowers would really consider that to be much of a “help.”

I have a post from last year describing circumstances in Japan that are eerily similar. Take a look.  It’s called “A cautionary tale: story from 1994 Japan.”

Predatory Lending?

I have another angle too.  You’ll notice I mentioned Maria is no financial wizard.  She probably does not appreciate the intricacies of mortgage finance.  Here are two points to consider.

1. In the state of California, you can just walk away because first mortgages on primary residences are non-recourse.  That means that the mortgage is only secured against the house you have bought.
2. However, in the state of California, refinance mortgages are recourse loans.  What does that mean?  It means you are on the hook for that loan.  You cannot just walk away.  The bank can come after you and take your car and the stocks in your E-Trade account. They can garnish your wages. They can even take your clothes and the shirt off your back, literally.  The only thing they can’t touch is your 401-K.  But it’s down 40% anyway.

Why would you trade a non-recourse loan from which you can walk away for a recourse loan that guarantees you’ll end up as bad as some poor slob at Tappahannock?  It doesn’t seem like an incredibly appealing choice, does it?

But, of course, this is a classic case of asymmetric information because you don’t know that you are getting a poor trade, but your bank and the government do.  In fact, the bank makes more money this way because of incentives it receives for refinancing these loans – incentives, I  might add that come straight from the taxpayer to the bank via the Federal Government (see my post “How refinancing helps the likes of Bank of America and Wells Fargo”).

So, to recap, you get shackled to a house with a recourse loan because you don’t know what the bank and government do.  Meanwhile, your bank gets to forgo a writedown (remember, your loan was for the same amount as before).  And the bank gets a refinance fee which is goosed by government incentives.

Is this predatory lending? Sure sounds like it to me.

Related posts:

• Can I borrow the full amount and an extra 25% too?
• Nationwide brings back 125% LTV mortgages
• The fixed rate mortgage is king again
• Home Equity Lines Pulled
• UK mortgage crunch

Apparently the answer to this question is yes.  CNBC is reporting that home ‘owners’ who refinance their mortgages through loans backed by Fannie and Freddie will be able to borrow up to 125% of their homes’ value (hat tip Marshall Auerback).  That’s not a typo: we’re talking no-money down and 25% cash back.  Sign me up.

Homeowners refinancing their mortgages through loans backed by government agencies will be able to borrow up to 125 percent of their homes’ value under new regulations enacted Wednesday.

The rule changes, part of the government’s attempts to restore housing affordability and stem the foreclosure crisis, apply to loans backed up by Fannie Mae and Freddie Mac.

Previously, homeowners could borrow up to 105 percent of their home’s value. The new loan-to-value ratio is set up at 125 percent in a further effort to address those mortgage holders who owe more than their homes are worth.

"By expanding refinance eligibility, we can bring relief to more struggling homeowners more quickly,” Treasury Secretary Timothy Geithner said in a statement.

Is this sitting well with you?  Doesn’t this seem like the reckless lending which got Fannie and Freddie nationalized? Well, if you were wondering whether Obama, Geithner and Summers were trying to reflate the economy by bringing back the bubble, I don’t imagine you will find better proof.

Apropos borrowing 125%, you will recall that over a year ago I was wondering why U.K. mega-lender HBOS wasn’t writing down more assets because they were a recklessly lending – you guessed it – 125% loan-to-value.

Looking through old e-mails, I read an article from the FT in 2006 that surfaced claiming that HBOS (Halifax Bank of Scotland)were poised and ready to go offer loans for 125% of value. That’s right, HBOS thought it a good idea to cover 95% of the house price and loan another 30% over appraised value unsecured as a personal loan.

Now that the UK has joined the housing bust, one must ask where are the massive writedowns that have to be sitting on HBOS’ books? Why aren’t they looking to do another rights issue like RBS? I fully expect some pretty horrific things coming from HBOS as the housing crisis heats up in Britain.

We know what happened there: HBOS would have gone bust after Lehman had Gordon Brown not foisted it upon Lloyds. And Lloyds was a bank that subsequently was almost fully nationalized despite having a relatively clean balance sheet – all because of its merger with HBOS and HBOS’ reckless lending.

Now that the U.S. government is underwriting similar policies on this side of the pond, shouldn’t we expect things to go seriously pear-shaped here too?

Addendum: just in case it isn’t clear, this measure is intended to keep banks from taking writedowns.  A homeowner now 20% underwater can borrow the full amount of the original loan even though the house is worth 20% less than that amount.  The home ‘owner’ stays in the house.  The bank gets its regular payments (and a nice re-financing fee to goose earnings in Q3).  And no one defaults. It’s all good, right?

Second addendum: Yves Smith, who also got the same e-mail, notes “in most states, a purchase money mortgage is non-recourse, but a refi is. So some borrowers will put themselves in worse shape it they take up this offer.”  Check out her post here.

Related posts:

• HBOS versus Freddie and Fannie
• Treasury Considers Plan to Halt Home Price Slide
• Where’s HBOS?
• Consumer loan delinquencies paint bleak picture
• Is the new affordable FHFA loan program predatory lending?

This morning I was reading Simon Johnson’s excellent post “President Obama’s Regulatory Reforms Announcement: A Viewer’s Guide” about what Barack Obama should say when he makes his regulatory reform pitch today at 12:30 PM.  I agree with what he has to say about the need to re-assure us his ‘administration ‘gets it.’  And I suggest you read his commentary.  But, all the while I was reading it, I couldn’t help but think: ‘what about the homeowner?’

See, we have bailed out the financial services industry to the tune of nearly $14 trillion in guarantees and support according to the U.S. bank regulator the FDIC.  Yet, time and again we see differential treatment elsewhere.  Chrysler and GM were forced into bankruptcy and, more recently, California was denied aid.  The preponderance of evidence suggests that President Obama views the banking industry as systemically important in a way these other industries may not be.  The question is: how does he view homeowners, who collectively are American workers, taxpayers and voters?

I ask this because mortgage debt was the trigger for the financial crisis. And I have yet to see any comprehensive legislation protecting homeowners from financial distress, while we have certainly put the financial services industry and its reform front and center.  Just yesterday, in his “Ideas for fixing the economy,” Felix Salmon mentioned an idea first proposed in August 2007 by Dean Baker and Andrew Samwick which I will dub ‘rent-to-own.’ Baker and Samwick propose the following:

There is a simple way to allow troubled homeowners to stay in their homes without also bailing out the mortgage issuers and speculators.

Congress can pass legislation granting current homeowners the right to stay in their homes as long as they like, simply by paying the fair-market rent. In other words, no one gets tossed out on the street, as long as they can pay the rental value of their house. The fair rent would be determined by an independent appraiser — exactly the same way that a lender is supposed to determine the size of a mortgage that can be issued on a home.

Under this plan, homeowners would turn over their property to the mortgage holder. This would generally not be a loss since borrowers currently face crises precisely because they owe more than the value of their house. If the value of the home exceeded their debt, then they wouldn’t have to sign up for the program.

As a renter with secure tenure, the former homeowner would have incentive to do necessary maintenance and keep the home from falling into disrepair. This would prevent the blight that is already hitting neighborhoods where foreclosures have become commonplace.

The mortgage holder would get possession of the house, but they would be stuck having the former homeowner as a tenant. Otherwise the mortgage holder is free to hold or sell the property as they choose. Being stuck with a renter may reduce the resale value of the house, but intelligent investors knew there was risk when they got into the business.

To limit the size of the program and to ensure that it only benefits those who are really in need, there can be a cap placed on the value of homes that qualify. For example, Congress could stipulate that only homes with a market value below the median price for an area are eligible for this plan.

This security-of-housing proposal meets the needs of the homeowners who were victimized by deceptive lending practices and pro-homeownership ideologues. It gives them the right to stay in their home as long as they want. It accomplishes this task in a way that provides minimal opportunities for fraud and should require very little by way of new government bureaucracy.

It also manages to benefit homeowners in crisis without also rescuing the financial institutions that were speculating in mortgages gone bad. This will give the presidential candidates, and other members of Congress, a clear choice between helping distressed homeowners or bailing out financial institutions that should have known better.

Although the Baker-Samwick proposal does not specifically include a rent-to-own provision, whereby the renter has the option within a certain timeframe of buying back the house, it can easily be added.  Clearly this proposal has merits, yet I have heard nothing on this score for months except via Felix’s post.

I might add that there is also a huge amount of shadow inventory – repossessed houses not currently on the market due to the glut of residential housing inventory – which needs to be dealt with.  Calculated Risk has a sobering video from Jim the Realtor which makes this issue plain. This glut of inventory is likely to push house prices down lower, forcing many into negative equity and default.

So, my suggestion is that you should keep the homeowner in the back of your mind as you listen to President Obama make his case for banking regulatory reform.  I certainly want to see real reform, much as Simon does – and I will be listening for cues that we are going to get it.  However, I also think the time is right for homeowners to move center stage as well.

Related posts:

• Baker-Samwick trial balloon floated by Obama
• Nationwide: UK house prices rise for fourth month
• Citi agrees to do cramdowns
• Can I borrow the full amount and an extra 25% too?
• Wow, judges now nixing lenders’ foreclosure claims entirely in court

It’s about time.  The SEC has finally charged a high level executive in the banking industry in connection with activities that led to the largest bubble in U.S. history.  The accused, as expected, is Angelo Mozilo, otherwise known as “The Man with the Tan.”  You will recall that I have been expecting this for some time and wondered why it was taking so long for this case to come to fruition in my post, “Where are the perp walks?”  Let’s take a walk down memory lane with Angelo, shall we?

• More reason BofA is crazy to take on Countrywide (Jun 2008)
• Countrywide: California sues too (Jun 2008)
• Florida sues Countrywide (Jun 2008)
• Ex-Countrywide CEO is the new Ken Lay (Aug 2008)

Then it was all quiet on the western front.  Nothing for months regarding Mozilo.  So, I’ll ask the question again from March:

Why has the Obama Administration not shown prosecutorial zeal with financial executives for alleged wrongdoings?  I would have anticipated that Eric Holder at the Justice Department  would have  signalling to the American public that the new administration was breaking with the old – that Barack Obama wanted to at a minimum investigate wrong-doing.

Is this a case of the SEC being more careful in compiling its case, a clear sign of regulatory capture, or something more sinister? Please, chime in.

UPDATE: Here is the official press release of the charges of fraud:

Related articles
SEC charges Countrywide co-founder Mozilo: source – Reuters
Countrywide’s Mozilo, Two Ex-Executives Accused by SEC of Fraud – Bloomberg

Related posts:

• Florida sues Countrywide
• Ex-Countrywide CEO is the new Ken Lay
• More reason BofA is crazy to take on Countrywide
• SEC Press Release on Mozilo’s fraud and insider trading
• Countrywide: California sues too

Jim Cramer is not just calling a stock market bottom, but now he’s calling a housing bottom too.  In fact, he says go buy a house.  “Buy a house and buy Bank of America too?”  Cramer says: “This is patently obvious.”

Take a look and tell me what you think.  Personally, I know his stock picking record is dubious so I tend to dismiss this too. Hat tip Joe Weisenthal.

Related posts:

• Nationwide: U.K. house prices down 16.6%
• UK house prices up for third time in fourth month
• Nationwide: U.K. house prices rise for second time in three months
• Nationwide: U.K. house prices down 17.6% in year to Februay
• House prices in the U.K. up for first time since Oct 2007

OK, I lied.  I am forced to used that dreaded phrase – one last time.  What did a commenter just call it: “Photosynthetically capable new plant growth?”  The reason the dreaded phrase is making a comeback is due to the excellent analysis of Niels Jensen, Senior Partner over at Absolute Return Partners in London. Visit www.arpllp.com to learn more about them.  You can reach them by email at info@arpllp.com.

Scott, this post is for you.

Asset bubbles are strange animals. Ideally, you would like to punch the air out of them relatively early before they become a real danger but, in practice, it is not quite so simple. Ben Bernanke and Alan Greenspan have actually both argued that asset bubbles cannot be detected and monetary policy should therefore not in any way be used to offset suspected bubbles.

I am not sure I agree with the two gentlemen, but that is less relevant for now. What is important to understand is what happens once the asset bubble bursts. In my experience, almost all post-bursting bubbles share two characteristics:

1. At the very least, asset prices revert to the mean, although many actually overshoot on the downside.
2. A long (and often painful) period ensues, where asset prices gradually claw back lost value. History suggests that this period is measured in years and sometimes in decades; never have asset prices recovered from a deflated bubble in just a matter of months.

The recent collapse of residential property prices – at this point still more advanced in the US than in Europe – is a classic asset bubble which is now deflating. The reason I have decided to write about it this month is because the ‘green shoot’ campaigners are missing a hugely important point about the effect that falling US property prices are going to have – not just on the US but also on the global economy.

Recovery will prove temporary Make no mistake. I always expected and continue to expect an economic revival later this year, which unfortunately will prove temporary. There are many good reasons to expect such a short-term recovery, as I discussed in detail in the April issue of this letter. However, it is what happens afterwards that I worry about. The economic uplift is likely to last no more than one or two quarters after which we will have to face more gloom and doom.

There are at least two reasons property prices are so important to the overall economy. The first reason has to do with leverage. There has been a lot of talk about de-leveraging in recent months, and the consensus seems to be that most of it is now behind us. Perhaps, in the narrowest possible sense, that is correct. But leverage is not confined to hedge funds and banks. Many private households run heavily levered balance sheets as a result of their home ownership and it is this leverage that is rapidly growing at the moment. Why is that? Because leverage is a function of both the numerator and the denominator and, as American home owners are about to find out for the first time, falling property prices can have a devastating effect on your balance sheet.

Secondly, property wealth has become an important part of many people’s lives. In both the US and the UK (and in numerous other countries as well) many people have directed their savings towards property in recent years, and no small part of the profits have been recycled into the economy through equity withdrawal schemes. This has created a level of consumption which cannot be sustained if property prices do not continue to rise.

Property prices are down 32% So let’s take a closer look at US residential property prices which have been falling steadily for almost two years now. One of the better measures of that market is the Case-Shiller index. The index peaked in July 2006 and has since dropped by 32%. Now, in order to revert to the mean, US property prices must fall by about 40% or so in total. Therefore, with a bit of luck, those long suffering US home owners are about 75% of the way through the bear market.

But that is not the point I want to make. In December 2006, only a few months after the peak of the housing bull market, the total value of US residential property stood at $21.9 trillion. Prices have dropped by 31% since the end of 2006, so the estimated value today is about $15 trillion; however, the mortgage debt remains more or less unchanged and stands at $10.6 trillion. In other words, whereas debt-to-equity in the US housing market was 48% as recently as in December 2006, it is now 70% and will rise to 80% once house prices have mean-reverted.

Wealth is extremely skewed Although painful, a rise in debt-to-equity of that magnitude would actually be manageable if it weren’t for the fact that income and wealth in the US is extremely skewed. The top 1% of income earners in the US account for a whopping 23% of national income while the median household has seen no improvement in income for the past ten years (see chart 1). Wealth is even more unevenly distributed. Almost 34% of all wealth in the US is held by the wealthiest 1% of the US population.

Chart 1: US Income Distribution

Source: BCA Research

The same picture emerges when you look at home ownership. Almost one-third of all US households have no mortgage. If you adjust for that, the 70-80% debt-to-equity ratio suddenly becomes a major challenge because it means that the two-thirds who do have a mortgage already face a debt-to-equity ratio in excess of 100%. Even worse, once the mean reversion has run its course, two-thirds of US households will be facing a debt-to-equity ratio of 120-125% on average.

US consumers are broke That is a shocking number and it blows a huge hole through the heart of the green shoots campaign so valiantly promoted by most of the mainstream media in recent weeks. The poorest two-thirds of US households are effectively broke, whether they realise it or not.

Obviously, households have assets and liabilities other than property and mortgages. Deutsche Bank has created a measure of liquid assets to liabilities which is illustrated in chart 2 below. As you can see, there has been significant damage done to households’ balance sheets in recent years. The first wave (2000-03) was mostly a function of the collapse of the dot com bubble. The second wave (2007- ) has come about as a result of the more recent collapse in property and share prices. It is probably fair to say that US households are more financially stressed than at any time since the Great Depression.

Chart 2: US Households’ Balance Sheets

Source: Deutsche Bank Global Markets Research

As DB points out in its report, households’ ability to spend is a function of three factors – cash flow (which again is driven mainly by income, mortgage rates and tax), credit (bank lending) and homeowner equity (property prices). Now, with negative equity against their main asset, with even more pressure on income as a result of the recession and with virtually no savings to cushion the pain, the majority of US households have no choice but to cut back drastically on their consumption. And with the US consumer being forced to pull back, the global recovery story turns very pale indeed.

Tax hikes on the agenda The wealthiest one third of US households may be in for a bit of a shock as well. The tax cuts implemented by President Bush are due to expire in 2010 and neither President Obama nor the Congress have shown any desire to extend the current scheme. In fact, tax hikes are already being discussed, and those Americans who think of European tax regimes as evil creatures should prepare for the beast to show up on their own door step. You only have to go back to the 1950s and early 1960s to find marginal tax rates of 90% in the US (President Roosevelt’s so-called ‘New Deal’). My guess is that before Obama’s first term is over the US will endure marginal tax rates of at least 60%.

So how is it possible for an economy to recover if two-thirds of its people are bankrupt and the remaining one-third will be taxed to death? It isn’t!!!

Mortgage rates under pressure Having said that, mortgage rates will be crucial to keeping the US consumer from suffocating completely, and there can be no doubt that the Fed will do everything in its power to keep a lid on them. But, lo and behold, interest rates are playing further havoc. Contrary to what most investors expected, long-dated government bond yields have actually crept up in recent weeks to the point where they may start to inflict some real damage on mortgage rates.

The situation is quite serious but, as far as I can tell, the average US house owner hasn’t really woken up to the fact yet. At the very least, this will slow down the US (and hence the global) recovery to a trickle. At worst, Americans in their millions will walk away from their homes and post the keys to the mortgage provider as many US states allow, further undermining an already fragile financial sector. The US government, desperately trying to avoid nationalisation of large parts of the banking sector, may have no choice in the end.

Over the years I have learned never to underestimate the determination of the US consumer. He has always been prepared to spend his last dollar. Even when the tank was empty, he re-mortgaged his house so that the spending spree could continue a little longer. 70% of the US economy is accounted for by the consumer. That is more than 10% higher than the EU average (see table 1). Within the EU, only the UK comes close. But his options are running out. There can be no doubt that the party is well and truly over.

Table 1: Private Consumption/GDP

Source: Eurostat. All data from 4Q08.

We need the US consumer! There is plenty of schadenfreude to detect here in Europe. Yet most of those people who argue that the American consumer has dug his own grave by acting so “irresponsibly” fail to understand that it is precisely the over-consumption in America which has driven the global economy to the lofty levels we have all come to like and enjoy. Without Americans being prepared to spend their last dime, there would have been no BRIC fairy tale and there would have been no German export boom, masking the fact that the domestic German economy has been on life support for a number of years now.

It is therefore an inescapable fact that with two of the largest consumer-driven economies in the world heading for a protracted slowdown, the global economy will take much longer to recover than most people realise, unless other countries such as Germany wake up and realise that their high savings ratio is as much part of the problem as the American and British über-spending. However, to persuade Mr. and Mrs. Schmidt to adopt Anglo-Saxon spending habits is a tall order – in particular when the problem is not recognised by supposedly intelligent people such as Angela Merkel, the German Chancellor. I could hardly believe my eyes and ears when, during the recent G20 summit in London, she declared that the German growth model would continue to be based on exports. To whom may I ask?

Niels C. Jensen

---

See for example http://www.federalreserve.gov/boarddocs/speeches/2002/20021015/default.htm

I have chosen to ignore the fact that property prices are now falling quite rapidly in many other countries as well. That only strengthens my case.

Related posts:

• Fitch: Prime RMBS loss estimates way too low
• Tapping the 401K and unrealized gains
• What’s different about 2008?
• Americans are not increasing savings
• Credit crunch hits autos, students and homes

Actually, I lied.  He really is not that bullish at all.  But he does sound relatively upbeat by comparison to 5 months ago.

I have seen Whitney Tilson of T2 Partners a lot in the media of late.  The two most recent appearances are with Tech Ticker where he talked about house prices and with the Financial Times, where he had a wide-ranging conversation with Aline van Duyn.  I have already linked to the Tech Ticker piece in our newsfeed. So I would like to highlight the conversation with the Financial Times.

Below are the three links to the videos of the conversation.  (Note: Tilson is a major investor in Berkshire Hathaway, the firm controlled by Warren Buffett.  He used to be short the financials.  He was pretty bearish in December. Watch the Bloomberg video to see what I mean.)

Tilson is a value investor who doesn’t think we are halfway through the unwinding of this debt bubble.  While I would characterize him as a proponent of the ‘fake recovery’ meme, I believe he is too fundamental an investor to invest in that recovery.  He sounds very cautious about what is coming down the pike for banks and the deleveraging of this debt bubble, but he does share my view that big banks will probably be able to see the eventual writedowns through as they will happen over a much longer time horizon.

• Whitney Tilson on Buffett and derivatives

“Whitney Tilson, managing partner of T2 Partners and well-known as a value investor and shareholder of Warren Buffett’s Berkshire Hathaway, discusses the recent pressures on the share price of Warren Buffett’s Berkshire Hathaway. Berkshire Hathaway shares are Mr Tilson’s fund’s biggest position. The huge increase in spreads on Berkshire Hathaway, which were the equivalent of those often quoted for highly distressed companies, followed the need of counterparties to hedge exposure to future payments they were due to receive from Berkshire Hathaway. The costs became so high that the original contracts were renegotiated in Berkshire’s favour. The wider CDS spreads – the result of technical factors – contributed to the decision by Moody’s Investors’ Services to cut Berkshire Hathaway’s triple A credit rating. Mr Tilson supports regulators’ plans to shift the CDS market to centralised clearing and for more disclosure about CDS positions.”

• Whitney Tilson on “panic buying” rally

“Whitney Tilson, managing partner of T2 Partners and well-known as a value investor and shareholder of Warren Buffett’s Berkshire Hathaway, says it is difficult to be a value investor when the behaviour of other investors is so panicky. Recent panic selling has now been replaced with panic buying of the same stocks. The recent economic indicators which have been interpreted as signaling a potential bottoming of the US housing market are merely reflective of seasonal factors. Foreclosures, on which there has been a moratorium, will start increasing again. “That’s going to continue to pressure home prices for, we guess, at least another year, and I think a lot of investors are looking at some short-term data and not quite seeing that we’ve got a ways to go on this,” Mr Tilson says.”

• Whitney Tilson  on mortgage losses

“Whitney Tilson, managing partner of T2 Partners and well-known as a value investor and shareholder of Warren Buffett’s Berkshire Hathaway, expects another wave of losses in the US mortgage market. As described in his new book New Mortgage Meltdown, he says the first wave of losses – which have reached over $1,300bn – was concentrated on mortgage-backed securities owned by banks and financial institutions. The second wave will hit mortgages still held on banks’ balance sheets, and losses end up being double or triple the current figure. With such losses looming, he says the strong rally, particularly in the financial sector, is “overdone”.”

Other sources

T2’s Tilson Short Sells Wells Fargo, Bank of America: Dec 2008 – Bloomberg

T2’s Tilson Selling Short Wells Fargo, Bank of America: Video – Bloomberg (video here)

Related posts:

• Whitney Tilson: "A pullback of some sort is likely"
• Subprime, Alt-A Delinquencies Rise
• Bill Miller and Meredith Whitney: The Bull and the Bear
• Even Buffett hit by higher funding costs
• Goldman partners get margin calls

Earlier today I posted an article about how accounting was favourable to banks in that it could help them weather the storm and appear well-capitalized until a recovery is underway.  Afterwards, a buoyant economy would increase earnings enough to allow the massive writedowns that need to flow through the income statement to be taken in stride.  As an addendum to the previous post, I added a note regarding how this turn-of-events can take place even though the housing market is considerably worse than most pundits felt it would be.

Calculated Risk has a story out (Revisiting the JPMorgan / WaMu Acquisition) which suggests that JPMorgan, if anything, under-provisioned for the eventual WaMu losses.  That would suggest a lot of writedowns over the life of the WaMu loans. This is an account that I would tend to believe as the housing market is worse than the baseline case JPMorgan presented after the acquisition (see my post "JP Morgan Chase buys WaMu out").  Again, I see WaMu as a bankrupt organization that was destined to fail.  Nevertheless, over the short-term, accounting from the transaction can be favourable to JPMorgan’s earnings – and I see that as a net positive for JPM.

I have another tack regarding bank earnings to share.  Feel free to express your agreement or doubt in the comments regarding this line of argument.  As a result of the securitization model of mortgage finance having replaced the traditional model, banks with large retail customer bases are geared to transactions and volume as a way of making money.  This means banks like high mortgage transaction volumes, whether through actual purchases or refinancing.  Some of the the banks geared in that direction include Wells Fargo and Wachovia, Bank of America and Countrywide Financial, and JPMorgan and Washington Mutual. All of these banks will benefit from having bought other bankrupt organizations with large mortgage operations. 

For example, say you buy a house in 2004 that is not underwater. Having seen your 5-year ARM reach the end of the ARM period, you are looking to refinance now in 2009.  Using some of the homeowner-oriented bailout schemes, your bank can lower your monthly payment but in return they get an incentive payment:

• A straight out cash incentive payment of say $1000 for doing a loan modification on a still current loan as the lender (say Wells Fargo) AND another cash payment as a servicer (say, Countrywide, now BofA).
• A amortized payment equal to half of the savings you just received (as long as you stay current, which 40% of loan-mods are not doing). So you save $100, but the bank gets $50 a month for the next five years as a lender. The servicer will get annual payments here as well.

Nice, huh?  Well read this from the Mortgage Bankers Association from last week’s Weekly Mortgage Applications Survey.  I have highlighted the points you should pay attention to.

The Mortgage Bankers Association (MBA) today released its Weekly Mortgage Applications Survey for the week ending May 15, 2009.  The Market Composite Index, a measure of mortgage loan application volume, was 915.9, an increase of 2.3 percent on a seasonally adjusted basis from 895.6 one week earlier.  On an unadjusted basis, the Index increased 2.0 percent compared with the previous week and increased 42.0 percent compared with the same week one year earlier.

The Refinance Index increased 4.5 percent to 4794.4 from 4588.6 the previous week and the seasonally adjusted Purchase Index decreased 4.4 percent to 254.0 from 265.7 one week earlier. 

The four week moving average for the seasonally adjusted Market Index is down 6.4 percent.  The four week moving average is up 0.1 percent for the seasonally adjusted Purchase Index, while this average is down 8.2 percent for the Refinance Index.

The refinance share of mortgage activity increased to 73.6 percent of total applications from 71.9 percent the previous week. The adjustable-rate mortgage (ARM) share of activity increased to 2.4 percent from 2.3 percent of total applications from the previous week.

The fact is bankers are looking to get A LOT of refinancing volume because both servicers and lenders stand to increase current net income significantly if refinancing volumes are high.  An increased refinancing transaction volume is a backdoor way of re-capitalizing banks.  Now, just in case you are interested, here is what the same MBA Weekly report looked like on Oct 8th, just after Lehman filed for bankruptcy.

The Mortgage Bankers Association (MBA) today released its Weekly Mortgage Applications Survey for the week ending October 3, 2008.  The Market Composite Index, a measure of mortgage loan application volume, was 465.5, an increase of 2.2 percent on a seasonally adjusted basis from 455.4 one week earlier.  On an unadjusted basis, the Index increased 2.2 percent compared with the previous week and was down 28.6 percent compared with the same week one year earlier.

The Refinance Index increased 0.9 percent to 1345.8 from the previous week and the seasonally adjusted Purchase Index increased 3.2 percent to 314.5 from one week earlier.  The Conventional Purchase Index increased 0.7 percent while the Government Purchase Index (largely FHA) increased 9.9 percent.
The four week moving average for the seasonally adjusted Market Index is down 1.4 percent.  The four week moving average for the seasonally adjusted Purchase Index is down 4.1 percent, while this average is up 1.8 percent for the Refinance Index.

The refinance share of mortgage activity decreased to 43.4 percent of total applications from 44.0 percent the previous week. The adjustable-rate mortgage (ARM) share of activity decreased to 2.3 percent from 2.5 percent of total applications from the previous week.

Clearly refinancing volume is through the roof as zero percent interest rates are an incentive for all mortgage-holders to refinance.  This increased volume of transactions will be very helpful to banks’ earnings over the near-term.  Notice that I haven’t mentioned Citigroup anywhere here because they lost out in the Wachovia transaction and they have a fairly small retail operation domestically.

Source

Mortgage Applications Increase in Latest MBA Weekly Survey: 20 May 2009 – MBA website

Mortgage Applications Increase Slightly In Latest MBA Weekly Survey: 8 Oct 2008 – MBA website

Related posts:

• More on Fannie and Freddie – Signs of life in the Refi Market?
• How much money is Wells Fargo really making?
• Fixed rate mortgages at a nine-month high
• Merrill – Bank of America deal
• WaMu: Mr. Smith goes to Washington and turns predatory

This is a video from Bloomberg Television yesterday. It underscores the fragility of this incipient recovery. You will notice that California is leading the way in terms of foreclosures, one reason the state will 00 bankrupt or be bailed out. Here are some tidbits from the related Bloomberg News story:

• 342,000 homes were seized, foreclosed on, or auctioned in April
• 1 of every 374 homes received a foreclosure filing.
• Foreclosure filings were up 32% from last April.
• California was #1 in filings (it is the largest state, of course).  Florida, Nevada and Arizona were next on the list.
• Florida and Nevada led the way in percentage increase in states with lots of foreclosures. Nevada’s April figure is up 111% and Florida’s 75% in one year. This compares to 42% for California and 40% for Arizona.

The increase in bankruptcies in Florida should be of particular concern for those tracking bank failures.  The FDIC has just opened an office of 500 there to handle the wave of expected FDIC seizures.

Incongruously, this article quotes from Nicolas Retsinas.  If I am not mistaken, he was a bubble denier when prices were going through the roof.  His organization provided statistical research cover for those who thought real estate was going to the moon.  Here’s what they say:

“What you’re seeing is the inevitable result of severe iob losses,” Nicolas Retsinas, director of housing studies at Harvard University in Cambridge, Massachusetts, said in an interview. “Until we stem the job losses, we can expect to see continuing foreclosures.”

Stating the obvious is not going to help regain credibility now. Just this past February, Dean Baker, who did call the housing bubble and crash, also noted that the media continued to go to Retsinas despite his track record during the bubble.

Nicolas Retsinas, Housing Bubble Denier, Is USA Today Expert On the Housing Market

When USA Today wanted to speak to a housing market expert on the rise in the housing vacancy rate, it turned to Nicolas Retsinas, the head of Harvard University’s Joint Center for Housing Studies. This was an interesting choice since Mr. Retsinas is perhaps best known as one of the people who denied the existence of a housing bubble in 2003 and encouraged low and moderate income families to buy homes.

Some of the assertions that can be found in this publications are:

“More importantly, it takes concentrated job losses – the likes of which have not been seen during this business cycle – to drive down home prices;” and

“Moreover, when house prices deflate, they do so slowly.”

–Dean Baker

I point this out because you might be inclined to believe what you see written in our newspapers. However, more scrutiny is often warranted.

Sources
U.S. Foreclosure Filings Hit Record for Second Month – Bloomberg

Related posts:

• Alt-A and Option ARMs set for big losses
• Bernanke urges more to be done on housing crisis
• Prime Foreclosures greater than subprime
• Extend and pretend and the growing divide between delinquencies and foreclosures
• Ivy Zelman: “Home prices are going back down”