Rate Watch #719 Some Real Solutions for "Too Big to Fail"
April 23, 2010
by Dick Lepre
dicklepre@rpm-mtg.com
www.loanmine.com
| Product | Rate | Points | Est. APR* | |
|---|---|---|---|---|
| CONFORMING LOAN PRODUCTS (Loans less than $417,000) | ||||
| 30 Year Fixed conforming | ||||
| 5.125% | 1.00 | 5.29% | ||
| 5.25% | 0.00 | 5.32% | ||
| 15 Year Fixed Conforming | ||||
| 4.25% | 1.00 | 4.51% | ||
| 4.50% | 0.00 | 4.61% | ||
| JUMBO CONFORMING (Stimulus) LOAN PRODUCTS (Loans greater than $417,000 and less that the new amount for your county) | ||||
| 30 Year Fixed Stimulus | ||||
| 5.5% | 0 | 5.58% | ||
| 5.25% | 1.0 | 5.41% | ||
| 15 Year Fixed Stimulus | 4.875% | 0 |
4.98% |
|
| 4.75% | 1 | 5.03% | ||
* conforming loan limits for 2009 are:
1 unit $417,000
2 units $533,850
3 units $645,300
4 units $801,950
Note that the above table now means something different than it used to. "Conforming" now means "traditional conforming" (<$417,000 for SFR is the new jumbo-conforming which depends on county.) You can find the new Jumbo-conforming limit for your county here. That page says "FHA" but those amounts also pertain to FNMA & FHLMC.
You must not read these as quotes because the rate and price which you will get depends on your precise situation and is affected by, but not limited to, the following factors: credit scores, property type, occupancy, income, value of property, length of time of the rate lock, whether of not values in your area are declining, and cash out (if refinancing).
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II) Fundamentals
Durable Goods ex-auto was +2.8%, Overall DGO was -1.3%. New Home Sales spiked from 324,000 previous to 411,000. The median price was down $8,000. The about-to-expire tax credit certainly helped sales. Initial Jobless Claims were 456,000 last week - above consensus and below previous. Core PPI was +0.1% matching consensus and previous. Existing Home Sales were up slightly. With all the support that the government has given to the housing industry the result has been to maintain values at what still may be unnaturally high levels. Compared to everything else, housing is still too expensive. In the long term, this may tend to inflate the cost of everything else. Leading Economic Indicators - Actual 1.4%, Consensus 1.1%, Previous 0.1.
III) The Technicals
The daily and weekly are both bullish which could lower rates slightly.
For those who are not long-time readers, the basis for these observations about technicals is the work of Jim Grauer which can be viewed at StoMaster.
IV) Analysis
One thing of interest this past week was local REIT Redwood Trust's announcement that it was going to attempt a Jumbo securitization of a $222 million package of Citimortgage loans. Securitization of mortgage debt not guaranteed by the government is a discussion topic this week. There is one annoying "fly in the ointment." There is concern that Congress will mandate that an mortgage issuer who sells mortgages keeps some skin in the game perhaps allowing that only 95% of a mortgage could be sold. No one is going to rush forward with mortgage securitization without seeing what Congress will come up with. I most definitely believe that we will see, later this year, a return on a modest scale at first of Jumbo mortgage securitization. These will likely start as very high quality loans in terms of credit scores, debt ratios and LTVs. The issue at present is that no one knows what the right price for this stuff is since there has been no market for it. There is a big reward for entities which can do this correctly. They could wind up taking the GSEs off Treasury's hands.
V) Too Big to Fail
The notion has been discussed for many years that some financial institutions have become "too big to fail," and are consequently prone to taking high risks. It has become the modus of the administration (and the media) to blame this on corporate greed and point to the high salaries of the executives of these firms as an indication that greedy capitalist bastards are behind what is wrong. The pitch is that banks and Wall Street lacked sufficient regulation to prevent the liquidity crisis.
That is not the entire truth. FHLMC, FNMA, and many big banks lost money because they did what government regulations steered them to. This consisted of the demand for more subprime mortgages, combined with steering of banks assets from whole loans to FHLMC/FNMA debt because regulations enable them to leverage GSE debt more than whole loans. Throw in two other factors: FHLMC & FNMA had capital requirements (2%) which were too low even before HUD forced then to do more subprime. Also, SEC lowered reserve requirements for investment banks as the subprime thing was happening, enabling those entities to go broke faster.
Capitalism involves greed and it involves risks and I believe that consequently it requires substantial regulation. In the subprime mess we had the worst of the worst. A HUD mandate to do subprime and bankers seeing short-term profits by answering HUD's call. Bad regulations + greed = disaster.
Getting back to the "too big to fail" theme, I believe that we need very large banks in order to compete with other nations and to develop technology. The issues are economy of scale and ability to compete in an era of world economy. Instead of cutting down the size of banks and creating more banks and more people who can screw up, it would make better sense to me to keep very large banks and make some significant changes:
- technology must be put into place to make it so that banks are electronically audited daily.
- an entity such as CFTC (U.S. Commodities Futures Trading Commission) must establish oversight on positions limits. If it decides at the end of a day that a bank is too heavily invested in any particular position, then that bank must either sell part of that position or come up with more capital the next day.
- there needs to be restriction of banks setting up spin-off entities which hold positions in, for example, credit default swaps which are OTC markets and lack transparency. OTC derivative trading is seriously lacking transparency. This is an enormous point. Once stuff is moved to OTC trading two bad things happen: 1) it is less likely to obtain the value of assets making it less possible for anyone to monitor net worth and 2) anti-competitive forces restrict trading to the Wall Street elite.
- a rework of Basel II needs to be put in place to force banks to retain larger amounts of capital to assure survival if a position goes bad. This should mandate higher reserves for high risks investments. There is no reason why the taxpayers should be guaranteeing deposits in banks which are gambling with those deposits. Let wealthy folks put their money into hedge funds and take these risks.
- non-banking entities akin to LTCM or AIG must be regulated in a similar manner. When the LTCM crisis happened, the Fed bailed them out, but 10 years later we still did not have the capability to understand the consequences of a failure of AIG, Lehman Brothers or any of the large banks. It is not just about size. It is about having good models and computer hardware and software in place so that someone can make some objectively meaningful statement about the consequence of the failure of any large bank, Wall Street investment bank, or insurance company. It is also about transparency so that assets and liabilities can not be moved off-sheet and potential losses obfuscated. I grant that "black swans" may still happen ,and it may be difficult to ascribe probabilities to outlier events, but we should start trying to build better models.
- the real fault that I place on Wall Street is not its size of the salaries of it executives, but its untenable position of maintaining an information headlock on OTC market derivatives. Derivatives should be traded on open markets with transparency and not OTC markets limited to a few players. What Wall Street needs to do is actually embrace capitalism rather than the feudal, but profitable choke-hold which it has on derivative trading. Make no mistake, this is where these guys are making gigantic profits. We would be better off if banks deployed their assets by actually doing novel things such as lending and, in the case of investment banks, investing.
One more point about size. The S&L crisis which happened in about 1987 did not involve S&Ls which were too big to fail. It involved a large number of relatively small S&Ls which had several recurring problems: incompetent management, lack of knowledge regarding interest rate risk management, brokered deposits and poor accounting rules which encouraged many S&Ls to make higher risk loans with several points because they were able to book that as profit. Also, S&Ls has just before this been given the ability to get into businesses they had little or no experiences. Some of this was induced by the Garn – St. Germain Depository Institutions Act. I am oversimplifying a complex topic here but my core point is that large systemic failures can occur even with a larger number of small institutions.
Banks (and bank-like entities) must be prevented by these suggestions from making risky investments when there is no downside if the government will bail them out when they blow it. Markets function well, as Adam Smith pointed out, when all the parties have the same knowledge. That paragraph about bringing credit default swaps and any other significant derivatives onto transparent markets may the the most important point made here.
I want to reiterate my subjective view here: I would rather that we place effective regulations on all banks so that fewer fail. I am uncomfortable with the notion that we are better off with breaking, say, Chase into four pieces and somehow believing that failure of one of those pieces will cause less net damage. The folly is that if one of the pieces fails, then we'll return to the present state as one of the other liquid pieces acquires the failed piece.
If you have something to add to this discussion please post a comment on the blog.
Dick Lepre
RPM - SF
435 Pacific Avenue #350
San Francisco, CA 94133
DRE License # 01143973
dicklepre@rpm-mtg.com
Web site: www.loanmine.com
Blog: economy.typepad.com
(415) 343.6789 (direct dial number)
(415) 244-9383 (cell)
(866) 488-2051 fax
California Department of Real Estate - real estate broker license #01201643
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