Thursday, December 06, 2007

Your MBS pool will freeze before you get past the first marker!

Bush and Paulson on the tape with their new sub-prime freeze plan. I've commented that I think it's a good idea, at least in concept, and we really didn't get much as far as new information today. I now understand that the mass mod will apply to borrowers with a 660 FICO or lower, and the average "teaser" rate they are currently paying is 7-8%. As Tanta at Calculated Risk, puts it, that kind of rate isn't what most people are probably thinking when they hear "teaser." Count me as one of those people who assumed we were talking about "teaser" rates below current market fixed rates. I think the 7-8% figure is very important here. According to Freddie Mac, the current 30-year fixed rate mortgage rate is about 6%. Anyway, that makes it realistic that some percentage of borrowers will be able to use FHA assistance and/or a municipal housing agency to eventually refi into a fixed rate mortgage. Erin Drankoski, of the New America Foundation estimates that 10-12% of subprime resets would qualify. If only 2-3% could wind up in a fixed rate mortgage, that would make a real difference.

For undoubtedly the best commentary available anywhere, check Calculated Risk.

Anyway, the question of how this all will impact mortgage pools is not currently known. There will likely either be lawsuits or something passed by Congress to prevent lawsuits. So until we get some more details, I'm not sure we can say what exactly will happen to mortgage pools.

However, here are some things I know, some things I think are true, and some things I have questions about. I'll put this out there for reader comment and maybe collectively we can figure this shit out.

Fannie/Freddie Pools
The interest rate on a Fannie or Freddie ARM pool is based on the rate the of the underlying loans less a servicing spread. So let's say that your pool starts out with a coupon of 6% and is set to adjust in 3 years. Let's say that the servicing spread is 50bps. That doesn't mean that all the loans have a rate of 6.50%. Some might be 6% some might be 7%. If it happens to be that the 7% borrowers refinance but the 6% borrowers don't, then the coupon on my pool goes down. My point here is that the GSE didn't promise me 6%, they promised me the full amount the borrowers are supposed to pay. Note this isn't how a fixed rate pool works, where they have indeed promised me a certain coupon.

My reading of the Offering Circular on GSE pools indicates that when a loan becomes seriously delinquent, the GSE buys the loan out of the pool. At that point, the GSE and the service will determine what the best course of action is: mod or foreclose. But as far as the MBS investor is concerned, its of no moment. The GSE buys the defaulted loan out of the pool at par either way.

I'd suspect what this means is that any loan in a GSE pool which would qualify for the freeze would wind up getting bought out by the GSE. Based on the 660 FICO limit, there aren't going to be a ton of loans in Fannie/Freddie pools which are frozen.

Whole Loan Pools
Non-agency MBS are more complicated. And I freely admit that I'm not an expert in all the different types of whole loan RMBS out there. I have (fortunately) always stuck with GSE pools. Anyway, here is how I understand it, and anyone who knows better should drop us all a comment.

Whole loan interest rates for ARMs are usually set based on some index. Typically LIBOR + a spread. When the deal is initially put together, the investment bankers will run models as to what kinds of LIBOR spreads the deal can afford based on various estimates of prepayments and defaults.

Whole Loan RMBS are subject to an available funds cap. This is a fancy way of say that the trust will pay out what its got, but if it ain't got it, it ain't paying it out. This is in contrast with a GSE pool, where interest and principal is guaranteed regardless. If the pool is running out of cash, then all P&I will start flowing to the senior tranches, and the junior tranches won't get anything until the senior is completely retired. How "running out of cash" is defined depends on how the deal was originally structured. Usually there is some kind of trigger calculation.

Obviously if the interest on the pools is frozen at the teaser rate, but LIBOR has risen, then the interest flowing to the pools will be less than what was assumed when the deal was modeled. Odds are good that this will trip the trigger, and all cash flow will go to retiring the senior. What's
unknown is whether A) the modified interest will still be enough to pay the senior in full and B) whether the senior would be better off just foreclosing and taking what they can get now as opposed to putting off receipt of principal in favor of getting more interest. I'll merely point out that the senior tranches usually had a very tight spread to LIBOR, less than 20bps in some cases. Whereas the deal as a whole probably has an average interest rate of 400bps over LIBOR or more. So the senior can lose a lot of interest in the pool before there isn't enough to pay the promised amount.

So my view is that the deal benefits senior tranche holders, and REALLY benefits monoline insurers, who mostly care about the senior holders. If the odds of senior holders remaining whole for a longer period of time goes up, that's certainly good for AMBAC, MBIA, etc.

36 comments:

Anonymous said...

The 1-800-HOPE cheerleaders have all overlooked the most obvious criticism of the plan... If its such a great idea for all parties involved, and if it does not violate any contracts -- then why does the Secretary of the Treasury need to get involved?

Either Paulson is unneeded -- or you folks are wrong

gramps said...

Many blogs are posting a snippet from a BofA report that details the top reasons for mortgage defaults. More than half are because of lack of income (the borrower took on too much loan). About 1.8% is the result of rate resets.

The simple, and indisputable facts are these:

1. We had massive asset inflation after Greenspan lowered rates in 2001. The average home price went from sort of high as a multiple of income -- to off the scale as a multiple of income.

No mortgage interest rate is going to change that. Either home prices must fall *A LOT*, or income levels must rise *A LOT*.

2) Greenspan lowered rates to 1% under the pretense that he needed to add liquidity to the system after the dot-com collapse. All he did was substitute an equity bubble (which effected a limited number of people) with a housing bubble (which effects almost everyone). No surprise to anyone, the added liquidity did not re-inflate a dot-com with no profits and no business model-- the credit was diverted into an unintended place.

Now all the "experts" that got us into this mess say we need to lower rates again. And no surprise, the Fed's cuts to date are not going into shady mortgages on overpriced houses. The Fed could lower rates to zero and it would have absolutely ZERO effect on housing. The Fed lowers rates and Libor spread blows out -- everyone knows the banks played fast and lose, and no one is going to trust them until they come clean. Heck, the banks don't even trust each other - they no the trouble each other is in because they are all in the same trades.


This whole exercise is worse than a waste of time. There are massive losses in the system, and more to come as housing prices re-normalize.

The problem is, when the Fed and Treasury go off and put "their muscle" behind a program -- and it predictably fails -- everyone now knows the government is impotent.

This is a confidence game, and most of the Fed's power comes from the mystique it has. Once everyone realizes its just a bunch of helpless humans -- that is when everyone will truly panic. The Fed and Treasury just revealed the Wizard is some fat guy behind the curtain with no power at all.

Its been a while since I read his book, but I think Bob Rubin mentions exactly this issue to explain why he refused to comment publicly on most matters.

The Fed has made a fatal error.

apprentice said...
This comment has been removed by the author.
apprentice said...

IMHO, I agree that the Fed's rate cut or rate freeze might not help the current subprime borrowers directly, but could help them indirectly. It's widely understood that this is just a measure to save time, so that demand for the housing market, incentivized by the low rates, would slowly catch up with the inventory gluts.

ST said...

"A) the modified interest will still be enough to pay the senior in full and B) whether the senior would be better off just foreclosing and taking what they can get now as opposed to putting off receipt of principal in favor of getting more interest."

You've convinced me that in terms of A) the seniors are better off, but in terms of B) doesn't this depend on how post- modification plan defaults work out? What I'm wondering is whether those RMBS deals that happen to have high post-mod defaults won't end up causing servicers to be sued after the fact for costing investors money. What legal protections would servicers have in this case?

cak said...

As for the legal issue, the Bush administration will most likely invoke "General Welfare" clause as FDR did when creating the HOLC, and many of the other New Deal acts (including the FDIC) in 1933?

Anonymous said...

Gramps is right IMHO.

Housing prices have to fall 50%.

Just to throw some gasoline on a lighted fire, I encourage speculation why Greenspan did what he did. He sure as hell didn't do it to protect the American economy.

We face a bleak deflationary future in which the subsistence basics of life will still be too expensive for a huge percentage of the American people...sort of like The Great Depression.

Anonymous said...

I also fervently recommend reading The Oil Drum blog:

http://www.theoildrum.com/

This is the true backdrop for what is happening in the world of "finance".

No more natural gas as of 2025. And, at the same time, no more fertilizer for food crops.

That's 17 years away. Sounds like a long time doesn't it...until you consider that most of the bonds talked about on this blog have longer maturities.

Anonymous said...
This comment has been removed by a blog administrator.
Accrued Interest said...

To whomever posted the comment I deleted, please read my feelings on quality comments here:

http://tinyurl.com/ytfrkp

You are welcome to repost your thoughts with actual substance and a different tone.

Gramps: I've seen that chart. I'm going to look more into it and possibly write a post soon on what I find. When I first saw it, what struck me was how many were defaulting because of negative equity. I think few people actually living in their house would do this, but speculators would certainly view this as a viable option.

Anyway, my view is that the freeze plan will have modest benefits in terms of reducing defaults. By this I mean, there is nothing that's going to prevent defaults from rising considerably from here. However, to the extent that we can spread out the supply of foreclosed homes dumped onto the market, that's got to help.

Accrued Interest said...

More Gramps: (Are you the real Gramps btw?) I agree that the housing bubble has something to do with the Fed. But the subprime bubble has to do with the CDO explosion, which really only got going in 2005 or so. We can debate whether the Fed's excess liquidity is to blame for the CDO explosion or not. I think the fact that European banks were common buyers of AAA tranches of ABS CDOs tells me that it isn't all about the U.S. Fed.

I can't get behind the 50% housing deflation figure. I've been working on a model for how far housing should fall, but I'm not there yet. I know it isn't going to come up with 50%.

And to the first anon poster: My opinion is that the servicers wanted to do this, but also wanted some legal cover. Getting Treasury involved (and Congress will likely get involved too) gives them that.

jag said...

anonymous@8:46: The Treasury Secretary needs to be involved because this is a classic collective action problem. A solution that might be in the best interest of all the major players, in aggregate, might not happen in a free market if it is not any single player's best interest to take the leadership on the issue, or everyone might simply be counting on someone else to get the ball rolling. The Treasury secretary is working as a facilitator, and this is entirely appropriate.

Governments can solve this kind of market failure without, in theory, doing anything coercive or in breach of contract. They simply need to state the conditions of a workable plan and encourage everyone to join it, providing essentially disinterested leadership that might not be forthcoming from private players.

jag said...

I recommend reading up on the Nash equilibrium, which shows how the solution that is in everyone's best interest might not be accomplished if each player acts in their own best interest.

flow5 said...

We necessarily have “regulated capitalism” And the disregard of reckless financial practices coupled with a flawed monetary policy created this housing orgy. Specifically, this housing bubble resulted from an inequitable distribution of, and an excessive volume of, available money and credit.

It is the responsibility of, and within the powers of, the House Committee on Financial Services and the U.S. Senate Committee on Banking, Housing, & Urban Affairs to regulate how savings & investments are channeled.

And in fairness to Alan Greenspan the money supply has gradually become unknown & unknowable since the DIDMCA.

DAB said...

Anon@4:37

An excellent counterpoint was provided by an executive at my company recently. He is one of these guys that has been around Oil forever, and aside from simple economics that dictates that price will rise sufficiently to prevent us from running out of natty by 2025 or whenever, there is an industry point to be made. This applies more to Oil than NG, but the reasoning is similar. We are not running out of Oil, not even remotely. We have basically run out of $20/bbl oil anywhere that the supermajors can exploit. Saudi Arabia still probably has some single digit priced oil, but then it is all heavy that there isn't sufficient refining capacity to do anything with now anyway (so high capital cost on the back end, and Motiva expanding their Port Arthur facility). There is plenty of $40/bbl oil out there. Until this year, if a geophysicist came proposing to exploit a $40/bbl find, he would either be kicked out of the president of the company's office at best or fired on the spot. Now, there are actually plans to start thinking about going after some of that $40/bbl oil. The concept is similar with NG, however there always has been a bit more of a wildcat tendency in gas. However however, there is a hell of a lot more gas in places that are inaccessible than there is crude. All someone has to do is build LNG facilities, and that problem is solved.

Cheap energy is over. There is plenty of capability to expand Nuclear and Solar and probably Wind at a high capital low production cost (fairly high cost). Low production cost Coal will be getting higher in production cost and much higher in capital cost. NG has and will have low capital cost, but high production cost. Existence is not in question. Inflation is.

Just to stay on original point for a minute, I am skeptical that the administration's plan will go anywhere since mortgages are still so heavily regulated at the state level. Any national modification is going to run into a hornets nest when trying to apply it across the board. The lawyers and some on Wall Street (maybe only Goldman) will make money, and basically everyone else will loose…
.

RowdyRoddyPiper said...

Nice post, none of the hysteria that you see on many other sites.

1) There are three reasons that you would need the Fed to step in on this (not that they should step in but why it won't happen without them sigining off).
A) The legal issue. As you point out some bond holders will be better off, some will not. People are sitting on their hands because they don't want to make a bunch of mods that screw the IO (interest only) holders and then spend the next 5 years in court.

B) FAS140 has very strict limitations on what are permitted activities inside a QSPE (qualified special purpose entities). Most deals are structured as Q's so that they receive off balance sheet treatment. Pro-actively restructuring non Blow your Q and the equity (or variable interest entity) holder has to consolidate all the trust assets and issued liabilities onto the balance sheet. That would suck.

C) REMIC regulations also seriously restrict the activities that can go on inside a pool. This is a tax consideration and therefore an IRS issue. I can't imagine that anyone would want to f around with this without first getting some sign off from Uncle Sam.

So the Treasury is in there telling servicers, hey do what's right and we'll shield you from the blowback. I think a more reasonable plan would have been to have the servicers submit their plans and if they looked like they work they could buy an indemnity from the Gov't and if not, well back to the drawing board. Each pool has different dynamics, different collateral and different investors so what works in one pool may not work in others. I hate the way this is being implemented but I understand the wisdom of some limited governement intervention on the matter.

Servicers do have a motivation to keep the pool out there as long as possible (increases the amount of servicing fees they get) but at some point the value of working out a loan is surpassed by the potential liability of investor suits. It's crappy but true.

Anonymous said...

AI: And to the first anon poster: My opinion is that the servicers wanted to do this, but also wanted some legal cover.

You don't need legal cover if what you are doing is legal. Implicitly you are arguing that Paulson's deal is on shaky legal ground.

If you watch CNBC or look at some of the on-line polls -- the deal is overwhelmingly opposed. The words "bailout for his Wall Street buddies" are used quite a bit. Even if this program turns out to be legal -- it clearly violates most people's sense of fair play.

Anonymous said...

Jag: you are vastly over-complicating matters. We don't need a Nash equilibrium. A mortgage contract is between borrower and the bank that makes the loan. Later, the bank's rights are (supposed to be) transfered to a trust that serves as a conduit to investors. There are only two legal entities involved (borrower and trust) -- investors are entitled to whatever the trust gets (in accordance with the trust agreement). Investors have no claim against homeowners directly.

This was born out recently with 14 loans in the midwest that Deutche Bank (DB) thought they owned. Turns out, the originating bank signed a letter of intent to transfer the lien on the deed to DB's trust -- however the paperwork was never filed. The judge denied DB's request to foreclose, as the trust had no legal status.

N.B.: DB argued the "everybody does it" excuse-- to which the judge said that even if the law hadn't been rigorously enforced in the past, that in no way invalidated the law requiring a lawful transfer of the lien.

Arguably, the local court may have been trying to appease local consituents -- but the ruling was upheld on appeal. The law in question was an Idaho law I think (midwest anyway) -- but the exact same law exists in all the states, having been carried over from British courts way back when.

The point remains: investors do not have legal standing against the borrower directly -- they only have legal standing against the trust. If the trust goes belly up, so do they. Any loan modification is between the trust and the borrower.

There is no "group" that needs a leader. No complicated Nash equilibriums.

Steve said...

RowdyRoddyPiper,

Excellent points. Regarding REMIC election, I have heard (but have been unable to verify) that IRS has today issued an interpretation that OK's the blanket mods. Which wouldn't be a surprise, since IRS is part of Treasury. The FAS 140 is more difficult; the usual interpretation is that servicers are automatons with limited discretion, and then only when a loan becomes delinquent--nothing proactive, no crystal ball stuff. What concerns me is that ASF has suddenly redefined servicer SOP. If this plan does not produce dramatic and I think unlikely improvement in fc rates and house prices, the door that Paulson has cracked open will swing wider. I can't see how fears of that won't tighten mortgage availability.

gramps said...

AI: yes this is the REAL gramps. My impostor has evidently decided to visit France :)

I was arguing that the Fed blew it with respect to mortgages and monetary policy in general -- not just subprime/CDOs. As I mentioned in the earlier post -- home prices grew markedly faster than income for a few decades, and it really took off in 2001 when Greenspan irresponsibly tried to monetize the dot-com debacle.

While I think Greenspan was a disaster as Fed Chair, I have to give him a partial slide since the problem was greatly exacerbated by relaxed lending standards.

The long time rule of thumb has always been a home buyer must put 20% down and the mortgage payment should be no more than 30% of income. Someone is bound to point out that most people cannot afford homes under these guidelines...

PRECISELY RIGHT That's why the lowering of rates will accomplish no good. It *may* postpone the day of reckoning-- but it will not fix anything. And the problem is likely to get worse in the meantime. Take heed from Japan's mistakes: lets take our lumps and then get back on track.

More alcohol does not fix a hangover, but it could turn you into an alcoholic. More credit is not going to fix our credit binge, but it *WILL* put us deeper in debt.


I agree with AI that the other commenter, who suggested 50% price reduction, may be a bit over pessimistic-- at least on a national level.

There may be some places where prices do fall in half -- the usual suspects like CA, FL, Las Vegas, etc. Other areas may have moderate declines, or materially flat. As the real estate saying goes: location, location, location. But my own back of the napkin calculations suggest a decline of 25-30% nationwide average.

Note that this puts a LOT of mortgages into negative equity. 2nd home owners with negative equity just walk away (I think this is the big surge so far).

1st homeowners with negative equity will just go do a "Texas Refinancing"

gramps said...

BTW -- did everyone see the comment on Calculated Risk about Paulson's plan? Sneaky...

The plan says you must have at least 97% LTV to be eligible.

In other words, if you have negative equity-- it is in your interest to walk away (leaving the mtge investors with a foreclosure / big loss).

But along comes Paulson. "We will freeze your rates!" So keep making cashflows to investors, at least for a little while. Eventually, you will figure out you have a lost cause and will default. At that point, foreclosure happens anyway. But with Paulson's plan, investors get a few more cashflows (albeit at lower rates). The borrowers still end up in default.

So everyone's intuition was dead on right: Paulson's plan helps Wall Street. It postpones the day of reckoning for a very small percentage of borrowers (at a price).

steven said...

I thought the issue of the ohio cases was lack of subject matter jurisdiction, since it was filed in a federal court and does not pertain to constitutional question, the plaintiffs need to demonstrate diversity of citizenship; which is intertwined with proof of standing at the filling of the complaint.

Even so, it was dismissed without prejudice, so a simple refiling would be sufficient. Judge Thomas M. Rose laid it out nicely what was needed for the federal court to hear the claim:

a sworn payment history showing that the amount in controversy exceeds $75,000, copy of the promissory note, mortgage and loan modifications, mortgage assignments, affidavit that the plaintiff is the owner of the note and mortgage, and a corporate disclosure statement. From these documents, the court noted that it can generally confirm standing and diversity jurisdiction.

Anonymous said...

Although I confess I am loathe to believe it, I am struck by the coherence of Gramps comment that all the "plans" to save borrowers are really plans to save lenders...as long as possible.

Certainly, the lenders have been in charge in the United States for a very long time.

Ah, you say, what about the national debt?

And I reply that the Norquistians actively sought to increase the national debt to make it impossible to pay for Social Security etc.

Grim, grim, grim.

AI, please post on how we avoid a deflationary episode worse than the now so-called "Great Depression".

P. Jackson said...

Accrued Interest and all -

A few things I didn't see discussed that will determine how this works, particularly for the non-agency market.

I'll plug that I've covered alot of this over at Housing Wire (http://www.housingwire.com) in various posts.

One, the biggest challenge here is going to be standardizing reporting of loan modifications to trustees/investors; my understanding is that the delinquent (and/or so-called 'high risk' performing) loans are not purchased out of their pools, which is important to remember in terms of the loans the freeze plan is targeting. How servicers report on these loans will directly impact calculations on things like cumulative loss and delinquency triggers -- and there hasn't been a standard on this in the past.

If servicers show modified loans under this plan as "current," there is a large risk of principal reduction of mezzanine and subordinate bonds while the senior-most bond is outstanding after a specified step-down date (often after 3 years). Various sources have said the ASF will propose a standard that modified loans continue to be reported as delinquent for up to one year, in order to maintain overcollateralization for higher-rated tranches.

Second, I think you're correct that this plan will benefit senior classes -- but there is another fly in the ointment here. The freeze plan might not allow deals to properly "season" -- meaning the assumptions on default performance over the lifetime of the deal may not hold. Sort of the "default later" problem, where loans that are frozen may be more likely to default after the freeze period, especially in areas expected to see significant price declines. Given how cashflow changes over time in MBS deals for different classes, it's possible that senior noteholders could be in for a nasty surprise five years down the road.

That being said, I just don't know how many loans this really affects. The confluence of FICO and LTV requirements strikes me as very limiting.

best, PJ

Anonymous said...

Just in case you thought running a hedge fund was all work and no play...

http://www.nydailynews.com/news/ny_crime/2007/12/08/2007-12-08_gay_porn_star_comes_clean_about_link_to_-1.html

Anonymous said...

Anon @ 5:39

I don't really follow politics closely anymore-- since I think ALL career politicians are out to live high on the hog while having someone else pay for it. The only difference I see between Dems and Reps is who the primary beneficiary is. The victim is always me.

So I am not familiar with what a "Norquistian" is?

Regardless, it makes zero difference if they secretly planned to run up the debt to avoid paying Social Security.

As dozens of people have pointed out for many many years: Social Security is a ponzi scheme. It always was. The day it was signed into law, the first beneficiaries started receiving checks having never contributed a dime.

Social Security lasted as long as it did because the baby boom generation came along and filled the coffers with cash -- which Congress (both parties) spent with drunken abandon.

The fiscal disaster known as Alan Greenspan was on a committee back in the 1970s to "fix" Social Security -- which was actuarially bankrupt even back then. Like all good bureaucrats, his "solution" was to raise taxes and collect more revenue-- which supposedly would be saved for future generations. But the extra revenue was "borrowed" by Congress (then controlled by Democrats) and spent.

There is no "Trust Fund" and there never was. There is a shoe box full of IOUs from Congress. All those special drawing rights that pay "interest" are nothing but a meaningless accounting entry.

If your family has a vacation fund, and you decide to "borrow" from it and you place an interest baring IOU to yourself in the jar instead, what happens when you want to go on vacation?

You must raise new revenue and/or cut your spending to pay yourself back (Or, you must skip going on vacation).

If the special drawing rights that Social Security Trust fund supposedly holds are to mean anything, Congress must raise new revenue and/or cut spending to pay the Trust back.

If you think about it: that is exactly the same position they would be in if there was no Trust Fund. Congress would have to raise new revenue or cut spending to fund Social Security directly.

The Trust Fund is nothing but an accounting entry.

Young people will never see a dime from Social Security-- at least not in real (inflation adjusted) terms. Congress must raise new taxes, cut government spending, or print money (run inflation) to keep the program going.

And at some point, they will fail-- no matter which political party is in power. Soc Security is a ponzi scheme -- it needs an ever growing population of workers to contribute ever increasing amounts. Sooner or later, workers will be asked to contribute more than 50% of their earnings to fund someone else's retirement -- and they will refuse.

Social Security has other design problems, besides being a ponzi scheme.

It is basically a tax on the economy, transferring wealth from the current workers to yesterday's workers. If people live longer (and improved medicine / health makes this likely) -- the pool of retirees will end up being larger than the pool of workers.

Also, the economy shrinks every few years (because it has a recession). But in those years, Social Security payments are increased anyways. By the power of compounding, this means Social Security payments are designed to increase faster than the economy over time.

Social Security, like all ponzi schemes, is guaranteed to fail once the available supply of "new entrants" dries up. On top of that, the Democrats decision to link increases in payments to constantly rising wage growth guarantees that the power of compounding will also work against Social Security. The decision by both parties not to index retirement age to life expectancy guarantees a third death to Social Security.

Whatever Bush and his neo-cons do doesn't really matter. Maybe he makes Social Security fail a year or two earlier than otherwise-- but it was poorly designed and guaranteed to fail from day one.

I should mention that other countries privatized their pensions after it became obvious that a public fund would always be robbed by politicians. Even in countries like Argentina, where education is (supposedly) not as good as the U.S., people have learned how to invest their money.

Remember, no one is going to watch your money for you for free. If they offer to do so (like the government or a boiler shop broker)-- be twice as suspicious. Politicians (from both parties) will rob you blind if you let them.

Wall Street *WILL* benefit from private retirement savings; but you are naive to think someone isn't living off you with a public plan. The big question (no matter who does it) is: how much are they charging, and is your money secure.

The answers with Social Security are: costs are not disclosed and they are robbing you blind.

Wall Street isn't known for ethics, but at least there boiler room brokers who pay early investors "returns" using new investors money get arrested.

Anonymous said...

(add on to last post)

BTW - I don't mean to take a partisan line and suggest the Democrats screwed up Social Security... Its just that plenty of people have suggested the Republicans did it / are doing it -- do I didn't feel the need to repeat. My point is neutral on political parties -- they are both crooks, just in different ways.

flow5 said...

What if interest rates rise and remain high while these folks are waiting to reset/refinance?

gramps said...

flow5: what *if* rates remain high?

1. Whatever CPI is doing, many people's cost of living (ie inflation) is several multiples higher.
2. Commodity prices, notably crude oil, are on an up trend. While I "think" oil will pull back and take a rest (high 70s/low 80s?)-- the "low priced oil" is gone. We aren't running out of oil, but we have run out of cheap oil. And now we must compete with other growing economies to get supplies of oil -- supply is constrained, demand is not.
3. The anonymous guy who wrote about social security is right. The US has massive entitlement spending baked in... Massive government spending (war, entitlments, whatever) tends to be very inflationary.
4. Foreign investors, who are our net creditors, must be pretty worried about our willingness to let the dollar sink and our lack of respect for centuries of private property laws. We are the biggest game in town, so I really doubt they will pull out of the US -- but I would be very surprised if they don't continue to diversify away.


Meanwhile, I think Ben Stein's estimate of a 15% decline in home prices may be a bit optimistic. If you do a linear regression through long term home prices, his guestimate looks dead on (prices would be 15% lower). However, given the massive overhang of supply, and many market's tendency to over-correct after a massive bubble...

So after paying whatever reduced / frozen rate for a few more years (and providing cashflow to Wall St) -- they will find themselves in exactly the same position as they are in today.

This is why I have argued that the Fed's lowering of rates is an exercise in futility. This is not a liquidity crisis-- it is an insolvency crisis.

Consult the trading book of your choice: when it comes to stopping out a loosing trade, your first loss is your best loss. Hanging on in vane hope that the price will go back up to your cost is a rookie mistake.

flow5 said...

What was the Fed’s involvement?”

The money supply can never be managed by any attempt to control the cost of credit.

There is only one interest rate that the Fed can directly control: the discount rate charged to bank borrowers. The effect of Fed operations on all other interest rates is indirect, and varies widely over time, and in magnitude.

Anonymous said...

Gramps should start co-blogging with you AI à la Tanta.

"This is why I have argued that the Fed's lowering of rates is an exercise in futility. This is not a liquidity crisis-- it is an insolvency crisis."

How very, very, very, very true.

flow5 said...

It isn't within the power or responsibility of the Federal Reserve to hold unemployment or even Gross Domestic Product to "tolerable" levels. In fact, to assume that the Federal Reserve can solve our unemployment problems is to assume the problem is so simple that its solution requires only that the Manager of the Open Market Account buy a sufficient quantity of U.S. obligations for the accounts of the 12 Federal Reserve banks. This is utter naivete.

The Board and most of the public apparently accept the dictum that high interest rates are prima facie evidence of a restrictive monetary policy. If the time frame of your economic policy is 24 hours rather that 24 months, they are. For example , if the manager of the Open Market Account puts in buy orders for Treasury bills for the accounts of the 12 Federal Reserve banks, the prices of these bills will tend to rise, and their yields (interest rates) fall. This particular procedure, taken alone, would be evidence of an easier or less restrictive monetary policy. And the opposite action would be evidence of a tighter monetary policy. But, as noted, this is a 24-hour phenomenon. Over a period of time, open market operations of the buying type, because they provide legal reserves (an increase in lending capacity) to the banking system, result in an expansion of bank credit and thus an increase in the money supply.

It is the excessive increase in the money supply combined with a sharp rise in the transactions velocity of our money that is largely responsible for our present high rates of inflation. This in turn is almost wholly the cause of our present high interest rates, i.e., the 17 consecutive target federal fund rate increases.

Unfortunately, the Federal Reserve doesn't guage the volume and timing of its open market operations in terms of the amount and desired rate of increase of "free gratis" legal reserves, but rather in terms of the levels of the federal funds rates (the interest rates banks charge other banks on excess balances with the Federal Reserve).

Since 1967 the federal funds rate has become virtually the sole criterion in the formulation and execution of open market policy. This policy is euphemistically referred to as accomodation the money market. It would be more accurate to characterize the policy as one that accommodates profligate bankers.

The structural alterations in our money markets and the practices thereby engendered, led to a mélange of excessively destabilizing price changes, especially of those assets, real estate, etc., which serve as loan collateral. The whole brew of ill-advised deregulation and regulatory permissiveness fostered an atmosphere in which greed seemed to triumph, especially if a little fraud was diluted with a heavy dose of incompetent supervision by the authorities and their examiners.

Anonymous said...

Accrued,

Thanks for providing a great blog!

Is there a flow chart to show the flow of mortages, abs, cdo, cmo, siv, etc. to each other?

Thanks,
J

Sivaram Velauthapillai said...

GRAMPS: """4. Foreign investors, who are our net creditors, must be pretty worried about our willingness to let the dollar sink and our lack of respect for centuries of private property laws. We are the biggest game in town, so I really doubt they will pull out of the US -- but I would be very surprised if they don't continue to diversify away."""



Name me a country that has better property laws than the US! You probably can't even count the choices on one hand (maybe Switzerland, Cayman Islands, and the like). Anyone that pulls out money is going to come running back the next time there is a crisis elsewhere...

You Americans don't realize that the reason US stocks, for example, trade at a higher multiple than, say, Europe or Singapore, or whatever, is because USA provides freedoms. Economic and political!

I think a declining US$ will not help investors but I don't think it's a bad thing. As Paul Krugman has remarked in the past, the US$ is likely to decline but that doesn't mean things will fall apart. In fact, you should see the current account deficit start to shrink, and I suspect US competitiveness will improve.

Accrued Interest said...

Wow. This is really getting to the point where its hard for me to keep up with the comments. Fortunately we've built a nice community here of people responding rationally to each other, which is exactly what I wanted to create when I starting AI.

Anyway, Gramps: its fair to say that the Fed and other regulators share some of the blame for relaxed lending standards. I'm thinking especially of allowing SIV and other off-balance sheet financing vehicles to proliferate. I mean, either announce there are no longer any minimum capital requirements, or enforce the capital requirements we have.

As far as the plan being more oriented to helping lenders vs. borrowers... the reality is that the government cares more about the lenders. Look, they didn't give a damn when Bear Stearn's hedge fund blew up. Nor did they give a damn when New Century went under. Nor would they care if a Rescap or some such went under. But start talking about WaMu or Nat City or Citigroup? Now we're in a whole other world.

That being said, I want every one who thinks this is just a bail out for Paulson's Wall Street buddies to think about it this way. If you still think it bails out Wall Street, fine, but keep an open mind and hear me out.

Here is the progression, as I see it:

1) Banks make bad loans, where the borrower will not be able to afford the reset. The bank should have reasonably assumed this from the outset, but for whatever reason ignored better judgement.

2) Borrower, in most cases, also probably knew s/he'd struggle to make the reset.

3) Both probably assumed something would bail them out, either another refi opportunity would emerge or price appreciation would bail them out.

4) Neither happened, so the banks are looking at a large number of foreclosures.

5) Banks have actually unloaded a lot of these risks onto ABS investors. However, they know the large number of foreclosures is going to put serious pressure on home prices and depress their own recovery.

6) Therefore they'd rather extend the fixed period, in essense eating the extra interest they expected to get at reset. This will help improve the loss severity of the loans they do foreclose upon.

7) The borrower really is bailed out, since s/he gets to keep his/her house and doesn't have any negative events on his/her credit report.

8) Banks and investors eat the loss. Both parties probably realize they'd be worse off without the modification, but indeed are eating the loss.

9) There may well be a high level of loans that eventually foreclose after the freeze period. But some loans will actually pay off: some will be able to refi into fixed, some will just sell the property, and some will grow into the payment through improved income. We can debate what percentage of loans will re-default, but it won't be 100%.

Now if you read all that and say that banks/investors are realizing a bigger benefit, perhaps. But it isn't like they are realizing the benefit on the backs of borrowers. Seems to me that the borrower is the one getting a risk-free deal here.

flow5 said...

Stop-out/FF Target

12/10 4.27
12/07 4.37 4.41
12/06 3.90 4.49
12/05 4.32 4.31
12/04 4.55 4.50
12/03 4.25 4.52
11/30 3.30 4.66
11/29 3.15 4.55
11/28 3.70 4.53
11/27 4.09 4.39
11/26 4.20 4.62
11/23 4.20 4.56
11/21 4.13 4.50
11/20 4.20 4.51
11/19 4.30 4.51
11/16 4.27 4.51
11/15 3.90 4.54
11/14 4.60
11/13 4.61
11/09 4.49
11/08 4.30 4.58
11/07 4.26 4.39
11/06 4.40 4.22
11/05 4.50 4.29
11/02 4.50 4.28
11/01 4.41 4.59
10/31 4.55 4.60
10/30 4.70 4.78
10/29 4.75 4.84
10/26 4.71 4.80
10/25 4.40 4.86
10/24 4.57 4.74
10/23 4.66 4.67
10/22 4.67 4.71
10/19 4.65 4.77
10/18 4.69 4.69
10/17 4.78 4.70
10/16 4.68 4.68
10/15 4.81 4.83
10/12 4.75 4.77
10/11 4.75 4.69
10/10 4.52 4.75

The FF rate is symbolic. The repo reflects the actual money market rate. Since 11/20 there seems to already be enough of a spread to cut by .25%