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Posts Tagged ‘Sub-Prime’

[Smoking Gun Crack] Signs Of Housing Recovery

July 14, 2008 | 10:15 pm | |

In a lapse of judgement, poor writing or an irrational need to be contrarian, the normally solid publication Barrons (I subscribe) drops the ball on their cover story:

Bottom’s Up: This Real-Estate Rout May Be Short-Lived

If IndyMac, Fannie and Freddie didn’t steal the headlines over the weekend, I wonder if this article would ever made it to print.

The article suggests housing is moving toward recovery based on a review of recent data:

  1. NAR exisitng homes have a 10.8 month supply in May versus a 11.2 month supply in April (ahem: Seasonality occurs in rising and falling market. Home sales rise in the spring.)

  2. Case Shiller showed prices rose in 8 of 20 housing markets in April, and the pace of decline is slowing in many of the cities surveyed. (see no. 1)

  3. Treasury Secretary Paulson recently said: “”we are well into the adjustment process.” (This is a political move to allay investors – other than that, what does this statement actually mean?)

  4. David Blitzer, chairman of the S&P Index Committee indicated the media was only interested in the “…bad year-over-year number.” (blame the media observation – see no. 1.)

  5. Pending Congressional bailout. FHA will reposition $300M in subprime mortgages. (For perspective, Fannie and Freddie have 5 trillion in outstanding mortgages, how does this save the market? It’s a drop in the bucket).

  6. Fannie and Freddie may be taken over by the government is a good thing. (no it’s not)

  7. A million unit drop in housing starts has signified the end of the last 3 housing corrections. (none of those period saw anything close to the speculation and poor lending practices seen the recent boom – no lessons learned by history here).

  8. Affordability (via price/income) has improved with price declines. (The rationalization for increased affordability is pretty silly since underwriting standards are much tighter. In other words, if your credit score and salary didn’t change from last year, and your home dropped in value, your buying power is probably much lower. In other words, affordability did not increase despite the mechanical calculations to the contrary).

  9. NAR reports 2% increase in co-op. condo and townhouses from April to May. (See no. 1)

  10. NAR economist Lawrence Yun is actually relied on in this article. (He called the credit crunch temporary last August and the housing market would return to normal in the fall.)

  11. Mortgage market weakness is front end loaded with foreclosures and defaults. (In theory the bad is behind us – for the life of me, I can’t understand the rationale. How does this mean housing is poised for a turn if the scope of the credit crunch is unprecedented?)

Good grief.

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[GSE Flat] Reality Sets In For Those Wide Knobby Tires

July 8, 2008 | 12:43 am | |

Real estate -> territorial -> turf -> self-preservation -> wide knobby bike tires

Ok, so the timeline doesn’t work, but hear me out. I used to fix my own flat tires, now I rely on the bike shop so I don’t have to get dirty.

As I have mentioned on more than one occasion, government on a federal level seems unable to ease the credit/housing market pain. Congress can’t seem to move forward with housing relief in any meaningful way. The Federal Reserve missed the signs of growing housing stress and took action too little too late. The GSEs seemed to be part of the problem as enablers of poor lending practices (made painfully apparent with its agreement with NY AG Cuomo).

GSEs Fannie Mae, Freddie Mac, plus FHA were designated as the housing saviors for Congress to rely on in the stimulous package. They’ve lost more than $15B in the past 6 months by my calculations and everyone is rooting for them.

On a monday, a comment by a Federal Reserve official and a Lehman analyst sent GSE stocks plummeting, an illustrating just how nervous investors are about the effectiveness of the GSEs role in all of this is.

Aside from letting time pass, I am fresh out of ideas, and I have resorted to incessant whining so watch out.

The problem is more complex than Congress can wrangle an effective compromise out of, and the OTS is still angry about the Cuomo deal with the GSEs.

It seems like a government solution’s time has passed.

On the bright side, the Tour de France, my all time favorite sporting event after March Madness, might have a prayer of being drug free this year or close to it. Of course, like housing, there is a turf war between the Tour de France and the International Cycling Union over their more stringent testing policy. Coincidentally, none of the usual cycling stars are in the race.

Perhaps an unknown, generic solution to housing may appear at some point. The current situation is over the heads (and handlebars (sorry)) of the usual government participants until they can get together.

UPDATE: Fed to Clamp Down on Exotic and Subprime Loans [NYT]

UPDATE2: Mortgage Fears Send Global Shares Down [NYT]

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[The Homeownership Preservation and Protection Act] Dodd Bill Places A “Hit” On Good Appraisers, With Bondage

June 6, 2008 | 3:22 pm |

Back in September 2007, US Senator Dodd from my home state of Connecticut submitted what appears to be hastily conceived legislation to solve the mortgage crisis in response to the prior month’s credit market meltdown. I believe it was created to address subprime lending, but because it was so loosely presented, it casts a wide blanket over the lending process to little effect and likely causes more problems because it embraces conventional wisdom rather than actual practices. As far as appraisals go, it clearly doesn’t recognize the fundamental problems that New York AG Cuomo has already recognized.

The appraisal related language in the bill is sloppy and contains slang, suggesting that someone with little experience drafted it or the the bill was not understood by the Senator. I am very disappointed. It found co-sponsors because it contains buzzwords like “appraiser”, “mortgage” and “meltdown”.

In fact, the language of the bill was so vague and misdirected (the appraisal part) that most appraisers never took it seriously, instead focusing on efforts by Senator Frank and NY AG Cuomo. However, it still has life and is being taken seriously.

The bill is now in the Banking, Housing and Urban Affairs Committee.

I think Senator Dodd’s introduction of the concept of bonding was to incentivize the appraiser to do good by having “skin in the game” but it does nothing to solve the current lending problem. Is this the best that can be done by Congress? It’s damaging to the lending industry and poorly written and thought out, and in my opinion, it allows Congress to say this takes care of the problem, when in fact, it makes it worse.

Here is the appraisal-related content summary provided by Senator Dodd’s web site.

V. Require good faith and fair dealing in appraisals.
– Prohibit pressure from being brought to bear on appraisers.
– Hold lenders liable for appraisals to avoid the appraisal problems created in the current climate.

Here’s the actual language of the appraisal related portion of the bill:

Title IV Good Faith and Fair Dealing In Appraisals

Requirements for Appraisers

  • Appraisers owe a duty of good faith and fair dealing to borrowers.

My comment: Generic boilerplate that probably needs to be said. On that note I propose legislation that government officials never abuse their power, the public shouldn’t commit crimes and all school kids show do their homework. In other words, its an ideal, but it has nothing to do with addressing the core systemic problem – remove the possibility of collusion from the process.

  • No lender may encourage or influence an appraiser to “hit” a certain value in connection with making a home loan. In addition, a lender may not seek to influence an appraisers work, nor select an appraiser on the basis of an expectation that he or she will appraise a property at a high enough value to facilitate a home loan.

My comment: They actually use the word “hit” in the legislation. Who wrote this? How is a lender prevented from attempting to “seek to influence an appraisers work.” These are just words.

  • A crucial cause of the current mortgage meltdown has been inflated appraisals. Many ethical appraisers complain that lenders will only use appraisers who consistently value properties at the levels necessary to allow the loan to close. Appraisers who do not cooperate simply do not get hired. This is particularly detrimental to the homeowner because it leads the homeowner to believe he or she has equity where little or none may exist.

Comment: “A crucial cause” implies appraisers initiated the problem. Wrong. They were the enabler of the lenders and the bad ones were rewarded for unethical practice. They actually use the word “meltdown” in this bill? This paragraph also infers that good appraisals are always low. You can say stuff like this all day long but that doesn’t stop it from happening.

  • Appraisers must obtain bonds equal to one percent of the value of the homes appraised.

Comment: “How do the costs of the bonding enter into this? I am not familiar with getting bonded I assume that means appraisers would file for a bond with a predetermined amount so we get enough coverage. That violates federal licensing law (USPAP). This does nothing to fix systemic fraud and burdens the appraisers that do the right thing with additional costs. How does it keep a bad appraiser from doing bad work? They charge the bond costs to their unwitting (or not) clients and it’s no skin off their back. Good grief.

  • Remedies available to borrowers

— Lenders must adjust outstanding mortgages where appraisals exceeded true market value by 10 percent or more.

Comment: Can you imagine the litigation costs that would result if this passes? Who determines whether the value is off by more than 10%? Another appraiser who is hired by the homeowner? An AMC? A real estate broker? Zillow? A lender using an Automated Valuation Model? What is “True” market value? Is this a new definition of market value and all other forms like “Fair” used by GAAP are “False”? I find it hard not to say the word “true” in this application without sounding sarcastic.

— When an appraisal exceeds market value by 10 percent (plus or minus 2 percent) or more, a borrower has a cause of action against the lender. A consumer who is awarded remedies under this section shall collect from the appraiser’s bond.

Comment: Can you imagine the the costs that will be endured by the consumer? I understand that bonding costs for the typical appraiser would be $10,000 to $40,000 per year (per appraiser). For what? Appraising is already a razor thin margin business. Two things are going to happen: appraisal services are going to probably double, and many good appraisers will be forced out of business.

— Actual and statutory damages up to $5,000.

Comment:The further destabilization of the lending industry is worth $5k?

Here are the Senators who think this is a good idea:

Sponsored by Christopher Dodd(D-Ct), with co-sponsors: Sen. Daniel Akaka [D-HI]
Sen. Barbara Boxer [D-CA]
Sen. Sherrod Brown [D-OH]
Sen. Robert Casey [D-PA]
Sen. Hillary Clinton [D-NY]
Sen. Richard Durbin [D-IL]
Sen. Dianne Feinstein [D-CA]
Sen. Thomas Harkin [D-IA]
Sen. Edward Kennedy [D-MA]
Sen. John Kerry [D-MA]
Sen. Amy Klobuchar [D-MN]
Sen. Frank Lautenberg [D-NJ]
Sen. Claire McCaskill [D-MO]
Sen. Robert Menéndez [D-NJ]
Sen. Barbara Mikulski [D-MD]
Sen. Barack Obama [D-IL]
Sen. John Reed [D-RI]
Sen. Charles Schumer [D-NY]
Sen. Sheldon Whitehouse [D-RI]

I’ll bet if the situation was explained to the Senators with clarity, they would have issues with the bill as written. Time is of the essence, but the solution needs to solve the problem. The problem is about self-dealing and allaying investor’s concerns with the products they are purchasing.

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[Cuomo Recipe] Ratings Agencies Take Hand Out Of Cookie Jar

June 4, 2008 | 12:46 am | |

Like he did for the relationship between mortgage brokers and appraisers, the three major bond-rating firms reached an agreement with Cuomo, the New York Attorney General that creates more independence for ratings agencies. Cuomo has been one of the only public official currently in office that hasn’t simply tried to slap more regulations on all parties, pointing the finger and saying don’t do bad things.

Give me a break.

Like him or not, Cuomo has done is to fix systemic flaws within the financial system by following the mortgage.

Rating agencies were one of the weakest links in the integrity of the lending system.

Today’s WSJ article Bond-Rating Fee Overhaul Looms in Settlement, discusses the potential agreement.

many critics claim has been a chronic problem with bond ratings: They are paid for by the entities being rated. That financial dependence has been blamed for the industry’s failure to predict that risky subprime mortgages would crumble, resulting in losses and shaken confidence.

If the firm gave too low a rating, it wouldn’t get hired by the investment bank who would simply go to the next agency to get the rating they needed:

Under the Cuomo settlement, which would cover the hardest-hit portions of the mortgage market, the firms would get paid for their review, even if they didn’t end up getting hired to rate the deal. This would mean the firms would get paid even if they were tough. The plan, which requires final agreement by Mr. Cuomo’s office and the rating firms, wouldn’t dictate the exact fees rating firms could charge. But the firms would be required to charge more than a nominal fee for their preliminary work.

It still doesn’t fully separate the rating agencies for preferential treatment from bond issuers but it sure is a good start.

Cuomo seems to be less abrasive that Spitzer, his predecessor was. At the very least, the bond agencies were guilty of gross negligence for using the wrong data to understand the potential default rates for the securitization of subprime, alt-a and for that matter prime loans. Last summer they suddenly downgraded highly rated mortgage bonds claiming the models they had didn’t work.

Cuomo seems to be more interested in fixing investor confidence than playing hard ball with the agencies. It’s refreshing to think there is a light at the end of the securitization tunnel.

Speaking of stirring things up, take a look at these videos of the recent Parkersburg Iowa tornados: [bank security camera] [house] (hat tip to Market Power)

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[Social Mortgaging] Using Social Capital To Seek Out Information

June 4, 2008 | 12:01 am |

In a recently released paper called The Use of Social Capital in Borrower Decision-Making by a doctoral student at Harvard, Cassi Pittman, with the support of the NeighborWorks America’s Emerging Leaders in Community and Economic Development Fellowship and the Joint Center for Housing Studies of Harvard University. This research focuses exclusively on black borrowers’ search for and obtaining of mortgage financing.

Because of wide variations on mortgage borrowing patterns based on race, this study looks at mortgage patterns from the demand perspective. In other words: how do individuals decide to go with a particular lender or mortgage product?

The preliminary findings indicate that borrowers’ preferences and subsequent demands for mortgage products were shaped by the informal and formal advice they received. Those borrowers who consulted the most diverse sources of information had loans with lower interest rates. Those borrowers who received advice only from family and friends did not fare as well as those who received help from credit counselors. Thus, arguably, their loan outcomes varied not just based on if they consulted others, but especially whom they consulted. When given the right advice, potential homebuyers make better decisions in choosing both a lender and a loan.

The report sample size is arguably small and because of the quickly changing environment, feels a little dated (ie 65% of origination is via mortgage brokers – it must be half that market share or less right now), but its well written, presented and even better…it’s interesting, covering such on an abstract subject.

Just sitting through a closing, illustrates the futility of federally mandated mortgage disclosures. Not only are the volumes of documents cumbersome and lack clarity, but it serves to confuse borrowers even more. When borrowers do not understand the terms of their mortgage and the fees associated with the transaction, they are more likely to be victims of lending abuses and to be charged “fees that far exceeded what would be expected justified based on economic grounds”. The mortgage rates charged were as high as 16% in a low mortgage rate environment. 2-28 (2 years fixed, 28 years adjustable) were among the most popular.

Of course, conventional mortgage denial rates played a role in fueling demand for subprime products.

Obtaining a mortgage in today’s mortgage market is a complicated process. When reaching a decision on a home loan, borrowers might feel compelled to use their social networks for information and guidance. Loan products have become increasingly complex. Federally mandated mortgage disclosure forms, instituted to display the cost of the mortgage transac- tion and to prevent “the uninformed use of credit,” have been found to poorly convey the true cost of borrowing.

With all the talk about social networks, the social network that influences a mortgage decision is particularly powerful and the financial stakes are high.

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[Premature Lecture] Agencies Go Full Court Press On Self-reflection

May 20, 2008 | 11:05 am | |

It seems a bit early to start reflecting on the lessons learned from the housing/mortgage problems we face, since, well, we still face them.

Don’t get me wrong.

It is always good to look back over your efforts and evaluate whether anything different could have been done to yield a different result. It is just that this infers closure and it is too early to summarize.

OFHEO – James Lockhart, the director spoke last week at the 44th Annual Conference on Bank Structure and Competition in Chicago (think Auto show, only less metallic paint) on the “Lessons Learned from the Mortgage Market Turmoil.”

He arrived on the scene after the party already begun and despite the criticisms levied towards both him and his agency, I actually think he did well with what powers he has to employ.

Plus, he likes charts “To set my remarks in context, I often like to start with a chart that gives some perspective…” Start with a chart and I am on your side.

Key lessons learned

  • what goes up too far goes down too far. In other words, bubbles burst.
  • mortgage securities are risky and that there is a long list of financial firms that have had problems with those securities, including problems related to model, market, credit, and operational risks. A key lesson from the savings and loan crisis that was ignored was not to lend long and borrow short, as structured investment vehicles (SIVs) did.
  • Another lesson ignored is that in bull markets investors and financial institutions tend to misprice risk, which can result in inadequate capital when markets turn.
  • A new lesson that should be learned is that putting subprime mortgages, which almost by definition need to be worked, into a “brain dead” trust makes no sense.
  • Another lesson is that overreliance on sophisticated, quantitative models promotes a hubris that has frequently caused serious problems at many financial institutions

Lessons learned specific to the GSEs

  • The first is about pro-cyclical behavior during the credit cycle. An important issue for supervisory agencies is how to create incentives for institutions to behave in a less pro-cyclical manner without interfering with their ability to earn reasonable returns on capital.
  • A second lesson from recent experience is the importance of capital. Capital at individual institutions not only reduces their risk of experiencing solvency and funding problems and of contributing to financial market illiquidity, but also helps them avoid the need to retrench in bad times and miss what may be very attractive opportunities in weak markets.
  • Those two lessons provide compelling arguments for a third: legislation needs to be enacted soon that would reform supervision of Fannie Mae and Freddie Mac and, specifically, give a new agency authority to set capital requirements comparable to the authority the bank regulatory agencies possess.

These are important points because the GSEs dwarf other debt and the GSEs have been losing money as of late. Here’s a few charts that may be of interest from his speech:

FDIC – Sheila Bair, FDIC CHairman was speaking in Washington, DC at the Brookings Institution Forum, The Great Credit Squeeze: How it Happened, How to Prevent Another on the same day Lockhart was speaking in Chicago. A full court press of self-reflection. Like Lockhart, Bair has been very outspoken and I believe lucid in her depiction of the problems at hand. To her credit, she has clearly articulated the problem with the mortgage system.

Her salient points are:

  • …things may get worse before they get better. As regulators, we continue to see a lot of distress out there.
  • Data show there could be a second wave of the more traditional credit stress you see in an economic slowdown.
  • Delinquencies are rising for other types of credit, most notably for construction and development lending, but also for commercial loans and consumer debt.
  • The slowdown we’ve seen in the U.S. economy since late last year appears to be directly linked to the housing crisis and the self-reinforcing cycle of defaults and foreclosures, putting more downward pressure on the housing market and leading to yet more defaults and foreclosures.
  • Reform is not happening fast enough
  • She explains HOP loans are NOT a bailout
  • The housing crisis is now a national problem that requires a national solution. It’s no longer confined to states that once had go-go real estate markets.
  • The FDIC has dealt with this kind of crisis before.

Take away

Both OFHEO and FDIC seem to be saying we need to take action now and they were powerless to do anything before this situation evolved into its current form?

It makes me wonder whether any regulatory proposals will do much good. Regulators did not take action or propose safeguards while the problem was building. How can they suddenly have wisdom now? While these recommendations and insight seem prudent but isn’t it kind of late for that?

Speaking of monoliths, here’s Steve Ballmer getting egged in Hungary.

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[NAR Forecast] You Can’t Make This Up

May 20, 2008 | 12:01 am | |

For as hard as the typical Realtor works to make a living, that goodwill is quickly undone when looking at the forecasts that come out of Lawrence Yun’s office at NAR. Disbelief has been a recurring theme in the blogosphere since LY took over the reigns from DL.

Nearly once a week, I am hammered with some sort of press release spin that is, for lack of a better word, gross.

Now that the subprime market has dried up, and loans insured by the Federal Housing Administration and those purchased by Fannie Mae and Freddie Mac are making a comeback, the housing markets will strengthen and prices are likely to begin a steady uptick in the coming months, Yun said.

Based on what?

“There are many reasons for people to get into the housing market today, and very few reasons not to. With the plentiful supply of homes for sale at affordable prices, interest rates approaching 40-year lows, and the strong track record of housing as a good long-term investment, conditions are ripe for buyers,” he added. “Those are the facts, plain and simple.”

Those aren’t the facts, plain and simple. It’s so simplistic a statement, it’s sad, actually. The problem remains with credit and the large drop in purchasing power that created artificially high demand. Bloated inventory levels are still a significant factor.

One could reasonably argue that Yun is committing consumer fraud by trying to entice people to buy into a market that is poised to fall further. I suppose he thinks his ridiculous predictions will restore confidence in the real estate market. If in fact his role is to spread optimism, the NAR should be legally required to post an appropriate disclaimer stating their real purpose.

Please watch this video – is it just me or is this just plain gross? What is the NAR thinking? They desperately need to reconsider this approach to public relations. The consumer needs to be given credit for having intelligence.

It’s embarrassing. Really.

You Can’t Make This Up


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[Miller Cicero] New York City Income Property Market Report Second Half 2007 Is Available For Download

May 15, 2008 | 11:49 am | Reports |

Our commercial advisory firm just released its New York City Income Property Market Report for the second half of 2007 for Massey Knakal. My commercial valuation partner John Cicero prepares the report. It’s the only report of its kind in the New York City commercial market.

Here’s an excerpt:

In the second half of 2007 credit tightened considerably as the losses in sub-prime mortgages worked their way through the financial markets. While indicators are somewhat mixed, in general during this period prices for income property remained stable throughout the city, though the number of sales dropped, in some instances quite dramatically. This reflects the “wait and see” attitude that characterized the period, with fewer buyers bidding and sellers reluctant to lower prices. The fundamentals of the market remained strong, however, with high apartment rents and very low vacancy. The prospect of turning over below market rent-regulated units to higher market levels continues to attract investors, and credit, though tighter, was still available albeit from different sources. Cap rates and gross income multipliers remained stable.

The number of sales dropped 16% from the first half of 2007 to the second half, though the decline was only 7% from the second half of 2006 to the second half of 2007. On a calendar year basis, there were overall 10.5% fewer sales in 2007 than 2006. Though the number of walk-up apartment buildings in Manhattan showed a sharp decline from the first half of the year, calendar year 2007 sales actually show a 16% increase over calendar year 2006…

Massey Knakal will distribute over 300,000 hard copies of the report over the next few months.

Massey Knakal New York City Income Property Market Report [2H07]

Report Methodology [Miller Cicero]

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[Mandatory Reading (Please)] The Giant Pool Of Money

May 12, 2008 | 12:16 pm | Radio |


One of the biggest podcast downloads on iTunes is This American Life by Chicago Public Radio hosted by Ira Glass. It’s an hour long program that is diverse and interesting. The May 9th broadcast was particularly interesting to me called: The Giant Pool of Money.

It is a simple narrative on a complex subject and how the last five years evolved from a housing boom to housing crisis.


  • $70 Trillion Dollars
  • boiler rooms
  • keeping up with the competition
  • thirst for high returns
  • NINA loans
  • subprime investors
  • from tending bar to buying mortgage pools
  • Wall Street
  • 2% default rates actually 50% default rates
  • Very smart people using the wrong data to manage risk.

I listened to it twice just because it is rare to hear a complex topic that is presented so clearly.

Intelligence beat common sense to a pulp.

Listen to the episode.

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[Indebtor’s Ball] Subprime Discussion Without The Junk

April 29, 2008 | 9:50 am | | Radio |

Lost a reliable Internet connection at home for the past 3 days so my posting has been non-existent (but I did change a few lightbulbs with my free time)

Back in the day, I loved to read books like Barbarians at the Gate, Den of Thieves and Liars Poker covering the truth and mythology of Wall Street (now I read books like Pontoon). Michael Milken was directly or indirectly connected to many of those stories, as well as the firm he worked for Drexel Birnham Lambert because of the financial vehicle he championed, the fabled junk bonds.

When the subprime crisis first became kitchen table talk last summer, initially there was discussion that it was another “junk bond” crisis. I cringed because junk bonds weren’t bad in and of themselves. The investors that used or purchased them got into trouble, because didn’t appreciate the risks associated with them. Higher returns, equals higher risk. Sounds a lot like subprime market participants doesn’t it?

Andrew Ross Sorkin’s excellent article in the New York Times today called Junk Bonds, Mortgages and Milken addresses this issue:

“The financial crisis we’re in today stems from the invention by Drexel Burnham Lambert of the junk bond,” Martin Lipton, the superlawyer who co-founded Wachtell, Lipton, Rosen & Katz, said derisively at a conference last month. “You can draw a straight line from Drexel Burnham to the financial world today.”

Milken disagrees:

Critics who compare the subprime debacle to the bubble in high-yield, high-risk corporate bonds that Drexel helped inflate two decades ago are “people who don’t understand markets very well,” Mr. Milken said. He suggests that “their rationale is that both types of financial instruments are risky.”

And he says junk bonds, or those rated below investment grade, “have little in common with mispriced subprime mortgages,” which he says are the real culprits.

“Having financed several of America’s largest home builders, I know a few things about the housing industry,” Mr. Milken said. “What happened to housing was not a failure of securitization, but rather a disastrous lowering of underwriting standards and other unfortunate practices.”

Criticizing securitization — the slicing and dicing of debt that he helped popularize — is “like condemning scalpels because a few unqualified surgeons have injured patients,” he said.

With the introduction of new financial instruments, users tend to go overboard at the end of the cycle and then new regulation is introduced that tends to go to far (ie mortgage current underwriting standards will become a self-fulfilling prophecy).

Ultimately what junk Bonds and subprime mortgages really had in common, were the people that used them. They didn’t reflect adequate risk into their pricing. A more pro-active SEC might keep that in check, but then squash innovation.

I need to change some more lightbulbs.

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Lenders Try Workout, But Sweat The Rise In Foreclosures

April 24, 2008 | 1:04 am | |

Banking commissioners have observed that efforts to work with borrowers going into default has been largely ineffective.

The study, compiled by the State Foreclosure Prevention Working Group, made up of banking regulators and attorneys general in 11 states, found that seven out of 10 borrowers who are seriously delinquent on their mortgages aren’t on track to receive any kind of help with their payment problems.

And that is not all.

Pew Charitable Trusts released a comprehensive report on the foreclosure problem called Defaulting on the Dream: States Respond to America’s Foreclosure Crisis which is a good read (homework: try to figure out why large organizations select lame stock photography pictures of houses. PCT did it for this report, and Fannie and PMI do it too – oh, the lack of humanity.)

Foreclosures are rising rapidly and that affects renters too. Housing is pushing the economy into a recession.

Almost every state in the country has seen a significant increase in mortgage foreclosures, largely triggered by defaults on subprime mortgages. Yet greater challenges lay ahead. Based on new foreclosure projections by the Center for Responsible Lending, Pew estimates that one in 33 current U.S. homeowners will be in foreclosure, primarily in the next two years—the direct result of subprime loans made in 2005 and 2006. Among the states hardest hit are Nevada, where one in 11 homeowners could soon be in foreclosure; California, with one in 20; Florida, with one in 26, and Georgia, with one in 27.

Of course there is a growing feeling of resentment by renters, which are one third of all US households, that a bailout of these borrowers is unacceptable.

“A third of the American public rents,” Brandon pointed out. “They’re saying ‘I’ve been saving for a mortgage for years. I could have jumped in on a subprime loan too. Now I’m going to have to pay for a government bailout.”

I don’t see how the Federal government can afford to bailout 1 out of every 33 homeowners. I don’t think it is going to correct the fundamental problem with the housing market. It’s about lack of liquidity in the credit markets. That has to be addressed in order for the free markets to work. Pumping money to borrowers won’t solve the problem.

The issue with the free markets as a solution is one of neutrality. If there is not a functioning structure in place that prevents the kind of collapse we are currently experiencing, it’s not a free market. It’s simply deja vu to the past problems. There was systemic collusion in the mortgage securitization industry – most parties to the ratings and collateral valuation process had their hand in the cookie jar. Until that is fixed, there isn’t much room for improvement and lenders will continue to sweat (and enjoy the large rate spreads).


[AAA] Ratings Agencies And The New Culture Of Partnership

April 24, 2008 | 12:42 am | |

There is an absolutely spot-on article in the New York Magazine called Triple-A Failure: The Ratings Game

I highly recommend that everyone read the article from start to finish.

In 1996, Thomas Friedman, the New York Times columnist, remarked on “The NewsHour With Jim Lehrer” that there were two superpowers in the world — the United States and Moody’s bond-rating service

Essentially in their quest for profits, the agencies’ relationship with Wall Street changed from a mysterious and powerful ratings entity to a firm working closely with their clients.

Rating agencies (Moody’s, S&P, Fitch are the biggies) sought fees from investment banks to rate securities. If the ratings were too conservative, the bank could simply go to one of the other agencies to get the rating they wanted to. The agencies were essentially behind the curve in understanding the sophisticated new products being introduced at a rapid rate.

A few years ago, as I was getting more and more frustrated at the lack of neutrality in the mortgage lending process and the shaft given to good appraisers in the form of pressure, even an outsider like me could see that something was wrong with the relationship. The system can’t allow a ratings agency to be at the mercy of fee driven investment banks. The proverbial hand in the cookie jar.

Rating agencies were the enabler of securitization much like appraisers were the enabler of shady lending practices. Search hard enough and long enough and anyone can find someone to make the deal work.

By providing the mortgage industry with an entree to Wall Street, the agencies also transformed what had been among the sleepiest corners of finance. No longer did mortgage banks have to wait 10 or 20 or 30 years to get their money back from homeowners. Now they sold their loans into securitized pools and — their capital thus replenished — wrote new loans at a much quicker pace.

Mortgage volume surged; in 2006, it topped $2.5 trillion. Also, many more mortgages were issued to risky subprime borrowers. Almost all of those subprime loans ended up in securitized pools; indeed, the reason banks were willing to issue so many risky loans is that they could fob them off on Wall Street.

The search for new profits and their close relationship with Wall Street placed them in a non-neutral position yet investors were relying on the ratings.

Thus the agencies became the de facto watchdog over the mortgage industry. In a practical sense, it was Moody’s and Standard & Poor’s that set the credit standards that determined which loans Wall Street could repackage and, ultimately, which borrowers would qualify. Effectively, they did the job that was expected of banks and government regulators. And today, they are a central culprit in the mortgage bust, in which the total loss has been projected at $250 billion and possibly much more.

The agencies have a very big credibility problem right now with investors. It’s all about the lack of activity in the credit markets right now.

It’s certainly telling that the three ratings agencies and four major mortgage related associations took the position with Congress that the current administration’s suggestions for fixing the problem were flawed. The Real Estate Roundtable, Mortgage Bankers Association, Commercial Mortgage Securities Association and the National Association of Realtors basically took the position not to do anything but teach investors how to, well…invest.

Are they kidding?

The credit markets are currently frozen because of the lack of neutrality in the rating and mortgage process, not because investors are ignorant. Next thing we will start hearing is that the agencies and associations will simply self-police.

Fear of change, living in denial.

Over rated.

Here’s something that’s not overrated: Joe’s Gizzard City, my favorite college hangout (note the Michigan State jersey).

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