Here’s another Karl Denninger informative rant, at The Market Ticker
Mr. Nocera (And Regulators): WAKE UP!
I like Joe. Really. I’ve talked to him before, and his mostly "gets it."
That, in part, is why I left stunned with the lack of analysis on this piece:
O.K., that’s a bit of an exaggeration. But I was reminded of that meeting on Thursday night when I was shown a letter that the administration had just sent out calling for yet another big meeting at Treasury with yet another sector of the financial industry. Signed by Treasury Secretary Timothy Geithner and Shaun Donovan, the housing and urban development secretary, the letter demanded that representatives from the top 25 mortgage servicers assemble in Washington on July 28. It is likely to be every bit as painful for them as that Paulson meeting last October was for the bank C.E.O.’s.
The subject of the meeting is going to be loan modifications. Specifically, the government is going to be asking — in none-too-friendly fashion — why the nation’s big servicers aren’t doing more to modify loans for homeowners who are in danger of defaulting on their mortgages. Back in the spring, after all, they all signed onto the administration’s new Making Home Affordable program, which uses a series of incentives — not the least of which is $1,000 to the servicers for every mortgage they modify — to help keep people in their homes and prevent foreclosures.
Joe goes on to talk about the fact that servicers aren’t modifying many loans, and that the Obama Administration is getting annoyed with this.
Tell me something I don’t know.
Toward the end of the article Joe hits on the real reason for the "sticky" behavior with this, quoted from Mr. Alpert from Westwood Capital:
“Banks are saying no because they don’t want to take the loss,” said Mr. Alpert. “They would rather foreclose. That is just wrong.”
And then he dismisses it with:
In truth, servicers and banks don’t yet have powerful enough incentives to do large-scale mortgage modifications.
And this morning, we have Merideth Whitney who also doesn’t get it – she’s got a nice thesis, but both she and Joe unfortunately miss the reason that the loans are not (and won’t be) modified.
These folks (and President Obama) wish it was, because if it was, then there’d be a solution that would be comprised of manpower or other "ordinary" things.
There isn’t, and the reason lies in my Ticker from all the way back to April 1st of 2007, the very first one, as I cited yesterday:
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Combined "loan to value" on ALT-A purchases in 2006 was 88% on average, with 55% of buyers taking out a second at the same time as the purchase.
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Low or no-documentation (stated income) loans were 81% of total originations.
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Interest only and option ARMs were 62% of purchase originations in 2006.
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1-year hybrid ARMs were 28% of ALT-A originations in 2006 (these loans reset in just one year!)
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Investors and second home buyers were 22% of ALT-A purchase originations in the last year.
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Approximately 40% of purchases in 2006 involved second mortgages taken at the same time as the purchase. This is important because these "piggybacks" are how you get around loan-to-value restrictions! While the industry has tried to say that this is primarily a subprime thing, THAT IS A LIE – 55% of ALT-As had piggypacks in 2006!
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TWENTY FOUR PERCENT OF ALL NEW ALT-A ORIGINATIONS WERE INTEREST ONLY OR NEGATIVE AMORTIZATION IN 2006!
That’s the problem right there.
Take all the "silent seconds" and HELOCs written out in California and Florida during the bubble years and write them down to market value, then add in the market value of the OptionARMs written in California and Florida, and you have one big pile of dead big banks.
To put this in perspective it is entirely possible for an OptionARM to lose very close to 100% of the original amount loaned. Here’s how:
OptionARMs typically "recast" between 110% and 125% of their original principal value. When that happens the borrower is required to make a fully-amortizing payment on the remaining term (typically 20 or 25 years, if not sooner, depending on if they hit the time or negative-amortization cap first.)
So let’s say that you take out a $500,000 OptionARM to buy a house in California at 100% LTV. You take this loan out in 2005, the peak. You then make "minimum payments" for five years, and hit the 125% recast, or $625,000. Your original payment was likely somewhere around $1,000/month. But your recast payment, $625,000 @ 7% for 25 years, fully amortized, is $4,391.75. There is not a snowball’s chance in hell you can make that payment, and you default.
Modification is a lost cause on these loans no matter what sort of "great terms" are offered – let’s assume we modify your loan into 30 years (we extend the note) @ 4.5% – your payment still goes to $3154.95, or more than three times what you were paying!
Note what happens next.
The house may have lost 75% of its value; it is now only worth $125,000. This, by the way, is not wild conjecture – it’s real in many areas of California and Florida. Go look around Ft. Myers for examples in Florida – there are lots of them.
Will the bank modify that loan (when they know you still can’t pay, and will re-default) or foreclose?
Like hell they will!
Not only do they have a $375,000 loss in the original loan they also have booked the additional $125,000 that you capitalized into the principal as a profit over the previous five years! That "profit" was in fact false and now they have to go back and restate their earnings – which of course are now losses, not earnings!
The bank’s loss on this loan is total, and since banks typically have an 8 or 10% reserve ratio, and a 6% Tier 1 Capital requirement, losses of this sort are like eating Polonium – that is, guaranteed death.
The banks have been carrying loans that have gone delinquent but which have not been foreclosed or modified at or near their full principal balance.
This is an outright scam, but it is what has been happening, both in the residential and commercial real estate marketplace.
The reason these loans are not being modified and people are literally living for a year or more in their homes after they stop paying their mortgage without having a foreclosure processed against them is that if the bank modifies the loan or forecloses it must recognize the actual loss, as there has now been an event that makes the possibility of "self-cure" go away and you can’t claim that a loan "might perform" once it has been extinguished through modification or foreclosure!
This is why for the last two years I have refused to buy any financial company’s stock for other than a "quick hit" trade – there is absolutely no way I can look at their balance sheet and get any sort of clarity on how they’ve marked this stuff, and I know for a fact that a whole lot of people are living in homes for months or even more than a year after making their last payment without getting hit with a actual foreclosure.
I am therefore forced to count the value of any OptionARM portfolio as zero when I do my analysis, since I can’t put a number on it, and if you do that all the banks that hold any material amount of these things are bankrupt!
Now does this mean they really all are? Probably not. But until we have clarity and truth, that’s how you must look at it as an investor, because the "surprise!" can come at any time, and when it does, and you discover that some significant percentage of these loans in fact have negative value (that is, they lost more than their original lent amount once resale costs, rehab and legal are added up) it becomes impossible to assign a value to any of these firms.
Turbo Timmy can "call on them to do more" all he wants, but I can predict exactly what the banks will tell Geithner in response: we can’t absorb the losses that we’re hiding, and if you force us to do so we will implode.
I have been calling on the regulators and Congress to force these marks to be taken now for more than two years. I have called for the truth to be told and if this means we have to shut down all of the big banks in this country, distribute their deposits to sound regional and local banks, sell off the assets and cramdown their debt-holders, then so be it. Yes, I realize that this will produce severe pain among pension plans and other investors who hold this debt but that doesn’t matter – the truth is what it is.
ONLY by getting the bad debt out of the system can we clear the economy and ultimately recover. There is no other way. The "zombie path" we are following now, where financial institutions are being allowed to play games with off-balance sheet vehicles and "suspending" foreclosure actions at whim to avoid having to recognize already-occurred losses is outrageous and is literally bleeding our economy dry.
The gambit that has been run for the last two years is that housing would bottom no later than this spring and thus the banks could "earn their way out of it" – that is, regulators, including Treasury, The Fed, OCC and Congress have deliberately allowed them to lie for the last two years under the belief that it would be "less damaging", and the economy and housing would turn by now.
That bet has now been shown to be a bust, as I have repeatedly predicted it would all the way back to the spring of 2007, and we, the taxpayers, are going to wind up with a gigantic smoking hole on our balance sheets in the form of impossible-to-finance federal debt if we do not force these firms to tell the truth and force each and every person in all of these regulatory agencies out of office RIGHT NOW!
What’s even worse is that it appears that we have now crossed the "zero line" in terms of new debt .vs. GDP – that is, taking on new debt in the system is actually depressing, not helping, GDP growth. This can and will get out of hand very quickly if we don’t cut it out, and could easily lead to an all-on collapse of our monetary and political systems. I’ve written about the marginal contribution of debt to GDP many times, and from the data it appears that we are either very close to or may have crossed already into negative territory. We must not allow that to happen under any circumstances.
We tried it Paulson, Bernanke and Geithner’s way and that path has been proved to be an utter and complete failure.
It is time to force everyone to come clean, tell the truth, and force the bad debt into the open so it can be cleared from the system.
Second Photo: Destruction du "Tripode" Image personnelle de Yann Chemineau, 2005 http://yann.ouvaton.org/ {cc-by-sa-2.0-fr} Film made by Marcin n. At Wikipedia.
