Sunday, April 06, 2008
2008 Credit Crisis
From the Washington Post, here is a good explanation of the recent actions of the Federal Reserve in connection with the credit crisis:
Dreams End With Collapse of Tinker Bell Market
By Allan Sloan
Tuesday, April 1, 2008; D01
What in the world is going on here? Why is Washington spending billions to bail out Wall Street titans while leaving struggling homeowners to fend for themselves? Why are the Federal Reserve and the Treasury acting as if they're afraid the world may come to an end, while the stock market seems much less concerned? And finally, what does all this mean to those of us who aren't financial professionals?
Yesterday, Treasury Secretary Hank Paulson officially unveiled his new regulatory proposals; however, those have no bearing on today's problems. So, take a few breaths, pour yourself a beverage of your choice, and I'll tell you what's happening -- and what I think is going to happen. Although I expect our current mess will resolve itself without a catastrophic meltdown, I'll also tell you why I'm more nervous about the world financial system now than I've ever been in my 40 years of covering business and markets. Finally, I'll tell you why I fear that the Wall Street enablers of the biggest financial mess of my lifetime will escape with relatively light damage, leaving the rest of us, and our children and grandchildren, to pay for their misdeeds.
We're suffering the aftereffects of the collapse of a Tinker Bell financial market, one that depended heavily on borrowed money that has now vanished like pixie dust. Like Tink, the famous fairy from Peter Pan, this market could exist only as long as everyone agreed to believe in it. So because it was convenient -- and oh, so profitable! -- players embraced fantasies like U.S. house prices never falling and cheap short-term money always being available. They created, bought, and sold, for huge profits, securities that almost no one understood. And they goosed their returns by borrowing vast amounts of money.
The fantasies began to fade last June when Bear Stearns let two of its hedge funds collapse because of problems with mortgage-backed securities. Debt markets, here and abroad, went sour big-time. That, in turn, became a huge drag on the U.S. economy, bringing on the current economic slowdown.
Whether we're in a recession is academic. What matters is that we're in a dangerous and messy situation that has produced an economic slowdown unlike those we're used to seeing.
How is this slowdown different from other slowdowns? Normally the economy goes bad first, creating financial problems. In this slowdown the markets are dragging down the economy -- a crucial distinction, because markets are harder to fix than the economy.
The last time this happened was in 1929. And it touched off the Great Depression. The precedent is unsettling, to say the least. You can only imagine how unsettling it is to Federal Reserve Chairman Ben Bernanke, a former economics professor who made his academic bones writing about the Great Depression.
Academics now feel that the 1929 slowdown morphed into a Great Depression in large part because the Fed tightened credit rather than loosening it. With that precedent in mind, you can see why Bernanke's Fed is cutting rates rapidly and throwing everything but the kitchen sink at today's problems. (Bernanke will probably throw that in too, if the Fed's plumbers can unbolt it.)
So why hasn't the cure worked? The problem is that vital markets that most people never see -- the constant borrowing and lending and trading among huge institutions -- have been paralyzed by losses, fear and uncertainty. And you can't get rid of losses, fear and uncertainty by cutting rates. Giant institutions are, to use the technical term, scared to death. They've had to come back time after time and report additional losses on their securities holdings after telling the market that they had cleaned everything up. It's whack-a-mole finance -- the problems keep appearing in unexpected places. We've had problems with mortgage-backed securities, collateralized debt obligations, collateralized loan obligations, financial insurers, structured investment vehicles, asset-backed commercial paper, auction rate securities, liquidity puts.
To paraphrase what a top Fednik told me in a moment of candor last fall: You realize that you don't know what's in your own portfolio, so how can you know what's in the portfolio of people who want to borrow from you? Combine that with the fact that big firms are short of capital because of their losses (some of which have to do with accounting rules I won't inflict on you today) and that they're afraid of not being able to borrow enough short-term money to fund their obligations, and you can see why credit has dried up.
The fear -- a justifiable one -- is that if one big financial firm fails, it will lead to cascading failures throughout the world. Big firms are so linked with one another and with other market players that the failure of one large counterparty, as they're called, can drag down counterparties all over the globe. If the counterparties fail, it could drag down the counterparties' counterparties, and so on. Meltdown City. In 1998, the Fed orchestrated a bailout of the Long-Term Capital Management hedge fund because it had $1.25 trillion in transactions with other institutions. These days that's almost small beer.
Add to that the Wall Street ethos: If you take big, even reckless, bets and win, you have a great year and you get a great bonus -- or in the case of hedge funds, 20 percent of the profits. If you lose money the following year, you lose your investors' money rather than your own, and you don't have to give back last year's bonus. Heads, you win; tails, you lose someone else's money.
Bernanke and his point man on Wall Street, New York Fed president Tim Geithner, know everything I've said, of course. They know a lot more, too, such as which specific institutions are running out of the ability to borrow and have huge obligations they need to refinance day in and day out. Walk by Fed facilities in New York or Washington and you can feel the fear emanating from the buildings.
Because these aren't normal times, the Fed has tried to reassure the markets by inventing three new ways to inundate the financial system with staggering amounts of short-term money. This is in addition to the Fed's existing mechanisms, which are vast. The three newbies -- the term auction lending facility, the primary-dealer credit facility and the term securities lending facility -- total more than half a trillion dollars, with more if needed. Much of this money is available not only to commercial banks but also to investment banks, which normally aren't allowed to borrow from the Fed.
How can the Fed afford this largesse? Easy. Unlike a normal lender, the Fed can't run out of money -- at least, I don't think it can. It can manage monetary policy while in effect creating banking reserves out of thin air and lending them out at interest. That's how the Fed reported a $34 billion profit in 2006, the last available year, of which $29 billion was sent to the Treasury. The Fed can even add to its $800 billion stash of Treasury securities by borrowing more of them from other big players.
Then there's the Treasury. In March, the Treasury unleashed Fannie Mae and Freddie Mac and the Federal Home Loan Banks to buy hundreds of billions of dollars of mortgage-backed securities, supporting a troubled market that was seeing prices drop sharply because of large forced sales from the collapse of Carlyle Capital and from hedge funds desperate to pay off some of their borrowings.
Still with me? Good. Now let me show you how we taxpayers are picking up the tab for much of this rescue mission to the markets, even though Uncle Sam isn't sending checks to Wall Street. Here's the math: Say the Fed extends $500 billion of emergency loans to firms in need of short-term money. They're paying about 2.5 percent interest to Uncle Ben (or Uncle Sam, if you prefer). That rate is way below what they'd pay to borrow in the open market, if they could borrow. The difference between the open-market price and 2.5 percent is a gift from us, the taxpayers. I think that's better than letting the world financial system collapse, but it's a serious subsidy to outfits that made a lot of money on the way up and that are now whining about losses. You gotta love it -- private profits, socialized losses.
Now to the infamous Bear Stearns deal. Bear shareholders are set to get $10 a share -- about $1.2 billion -- from J.P. Morgan Chase. That's $1.2 billion more than they were likely to realize in a bankruptcy had the Fed and the Treasury dared let Bear go broke. More important, Bear's creditors, who were asleep at the switch and ought to be forced to pay for it, got out whole because J.P. Morgan agreed to take over Bear's obligations.
The only reason Morgan did that is its deal with the Fed, in which the Fed is taking over $30 billion of Bear's financial toxic waste. J.P. Morgan eats the first $1 billion of losses -- a concession it made to the Fed, which was embarrassed and enraged when Morgan raised the price it was paying for Bear to $10 a share from the $2 originally agreed to.
The securities that Bear is shedding aren't worth $29 billion in today's markets. If they were, Morgan wouldn't need the Fed's dough. The Fed -- which is to say the taxpayers -- is eating the difference between $29 billion and what that stuff is worth. It wouldn't surprise me to see the Fed end up with a $4 billion haircut, but we'll probably never know. (Once you take that haircut into account, you see why Bear shareholders should stop complaining about getting "only" $10, and why Bear debt-holders should erect a statue to Bernanke.)
Fedniks are furious about the Wall Street enablers of the mortgage mess and other financial excesses being able to escape the full cost of their folly, with the public picking up the cost. But as one of them asked, "Is it better to let Bear Stearns fail and risk setting off a market collapse that costs a million jobs?" The answer, of course, is no. Bear had about $13 trillion of derivatives deals with counterparties, according to its most recent financial filings. If Bear had croaked, large parts of the world could have croaked. And the economic damage could have been catastrophic.
Okay. Is there good news here? Indeed, there is. Sooner or later, all this money being thrown at the debt markets will stabilize things.
But the costs will be steep. Those of us who have been prudent, lived within our means, and didn't overborrow are paying a huge price for this. Income on our Treasury bills, money market funds, and CDs has dropped sharply, thanks to the Fed's rate cuts, and our wealth has eroded relative to foreign currencies and commodities. As an indirect result of the Fed cutting short-term rates, we've already seen a loss of faith in the dollar by our foreign creditors. That's helped run up the price of commodities that are priced in dollars and may well be stirring up inflation even as the Fed lowers retirees' incomes.
It's going to get harder and harder to finance our country's trade and federal budget deficits, with our seemingly ever-falling dollar carrying such low interest rates. The dollar has been the world's preeminent reserve currency, but I think those days are drawing to a close. Don't be surprised if in the not-too-distant future the United States is forced by its lenders to borrow in currencies other than its own. It could get really ugly.
It's going to take years to work out our country's excess borrowings, with lenders and borrowers -- and quite likely American taxpayers -- all bearing the cost.
So, after all this, we end up with the same old story. Whenever you see a financially driven boom and people tell you, "This time it's different," don't listen. It's never different. Sooner or later, the bubble pops, as it has now. And you and I end up paying for it.
Allan Sloan is Fortune magazine's senior editor at large. His e-mail address email@example.com.
Trillion Dollar Meltdown? The 2008 Credit Crisis
1. The Fed spikes the punch bowl. In the wake of the dot-com bust and 9/11, the Fed lowers interest rates to 1 percent, the lowest since 1958. For more than 2½ years, long after the economy has resumed growing, the Fed funds rate remains lower than the rate of inflation. For banks, in effect, money is free.
2. Leverage soars. Financial sector debt, household debt, and home prices all double. Big banks shift their business models away from executing transactions for customers to “principal trading”—or gambling from their own accounts with borrowed money. In 2007, the principal-trading accounts at Citigroup, JPMorgan Chase, Goldman Sachs, and Merrill Lynch balloon to $1.3 trillion.
3. Consumers throw a toga party. Soaring home prices convert houses into ATMs. In the 2000s, consumers extract more than $4 trillion from their homes in net free cash (excluding financing costs and housing investment). From 2004 through 2006, such extractions exceed 7 percent of disposable personal income. Personal consumption surges from its traditional 66 to 67 percent of GDP to 72 percent by 2007, the highest rate on record.
4. A dollar tsunami. The United States’ current-account deficits exceed $4.9 trillion from 2000 through 2007, almost all for oil or consumer goods. (The current account is the most complete measure of U.S. trade, as it encompasses goods, services, and capital and financial flows.) Economists, including one Ben S. Bernanke, argue that a “global savings glut” will force the world to absorb dollars for another 10 or 20 years. They’re wrong.
5. Yields plummet. The cash flood sweeps across all risky assets. With so many people taking advantage of cheap loans, the most risky mortgage-backed securities carry only slightly higher interest rates than ultra-safe government bonds. The leverage, or level of borrowing, on private-equity company buyout deals jumps by 50 percent. Takeover funds load even more debt onto their portfolio companies to finance big cash dividends for themselves.
6. Hedge funds peddle crystal meth.Aggressive investors pour money into hedge funds generating artificially high returns by betting with borrowed money. To maximize yields, hedge funds also gravitate to the riskiest mortgages, like subprime, and to the riskiest bonds, which absorb losses on complex pools of lower-quality mortgages known as collateralized debt obligations or CDOs. The profits from selling bonds based on very risky underlying securities override bankers’ traditional risk aversion. By 2006, high-risk lending becomes the norm in the home-mortgage industry.
7. A ratings antigravity machine. Pension funds cannot generally invest in very risky paper as a mainstream asset class. So, banks and investment banks, with the acquiescence of the ratings agencies, create “structured” bonds with an illusion of safety. Eighty million dollars of “senior” CDO bonds backed by a $100 million pool of subprime mortgages will not incur losses until the defaults in the pool exceed 20 percent. The ratings agencies confer triple-A ratings on such bonds; investors assume they are equivalent to default-proof U.S. Treasury bonds or blue-chip corporates. To their shock, investors around the world discover that as pool defaults start rising, their senior CDO bonds rapidly lose trading value long before they suffer actual defaults.
8. The Wile E. Coyote moment arrives. Suddenly last summer, all the pretenses start to come undone, and the market is caught frantically spinning its legs in vacant space. The federal government responds with more than $1 trillion in new mortgage lending and lending authorizations in multiple guises from Fannie Mae, Freddie Mac, the Federal Housing Finance Board, and the Federal Reserve. Home prices still drop relentlessly; signs of recession proliferate; risky assets plummet.
The collapse of Wall Street investment bank Bear Stearns may be a watershed moment. Participant reports suggest that JPMorgan Chase came into weekend negotiations last month prepared to do a deal without Fed support. But after examining Bear’s balance sheet, which looks completely conventional, except for $46 billion of hard-to-value mortgage assets, Morgan apparently said, “Hell no!” The $30 billion backup line of credit Morgan got from the Fed implies that they expect mortgage portfolio losses of some 70 cents on the dollar. Had Morgan recognized those losses, they could have forced comparable write-downs on a string of other banks. Bear’s default, in addition, could have triggered huge cash liabilities by thinly capitalized “bond insurers” and hedge funds that had guaranteed Bear’s debt. Many of the guarantors might have failed to have made good their guarantees. The Fed chose to pay up.
Analysts at Goldman Sachs recently estimated the total losses from this mess at $1.2 trillion, including nearly $500 billion at the banks. The cleanest solution would be for regulators to force banks to revalue their assets down to realistic levels in one fell swoop. (If the Fed and the Securities and Exchange Commission drive such a process, it might be accomplished within a single quarter.) The revaluations would almost certainly wipe out all or most equity capital at a number of the larger banks. Since it is unlikely that new private, nongovernmental capital could supply the entire shortfall, the federal government would have to act as the equity supplier of last resort.
But what about the homeowners who are stuck with mortgages they can no longer pay? Helping them will be simpler once their problems are untangled from the banks’ goal of protecting overpriced assets. A change in the bankruptcy laws, for example, could empower judges to convert excessive mortgages into market-rate rentals, which are usually much cheaper.
All current rescue proposals being floated in the U.S. Congress have the taxpayer buying up the loans the banks no longer want, absorbing the losses just as taxpayers did in the savings and loan crisis of the late 1980s. As an equity investor, however, the U.S. government would get the same terms as other private investors, leaving the losses to fall on the shareholders and executives who either caused the debacle or allowed it to happen. Concerns about the government’s holding bank stock directly could be allayed by depositing the shares in the Social Security trust funds. As the banks return to normal operations, they would become quite valuable securities and probably greatly improve the system’s returns.
Bank shareholders and executives made extraordinary financial gains during the 2000s. Now that their Ponzi scheme has been exposed, they are demanding that the public absorb much of their losses, and the Federal government has been responding with huge showers of money. The Bear Stearns rescue demonstrates the need to draw a line. From now on, the banks, their shareholders, and their executives should eat their own losses. If that wipes out the capital of essential depositary institutions, the federal government should step in. Save the banks and help struggling homeowners, yes. But no more largesse for bank executives and shareholders.
Fort Lauderdale Law Firms Cashing In On Foreclosures in Hillsborough County
On April 1, 2008, the Tampa (Florida) Tribune published an article concerning the filing of mortgage foreclosure lawsuits in Hillsborough County, Florida during February 2008.
First, they found that foreclosure filings in Hillsborough County had more than doubled from the previous year. According to clerk records, there were 1,475 new mortgage foreclosure suits in Hillsborough County in February compared with 562 cases in February 2007 and 271 cases in February 2006.
Second, they determined which law firms were responsible for the most foreclosure filings in Hillsborough County during February 2008. Not surprisingly, a Tampa-based firm had filed the most. That firm was followed, however, by a number of "foreclosure mill" law firms based in the Miami/Fort Lauderdale area. The list follows:
1. Florida Default Law Group — Tampa.......415
2. David J. Stern — Plantation....................263
3. Marshall C. Watson — Fort Lauderdale.....182
4. Shapiro & Fishman — Tampa..................133
5. Smith, Hiatt & Diaz — Fort Lauderdale......75
6. Albertelli Law — Tampa...........................61
7. Daniel C. Consuegra — Tampa................47
8. Adorno & Yoss — Miami...........................41
9. Ben-Ezra & Katz — Fort Lauderdale..........33
10. Spear and Hoffman — Miami..................33
Fort Myers/Cape Coral Florida Has Highest Rate of Subprime Mortgage Foreclosures in the U.S.
According to the April 6, 2008 New York Times here, the highest rate of subprime mortgage foreclosures in the United States is in the Fort Myers/Cape Coral area of Southwest Florida.
Florida Attorney General Issues Consumer Advisory on Mortgage Foreclosures
A page dedicated to helping consumers educate themselves about mortgage foreclosures is available online here:
How to Protect Yourself: Tips for Avoiding Mortgage Foreclosures
Contact your lender or loan servicer as soon as you realize you may have a problem and may have missed a payment. Studies show that at least 50 percent of all consumers that have defaulted on a mortgage or missed payments never contact their lender. This is a mistake. Lenders can discuss options with you to help you work through payments during difficult financial times. Lenders prefer to have you keep your home and most will work with you. Be honest with your lender about your financial circumstances. For more information about contacting your lender and what documents you should gather before speaking with your lender, refer to http://www.fha.gov/ or use this link http://portal.hud.gov/portal/page?_pageid=33,717348&_dad=portal&_schema=PORTAL.
Gather information. Learn all that you can about your mortgage rights and foreclosure laws in Florida. Review your loan documents to determine what your lender may do if you can’t make your payments. Review Florida laws, particularly Chapter 702, Florida Statutes and Section 45.031, Florida statutes to learn about foreclosure proceedings. Attend a foreclosure prevention information session. Information on local sessions may be available on http://www.fha.gov/ under “hot topics, foreclosure prevention events for homeowners.”
Contact a nonprofit housing counselor. Help and information is available to you free of cost. The HOPE NOW alliance provides a 24-hour hotline to provide mortgage counseling assistance in multiple languages. 1-888-995-HOPE. You may also obtain a list of HUD-approved counseling services in Florida at http://www.hud.gov/ or at this webpage:http://www.hud.gov/offices/hsg/sfh/hcc/hcs.cfm?webListAction=search&searchstate=FL .
Understand the relevant terms: If you are working with your lender or an approved housing counselor to keep your home, there are several options:
Reinstatement: Your lender may agree to let you pay the total amount you are behind, in a lump sum payment and by a specific date. This is often combined with forbearance when you can show that funds from a bonus, tax refund, or other source will become available at a specific time in the future. Be aware that there may be late fees and other costs associated with a reinstatement plan.
Forbearance: Your lender may offer a temporary reduction or suspension of your mortgage payments while you get back on your feet. Forbearance is often combined with a reinstatement or a repayment plan to pay off the missed or reduced mortgage payments.
Repayment Plan: This is an agreement that gives you a fixed amount of time to repay the amount you are behind by combining a portion of what is past due with your regular monthly payment. At the end of the repayment period you have gradually paid back the amount of your mortgage that was delinquent.
Loan modification: This is a written agreement between you and your mortgage company that permanently changes one or more of the original terms of your note to make the payments more affordable.
Short Payoff: If you can sell your house but the sale proceeds are less than the total amount you owe on your mortgage, your mortgage company may agree to a short payoff and write off the portion of your mortgage that exceeds the net proceeds from the sale.
Deed-in-lieu of foreclosure: A deed-in-lieu of foreclosure is a cancellation of your mortgage if you voluntarily transfer title of your property to your mortgage company. Usually you must try to sell your home for its fair market value for at least 90 days before a mortgage company will consider this option. A deed-in-lieu of foreclosure may not be an option if there are other liens on the property, such as second mortgages, judgments from creditors, or tax liens.
Assumption: An assumption permits a qualified buyer to take over your mortgage debt and make the mortgage payments, even if the mortgage is non-assumable. As a result, you may be able to sell your property and avoid foreclosure.
Refinancing: While refinancing is not necessarily a good option when facing foreclosure and can sometimes even be a predatory practice, there are instances where it may help. Talk to your lender to see if refinancing is an option for you.
Avoid foreclosure prevention or loss mitigation companies. If you fall behind in your mortgage payments, many for-profit companies will contact you promising to help you avoid foreclosure. Some may even appear to be affiliated with your lender. Many also list their services on the internet and ask that you fill out a referral form online. It is best to avoid dealing with these companies. Most will charge you a hefty fee upfront for information that your lender or a HUD approved counselor will provide to you for free. You can obtain the same workout plan or a better plan for free by contacting your lender or a HUD approved counselor. Use your money to pay the mortgage instead.
Do not fall victim to a foreclosure recovery scam. If any business or individual offers to help you stop foreclosure immediately by signing a document authorizing them to act on your behalf or to set up financing for you, do not sign without consulting a professional (an attorney or HUD-approved counselor). This may be a trick to get you to sign over title to your home. You are then vulnerable to losing your home and all of your equity in your home to the so called “rescuer.”
Carefully examine your finances. Can you cut spending on optional expenses, delay payments on credit cards or other unsecured debt until you have paid your mortgage? Do you have assets that you could sell to help reinstate your loan? Can anyone in the household get a second job to help with income? These efforts to manage your finances may help you find income to apply to your outstanding payments and will demonstrate to your lender that you are willing to work on your finances and make sacrifices in order to keep your home.
For more information contact the AG consumer hotline at 1-866-966-7226 or visit http://www.hud.gov/ for these and other helpful tips.
Lenders Swamped By Foreclosures Let Homeowners Stay
The number of borrowers at least 90 days late on their home loans rose to 3.6 percent at the end of December , the highest in at least five years, according to the Mortgage Bankers Association in Washington. That figure, for the first time, is almost double the 2 percent who have been foreclosed on.
Banks are reluctant to foreclose on homeowners for a variety of reasons that include the cost, said Peter Zalewski, real estate broker and owner of Condo Vultures Realty LLC, a property consulting firm in Bal Harbour, Florida.
Legal fees and maintaining a vacant property while paying the mortgage, insurance and taxes can add up to as much as 15 percent of the value of the home, and it may take months for the foreclosure to work through the legal system, he said.
``The end result is taking back a property that the bank will have to manage, rent out and or sell,'' Zalewski said.
In many cases, lenders also have to foot the bill for fixing up vacant homes that have been vandalized.
``What are the banks going to do?'' Fishman said. ``They don't want the house. They have a mortgage for $1 million and the house is worth $750,000.''
Efforts to keep borrowers paying their bills have slowed the foreclosure process, Mark Rodgers, a spokesman at CitiMortgage, a division of New York-based Citigroup Inc., said in an e-mail message.
``In a number of cases, we have delayed foreclosure proceedings to allow our loss mitigation teams additional time to explore potential solutions to keep distressed borrowers in their homes,'' Rodgers said.
Joe Ohayon, vice president of community relations for Wells Fargo Home Mortgage in Frederick, Maryland, a unit of San Francisco-based Wells Fargo, said trying to modify loan terms case by case adds time to the foreclosure process.
``Foreclosure is only a last resort after all available options for keeping the customer in the home have been exhausted,'' Ohayon said in an e-mail message.
Olivia Riley, a spokeswoman at Seattle-based Washington Mutual, said in an e-mail that the company's goal is to keep customers in their homes ``with payments they can afford.''
Representatives for Calabasas, California-based Countrywide, the biggest U.S. mortgage servicer last year, didn't respond to requests for comment.
Few mortgage companies will admit they allow homeowners to stay in their homes without paying their bills.
``No servicer will say you can live rent-free for six months, go ahead,'' said Paul Miller, a mortgage industry analyst at Friedman Billings Ramsey & Co. in Arlington, Virginia. ``Eventually, the servicers will clear these guys out.''
Homeowners usually get 90 days to resume paying before foreclosure proceedings begin with the filing of a complaint or notice of non-payment.
State laws determine the length of time between the filing and an auction of the house. In most states, it's two to six months, according to Foreclosures.com. In Maine, it can be up to a year and in New York, 19 months; in Georgia, it's as quickly as one month, and in Nevada, it can be 35 days, according to the database.
Borrowers in California who fight foreclosure can stretch the process to 18 months, said Cameron Pannabecker, chapter president of the California Association of Mortgage Brokers and president of Cal-Pro Mortgage Inc. in Stockton.