After all – if the government could wipe you out why would you ever invest in low risk margin debt?

TO BE NOTED: From Bronte Capital:

"Do you or did you ever have friends in the FDIC?

"Here in my hand is a list of 205 communists in the blogosphere and the mainstream media."

Well – no actually – but I have a long list of people who – on the record – supported the confiscation of Washington Mutual.

Washington Mutual – by far the biggest bank confiscation in US history – happened during the AIG/Lehman week. It was confiscated despite being liquid and adequately capitalised at the time. Sheila Bair – the head of the Federal Deposit Insurance Corp (FDIC) did the deed – and in my opinion it was not her finest hour.

Washington Mutual was given to JP Morgan who did not need to honour all of WaMu’s debts. Debt holders – who would normally have expected to recover most or all of their investment were wiped out.

After this – and until very recently – no major US bank could raise any debt without a government guarantee. After all – if the government could wipe you out why would you ever invest in low risk margin debt?

The confiscation of Washington Mutual thus forced the entire system onto the government guarantee tit. The cost to taxpayers is thus potentially enormous.

Now at the time the confiscation looked justified to many because they assumed that Washington Mutual was insolvent no matter what their accounts said. JP Morgan – the acquirer – obliged this view by writing down the value of WaMu’s assets by about 20 billion. This write-down also justified the action by Sheila Bair. I said at the time that Sheila Bair was acting improperly despite this – and I said later that JPM was lying.

However if JPM was telling the truth – and Sheila Bair had a decent basis for believing them – then this was not arbitrary confiscation – though it was confiscation without appeal. It would be costly for the system – and it might have been justified.

Alas the facts have a neat way of outing the incompetence of Sheila Bair. JPMorgan is now confessing that almost all of the charges taken when Washington Mutual was confiscated will be reversed through their P&L. Washington Mutual was never insolvent and should never have been confiscated. [Hat tip – Felix Salmon.]

Sheila Bair – a Republican appointee no less – confiscated without compensation and without right of appeal valuable private property. I have argued repeatedly that she should resign – but now my basic thesis is proven her position is totally untenable.

A huge number of people supported her at the time. These are people who supported the confiscation of private property without appeal. Usually such people are called communists. The alternative explanation is that these people are just dopes.

Actually I know a lot of these people and they are not dopes. [Using McCarthyist logic therefore they must be communists.]

But they are not Communists either. Instead they were dopes on this occasion. Panics – be them financial or political do that. They turn thinking – even iconoclastic people like high profile bloggers – into dopes.

Now Washington Mutual was in fact very easy to add up. It was obviously solvent if you ran the numbers properly – but people find it quite difficult to run the numbers on banks. This applies to senior government officials too. And that explains why financial crises happen. People thought there was no risk in financial assets that were obviously risky during 2005 and 2006 and even into 2007. Thereafter they thought that financial assets that were most likely safe were (near) worthless. Government officials seemingly arbitrarily confiscating assets into the height of the crisis just added to that fear. A preferred stock is worthless if the government steals the underlying collateral (as I found out to my cost in the WaMu case).

After the confiscation of WaMu we needed not only to judge the solvency of banks (something which I think I am capable of doing) but also to judge the behaviour of individual officials in crisis (which I am not capable of doing).

The irrational fear in markets was not unlike the irrational fear that other manias (eg Joe McCarthy) engendered. That doesn’t make the fear less real or less destructive.

I thought at the time that Sheila Bair’s resignation would heal that wound– and would be the single best thing that the government could do to ease the financial crisis. Her resignation would break the nexus between fear in the market and the fear of seemingly arbitrary confiscation by government officials.

That nexus is broken now through repeated and consistent subsidy at huge potential cost to the taxpayers. The government – through repeated capital injections and guarantees – has managed to convince most people that American banks are safe.

It would have been cheaper for Sheila Bair just to resign.

However – the immediate and pressing need for Sheila Bair to resign as a matter of policy has past. The market is no longer outright afraid of arbitrary government confiscation of financial assets though they might have some fear about government intervening in Detroit’s bankruptcy.

But whilst the time for Sheila Bair’s resignation as a matter of national priority is past, the time for her resignation for proven incompetence has just begun.

John

Posted by John Hempton

thanks to an accounting rule that lets the second-biggest U.S. bank transform bad loans it purchased from Washington Mutual Inc. into income

TO BE NOTED: From Bloomberg:

"JPMorgan’s WaMu Windfall Turns Bad Loans Into Income (Update2)

By Ari Levy and Elizabeth Hester

May 26 (Bloomberg) -- JPMorgan Chase & Co. stands to reap a $29 billion windfall thanks to an accounting rule that lets the second-biggest U.S. bank transform bad loans it purchased from Washington Mutual Inc. into income.

Wells Fargo & Co., Bank of America Corp. and PNC Financial Services Group Inc. are also poised to benefit from taking over home lenders Wachovia Corp., Countrywide Financial Corp. and National City Corp., regulatory filings show. The deals provide a combined $56 billion in so-called accretable yield, the difference between the value of the loans on the banks’ balance sheets and the cash flow they’re expected to produce.

Faced with the highest U.S. unemployment in 25 years and a surging foreclosure rate, the lenders are seizing on a four- year-old rule aimed at standardizing how they book acquired loans that have deteriorated in credit quality. By applying the measure to mortgages and commercial loans that lost value during the worst financial crisis since the Great Depression, the banks will wring revenue from the wreckage, said Robert Willens, a former Lehman Brothers Holdings Inc. executive who runs a tax and accounting consulting firm in New York.

“It will benefit these guys dramatically,” Willens said. “There’s a great chance they’ll be able to record very substantial gains going forward.”

JPMorgan rose $2.13, or 6.2 percent, to $36.54 at 4 p.m. in New York Stock Exchange composite trading. Wells Fargo gained 1.3 percent to $25.65 and PNC Financial climbed 5 percent to $43.25. Bank of America fell 9 cents to $10.98.

Purchase Accounting

When JPMorgan bought WaMu out of receivership last September for $1.9 billion, the New York-based bank used purchase accounting, which allows it to record impaired loans at fair value, marking down $118.2 billion of assets by 25 percent. Now, as borrowers pay their debts, the bank says it may gain $29.1 billion over the life of the loans in income before taxes and expenses.

The purchase-accounting rule, known as Statement of Position 03-3, provides banks with an incentive to mark down loans they acquire as aggressively as possible, said Gerard Cassidy, an analyst at RBC Capital Markets in Portland, Maine.

“One of the beauties of purchase accounting is after you mark down your assets, you accrete them back in,” Cassidy said. “Those transactions should be favorable over the long run.”

JPMorgan bought WaMu’s deposits and loans after regulators seized the Seattle-based thrift in the biggest bank failure in U.S. history. JPMorgan took a $29.4 billion writedown on WaMu’s holdings, mostly for option adjustable-rate mortgages and home- equity loans.

‘Price Judgment’

“We marked the portfolio based on a number of factors, including housing-price judgment at the time,” said JPMorgan spokesman Thomas Kelly. “The accretion is driven by prevailing interest rates.”

JPMorgan said first-quarter gains from the WaMu loans resulted in $1.26 billion in interest income and left the bank with an accretable-yield balance that could result in additional income of $29.1 billion.

The difference in accretable yield from bank to bank is due to the amount of impaired loans, the credit quality of the acquired assets and the state of the economy when the deals were completed. Rising and falling interest rates also affect accretable yield for portfolios with adjustable-rate loans.

It’s difficult to gauge how much the yield will add to total revenue because banks don’t disclose the expenses that chisel away at the figure. The income is also booked over the life of the loans, rather than in a lump sum, and banks don’t spell out how long that is, Willens said.

Wachovia ARMs

Wells Fargo arranged the $12.7 billion purchase of Wachovia in October, as the Charlotte, North Carolina-based bank was sinking from $122 billion in option ARMs. As of March 31, San Francisco-based Wells Fargo had marked down $93 billion of impaired Wachovia loans by 37 percent. The expected cash flow was $70.3 billion.

The Wachovia loans added $561 million to the bank’s first- quarter interest income, leaving Wells Fargo with a remaining accretable yield of almost $10 billion.

Government efforts to reduce mortgage rates and stabilize the housing market may make it easier for borrowers to repay loans and for banks to realize the accretable yield on their books. With mortgage rates below 5 percent, originations surged 71 percent in the first quarter from the fourth, a pace that may accelerate during 2009, said Guy Cecala, publisher of Inside Mortgage Finance in Bethesda, Maryland.

Recapturing Writedowns

Wells Fargo, the biggest U.S. mortgage originator, doubled home loans in the first quarter from the previous three months, in part through refinancing Wachovia loans.

“To the extent that the customers’ experience is better or we can modify the loans, and the loans become more current, that could help recapture some of the writedown,” Wells Fargo Chief Financial Officer Howard Atkins said in an April 22 interview.

Banks still face the risk that defaults may exceed expectations and lead to further writedowns on their purchased loans. Foreclosure filings in the U.S. rose to a record for the second straight month in April, climbing 32 percent from a year earlier to more than 342,000, data compiled by Irvine, California-based RealtyTrac Inc. show.

The companies bought by Wells Fargo, JPMorgan, PNC and Bank of America were among the biggest lenders in states with the highest foreclosure rates, including California, Florida and Ohio. Housing prices tumbled the most on record in the first quarter, leaving an increasing number of borrowers owing more in mortgage payments than their homes are worth, according to Zillow.com, an online property data company.

Accretable Yield

“We’ve still got a lot of downside to work through this year and probably through at least part of next,” said William Schwartz, a credit analyst at DBRS Inc. in New York. “If I were them, I wouldn’t be claiming any victory yet.”

PNC closed its $3.9 billion acquisition of National City on Dec. 31, after the Cleveland-based bank racked up more than $4 billion in losses tied to subprime loans. PNC, based in Pittsburgh, marked down $19.3 billion of impaired loans by 38 percent, or $7.4 billion, and said it expected to recoup half of the writedown. After gaining $213 million in interest income in the first quarter and making some adjustments, the company has an accretable-yield balance of $2.9 billion.

“We’re just being prudent,” PNC Chief Financial Officer Richard Johnson said in a May 19 interview.

‘Huge Cushion’

Johnson said he expects the entire accretable yield to result in earnings. The company has taken into “consideration everything that can go wrong with the economy,” he said.

Bank of America, the biggest U.S. bank by assets, has potential purchase-accounting income of $14.1 billion, including $627 million of gains from Merrill Lynch & Co. and the rest from Countrywide. Bank of America bought subprime lender Countrywide in July, two months before the financial crisis forced Lehman Brothers into bankruptcy and WaMu into receivership.

As market losses deepened, Bank of America had to reduce the returns it expected the impaired loans to produce from an original estimate of $19.6 billion.

“The Countrywide marks in hindsight weren’t nearly as aggressive,” said Jason Goldberg, an analyst at Barclays Capital in New York, who has “equal weight” investment ratings on Bank of America and PNC and “overweight” recommendations for Wells Fargo and JPMorgan.

Bank of America spokesman Jerry Dubrowski declined to comment.

The discounted assets purchased by JPMorgan and Wells Fargo make the stocks more attractive because they will spur an acceleration in profit growth, said Chris Armbruster, an analyst at Al Frank Asset Management Inc. in Laguna Beach, California.

“There’s definitely going to be some marks that were taken that were too extreme,” said Armbruster, whose firm oversees about $375 million. “It gives them a huge cushion or buffer to smooth out earnings.”

To contact the reporters on this story: Ari Levy in San Francisco at alevy5@bloomberg.net; Elizabeth Hester in New York at ehester@bloomberg.net."

From Calculated Risk:

"Revisiting the JPMorgan / WaMu Acquisition

by CalculatedRisk on 5/26/2009 03:01:00 PM

From Bloomberg: JPMorgan’s WaMu Windfall Turns Bad Loans Into Income (ht Mike in Long Island)

When JPMorgan bought WaMu out of receivership last September for $1.9 billion, the New York-based bank used purchase accounting, which allows it to record impaired loans at fair value, marking down $118.2 billion of assets by 25 percent. Now, as borrowers pay their debts, the bank says it may gain $29.1 billion over the life of the loans in pretax income before taxes and expenses.
...
JPMorgan took a $29.4-billion writedown on WaMu’s holdings, mostly for option adjustable-rate mortgages (ARMs) and home- equity loans.

“We marked the portfolio based on a number of factors, including housing-price judgment at the time,” said JPMorgan spokesman Thomas Kelly. “The accretion is driven by prevailing interest rates.”

JPMorgan said first-quarter gains from the WaMu loans resulted in $1.26 billion in interest income and left the bank with an accretable-yield balance that could result in additional income of $29.1 billion.
emphasis added

Let's review the JPMorgan's "judgment at the time" of the acquisition. First, here is the presentation material from last September.

Click on graph for larger image in new window.

Here are the bad asset details. Also see page 16 for assumptions.

This shows the $50 billion in Option ARMs, $59 billion in home equity loans, and $15 billion in subprime loans on WaMu's books at the time of the acquisition. Plus another $15 billion in other mortgage loans.

And the second excerpt shows JPMorgan's economic judgment at the time of the acquisition.

JPMorgan's marks assumed that the unemployment rate would peak at 7.0% and house prices would decline about 25% peak-to-trough.

Note that the projected losses at the bottom of the table are from Dec 2007. As the article noted, in September 2008, JPMorgan took a writedown of close to $30 billion mostly for Option ARMs and home equity loans.

This graphic shows the unemployment rate when the deal was announced (in purple), the three scenarios JPMorgan presented (the writedowns were based on unemployment peaking at 7%) and the current unemployment rate (8.9%).

Clearly JPMorgan underestimated the rise in unemployment, and this suggests the $29.4 billion writedown was too small.

And the last graph compares JPMorgan's forecast for additional house price declines and the actual declines using the Case-Shiller national home price index and the Case-Shiller composite 20 index.

House prices have declined about 32.2% peak-to-trough according to Case-Shiller - nearing JPMorgan's 37% projection for a severe recession.

This shows JPMorgan underestimated additional house price declines when they acquired WaMu. Instead of $36 billion in additional losses since December 31, 2007 (and the $29.4 billion writedown), this suggests JPMorgan expects losses will be $54 billion or more.

Posted by CalculatedRisk on 5/26/2009 03:01:00 PM "

It’s worth remembering that these are the only two US financial institutions where senior lenders took a haircut

From Reuters:

"Felix Salmon

is summer arriving?

« Previous Post

May 26th, 2009

Revisiting WaMu

Post a comment (2)

Posted by: Felix Salmon

Tags: banking, regulation

JP Morgan, having lopped $29.4 billion off the value of WaMu’s loans when it took over the troubled lender, now reckons it’s going to get the lion’s share of that money back:

When JPMorgan bought WaMu out of receivership last September for $1.9 billion, the New York-based bank used purchase accounting, which allows it to record impaired loans at fair value, marking down $118.2 billion of assets by 25 percent. Now, as borrowers pay their debts, the bank says it may gain $29.1 billion over the life of the loans in pretax income before taxes and expenses.

WaMu failed in the middle of the sleepless craziness following the Lehman collapse, and in hindsight might well have been at least as much of a factor in the scary gapping-out of Libor as Lehman was. It’s worth remembering that these are the only two US financial institutions where senior lenders took a haircut — and in both cases the senior lenders were pretty much wiped out. In other bank failures, even the junior lenders generally emerged unscathed.

It increasingly seems as though a panicked FDIC thrust WaMu into the arms of Jamie Dimon, who could — and did — ask for pretty much anything he liked, including the right not to have to pay back any of WaMu’s creditors. The result was that the bank wholesale-funding market went straight into crisis: one sui generis default (Lehman) might have been navigable, but when you have two in as many weeks, it’s pretty clear which way the wind is blowing.

We’ve had endless rehashings of the weekends leading to the Bear Stearns and Lehman Brothers failures, but I’ve seen much less on the subject of WaMu, which is equally if not more fascinating and just as systemically important. The news out of JP Morgan that it massively undervalued WaMu’s loan books certainly seems to indicate that the likes of John Hempton have a point when they say that Sheila Bair got this particular decision spectacularly wrong, and in doing so put the entire US retail banking system on a much more fragile footing than was necessary.

Bair also took a relatively consumer-friendly bank (WaMu) and forced it to adopt the practices of a relatively consumer-unfriendly bank (Chase) — with predictable results: Chase is now telling former WaMu customers that even if they have directed the bank not to let their accounts go overdrawn, the bank can still push the account into overdrawn territory anyway, and, of course, “will assess an Insufficient Funds Fee” for doing so.

It’s clear that the big winner here is JP Morgan, but the rest of us — taxpayers, WaMu account holders, WaMu creditors — increasingly look like very big losers."

Me:

I agree that the WaMu seizure and sale was a mistake, but I think that it follows from Lehman. Now being quite aware that mergers were the only option for large banks and financial entities, they didn’t want to wait and chance a Lehman like situation, where the B of A and Barclays deals didn’t work out. So, they proactively seized and merged, scaring the hell out of bondholders and creditors.

Oddly, Lehman had scared investors that the government wasn’t guaranteeing the unwind. Now, WaMu scared investors that, even if the government got involved, they were in for a hellish ride of possible losses.

Of course, if you believe as I do, that the government needed to guarantee everything right off, like Geithner, then both of these actions are terrible mistakes.However, in both cases, Lehman and WaMu, I can understand why the government acted as it did. Too bad that’s not going to stop them from looking like idiots in the history books, because a good plot needs dunces by which to measure the ultimate heroes intellect.

- Posted by Don the libertarian Democrat

Note: there are approximately 8,300 FDIC insured banks currently.

TO BE NOTED: From Calculated Risk:

"FDIC Bank Failures: By the Numbers

by CalculatedRisk on 5/22/2009 10:40:00 PM

Three banks were closed by the FDIC this week, for a total of 36 banks so far in 2009. The largest was BankUnited in Florida with $12.8 billion in assets.

To put those failures into perspective, here are three graphs: the first shows the number of bank failures by year since the FDIC was founded, and the second graph includes bank failures during the Depression. The third graph shows the size of the assets and deposits (in current dollars).

Click on graph for larger image in new window.

Back in the '80s, there was some minor multiple counting ... as an example, when First City of Texas failed on Oct 30, 1992 there were 18 different banks closed by the FDIC. This multiple counting was minor, and there were far more bank failures in the late '80s and early '90s than this year.

Note: there are approximately 8,300 FDIC insured banks currently.

The second graph includes the 1920s and shows that failures during the S&L crisis were far less than during the '20s and early '30s (before the FDIC was enacted).

Note how small the S&L crisis appears on this graph! The number of bank failures soared to 4000 (estimated) in 1933.

During the Roaring '20s, 500 bank failures per year was common - even with a booming economy - with depositors typically losing 30% to 40% of their bank deposits in the failed institutions. No wonder even the rumor of a problem caused a run on the bank!

The third graph shows the bank failures by total assets and deposits per year in current dollars adjusted with CPI. This data is from the FDIC (1) and starts in 1934.

WaMu accounted for a vast majority of the assets and deposits of failed banks in 2008, and it is important to remember that WaMu was closed by the FDIC, and sold to JPMorgan Chase Bank, at no cost to the Deposit Insurance Fund (DIF).

There are many more bank failures to come over the next couple of years, mostly because of losses related to Construction & Development (C&D) and Commercial Real Estate (CRE) loans, but so far, especially excluding WaMu, the total assets and deposits of failed FDIC insured banks is much smaller than in the '80s and early '90s.

Of course this is FDIC insured bank failures only. An investment bank like Lehman isn't included. Nor is the support for AIG, Citigroup and all the other "too big to fail" institutions ...

(1) The FDIC assets and deposit data is here. Click on Failures & Assistance Transactions.

Posted by CalculatedRisk "

Sheila Bair confiscated a solvent bank encouraged by lying bankers

TO BE NOTED: From Bronte Capital:

"JP Morgan lied to regulators

I purchased preferred shares in Washington Mutual when it was in distress and lost money when it was confiscated by Sheila Bair. I have argued that it was the most extraordinary action made by government during this crisis and that an essentially solvent bank was confiscated.

In anger I posted my response to the WaMu takeover the day after it happened. I also purchased adwords on Google so that when you google Sheila Bair’s name you will get an advert linking to my blog and explaining why she should resign. It is no secret I dislike Sheila Bair.

Moreover there are law suits (whose basic premise I agree with) that JP Morgan whilst doing due diligence on Washington Mutual was also badmouthing them in the press and encouraging the regulator to take them over. [It is easier to sue JPM than the Federal Government.]

That said – we have a fairly comprehensive proof that JP Morgan did lie to regulators. The only issue is did they lie to regulators when encouraging them to confiscate Washington Mutual or did they lie when they were conducting the stress test? If they lied to Sheila Bair to get them to confiscate WaMu and she believed them then she must resign. But the alternatives I see are worse.

Detailing the JP Morgan lies

First you need to look at the document that JPM released when it took over WaMu.

Here is – with what they think the losses will be in the various stress scenarios.

JP Morgan is predicting $36 billion in losses in WaMu's book in their base case and $54 billion in the "severe recession" case.

These losses are measured since December 31 2007. The losses as estimated in the stress test are from the end of 2008 – and to get the numbers consistent you need to take about 8 billion dollars off these numbers as about 8 billion in losses were realised during 2007.

It already looks like we are in the severe recession. Unemployment is well over 8 percent. On these numbers – numbers that were presented by JP Morgan to the market and to regulators – JPM has to take a further $46 billion in losses on the Washington Mutual book alone. (46=54-8).

Almost all of these losses come from mortgages. Indeed in the presentation JP Morgan made when it merged with Washington Mutual all the losses except about a billion dollars came from the mortgage book.

The only problem is that the losses estimated on mortgages by the regulators (including Sheila Bair) in the stress test include only $39 billion in losses – being 12 percent of the entire mortgage book. Here are the results of the stress test on JPMorgan.

The implication is that there are negative losses in the rest of JP Morgans very large book. This is unlikely.

So we are left with two possibilities both of which involve JP Morgan telling porkys:

1. The losses as estimated by the JP Morgan and told to regulators when they were manipulating Sheila Bair into confiscating Washington Mutual were lies – indeed were so grotesquely over-estimated as to be absurd criminal lies or
   
2. The losses as estimated by JP Morgan and the regulators in the stress test are grotesque under-estimates – which – in order to be that grotesquely wrong had to involve major misrepresentations of their book by JP Morgan.
   

It is possible that both sets of losses were grotesquely mis-estimated - though the differences here are so stark that a simple and honest "bit of both" is not possible.

I prefer the first choice. The losses at WaMu as suggested by JPM never made any sense – and I prefer the idea that – encouraged by JPM’s lying – Sheila Bair confiscated a solvent bank.

The second choice suggests the stress tests were totally phoney and allowed JP Morgan to lie at will. If that is correct the regulators have a duty to confiscate JPMorgan as its embedded losses (using similar ratios as they used in arguing for the Washington Mutual takeover) leave it desperately and diabolically insolvent.

The idea that Sheila Bair confiscated a solvent bank encouraged by lying bankers should not surprise anyone familiar with big-bank lobbying prowess. Most the bears in the blogosphere would prefer believe the stress test was phoney without any real assessemnt of likely losses.

John

Technical accounting note the losses in the stress test page were before 20 billion in purchasing adjustments. Those purchasing adjustments were JPMorgan over-estimating the losses at WaMu so - as the loans come in a little better than expected JPM shows better-than-real earnings.

POST SCRIPTS: The first response I got to this suggests a third possibility - that JP Morgan (and presumably all the other banks) were ASKED to give the regulators the information that they wanted to hear for the stress test - that they were asked to lie. That I suspect stretches reality. It is hard to keep things like that quiet - and also some banks (notably Wells Fargo) are very unhappy.

Posted by John Hempton "

JPMorgan held “sham negotiations” about a potential merger and made public some confidential data

TO BE NOTED: From Bloomberg:

"WaMu Asks Judge for Probe of JPMorgan Merger Conduct (Update1)

Share | Email | Print | A A A

By Vivek Shankar

May 1 (Bloomberg) -- Washington Mutual Inc., the bankrupt former parent of the biggest U.S. bank to fail, asked a Delaware judge for an investigation of JPMorgan Chase & Co. related to its conduct in acquiring the failed bank.

The motion expands on a Texas case in which stakeholders in Washington Mutual seek billions of dollars from New York-based JPMorgan, alleging misconduct leading up to the $1.9 billion acquisition of Washington Mutual’s thrift unit.

Washington Mutual, based in Seattle, alleged JPMorgan held “sham negotiations” about a potential merger and made public some confidential data that drove down the value of its thrift unit. Joseph Evangelisti, a spokesman for JPMorgan, declined to comment on Washington Mutual’s investigation request filed today in U.S. Bankruptcy Court in Wilmington, Delaware.

Regulators seized Washington Mutual’s banking units and sold them to JPMorgan on Sept. 25. Washington Mutual filed for bankruptcy the next day.

The case is In re. Washington Mutual Inc., 08-12229, U.S. Bankruptcy Court, District of Delaware (Wilmington).

To contact the reporter on this story: Vivek Shankar in San Francisco at vshankar3@bloomberg.net"

CDS give financial institutions a cash call at precisely the wrong time. That is why – if anything – they exacerbated the crisis.

TO BE NOTED: From Bronte Capital:

"Liquidity and banks – a primer

Several of the responses to the last post (about bank excess liquidity) seemed to confuse liquidity and solvency. Indeed several confused “cash reserves” with “loan loss reserves” and the like.

Aaron Krowne – a fairly sophisticated guy and the proprietor of the Mortgage Implode-O-Meter for instance suggested that the 170 billion in cash is necessary to meet loan losses.

Let’s get this right. A bank’s liquidity goes down when they lend money. They lend their liquidity.

A bank’s liquidity does not go down when there are loan losses. You do not need cash to deal with loan losses. You need net worth to deal with loan losses.

A bank really needs liquidity to deal with people being unwilling to leave their funds either on deposit to a bank or on loan to a bank. If a bank gets a run on deposits (even a small run) it needs liquidity and it needs it bad. This is essentially unpredictable. If it cannot roll its own funding it needs liquidity and it needs it bad however this is more predictable because there will be a known debt maturity schedule they need to meet.

Bank of America carries 170 billion in cash rather than the more normal 30-40 billion because it is scared of runs (both retail and wholesale).

The wholesale run is happening and has been happening ever since that fateful week in September when bank creditors realised that – on the say-so of Sheila Bair – they could lose their assets entirely. [Washington Mutual as originally confiscated left the senior debt holders essentially nothing.]

Still fear – and fear alone – can run a big bank out of liquidity. You do not need to be insolvent as a bank to become illiquid. Pretty well the entire Norwegian banking system was illiquid and confiscated during the 1992 Norwegian banking crisis. Capital was constrained but the government made a profit on the bank-bail-out suggesting (ex-poste) that the problem was a liquidity crisis and not a solvency crisis. [Unfortunately nobody, government or private sector, knew for certain whether the issue was solvency or liquidity during 1992 though plenty of people expressed very strong opinions many of which were wrong.]

But get this – and remember it well. In traditional banking cash held by the bank beyond simple transactional balances exists solely to deal with fear. If there is no fear then banks have no liquidity problem. And they will have no liquidity problem even if they are staggeringly insolvent. Indeed many Japanese banks had no fear, staggering insolvency and operated for more than a decade. Closer to home Conseco Finance was almost certainly insolvent a few years before it collapsed.

I got at least a dozen emails that thought that liquidity at Bank of America was to do with losses. All of them misunderstood this simple and key point.

Now investment bank liquidity is much more complicated. The most controversial example is credit default swaps – especially margined credit default swaps.

Writing a credit default swap is in many respects very similar to making a loan. The credit risk – the key risk – is almost identical.

But when you make loans cash walks out the door immediately. You have to have cash to make loans. If you have only limited cash then you cannot make unlimited loans and so you will tend to be selective about the loans you make (choosing better credits). If you have to raise cash in order to finance lending then you need to go to market (issue bonds etc) and that imposes some discipline and costs on you.

When you write a credit default swap you just need someone to have faith that you are good for the exposure.

No cash walks out the door.

Lending imposes the discipline of being required to have cash. Writing CDS does not.

Felix Salmon (and others) have had long arguments about whether CDS caused or exacerbated the crisis. In most this argument I agree with Felix, but the ability to write vast amounts of CDS without needing cash was important in some parts of the crisis. Plain old lending has more discipline. This was certainly a large part of the problem at AIG, MBIA and Ambac.

But CDS have another property. CDS (unlike loans) do not require cash when they are written. But CDS (also unlike loans) cause a cash drain when they default.

A bank which writes CDS needs cash to deal with credit losses. A bank which does traditional lending does not.

Unfortunately CDS cash requirements go up in a financial crisis. That is when the cash gets called.

And that is also precisely the time when banks have most fear surrounding them and hence most difficulty raising cash. CDS give financial institutions a cash call at precisely the wrong time. That is why – if anything – they exacerbated the crisis.

Lines of credit written by banks (Citigroup and JP Morgan were huge writers) also require cash precisely in times of crisis. Most the time you write the line of credit and there is no cash drain on the bank. But when the customer is stressed the lines of credit will be drawn. That also – by usual correlation – tends to be the time that bank liquidity is most difficult.

Still – and this is my reaction from picking apart Bank of America – most of the huge cash balance of bank of America is to deal with fear in the funding markets – and very little is required to deal with loan losses.

Capital – that is net assets – is what is required to deal with loan losses. Cash on hand is frankly irrelevant for that. Whether Bank of America has sufficient net assets to deal with their (large) loan losses is a matter of widespread disputes. Many strong and differing opinions exist – and inevitably some of them will be wrong.

Posted by John Hempton"

the confiscation of Washington Mutual was perhaps the single most destructive government action of this cycle

From Bronte Capital:

"Mixed up policy responses and liquidity preference

I frequently get emails suggesting that governments should force banks to lend and that would solve the recession. I tend to agree but it would be difficult – and the government actions to date have exacerbated the lack of lending.

As it is, there is little to no balance sheet growth at any major bank in America and aggregate bank lending is falling. Excess cash at the Federal Reserve is building up fast. The economy is still sour (and getting more so) and bank credit losses are continuing to rise.

Meanwhile banks sit on cash.

Bank of America (for recent and topical example) is carrying $173 billion in cash and cash equivalents – a number which immunises them against many but not all ills and is about $140 billion higher than normal.

This excess cash inhibits BofA profitability by maybe 5-7 billion per annum (pre-tax). They don’t really want that profit drain – but – in a telling comment – they thought it was worth it to have that negative carry because the cost to running short of liquidity was too high.

The excess cash across the entire banking system probably exceeds a trillion dollars. If only it could be spent – then we would have the stimulus we need.

Alas – that is what is meant by being at the zero constraint of monetary policy. We have banks with a seemingly endless liquidity preference. It is not that there is no demand for loans (though demand is much ameliorated). Banks are rapidly tightening lending criteria too and indeed some banks are just not lending to new customers.

Now lending standards needed to tighten. 2006 was insane. But early 2009 is also insane– and if it were a perfect world lending would have moderated much slower so as to displace maybe 200 thousand workers per month. (The economy can usually generate new jobs that fast.) Indeed the whole idea of stimulus is to slow the rate of job loss in the economy down to a level where normal functioning of the labour market can deal with it.

That is not where we are. We have an extraordinarily rapid change in liquidity preference for banks, an extraordinary tightening of standards and an extraordinary recession.

Now some people are into forcing the banks to lend. Willem Buiter (who is often clever and sometimes wrong) suggests confiscating banks that will not lend. Useless as tits on a bull he says.

That would be fine if he did not want to confiscate marginally insolvent banks too. A bank that is stretched for capital or liquidity would usually preserve both by restricting lending. You restrict lending so as not to be confiscated – except in Willem Buiter’s world where you lend to avoid being confiscated.

Now I thought that the confiscation of Washington Mutual was perhaps the single most destructive government action of this cycle. That was a minority view – and remains one. Felix Salmon thinks I am alone – but a paper from the New York Fed makes it clear that the confiscation of WaMu very rapidly increased the liquidity preference of mainstream banks and hence spread the crisis from the Wall Street Banks to Main Street.

The lesson of Washington Mutual – learned hard – was that you could have adequate capital but a minor run and be confiscated. The only way to cope was to have massive excess liquidity.

And so we are in an unusual liquidity trap. In the Japanese liquidity trap the general populace had massive excess cash savings. The liquidity preference was the preference of the legendary Mrs Watanabe who liked sitting – in cash – on three years of Mr Watanabe’s salary.

In America the liquidity preference belongs to banks. Mr and Mrs Middle America are not swimming in cash. Indeed all the evidence suggests that they are over-indebted. It’s the banks that are swimming in cash. And it is the bank’s excess demand for liquidity that makes monetary policy ineffective.

Now Paul Krugman has argued that it doesn’t really matter why we are at the zero bound in monetary policy – but I think it does. If we are at the zero bound because Mrs Watanabe wants to save to excess then we should target Mrs Watanabe. If we are at the zero bound because Bank of America is scared of arbitrary government action (as evidenced in the confiscation of WaMu) then we should address Bank of America’s concern.

The first way to address Bank of America’s concern is for Sheila Bair to fall on her sword. She should resign because – through confiscating Washington Mutual – she spread the crisis to Main Street. But regular readers should know I have a very low opinion of her and will not be surprised by that comment.

But I have a second proposal. It is floated for discussion only as it is obviously risky. The idea is that the bank capital adequacy requirements be dropped a couple of percentage points – but only if their genuine third party loans fully owned on the balance sheet are growing by more than say five percent per annum.

Posted by John Hempton "

Me:

Don said...

OK. I agree that WaMu was a mistake. But Figure 2 still supports my contention that Lehman started the crisis. You can only interpret the WaMu seizure within a context of a Calling Run having begun. However, I believe that the government should have intervened to save WaMu, given its circumstances. Or, at the very least, given WaMu more time. This still supports my view that government intervention was expected and depended upon. I don't know if you agree.

Absent Lehman and a Calling Run, I don't think WaMu would have been seized. However, remember, you're for consolidation. I'm not.

Don the libertarian Democrat

April 23, 2009 5:43 AM

the thrift was seized and it was sold at a "fire-sale price" or "blue-light special" without a good reason

TO BE NOTED: From THE DEAL.COM:

"WaMu zombies arguments on the rise

Share E-Mail Return To Full Story

Published March 25, 2009 at 8:26 AM

As Dealscape posted Monday, the holding company for Washington Mutual Inc. is suing the Federal Deposit Insurance Corp. for over $13 billion for the loss of its banking operations and a total of $40 billion in damages for allegedly denying claims against the firm's former banking unit.

The holding company claims federal regulators should have instead conducted a "straight liquidation" instead of seizing the bank and selling it to J.P. Morgan Chase & Co. (NYSE:JPM) for $1.9 billion. The belief is that it could have produced more money for creditors and the holding company, which filed for Chapter 11 bankruptcy after the thrift was seized and it was sold at a "fire-sale price" or "blue-light special" without a good reason. The question is: Was it? There seems to be some controversy over this.

Right before the holding company filed for bankruptcy, Washington Mutual was searching for a buyer or a stakeholder that might buy the company at a later date. The concern for buyers at the time was the $19 billion in mortgage losses the bank would accrue over the next 2-1/2 years, according to The Deal's Vipal Monga (see story in Pipeline), who wrote the story Sept. 23, 2008:

"A WaMu representative declined to comment, but a source close to the situation said that there has been no indication by the FDIC of its intentions. 'If they're running a parallel track, they're doing it without telling the bank,' the source said, noting that WaMu's managers do not feel they are operating under a government-imposed deadline to complete a deal. This source added that an auction for the company has been ongoing for five days, and bids have been coming in from multiple parties. The government, the source added, has been watching closely.

"According to one banking source not involved in the sale process, any buyer would face immediate mark-to-market pressures from WaMu's mortgage portfolio. Noting that purchase accounting rules would force a buyer to immediately mark the portfolio to market prices, the banker said that the hole in WaMu's balance sheet upon purchase could be as high as $52 billion. On the other hand, if the bank was not sold, but recapitalized, the hole would be anywhere from $12 billion to $19 billion.

"It is unclear if the FDIC would retain the toxic securities in any bid to sell the bank itself."

The Federal Office of Thrift Supervision seized Washington Mutual Bank on Sept. 25 when no buyer emerged and turned it over to the FDIC, which sold the company's assets and most of its liabilities to J.P. Morgan.

As one blogger for The Seattle Times states:

"We'll never know what might have been, say, if WaMu would have been politically connected enough to get Washington to bail out its 'toxic assets' while saving the retail banking operation that would have remained a Seattle economic pillar. WaMu's troubles will likely turn out to be small compared to the balance sheet of Bank of America, among others. Instead, WaMu was pretty much given away to the very connected JPMorgan Chase, which became even more 'too big to fail.' "

The point is taken, but WaMu did fail, and here is why, via the International Herald Tribune:

"At WaMu, getting the job done meant lending money to nearly anyone who asked for it - the force behind the bank's meteoric rise and its precipitous collapse this year in the biggest bank failure in American history. By the first half of this year, the value of its bad loans had reached $11.5 billion, having nearly tripled from $4.2 billion a year earlier.

Between 2001 and 2007, Killinger received compensation of $88 million, according to the Corporate Library, a research firm. During Killinger's tenure, WaMu pressed sales agents to pump out loans while disregarding borrowers' incomes and assets, according to former employees. The bank set up what insiders described as a system of dubious legality that enabled real estate agents to collect fees of more than $10,000 for bringing in borrowers, sometimes making the agents more beholden to WaMu than they were to their clients."

Meanwhile, federal agents and prosecutors are interviewing former Washington Mutual officials and going through documents to see whether fraud played a role in the largest bank failure in U.S. history. After all, it's hard to imagine one of the U.S.'s largest bank just went up in smoke over night, according to The Seattle Times.

"The lawsuit runs to nearly 500 pages and quotes more than 90 unnamed "confidential witnesses' -- including some identified as mid- and upper-level WaMu managers -- who allege Washington Mutual lacked risk management, demanded that appraisers inflate home values to justify larger loans, and used "dangerously lax" underwriting standards."

So should the holding company for WaMu be suing for more cash or should they have had their executives practicing better risk management skills? As The Big Picture states: "At what point do you just liquidate every last one of these sons of bitches -- and throw their management in jail?"

Despite a possibly flawed business model that offered up loose credit, a group with over 400 members called the The Washington Mutual Equity Group still blames the FDIC. Here are some of the issues being considered that Washington Mutual will likely cover if the lawsuit gets a jury, according to The WaMu Story:

• Naked short-selling of Washington Mutual continued to damage it severely, and although it is illegal, the SEC did nothing to stop it. WaMu was not put on the list of banks that were not to be shorted. WaMu CEO Killinger specifically asked for WaMu to be added to the list but was refused.
• Were all banks given the same information at the same time? By some reports J.P. Morgan knew of the auction three weeks prior. Did other banks have that same advantage?
• J.P. Morgan was notified on Sept. 19 that it would get the bank. That was days before the auction officially began. Of note, J.P. Morgan raised approximately $11 billion for the purchase, yet they managed to buy the bank for a mere $1.9 billion.
• The fair value of the net assets acquired exceeded the purchase price, which resulted in negative goodwill. In accordance with SFAS 141, nonfinancial assets that are not held for sale were written down against that negative goodwill.
• The FDIC auction "offer" essentially says that the bidders can have the bank for nothing as long as they pay the administrative costs of the transaction (which are left blank). It also says they can have any assets, whether they are on the banks books or not (this info is on page one).

There are several other "conspiracy laden" bullet points that are on The WaMu Story Web site. In addition to the $8.2 billion in debt that Washington Mutual had when it was seized, the IRS claims the company owes another $12.5 billion in back taxes that is being disputed.

Were Washington Mutual's retail branches sold at a "fire sale"? We'll let the court decide. - Maria Woehr

Also see:
FDIC attacked by zombie WaMu"

"As the crisis has worsened, the institutions have come to rely almost entirely on government help. "

Can you say "predictable"? This is why we should have adopted the Swedish Plan. We're basically buying the banks, and allowing them to continue showing us how incompetent they are. From the Washington Post:

"Bank Losses Complicate U.S. Rescue
Pressure Grows on Obama to Allocate More Money for Distressed Financial Firms

By David Cho, Binyamin Appelbaum and Lori Montgomery
Washington Post Staff Writers
Thursday, January 15, 2009; A01

A new wave of bank losses is overwhelming the federal government's emergency response, as financial firms struggle with the souring U.S. economy, the rapid deterioration of global markets and the unexpectedly high costs of shotgun mergers arranged by federal officials last year.

The problems are intensifying the pressure on the incoming Obama administration to allocate more of the $700 billion rescue program to financial firms even as Democratic leaders have urged more help for distressed homeowners, small businesses and municipalities. Senior Federal Reserve officials said this week that the bulk of the money should go to banks.( GOOD JOB )

Some Fed officials suggested that even more than $700 billion may be required, and financial analysts at Goldman Sachs and elsewhere say banks will have to raise hundreds of billions of dollars from public or private sources( IT WILL MAINLY BE PUBLIC ).

This year is expected to be worse for banks than last year, senior government officials and analysts say. The money from the first half of the rescue program helped banks replace most of the money they lost during the first nine months of 2008. But the firms are beginning to report fourth-quarter losses that are larger than analysts expected, and the economic environment continues to worsen quickly.( THE CALLING RUN COULD GET WORSE. GREAT. )

The markets got a taste yesterday of just how badly the year ended. European giant Deutsche Bank revealed an unexpected estimated loss of about $6.3 billion for the fourth quarter. HSBC, which has not yet raised capital during the financial crisis, may need $30 billion from investors, according to Morgan Stanley analysts.

Global stock markets reacted by plummeting, with financial shares falling the hardest. The Dow Jones industrial average dropped nearly 3 percent.

Meanwhile, Bank of America was on the verge of receiving billions more in federal aid to help it absorb( WE SHOULD HAVE DONE THIS ) troubled investment bank Merrill Lynch, whose losses had outpaced expectations, according to people familiar with the matter. That money would come on top of the $25 billion the government has already invested in Bank of America, including $10 billion specifically in connection with the Merrill Lynch deal.

Senior economic advisers to President-elect Barack Obama have said that restoring health to financial markets and the slumping economy requires the second half of the $700 billion rescue program as well as a massive stimulus package with a price tag approaching $850 billion.

On Tuesday, Federal Reserve chairman Ben S. Bernanke, suggested that more help for banks could be needed. "History demonstrates conclusively that a modern economy cannot grow if its financial system is not operating effectively," he said, adding that both the stimulus and the rescue package were essential to restoring health to financial firms.( HE'S CORRECT )

Yet it remained unclear yesterday whether Congress would approve the release of the last $350 billion in the program known as the Troubled Asset Relief Program, or TARP. Obama's transition team asked lawmakers to do so Monday, saying it was urgently needed. But Democrats are growing increasingly concerned about their ability to quickly deliver the money to Obama.

In the Senate, Republican support for release of the funds has evaporated in the face of public anger over the Bush administration's management of the program. With more than a handful of Democrats also opposed, Senate leaders scrambled yesterday to rally support.

The Senate is set to vote today on a resolution to block the release of the money.

Late yesterday, Lawrence H. Summers, Obama's top economic adviser, and Rahm Emanuel, Obama's incoming chief of staff, met with Senate Republicans to try to persuade them to come aboard. But even many Republicans who voted to create the bailout program in October now say they are unlikely to back the release of the money.

If Congress votes to block the cash, Obama has the power to veto the resolution, all but ensuring the money would be in place early in his administration. Some Republicans said they see no point in casting an unpopular vote simply to spare Obama the discomfort of issuing a veto against the Democratic Congress as one of his first acts as president.

"The Republican base hates this. So a lot of people are saying why anger the base in the name of good policy( TRY DOING WHAT'S BEST FOR THE COUNTRY CINCINNATUS ) when it's going to happen anyway?" said Sen. Robert F. Bennett (R-Utah), a senior member of the Senate Banking Committee, which was at the center of negotiations during the TARP's creation.

Republicans -- and many Democrats -- also say they are dissatisfied with Obama's pledges to dramatically reshape the rescue package to more directly assist distressed homeowners, small business and other consumers in search of credit, as well as to bolster oversight.

Republicans, in particular, want assurances that the money would be reserved to help ease the credit crisis in the financial system. They do not want the funds to go to other sectors, such as the faltering auto industry, which last month won a small share of the money from the Bush administration. That decision, said Sen. Bob Corker (R-Tenn.) turned the program into a "$350 billion slush fund."( IF THE MONEY IS JUST SPENT ON THE FINANCIAL SECTOR, IT WILL BE SEEN AS FAVORITISM AND CRONYISM, WHICH YOU SHOULD UNDERSTAND, SINCE YOU'RE AN EXPERT IN IT. )

After an hour-long meeting with Summers and Emanuel, many Republicans, even those who supported the TARP last fall, said they remained skeptical.

"They probably haven't said quite enough yet for most Republicans," said Minority Leader Mitch McConnell (R-Ky.).

Lawmakers were initially swayed to vote for the bailout program in October because of evidence that some banks were in extreme trouble. At that time, the government pushed healthier banks to acquire faltering rivals.

Now the buyers, which included Bank of America, J.P. Morgan Chase and other major banks, are struggling to make the mergers work. The prices they paid seemed like bargains at the time, but losses have been greater than the banks expected.( GEE. THEY'RE SUCH EXPERT FORECASTERS. )

J.P. Morgan Chase will be the first of several major U.S. institutions to report earnings in coming days. Last year, it acquired two troubled firms, Bear Stearns and Washington Mutual. Analysts expect J.P. Morgan to report a narrow profit after a very tough year-end quarter.

Citigroup, which has received $45 billion in government aid, is expected to report a loss of more than $3 billion on Friday. The company also plans to announce that it will sell several major units to raise capital.

Bank of America, which reports earnings next week, has had enough capital to support its own operations but not enough to absorb Merrill Lynch's losses, according to two people familiar with the situation. Losses at Merrill Lynch have outpaced expectations since the merger was announced in September.

The banks closed the deal Jan. 1 after the Treasury Department committed( GUARANTEED ) in principle to making an additional investment, the sources said.

Bank of America and the Treasury declined to comment.

In total, banks raised about $456 billion in 2008, of which 41 percent came from the U.S. government, according to investment bank Keefe, Bruyette & Woods. But most of the money from private sources was raised in the first half of the year. As the crisis has worsened, the institutions have come to rely almost entirely( YOU THINK? ) on government help.

Staff writer Paul Kane contributed to this report."

If we had simply nationalized these banks, we would have saved ourselves money and aggravation. A hybrid plan pits the banks against the government, even as the money is handed over to the banks, who will continue to lobby for favors. Here's another obvious mess that people can't seem to see. Does anybody who favors the free market really believe that these banks believe in it, or would even be competent to do business in it? Please.

"They are acting worse now with respect to mortgage mods than during the bubble years with exotic loans. "

Mr. Mortgage doesn't like what he sees in Mortgage Modifications:

"WaMu’s New $1 million 5-year 1% Balloon Loan (mod) - $878 Per Month!( THAT SEEMS LOW )

Posted on January 7th, 2009 in Daily Mortgage/Housing News - The Real Story, Mr Mortgage's Personal Opinions/Research

WaMu takes the game of re-leveraging the home owner in order to avoid a default, foreclosure and subsequent credit loss to the next level. Banks can not be left to modify trash mortgages on their own - they do not have enough of a sense of responsibility. ( THIS SEEMS TRUE, IF WE EXPECT SOME SOCIAL LARGESS ON THEIR PART. )

They are acting worse now with respect to mortgage mods than during the bubble years with exotic loans. I have seen many mortgage mods over the past year but nothing I have ever seen is as irresponsible as this mod WaMu recently authorized…Bank of America came close (see link below).

• Countrywide/BofA - A Direct Threat to Borrowers & Shareholders (109)
  Posted on September 3, 2008 1:32 PM

DISASTER OF EPIC PROPORTIONS

Mortgage modifications have turned into a disaster of epic proportions. Every where you look, mortgage mod firms are promising things that I do not believe can be attained. Back in the good old days of nine months ago when I became hot and heavy on private sector loan mods, the banks and servicers were actually looking at the entire picture and reducing principal balances when necessary. The home owner or mod company would present a ‘present’ and ‘proposed’ solution to the note holder of which one of the choices was a principal reduction — and many times it was granted.

As you know, I am a big proponent of mortgage modifications done the right way. I have swung completely over to this side of the fence as regulators, law makers and banks have rolled out their harmful, boiler-plate loan modification initiatives that leave many underwater, over-leveraged renters for life.

It is obvious that these loan modification plans have been born as a result of panic and the need to protect the bank’s balance sheets( TRUE ) rather than doing what is beneficial for the home owner and broader housing market. Fannie/Freddie and FDIC ‘mod in a box’ examples below.

• Fannie/Freddie - Come Get Your Loan Mod & Pay For Life (81)
  Posted on December 17, 2008 1:52 PM
• Mr Mortgage: Actual IndyMac (Exotic) Loan Modification (63)
  Posted on December 3, 2008 2:13 PM

MORTGAGE MODS DONE RIGHT

A mortgage mod done right is a ‘mortgage banking model’ mod where the borrower is fully re-underwritten using present income and debt levels, prudent 28/36 debt-to-income ratios and current market rates — similar to a cram-down. ( SOUNDS GOOD )

This immediately de-levers the home owner enabling them to freely sell, refi, save money, shop etc. Typically a principal balance reduction is needed to bring these home owners in line, but it is the only permanent solution( I AGREE ). It is also the only solution that can prevent the broader housing market from being a dead asset class with zombie homeowners for two decades. ( I AGREE )

• Mr Mortgage: My Case FOR Mortgage Principal Reductions (124)
  Posted on December 14, 2008 1:49 PM

Given the push by regulators, law makers and banks into ‘modifications in a box’, I now have my doubts that private mortgage modification firms will have the types of successes we saw earlier in the year. Most modifications I am being told about coming out of loan mod firms around the nation are identical to the FDIC, Fannie/Freddie, Bank of America and WaMu examples herein.

These I do not endorse in most cases - specifically if they do nothing more than offer a term teaser-rate, extend the term, defer interest or principal, come with large balloon payments etc. These do nothing more than kick the can down the road and in the case of large deferred interest or principal balances make the home owner a trapped, underwater, over-leveraged renter for years, if not life. ( A GOOD POINT )

NEW WAMU LOAN MOD - THE 5-YEAR BULLET!

Below is an actual example of a recent WaMu loan mod with a 5-year $1 million bullet payment. This mod takes exotic lending to level I have never witnessed in my 20-years of mortgage banking. This makes a Pay Option ARM looks safe and cozy — and puh-lease do not tell me this is great because it frees him up to spend money into the economy.

Banks offering and borrowers actively accepting this style loan mod will guaranty that the housing crisis stays will us for a long time to come. This borrower will lose his home in 5-years, I have no doubt. That is of course unless his house price goes up 100% AND great, low rate super jumbo money returns to the market so he can refi out of it - then again, many lenders won’t even refi a loan that has had a previous loan mod done.

Property Value: $800k

Note amount: $1 million plus deferred interest

New Mod amount: $1.053 million

First TWO years rate/payment: 1% and $878

Third year rate/payment: 3% and $2633

Forth year rate/payment: 5% and $4389

FIFTH YEAR PAYMENT - THE BULLET: ALL OUTSTANDING BALANCE DUE AND PAYABLE

All rights to future predatory lending claims waived.

There are some very good points here. First, a Mortgage Modification must lower the principal as well as monthly payments. I liked the idea of giving the lender some of the principal when the house is sold, but Felix Salmon says the lenders don't like this idea. Second, the lenders are dealing in their own best interest as they see it, just as the banks are doing with TARP. That's how the system works, but then we shouldn't expect any social largess on their part. The lenders are , in essence, pushing foreclosures down the line in the hope of stabilizing home prices. They're trying to have it both ways. At first, of course, the lenders were hoping to be made whole by government intervention. One McCain proposal did just that. Now, barring some government plan, they're just deferring their foreclosing actions until a better time in the future. Thirdly, to the extent that fraud and other abuses occurred in the mortgage business, it doesn't look like the lenders have any fear of this being seriously pursued. If Mr. Mortgage is correct, the lenders have simply found a new way of selling dodgy loans, under the pretext of doing social good. Loans that have no real chance of working out are not kosher.

Earlier, I said that the government would have to impose a deal on the lenders in order for the plan to work, but that I didn't agree with that since it was essentially seizing private property. Without that, it's hard to see how many mortgage modifications will actually last, although some undoubtedly will. Obviously, there will be differences in the modifications depending upon how seriously each lender deals with this problem.