Subprime Contagion?

Kash Mansori casts his vote in the debate about whether problems in the subprime mortgage market will spill over into other markets and cause problems for the overall economy:

Bad Loans, Banks, and the Coming Credit Crunch, by Kash: I've been thinking about the health of the banking sector of the US economy, and pulled together a couple of charts that have gotten me thinking. And worried.

First, take a look at this picture of the total quantity of loans outstanding at commercial banks in the US, broken down by type of loan.

The two things that strike me about this picture are 1) the obvious cyclicality of lending, particularly to businesses (more about that later); and 2) the incredible growth of real-estate lending over the past several years. Note that all series have been deflated by the CPI, and thus reflect real changes. Even after adjusting for inflation, real estate lending has nearly doubled since the start of 2000.

Now consider that the Mortgage Bankers Association (MBA) recently estimated that about 5% of all mortgages are currently in default, and that the delinquency rate that is growing rapidly. Suppose that we use that statistic to infer that 5% of commercial banks' real-estate loans will shortly have to be classified as non-performing. (Since commercial bank real-estate loans also include commercial real estate loans this estimate is a bit high, but since we know that the big growth in real-estate lending over the past several years has been for residential and not commercial property, the 5% figure at least makes a good starting point.)

That would imply about $170 billion in bad loans, or about 3% of the $6.1 trillion in total outstanding loans (real-estate plus non-real estate loans) on the books of commercial banks. Not all of that $170 bn will be lost to banks, since they should be able to foreclose and sell some of the underlying properties, but it seems safe to guess that banks will end up writing off some fraction of that total - probably many tens of billions of dollars worth of loans, or several tenths of a percent of all bank loans.

Now comes the scary part. Consider the following picture, which shows the rates of non-performing loans and loans that banks have had to write off over the past 19 years.

As of December 2006, both ratios were at comfortingly low levels. But the MBA data suggests that -- even if delinquency rate abruptly stops rising today -- we should expect the ratio of non-performing bank loans to rise by a few percentage points, and the portio of bank loans that banks are forced to write off to rise by some tenths of a percentage point. Those developments would quickly move the series in the graph above into the range where they were during the period 1990-92, when bad loans caused the massive Savings and Loan crisis and a widespread recession-causing (or at least recession-exacerbating) credit crunch through the US economy. (At this point, feel free to refer back to the top chart to see the effects of that credit crunch on business lending in the early 1990s.)

I hope it's now clear why I'm in the camp of those who are worried about the financial spillovers that the housing slump will have on the broader US economy.

Sticking with the topic of subprime mortgages, Robert Kuttner says there is a lesson to be learned from the collapse of this market:

The dangers of deregulation, by Robert Kuttner, Commentary, Boston Globe: The Bush administration and the US Chamber of Commerce picked an awkward moment for their latest assault on financial and consumer-protection regulation. At the very moment that Treasury Secretary Hank Paulson was meeting with Wall Street bigwigs in a high-profile confab this week to call for weakening of the post-Enron Sarbanes-Oxley Act and other investor and consumer protections, the stock market was tanking.

Why is the market so nervous? Mainly thanks to the latest bitter fruit of financial deregulation : the collapsing $1.3 trillion "subprime" mortgage business, which now accounts for one mortgage in three. Here is a textbook case of why financial institutions need to be regulated, to protect both consumers and the solvency of the larger economy.

In the past decade, as regulators discarded rules, shady mortgage banking companies, financed by the bluest-chip outfits on Wall Street, calculated that they could make a lot of money offering bait-and-switch mortgages to poor credit risks. Default and foreclosure rates would be greater, but higher profits would more than compensate for the risks. So the subprime mortgage industry, enabled by the big banks, invented amazing gimmicks. These included not just variable-rate mortgages, but mortgages that were initially interest only, mortgages with introductory teaser rates, mortgages with no down payment. No income verification required! No credit check! Subprime operators targeted people with horrific credit histories and families desperate for housing who could not afford the debt they were taking on. Last year, 60 percent of subprime loans required no meaningful documentation.

Then came the morning-after: As higher payments kicked in, people couldn't meet them. Defaults skyrocketed, to an estimated 13 percent of all such loans. At least 25 subprime lenders have gone out of business. The big dogs on Wall Street, who had invested in the subprime operators, took a big hit, too.

It's not clear where this will end. Many low-income families will lose their homes. Innocent investors will suffer the spillover effects on the stock market, and general mortgage rates may have to go up to compensate for these losses of reckless speculation.

But wait. Weren't these subprime lenders doing good works by making it easier for low-income borrowers to become homeowners? ... If the goal is to promote low-income homeownership, there are far better ways that don't put financial markets at risk and don't cause people to lose their homes after a few years.

For instance, the FHA has long had a program of insured loans that require only a 3 percent down payment (and have a much lower default rate). Non profit and public programs like Neighborhood Housing Services offer long-term help to moderate-income homebuyers on credit counseling. If we were serious about promoting first-time homeownership, we would offer subsidized, low-rate mortgages, as we did in the Great Society era, before Reagan and the Bushes gutted social spending. ...

Supposedly, the wizards of the private secondary mortgage market, such as Fannie Mae, vet the mortgages to make sure reasonable standards are being met. But Fannie has been reeling from her own scandals, and obviously someone was asleep at the switch. ...

Congress is ... investigating the entire mess, while mortgage industry lobbyists hope to fend off regulation by using the low-income family as poster child for the industry's misdeeds: Regulation would just hurt the poor.

But before the mid-1970s, this kind of meltdown didn't happen, because there were regulations and prudent credit standards; low-income people got government help rather than private-market scams -- and there were hardly any defaults. How many more financial scandals will it take before we get back to that model?

I don't want to go back that far, i.e. to the 1970s - it was too hard even for good credit risks to buy a house, but rethinking how these markets are regulated is clearly needed.

Comments

[maria]

The flip side of a meltdown would be super bargains in the stockmarket. I checked on the adjusted price for Citigroup. It was selling for $1.78 on March 1, 1991. Bank of Boston (now merged into Bank of America) for some other incredible firesale price that led the Tisch brothers to scoop up a shovelfull of it. The only drawback was overcoming the fear these banks would go bust. Come again, please. LOL.

[Elvis]

I think maria has a good point. Part of me wishes for this to be a big deal. After a major meltdown, I can stop worrying about whether or not it will happen and then I can start shopping around.

[spencer]

Maria-- one of the reasons the relative performance of the S&P bank stock index actually has a 0.33 positive correlation with bond yields is this fear of credit quality. Bank stocks typically underperform when interest rates are falling because this is exactly when markets worry the most about the quality of the banks loan portfolio.

So stepping up too early to buy banks stocks is a very dangerous game. The market can stay irrational a lot longer then you can stay solvent.

[Lafayette]

RK: "For instance, the FHA has long had a program of insured loans that require only a 3 percent down payment (and have a much lower default rate). Non profit and public programs like Neighborhood Housing Services offer long-term help to moderate-income homebuyers on credit counseling. If we were serious about promoting first-time homeownership, we would offer subsidized, low-rate mortgages, as we did in the Great Society era, before Reagan and the Bushes gutted social spending..."

Of course there’s a better way to do it and in such a manner that the poor have access to a home and not confiscation proceedings. Yes, the poor may need credit counseling, but more so, they need a state guaranteed loan to tide them over the time when they may be out of a job. (The unemployment compensation could include a suspension in mortgage repayment that kicks in again once they are reemployed.)

There are ways to make such a program work such that people take pride of ownership and therefore want to maintain that value, but do not get thrown onto the sidewalk at the first cold wind that passes.

But, don’t expect private enterprise to propose that solution. There is no profit in benevolence. So, where private enterprise cannot meet the standard, then the state/government must.

Meaning, yes, more government spending. Meaning above all a standard. Like a Bill of Rights that guarantees house and home, regardless of one's economic circumstance.

[Elvis]

Here's a thought...
put some yeast in a barrel of sweet malt and it begins to grow, feeding on the sugar. Well, you know the rest. Organisms grow exponentially when introduced to a new food source until that resource is fully developed and then there is a collapse (and hangover)

Isn't exactly the same behavior with booms and bubbles?
Easy loans were made available. Individuals took advantage of it. There was a flourishing, then a point where the food ran out and now we are seeing collapse. Aren't we witnessing the same behavior as an algae-bloom?

[maria]

Well I agree not to jump in too soon as many do. Wait until you think things cannot get any worse and then wait a bit more. But I recall when Citi was selling for $9 a share (now adjusted to about $1.75) and Bank of Boston at $4, that I cannot adjust since it has merged several times and now is part of B of America. I think a good time to jump in is when you see people like the Tisches jump in. Piggy back, as it were.

[dd]

The real contagion is the loss of confidence in regulatory structures that acted as aiders and abettors rather than watchdogs protecting the public interest. FDR's regulatory legacy is dead as a doornail; but its demise does provide profit opportunities for investors willing to take risks in pseudo-regulated and increasingly opaque US markets.

[Bruce Webb]

This is the kind of thing that drives me nuts. In the course of an article about the melt-down of sub-prime in America's paper of record we have this poster child:

"Consider Nathaniel Shields, who expects to lose his four-bedroom Cape Cod house in southwest Chicago to a foreclosure in May.

He cannot afford his mortgage payment, which jumped to $1,300 a month from about $1,000 after his loan reset to a higher interest rate last summer. A divorce and the loss of his county government clerical job, which paid $14.80 an hour, have also hurt."

Has there ever been a mortgage market anywhere where losing your job while going through a divorce might not be a sufficient enough explanation for default? No it is all about the ARM.

Now you can argue that a $1000 payment on a $2600 monthly gross is within standard guidelines, while a $1300 payment is not, you want to keep housing costs below 40%. And without knowing about how many kids Mr. Shields has we could debate the wisdom of his buying a four bedroom house on a clerk's salary. But is this the best they can do to condemn sub-prime lending?

The plural of anecdote isn't data, and certainly the plural of crappy anecdotes that don't even make the point you are trying to make isn't data.

You lose your job and unless you have done some planning you have difficulty paying your bills. This isn't exactly stop the presses material. I made appreciably more than Mr. Shields and live in a much smaller house. I lost my job unexpectedly a week ago and regard it as an opportunity to take an extended vacation, that is the difference between carrying a mortgage balance of $108,000 and $600,000.

I don't think those graphs are illustrating the points people want them too. Until a week ago I worked with a financial services company that used various types of sub-prime loans very aggressively to get investors in rental properties. And our lending officers pushed the underwriting guidelines very, very hard. Lets just say that not every business license was actually backed up by enough business to justify the stated income we had our borrowers claim. And the lenders know that clearly, you really would not believe the levels of cynicism on all sides of these transactions.

On the way up real estate investors were able to get into properties with little to no down. In return they had to pay a point or two more in interest. They in turn gained all of the appreciation, while the loan originators earned their fees, and the lenders were able to package the loans at attractive rates. Win, win, win.

But boy howdy like in any heavily leveraged investment it doesn't take a lot of changes at the margin to put you under water. Look over the last few years sub-prime went from a way to lend money to people with poor credit to the financing choice of investors who wanted to leverage themselves to the hilt. I am still waiting for a breakdown in delinquencies by SMSA and by investor vs. owner occupied, the latter corrected by the fact that a whole bunch of "owner occupied" loans were not in fact actually occupied by the owner. Because nobody was checking. Because nobody had an interest in checking. Because over the last four or five years the money was in writing the loan and not denying it.

In real estate it has long been nthat the three key factors are "location, location, and location". Well in the meltdown in sub-prime it seems that the three key factors are "exposure, exposure, and exposure". There is clearly a concerted effort to keep the focus on the poor shlumph losing the house, but the fact is that what puts the "sub" in sub-prime is the fact that the borrower doesn't necessarily have much skin in the game. If they had the credit, income and assets to make a regular down payment they probably would be in a conventional loan to start with.

Maybe this will all bleed over into Housing Apocalypse Now. But the fact is that this 'crisis' is going to run head on into the market of people who make more than their mortgage payment and have no reason to sell into a down market. Which in most markets is most people. May not be true for Phoenix or the Inland Empire. On the other hand I don't live in either place.

[Lafayette]

Elvis; "Aren't we witnessing the same behavior as an algae-bloom?"

Oh, I see ... we are to assume that what happened was a NATURAL biological phenomenon?

I was thinking it was regulatory oversight negligence and that heads might roll.

Right. Now we can get on with our existence. I am soooo relieved ...

[dd]

Heads will not roll; instead private equity and hedge funds will go public (with the SEC's blessing) to cover losses relating to subprime.

[luci]

Lenders effectively became real estate speculators. I don't see a huge problem with it. If lenders end up owning (foreclosing on) a significantly bigger slice of the real estate market, they'll take some hits, prices will fall a bit in the frothier markets.

Yeah, some people are gonna lose their homes (barring govt intervention). Most of these people couldn't have afforded what they bought without the sub-prime gymnastics.

In the US, we've been swimming in liquidity for years now. Super-low interest rates were bound to result in an irrationally exuberant market somewhere, as the cash chased returns.

Home ownership is at all-time highs. That'll fall some, prices will fall. A few banks will get hurt. Genuinely poor people aren't really a part of this story.

[bullbust]

Bruce,

>But the fact is that this 'crisis' is going to run head on into the market of people who make more than their mortgage payment and have no reason to sell into a down market.

If this is right, then most people wont have any problems when ARMs reset. Most people that will get hit by the 'crisis' can right now refinance into a fixed loan. Because they "make more than their mortgage payment" and can very well afford the mortgage payment. Right?

I beg to differ. Most of the people who took out ARMs, option ARMS, I/O loans did so because they could not afford the fixed. Those things were pushed as affordability products.

Those who are in stable loans, with equity and good DTIs have nothing to worry about. But that's not the market the last 2-3 years.

What was really bad was the way people with good credit were pushed into loans far above their ability, to get them into that "better" house, using these affordability products

[Bruce Wilder]

Credit card banks now routinely charge 33%! (And, Brad DeLong probably still can't find the mechanism by which wealth and income have been radically redistributed.) CNN now has ads from the check cashing/payday loan "industry" piously warning people not to abuse their offerings, and ruin their lives.

Income and wealth can and are being redistributed from the poor and middle class to the extremely wealthy and giant business corporations by depriving the poor and middle class of sources of cheap insurance and by imposing increased financial risk. The redistribution follows from simple abrasion.

I, personally, loathe the EITC. (No, this not a non sequitur, read on.) It is a subsidy for merit-less employers, offering lousy jobs, in a economy stripped of meaningful opportunity. And, it is typical of the Milton Friedman analysis, which carefully avoided taking note of externalities or risk, in order to argue for social and economic ideal, which would enable the kind of post-Reagan crap which is dragging this country into the sewer -- an economic ideal in which the government deliberately redistributed income from rich to poor by writing checks -- welfare as a handout, a proposition with very little political appeal -- while all the institutions, which created and maintained a middle class, by providing cheap insurance -- the assurance of a good education for children, of security in old age and ill health, of home ownership and secure savings -- were gradually stripped away, as part of a program of freeing people otherwise on the road to serfdom, freeing people to accept responsibility for their own lives.

And, yeah, it was hard to buy a house in 1970; FHA loans were hard to qualify for. But, that process of qualification ensured that the house, itself, was of sound construction, and that the borrowers were ready to commit. Whatever its bureaucratic demerits, the FHA and the banks were encouraging people to behave responsibly, and rewarding them for it. It wasn't about fueling a real-estate froth, from which some sunavbitchs could skim billions, or separating fools from their money and credit.

No doubt, we will see many proposals to "re-invigorate" the FHA, not a few of them from the Right, which will see an opportunity to have the Federal government rescue the subprime scammers. (I'll believe that the subprime lenders, and not just their victim-borrowers, are in trouble, when Countrywide, the biggest loan sharks in the country, drop their ad campaign for no-fee re-fi.

I hope we will see some pushback from pundits and politicians, and, yes, liberal economists, so that the government's response to the subprime meltdown, doesn't become just another Medicare Part D -- a dubious aid to people, who don't need help, and a huge giveaway to a bloated industry and its overpaid executives.

[bullbust]

>No doubt, we will see many proposals to "re-invigorate" the FHA, not a few of them from the Right, which will see an opportunity to have the Federal government rescue the subprime scammers.

Exactly. All of the proposals will have the home-owner as a pass-through, and the real bail out will be for the lenders.

I am all for rescuing distressed home-owners, provided,

-the note is written down to what the property is worth (lender eats the loss, value of property gets reduced, etc)

-the resulting mortgage after the write down is within the means of the home-owner ( i.e it does not need teaser and option gimmicks to make it within their means)

[robertdfeinman]

One should look at what happened in Japan when the real estate bubble popped. Many banks were technically bankrupt since their non-performing loans exceeded their assets.

Rather than foreclose or write off the loans the government changed the rules and allowed the whole situation to slide. After a decade things worked out. The only side effect was a decade of economic stagnation.

We can't predict the future when the government can change the rules whenever those who are at risk of getting burned put on the screws.

I'm willing to guess that the worst scenarios won't unfold. Some program of bridge loans or credit stabilization or some other mechanism will be created.

[maria]

Well making money has often been about taking advantage of the weak and the foolish. Making money has never had much morality to it, in spite of the funds that tell you they will invest in only socially responsible, etc., companies. One thing government is for is to give some measure of protection to the weak and the foolish, but the US government and the people who run it in recent times haven't had any interest in doing that. They tell the weak and the foolish to believe in "rapture" and religion and forget their material well being, the better to pick their pockets as they pray. LOL?

[calmo]

Well if this doesn't draw eva Making money has never had much morality to it, in spite of the funds that tell you they will invest in only socially responsible, etc., companies I think we can be the first to have announced his death.

I dunno, maria is spooking me with question marks behind "LOL": They tell the weak and the foolish to believe in "rapture" and religion and forget their material well being, the better to pick their pockets as they pray. LOL? Hyena laughter maybe.
Lemme give it a go: They? You tellin me?

What dd said and mostly that the opacity is engendered by the few who have voices and the many who would rather follow those voices than do that thinking that has produced such a dismal record. QED.
FCOL?

[dd]

Maria, agreed. The Borgia/Medici model is always a money winner for the upper classes.

[dd]

There was a time long ago when the term "public interest" included the everyday citizenry. Greenspan's testimony after the tech bubble burst pretty much redefined that notion and in his own indecipherable way he allowed as how "the strong demand for household credit" saved the banking industry from itself and then of course there was the call to ARMS.

[Winslow R.]

There is still a possiblity of a 'benign' outcome. Given that GS and MS have access to the nonregulated Chinese banking system and a solid dollar peg, all kinds of games could be played.

Article on the Shibor

http://www.iht.com/articles/2007/01/10/bloomberg/sxpesek.php

[evagrius]

"Well if this doesn't draw eva

Making money has never had much morality to it, in spite of the funds that tell you they will invest in only socially responsible, etc., companies
I think we can be the first to have announced his death."

You talkin' to me?

Well, it's true. Making money is making money. Sometimes it's honorable, as when someone makes a product or provides a service with a bit of pride and professionalism. When that is so, making money is honorable.

But that's a far cry from speculation or gambling, betting on one's own greed and the greed of other people, ( and their credulity).

When money is made that way, it's fairly dishonorable.

The present housing crisis is only a small prelude to a deeper one. Don't forget how many people have refinanced their homes, or taken out equity loans, etc;

When the housing price goes down, even only a few percentage points, they're going to hurt.

There's a lot of fools out here.

Easy pickin'.

[jm]

"...shady mortgage banking companies, financed by the bluest-chip outfits on Wall Street, calculated that they could make a lot of money offering bait-and-switch mortgages to poor credit risks. Default and foreclosure rates would be greater, but higher profits would more than compensate for the risks."

I suspect that what they really calculated was not that "higher profits would more than compensate for the risks," but rather that they could plausibly argue that in order to fob the risk off onto MBS and CDO buyers, while making their own profits from sales of option stock before the wheels came off. The Shady Bunch are well clear of the wreckage and can just retire in comfort.

[Lafayette]

dd: "The real contagion is the loss of confidence in regulatory structures that acted as aiders and abettors rather than watchdogs protecting the public interest."

The moral high ground is difficult to find in this situation.

People contracted debt and now they will have to yield property they can no longer pay for. I am wondering what should a regulatory agency have done.

There is no analogy in the banking system. The Fed guarantees bank deposits. Why should a government body protect debtors who contract credit that is beyond their means to pay?

I appreciate that the credit companies offered the ability for the poor to obtain a house. But, I am wondering as well, given the stories mentioned, if there were sufficient safeguards in place.

A loan from a bank always required a worthiness check. Now, some fool invents a system where worthiness is not a criteria. The only requirement is that a borrower be breathing when they sign the contract.

This situation is not extra-legal. The contracting debtor was enticed/seduced/snookered into a debt that should not have been contracted. But, they remain responsible adults.

What should be done is to have the FHA take over the role of "first lender" to a class of people who are obtaining their first mortgage. Since the FHA is a government entity it could lend at a lower rate to insure that they are considered initially by first-time buyers.

Then an arrangement can be made such that those who had a job but lost it are given a suspension of payment during their period of unemployment (perhaps consonant with other conditions as well), so as to continue residing in the property.

But, as a condition, they must prove that they are actively looking for a job as well as taking training courses in skills enhancement. They could also be placed on a volunteer list for part-time work with the city or state. (People like the social interaction of the work place and social exclusion must be avoided or individuals lose their self-confidence.)

People who want to contract debt (beyond the government "safety net") with private credit companies of course can do so - but the risk of eviction in case of non-payment is theirs as well.

The state has a duty to help the less fortunate into decent housing. But, it cannot accept the role of guardian to those who would behave foolishly.

[dd]

Not "a" regulatory system but the regulatory system which lurches from one foreseeable debacle to the next (junk bonds, risk arbitrage, S&L, LTCM, tech meltdown, Enron, World Com et.al., derivatives accounting scandal, investment banking conflicts, mutual fund timing scandal, options backdating, and now subprime to name a few). All these "disasters" are studies in regulatory arbitrage that not only threaten individuals but also the integrity of the financial system. When, as jm points out, the major profiteers walk with at best slapped wrists and all the profit that raises substantial integrity issues. So, yes debtors were foolish; but a financial system functions on the full faith and credit of the government and its financial regulators providing at least the illusion that fraud is being policed.
I fully expect that these debtors will not be bailed out by the government; the risk transference much like the tech meltdown is adequately spread across individuals and probably will not threaten the "system." A taxpayer bailout is not likely and it will be treated like Katrina. Lots of handwringing but in the end the lower 9th is still ravaged.

[elvis]

Lafayette,
Oh, I see ... we are to assume that what happened was a NATURAL biological phenomenon?
Well, I was thinking (and I'm sure it ain't original) that the economic behavior individuals mimics that of biological organisms.
I was thinking it was regulatory oversight negligence and that heads might roll.
Yes, negligence opened the gate to new pastures; i.e. easy credit to high risk borrowers.
At first, there is a rapid increase in the population, and it is viewed as a success. Then quite quickly there is a point where success changes to crisis. In this case, supply of nutrient (cash) becomes fully exploited. This occurs in conjunction with a "poisoning" of the environment by the new organism. In beer brewing, the yeast's viability is compromised by its own waste product, alcohol. In this economic situation, the waste product is defaults--and excess housing.
There will be a die-off, (what is it usually? 90%?). Surviving individuals will continue at a lower metabolic rate.
What is one organism's die-off can be another's bonanza-- corks pop off champagne bottles.

In this case, the die-off of high-risk lenders/borrowers will adversely affect neighboring organisms (low risk borrowers)because there will be a loss of cash nutrient and an abundance of waste product (excess housing).

The environment's overall metabolic (economic) rate will be much diminished.

[TJM]

Two things about regulators, although I believe most of the sub-prime lenders are unregulated, but the S&L crisis arose largely because the regulators were underfunded. Without enough personnel to cover all the banks and S&Ls, there were all sorts of "loans" being booked. I was on a team reviewing an S&Ls books prior to us underwriting their conversion from a mutual to a stock S&L. There were so many bad loans, including one where the "bank" was continuing to finance a construction loan despite mechanic's liens filed on the property. Avarice and greed are hard to regulate away, especially when there are insufficient regulators.
I would also point out that the regulators themselves are all too often the graduates in the bottom 25% of their class. They have good bennies but salsry is a bit low. You do get every other Friday off though.

[dd]

TJM, true now; but not back in the '70's & '80's before professional income inequality reared its ugly head. The S&L crisis was the first financially engineered debacle stemming not just from bad loans but the junk bonds providing the liquidity tool for uber-lending. Florida for example didn't allow below AA bonds; but unrated junk bonds got a pass. Much of the S&L and insurance liquidity was based on Drexel's illiquid junk bonds. Regulators knew; but deregulation and politics prevented a unified response. That aspect has dominated the last 20 years and too income inequality finds the upper tiers migrating to the private sector.
Grand plans do come together. Fraud is no different from any other crime; the key is enforcement which is nonexistent.

[calmo]

I feel like Tonto and dd has not only the taller horse but all the silver bullets, you know?
A pleasure to read how convincingly you mince through this opaque financial forest dd. [I have my trusty bow and arrow, but right now I think I'll just sit down and listen.]
Thanks eva, death announcement duly retracted and hopefully postponed indefinitely.

[dd]

Calmo, the sadness rests in understanding banking regulators learned a valuable lesson from the S&L debacle: ie taxpayer bailouts equal systemic integrity risk so shift the financial risks of deregulation across the individual spectrum thereby avoiding a "taxpayer" bailout but providing a bailout nonetheless. The deadbeats bailed out the tech bust via "household credit" and provided astounding investment banking profits via subprime loans. Investors are nervous for good reason.

[evagrius]

Ah, it's all a big con game. Everyone looking for the easy profit, quick and dirty and right now, if not sooner. Fairy gold. Elfin gold.Leprechaun gold.
There's an air of wizardry about all this.
Harry Potter and friends would have it sorted out with ol' Dumbledore giving some tips.
Valdemort, he who must not be named, is behind all this chicanery.

It's typical muggle idiocy.

[calmo]

Kuttner from the Globe writesBut before the mid-1970s, this kind of meltdown didn't happen, because there were regulations and prudent credit standards; low-income people got government help rather than private-market scams -- and there were hardly any defaults. How many more financial scandals will it take before we get back to that model? and it dawns on me that this whole notion of looking for the Next Big Thing (nano-tubes being one poster child) that will take the housing baton (a latent heist as it turns out) now that it shows signs of being punctured, is so naive (hey if you have to wait for the red/green decision, be merciful).
It's the Next Big Heist that we (you figure that's too cynical? Principals of Drexel are still heisting...) are waiting for...and now that it's clear the press is largely a promoter and not an oversight body (like in those good old days when Presidents actually were impeached by the work done by diligent reporters and their employers) its only a matter of time.
Kuttner could be a little more explicit about who "we" is and what a miserable record the press has had in reporting this lapse in regulation. Not surprising that the public mirrors the same civic responsibilities that the press does.

[Lafayette]

evg: "There's an air of wizardry about all this."

That is not quite the smell I had in mind.

Let me place a European view up for consideration: GE Money Bank, whom I contacted in France, was quite prepared to offer me an interest-payment loan only. They proposed this type of home-purchase loan because they noted, in France, that people change houses about every seven years.

So, paying pure interest on a fifteen or twenty-year loan that will likely be rolled-over every seven years is seemingly not a bad idea - given that the principle need not be paid until the end of the credit period (15, 20 even 25 years), when the realty value of the house will have increased by 3 to 5% per annum.

They were prepared to give me a "fixed-variable" rate, meaning that the loan was pegged at a rate that was fixed over a period of one year. So, in fact, it was a moderated variable rate, that still followed the Euribor rate more or less on an annual basis.

GE Money Bank DID NOT dispense with either a credit check or a worthiness analysis that required that I submit documents proving my income. Why? Because French debtors law requires that ALL loans be substantiated so as to assure that the debtor has at least, as income, three times the amount of monthly payments. And, there is a file at the Central Bank of all loans and their amounts that a person may contract above a minimal limit, implying those loans that are for major purchases.)

So, there is a bit of sense in the matter, here in France at least, and not the callous "wizardry" of which you write. Why? Because the poor are involved in more personal bankruptcies than any other class - far more. (And, the result is that the responsibility for their charge in case of personal bankruptcy falls back upon the state.)

Why? Because these are the people who need the most protection by a regulated environment.

But, no, we can't have that in the US, can we? That would be assault on a fundamental "freedom to screw people" up one side and down the other for profitable gain.

When are we gonna learn .... the flip side of freedom is responsibility. And, the government has its part in that responsibility. Debtors also have a responsibility in the matter and those who cannot manage their debt perhaps need the guiding hand of an assigned personal tutor. This too is an component of the French debtors law.

[Lafayette]

dd : “All these "disasters" are studies in regulatory arbitrage that not only threaten individuals but also the integrity of the financial system.”

Agreed, but their persistence over time indicates a regulatory mentality that is, in fact, ambivalent.

There is a fine line to be drawn between allowing enterprises to contract business as freely as possible and the fact that, as regards consumer credit, there is in consideration the financial well-being of ordinary citizens.

In this case, of subprime lending, the regulatory powers should have been more awake. But, in order to be “awake”, there must be a process in place that signals consumer credit being given at too high a risk. How does one measure that “high risk”? That would depend upon personal information of the credit record and indebtedness of each consumer in the nation.

The US is not about to put such a centralized system into place. And yet, it is the best way to regulate consumer financing. (In fact, I am assuming that credit rating history in the US does not cover mortgage loans ...)

There will come a time when Americans must understand that the freedom to choose of each individual or even an enterprise conflicts with the public interest in general under certain circumstances.

Our notion of “freedom” needs some further reflection. In light of the notion of “personal responsibility” – and how the two are to be made compatible.

The balance is, as I have noted often in this forum, between that of the individual and the collectivity (meaning the public interest at large).

[satish]

defaults spread like wild fire.If my neighbour is not
paying the installments why should i pay.Afterall lenders cannot come to every house to collect the payments.It will even deter who are disciplined to pay
their mortgage payments.Thus delinquencies will rise
exponentially rather than baby crawl.complacencies
thrive

I think it's just matter of months before credit standards tighten very harsh.credit spreads widen.
Even helicopter drop wont help

[evagrius]

"Our notion of “freedom” needs some further reflection. In light of the notion of “personal responsibility” – and how the two are to be made compatible."

Lafayette- Sorry but "personal responsibility" has been co-opted by those who advocate YOYO, ( Your on your own).
It's in the title of the 1996 welfare reform act.

[Bruce Webb]

Not to beat a dead horse. But it has yet to come to light how much of this was lenders lending money to people with bad credit to get them into a house they can't afford, i.e. bona fide predatory lending. Versus lenders writing loans to investors that had already exhausted their conventional credit.

There is a huge difference between a foreclosure that moves someone into their car and a foreclosure that is the result of an investment not making a sufficient return to cover the carrying costs and the investor walking away.

I saw this from the inside and it was an eye-opener. It is perfectly possible for an investor to have three or four "owner-occupied" loans on two or three properties that are not in fact owner-occupied at all. You just have to spread out those loans in space between lenders and time between taking out a new loan. Because once the loan is packaged and sold the intermediate lender no longer cares, they are free to assume that for some inexplicable fashion you have chosen to move from that $600,000 house to a $180,000 fixer.

If you want to see an exercise in cynicism in action you could do no better than sitting in a discussion between a loan initiator and a loan rep (one 'representing' the borrower and the other 'representing' the lender). Each works on a fee/commission basis and gets paid up front when the loan funds. In short they get paid to write loans and not to deny them. And being human they will push up to the limits, and depending on the extent of the scrutiny beyond those limits.

There was little to no adult supervision in home lending until late last year and the results would be predictable by any kindergarten teacher. The kids got rambunctious and then out of hand. Lenders got more and more creative, after all in this new era they were not holding the risk, this wasn't your daddy's household savings bank, you just packaged those loans and sold them. Just not to Fannie Mae and Freddie Mac, who both had those pesky underwriting standards, nope you just shipped them off to Wall Street.

Real Estate speculators borrowed a bunch of easy money to buy properties in hopes of capitalizing on double digit appreciation. Wall Street investors eagerly snatched up mortgage portfolios because they carried rates a point or two above prime loans. In between loan initiators and lenders made fortunes on fees. Well in recent months some of the wheels have come off of this particular wealth wagon.

Of course as usual they are trying to spin this as poor people making bad choices rather than rich people mistiming investments. Before we jump off the cliff of bailout maybe we should sit back and figure out whose ox is really being gored here.

[yartrebo]

"Making money has never had much morality to it, in spite of the funds that tell you they will invest in only socially responsible, etc., companies."
- maria

I second that. Take a step back and compare how a business operates and the moral dictates of most philosophical and religious codes, especially the Christian and Muslim religious codes, which are quite strict on things like the greater good and usury.

This holds for any business, even including many non-profits (which are often more interested in growing their business and raking in donations/money than efficiently providing services - no less ones that are really for-profit such as lobbies and front groups).

[Lafayette]

satish : "If my neighbour is not paying the installments why should i pay."

If your neighbor is robbing the local bank to pay installments, should you?

What sort of rubbish notion is this?

[Lafayette]

evg: "Take a step back and compare how a business operates and the moral dictates of most philosophical and religious codes, especially the Christian and Muslim religious codes, which are quite strict on things like the greater good and usury."

I doubt that most companies do not have a business ethic, even if not articulated on a web-site. So, the question devolves to this: Is the rot due to some apples or the barrel?

The fact of the matter is that inadequate regulation permits top directors to legally skim corporate revenues that they offer themselves by means of stock options. The BoD decides the amount of stocks, their value and, most importantly, the recipients.

I own stocks and never once have I been asked to vote directly the "management performance incentives" of a company. In fact, the use of stockholder voting on corporate affairs is a comedy.

SarbOx did not go nearly far enough and the fact that corporations are crying foul indicates that it must have hit the right target.

Holding stock today, in most western countries, is simply an investment vehicle. Few people look upon it as other than an equity position when, in fact, it confers ownership on the holder. Property rights, well codified, are therefore in play.

I cannot imagine why the abuse of such rights has been tolerated without the slightest whimper from stockholder owners. It is, utterly, beyond belief.

But, when they are out of job because of foreign competition, they are all over this forum crying foul. When they see the Enrons that go down in flames, they are scandalized. Shock and horror at the back-dating of stock options. Dismay at the corporate jet with hot and cold running bimbos - all paid for by the corporation.

Tired of it all? Then make corporate governance a campaign issue. Want to do something about income inequality? Start with corporate governance, from where most of it comes.

[real person from the real world]

Accredited gets high-interest $200 mln loan
NEW YORK (Reuters) - Subprime lender Accredited Home Lenders Holding Co., trying to avoid a cash crunch, said on Tuesday it had received a five-year, $200 million loan with an annual interest rate of 13 percent. ....Accredited said the loan comes from Farallon Capital Management, which will receive 3.3 million warrants from the mortgage company, with an exercise price equal to $10 a share. That means Farallon could cash in those warrants and own about 14 percent of Accredited.

SO, WHAT DO YOU ALL THINK OF THIS? WHO IS MAKING $ AND HOW ARE THEY DOING IT?

[dd]

It's not always about making money. Sometimes investments are made to preserve portfolio positions that may be tied to the health of the originating entity or upping creditor status in a potential bankruptcy. A wise creditor wants to preserve the health of the debtor and failing that wants to be the first tier secured creditor in bankruptcy. Not saying that's what's happening here; just that it's not always about an immediate short term profit.

[calmo]

Thanks for that perspective dd. I did note that share price of Accredited gained over $2 to climb above that strike price to $11+...so immediately there is an Option play for Farallon if they can find another buyer...not related to those who were buying up and beyond $10...perfect gullible strangers, say, who think this company can be a survivor with that kind of backing in the quarters ahead...should Farallon stay with them with additional $200M @13% loan packages in the months ahead.