Brilliant Comment

I felt I had to draw attention to the comment by “Conscience of a Conservative.”

He’s a long-time participant in the market who has one of the remaining jobs, in spite of being there when we were creating CMO structures for half million dollar profits while risking hundreds of millions in capital.

That contrasts sharply with the five and ten million dollar fees Wall Street ginned up in its CDO business in the new millenium, all while pushing 100% of the risk onto investors and borrowers (and eventually, taxpayers).

The reason I liked his comment was that it had a realist’s view of the compromised principles of both the “left” and the “right,” since neither group is doing much at all to advance their claimed goals, and both are proving themselves to be lackeys of the corporate overlords.

After the break, I’ll repeat his cogent comment, and make a few of my own….From Conscience of a Conservative:

The Fannie/Freddie debate is a smoke screen with the real fight about which group vision gets to reshape the country. Chris Whalen had a great quote about Obama wearing Herbert Hoover’s Concrete Booties.

In either case, I’m more worried about how current policies are putting the nail in the capital market’s coffin. We have zero interest rates which throws a huge monkey wrench in CAPM decision making, a Fed who is making what shouldn’t be callable MBS callable, a president who has supported rewriting contract law to make private investors in 1st lien mortgages and not banks in 2nd liens bear the brunt of mortgage write-downs, and a lack of will by the DOJ to investigate and go after fraud.

The way I look at it, whether it’s the Republican vision or the Democratic vision the rule of law goes away with more corporatism. In mortgages the way money is made now is by four large banks capturing half the spread of new mortgages being delivered to pools guaranteed by the tax payer.

This remarkably insightful comment follows a weekend of talking heads and financial analysts buying into yet another smokescreen.

I’m talking about the foreclosure settlement (thanks for asking, Alex).  My former colleague and clever bond trader Scott Simon summarized it pretty well:

“This was a relatively cheap resolution for the banks,” said Simon, the mortgage head at Pimco, which runs the world’s largest bond fund. “A lot of the principal reductions would have happened on their loans anyway, and they’re using other people’s money to pay for a ton of this. Pension funds, 401(k)s and mutual funds are going to pick up a lot of the load.”

First, let’s get past the headline numbers and see what they actually agreed to do.  The banks actually agreed to pony up about $5 billion in cash.  That’s around 10 percent of the profits they made last year, profits that came, in large part, from the taxpayer-guaranteed mortgage business they dominate, and from the incredibly low rates they pay out on CDs while collecting much fatter yields on MBS.  And, as C of a C pointed out, on new loans they don’t keep in portfolio, they are consistently extracting about the half the lifetime profit of the new 30-year mortgages they  make, up front, as they transfer all the credit risk to the taxpayers and all the interest rate risk to the investors.  Just to complete the hat trick with a third goal, as Scott Simon points out, most of the remaining $20 billion of the headline number from the settlement is actually being taken out of the pension funds, insurance companies, etc., who hold the private-label (formerly) senior bonds.

Where do the banks skate free?

On their second mortgages and HELOCs (Home Equity Lines of Credit) that they hold in portfolio.  That slug of assets, still totaling hundreds of billions, is rather amazingly being promoted to first in line when those long-suffering borrowers go to sell their homes.

Think about it.  Why wouldn’t the banks have those second mortgages marked down to near zero now that so many borrowers have houses that are underwater on the 70% or 80% (original) LTV first loans.  Answer:  Because they weren’t forced to.  That’s not to say they haven’t taken substantial markdowns.  Those have totaled tens of billions each year among these big banks since the bubble burst. After all, the typical outcome of a foreclosure sale or short sale on an underwater first mortgage situation is to pay off the second lien holder with a thousand bucks or so to keep them from being a pain in the butt about signing releases.  So there you have it…  They’re paying out $5 billion, reordering priorities of losses for outside investors for $20 billion, and comparing that to the tens of billions they were already acknowledging each year.  Such a deal!

How can this be?  Aren’t second mortgages always and forever subordinate to first mortgages?

For the worst of the worst, the “no doc” alt-A loans that Goldman’s mortgage subsidiary and others specialized in, the payoff to the originating bank has been going on for years as they drag their heels in foreclosing.   That payoff comes in the form of super-senior position (above even the top AAA bonds from the first mortgages) for their fees and expenses as a servicer.  Only those of us in the business seemed to notice that the servicing bank also made the second mortgage, and held onto that instead of selling it off like they did the first mortgage.  That loan, with its higher interest rate, has been steadily “paying” its interest these past five years, if only through the legerdemain of the servicing division of Bank A advancing payments, some of which go to that same bank’s investment division.  Leapfrog maneuver complete!

That said, I do have to compliment the holdout Attorneys General who refused to let this foreclosure robo-signing settlement get generalized to cover all sins and crimes committed.  If that were the deal, the banks should have gotten off easily even if they had ponied up a hundred billion.

hh

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6 Responses to Brilliant Comment

  1. Cy Berlowitz says:

    Howard, this is one of your best posts ever. This “conservative” most assuredly does have a conscience. Cy

  2. jivko says:

    Not surprising. And isn’t the case that most of the second mortgages were done in parallel with the first mortgages in order to make otherwise unqualified borrower qualified and make the first mortgages conform to the standard and therefore sellable

    • hhill51 says:

      You’ve got it. And then the first went off to GSAMP (Goldman Sachs Alternative Mortgage Products) or to BSALTA (Bear Stearns alt-A conduit) or others. At least half of them were the deadly negam loans, to boot, so the servicers make out like bandits as long as they don’t advance more than the net recovery value of the foreclosure.

  3. irongate says:

    ditto what berlowitz said. i had never thought about consequence of the 2nd mortgages

  4. Conscience of a Conservative says:

    The Interests of the servicer and the investor are clearly not aligned here. If the servicer is owned by a bank that holds 2nds the conflicts are very apparent. What’s new is how gov’t policy via the mortgage foreclosure settlement has added another dimension to the conflict rather than help resolve it.

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