1. An FDIC document on the risk weights of different bank assets. The higher the weight, the more capital the bank has to hold against that asset. As I read table 1 and table 3, if you originate a loan with a down payment of 20 to 40 percent, the risk weight is 35. But if you buy a AA-rated security, the risk weight is only 20. So if a junk mortgage originator can pool loans with down payments of less than 5 percent, carve them into tranches, and get a rating agency to rate some of the tranches as AA or higher, it can make those more attractive to a bank than originating a relatively safe loan. If you want to know why securitization dominated the mortgage market, this explains it. Regulatory arbitrage, pure and simple.
So it seems banks have to hold more money in reserve if they hold low risk mortgages than when they hold a “good” slice of much riskier mortgages.
That is, the banks can leverage the good slice of bad mortgages a lot more than they can the actual good mortgages.
I think “regulatory arbitrage” could add another piece to the puzzle.
I’m not taking that as a vote of confidence in the Wall Street Bailout Financial Market Rescue Bill signed a week ago.
More on the Stock Market last week
ADDED:
This “legendary investor” on CNBC says, “The way to solve this problem is to let people go bankrupt.”
Don’t miss the video, “All of this pumping of money into the system is not going to save it. You see what the market is saying… The market hates it.”
ADDED LATER:
I bet some on Wall Street are worried that once the credit freeze is over and mortgage-based assets are priced more or less correctly that we’ll all find out that a lot of companies are, in fact, insolvent.
If after passing a $700 billion rescue package, the market falls 20%, you have a big problem. You could easily interpret that to mean the market is saying the $700 billion rescue package made things worse, not better.
Trend Homes is back in business. Actually, the old Trend Homes is still in bankruptcy but it sold the name “Trend Homes” and “Classic Communities” and many of it’s assets such as homes, lots, computers and equipment to a brand new legal entity now called “Trend Homes” (they bought the name after all).
In fact, the new Trend Homes hired all the old Trend Homes employees.
Is this a trend?
The housing industry went down before the banking industry.
I wonder if this type of arrangement foreshadows what we might also see in the banking industry. That is, changes where not much changes except the old company’s debts are wiped out (more or less) through bankruptcy and a new owner comes in with a clean slate (more or less).
You’ll probably start to hear the term, liquidity trap, soon. It’s not just for college economic students anymore.
One of the great tools the government has to manage the economy is the interest rate. If the government lowers the interest rate, people spend more money which stimulates the economy.
Unfortunately, as the rate gets lower, the effect of an interest rate cut becomes less. That is, cutting the rate from 2% to 1.5% has much less effect that cutting the rate from 5% to 4.5%.
When interest rates get very low indeed, one of our best economic tools loses it’s ability to stimulate the economy.
In a move to boost economic growth in the midst of a worsening global financial crisis, the Federal Reserve lowered its fed funds rate by half a percentage point to 1.5%.
Many of the banks that have already failed or have been bought out were those that specialized in the most risky of all mortgages, Option ARM mortgages.
The financial industry shake out started with the most risky lenders and will now move on to less risky lenders.
Any bank that made a lot of mortgage loans in 2005 and 2006 would seem to be in real jeopardy even if they weren’t selling option ARM’s or other crazy risky loans.
The median home price in metro Phoenix has fallen 34% from the peak. The median home price at the peak was about $260,000. Now, it’s about $190,000.
I don’t see how many of those 2005 and 2006 lenders can survive. Were the lenders making so much money that they could lose on average many tens of thousands of dollars on every foreclosure and still survive?
It’s going to take a lot of checking account overdraft fees to cover one of those foreclosures.
And, oh yeah, home prices are still headed down.
Many lenders who made mortgage loans in 2005 and 2006 will go out of business over the next couple of years.
Nevertheless, I believe that once home prices bottom out, new lenders will appear like magic to lend money to Arizona home buyers.
“The banks were forced - literally forced - to make mortgage loans to a lot of people that in the past they hadn’t made them to, because (the people) couldn’t afford them,” Kyl said in a teleconference with Arizona reporters.
“But they were deemed to be red-lining, to be discriminating against people who need to share in the American dream of home ownership. Well, it’s a great dream, and we want as many people to share in it as possible, but not if they can’t afford it,” he said.
Well, that is about as clear an explanation as I’ve heard.
Loans to marginal lenders became troubled. Fannie Mae and Freddie Mac took care of the loans by bundling them and selling them to other financial institutions.
Kyl said he helped draft bills in 2003 and 2004 intended to tighten regulation of Fannie and Freddie in an effort to forestall a potential multibillion-dollar bailout.
“Several pieces of legislation were offered up. I could be partisan and tell you who they were offered by and who stopped them, but I won’t. The bottom line was that the prediction, unfortunately, came true,” he said.
Sen. Kyl was a key player in negotiating the Wall Street Bailout Bill (A.K.A., Economic Stabilization Bill).
I did jury duty last Friday at the City of Scottsdale. I didn’t even know they had jury trials at the City of Scottsdale!
Well, it turns out the City of Scottsdale does indeed have jury trials but only for misdemeanors. So I’m thinking, “Why would anyone go to trial on a misdemeanor?!”
It was an alcohol related driving offense. So then I’m thinking, “What kind of alcohol related driving offense is only a misdemeanor?!”
Anyway, I never found out because I wasn’t selected for the jury.
Maybe having two brothers who are lawyers, a brother-in-law and a sister-in-law who are lawyers and a sister who does pre-sentence reports was a factor.
I did find out, however, that about 90% of the jury trials in Scottsdale are DUI’s.
Now, the silly stuff!
While waiting with the other potential jurors, they showed this ancient video with newscasters describing the jury process. It was actually pretty useful. One of the newscasters, however, was Liz Habib.
Boy, I hadn’t thought of Liz Habib in years. She was the golden girl in broadcasting in Phoenix for a while in the mid-1990’s.
Liz Habib was so young and cute in the jury video. She looked like a little girl with almost chubby cheeks and blinking her eyes like she just got her first pair of contacts yesterday.
So I thought I would see what Liz Habib was up to since leaving KTVK in Phoenix. I’m sure a lot of my fellow jurors were wondering the same thing. Heck, this post could qualify as a public service message.
It turns out, Liz Habib isn’t shy anymore. She shows a lot of personality now and she comes across more the wild child than the school girl.
Now back to our regularly scheduled boring broadcasting.
The 6th Scottsdale Classic is the first horse show to take advantage of the major upgrades underway at WestWorld. New barns, new show offices new restrooms are all part of the project. Jerry Kimmel, co-founder of the Scottsdale Classic said “I’ve always liked coming to WestWord because it has so much space and so many arenas. You can always find a place to ride or warm up.” Kimmel adds, “ now with the improvements, its even better.”
The is an intriguing one-hour program on Charlie Rose.
‘You don’t want artificial prices being paid.’
‘Is this being done at market?’
Well, it is certainly nice know that Warren Buffett has the same major concern that I do with the plan. I will certainly breath easier if these mortgages and mortgage backed securities are bought at market prices.
‘Inflation is a likely consequence of what we are doing now.’
But Warren thinks future inflation is simply a price we have to pay to save the economy now. (That is the second person I’ve heard refer to higher future inflation.) (FYI; Real estate became to be seen as a hedge against inflation during the 1970’s.)
It is clear to me after listening to Warren Buffett that the Treasury is only concerned about buying real estate related assets and that no attention is being paid to the eventual sale of the assets.
I sense that the government will hold these assets for many, many years.
I fear that the longer the Treasury holds those assets, the more mission creep we will see and government policies will change toward using the mortgages to promote social change.
Tom says Zillow currently displays Trustee Deeds as the most recent sale!
Trustee Deeds come from foreclosure auctions (Trustee Sales) and they are certainly not open market transactions. You get a Trustee Deed when you buy a home at a foreclosure auction (Trustee Sale). Banks get a Trustee Deed if no one successfully bids at a foreclosure auction and the bank takes ownership.
Currently, about 95% of these foreclosure auctions end up with the bank taking ownership. That means that about 95% of the time the value shown on Trustee Deeds is the opening bid amount of a FAILED foreclosure auction (Trustee Sale) and does not reflect an open market transaction.
The value given on a Trustee Deed has little to do with the market value of the home. The banks can make the opening bid whatever they want, for example, the banks often make the opening bid the outstanding mortgage amount.
The values shown on Trustee Deeds should not be used in any home price valuation model such as Zillow’s “zestimates” because they are not open market transactions.
Tom says Zillow’s model is “not only naive, it’s dangerous.”
[CORRECTION: Read the comments. Zillow does not include repossessions in calculating the Zestimate but they do at this time display repossessed homes as being sales on their maps of home sales in metropolitan Phoenix. Hopefully, Zillow will correct this soon.]
In the data I use here at Arizona Real Estate Notebook and in my weekly newsletters, Home Sale News, I do not include Trustees Deeds because they are not open market transactions.
… millions in tax breaks and related pork for kids’ wooden arrows, Puerto Rican rum producers, auto race tracks, and corporations operating in American Samoa.
The Congressional Budget Office said the package of breaks - including obvious pork and some more defensible tax-relief measures - will add about $112 billion to budget deficits over the next five years because the bill doesn’t contain enough offsetting revenue hikes to keep the budget balanced.
A hundred billion here, a hundred billion there and pretty soon you’re talking about real money.
Divide $700 billion by the population of the United State, 300 million people, and you get a cost of $2,333 for every man woman and child in the United States.
[Please forgive my lack of focus on Arizona specific real estate issues lately. I’m totally captured by The Bailout and trying to figure out the possible consequences for Arizona home buyers and Arizona home sellers.]
That title of a Wall Street Journal opinion piece from Martin Feldstein pretty much sums up my position on the credit crisis.
A successful plan to stabilize the U.S. economy and prevent a deep global recession must do more than buy back impaired debt from financial institutions. It must address the fundamental cause of the crisis: the downward spiral of house prices that devastates household wealth and destroys the capital of financial institutions that hold mortgages and mortgage-backed securities.
The recently enacted financial rescue plan does nothing to stop this spiral. Credit will not flow and liquidity will not return to the banking system until financial institutions have confidence in the solvency and liquidity of other banks. [I added the bolding.]
Financial institutions will not regain confidence in the solvency of other institutions that hold mortgages until after home prices stop falling.
Overshooting on the way down
Because of the 20% fall in the price of homes since the bursting of the house-price bubble, there are now some 10 million homes with mortgages that exceed the value of the house. Residential mortgages are generally “no recourse” loans, meaning that if the homeowner stops making payments, the creditor can take the property but cannot take other assets or attach income. Individuals with loan-to-value ratios greater than 100% therefore have an incentive to default even if they can afford their monthly payments, and to rent an apartment or other house until house prices stop declining. When individuals default and creditors foreclose, the property is added to the stock of unsold homes. That depresses prices further, increasing the number and magnitude of negative equity houses.
The Bailout won’t make under-water mortgages profitable nor will it stop those mortgages from continuing to lose value.
I’m not sure if I buy the author’s proposed solution, however, I think he did a great job of defining the problem.
Fed’s purchase mechanism and arbitrary pricing
On the Fed’s purchase mechanism, my suspicion is the Fed will overpay for mortgages in order to help the banks.
There are also important technical problems in using the $700 billion fund to buy impaired securities. The Treasury’s preliminary idea was to use a “reverse auction,” a method that works well when used to buy a single homogeneous security (like a firm buying back its own shares). But that is not feasible for buying the impaired securities, because of the enormous variety of underlying mortgages and of the almost limitless number of different derivatives based on those mortgages. The buyback will therefore involve a large number of arbitrary valuation decisions by the Treasury staff and their investment-banker advisers.
“Arbitrary pricing” also means the government will likely overpay for many, perhaps most, of the mortgages they buy, and it will be difficult to prove they overpaid.
The features that Congress added to the initial Treasury plan do nothing to achieve sustained confidence in the financial institutions. They provide Congressional oversight, delay the use of funds, create partial government equity ownership in some firms and do other things to protect taxpayers. But they do not address falling home prices. [I added the bolding.]
