Tag Archives: securitization

The Great Pension Swipe Coming to a State Near You

Burglar

“Elections have consequences” and this time the results may be a disaster for public employee pensions.  The rationale underpinning this contention is simple.  Wall Street is running out of Big Pots of Money.  They’ve already run through the money which flowed in from the earnings of more women in the work force – the Wall Street Casino used up the proceeds from the increasing number of two income families by 2000, when the number of women in the work force increased from 18,389,000 in 1950 to 65,616,000 in 2000.  To add a bit of context here:  In 1950 there were 43,819,000 men in the work force, and 18,389,000 women.  By 2000 there were 75,247,000 men working and 65,616,000 women. [BLS pdf]   Some families were induced to join in the new Money Market Accounts made possible by the Garn-St. Germain Depository Institutions Act of 1982.  This new form of “savings” account allowed the banks to get and keep the deposits.

“Banks are required to discourage customers from exceeding these limits (on withdrawals), either by imposing high fees on customers who do so, or by closing their accounts. Banks are free to impose additional restrictions (for instance: some banks limit their customers to six total transactions). ATM, teller, and bank-by-mail transactions are not counted towards the total.”  [link]

And so, Wall Street had a big pot of money to play with. But enough is never enough.   Wall Street invented more money pots – using securitized assets. These were non-existent before the 1970s.  For review, a securitized asset is something done to create “debt securities, or bonds, whose payment of principal and interest derive from cash flows generated by separate pools of assets.”  [ HFS pdf 2003]  In plainer English this means that Wall Street can use securitization to immediately (and that’s a key word – immediately) make money on any “cash-producing asset” – like trade receivables, leases, auto loans, credit card lines, and, of course, mortgages.

Now the Money Mad Denizens of Wall Street have run through the addition of women’s earnings, the accumulation of funds in money market accounts created thereby, and they mis-managed their money in securitized assets such that the Housing Bubble of the early 2000’s burst and splattered all over their operations.  But enough is never enough.  One former Wall Street trader described the Wealth Addiction rampant in the firms:

“But in the end, it was actually my absurdly wealthy bosses who helped me see the limitations of unlimited wealth. I was in a meeting with one of them, and a few other traders, and they were talking about the new hedge-fund regulations. Most everyone on Wall Street thought they were a bad idea. “But isn’t it better for the system as a whole?” I asked. The room went quiet, and my boss shot me a withering look. I remember his saying, “I don’t have the brain capacity to think about the system as a whole. All I’m concerned with is how this affects our company.” […]

“From that moment on, I started to see Wall Street with new eyes. I noticed the vitriol that traders directed at the government for limiting bonuses after the crash. I heard the fury in their voices at the mention of higher taxes. These traders despised anything or anyone that threatened their bonuses.” [NYT]

What might threaten those bonuses? Not having Big Pots of Money to play with.   There are some money pots out there – and more and more of them are being “touched” by the Wall Street bankers who see them as ways to enhance those precious bonuses.  Pension funds.

How to unlock that next Big Money Pot for the Wealth Addicts of Wall Street?  The strategy has been alarmingly simple.

First, bash public employee unions – the organizations which negotiated defined benefit plans for retiring public employees.  Union bashing has been a staple of Republican politics since time out of mind, so it makes perfect sense to incorporate it into the strategy for raiding public pension funds. Public employees are no longer to be seen as the helpful librarian, or the firefighter who saves the kittens, or the police officer who donates time to direct traffic at the high school football game.  He or she is no longer the person willing to work in frigid temperatures clearing snow from highways at 3:00 A.M. Nor is the public employee to be thought of as the bookkeeper who diligently keeps track of taxes paid, fees assessed, or paper-work properly filled out to prevent fraud.  No! These people are to be seen as “greedy teachers” who think only of job security, “lazy” bureaucrats who create paperwork, and “leagues of over-paid shovel leaners” who don’t care about the snow on the roads…. The cynicism of this is excruciating.  The result is little else than a contemptuous, divisive, misanthropic perspective which divides private sector employees earning $45,000 per year from public sector employees earning $45,000 per year.

Secondly, once the bashing begins the misanthropes add in a measure of jealousy.   Publish the retirement incomes of Everyone, because surely someone is making more money in retirement income than the targeted population of disaffected voters.  Cover this in the banner of Right to Know. “You,” meaning the disenchanted audience, have a “right” to know what “each and every public employee is making” because, “you know” they have been “feeding at the public trough.”  The argument is predicated on the jealousy factor – who else would care what a firefighter, police officer, highway department employee, teacher, librarian, public health nurse, etc. would receive in a year?

That the release of this information would allow personal identity thieves to thrive is of little consequence to the advocates of total transparency – so much transparency that the former public employees have no right to any financial privacy whatsoever.

Third, flat out lie about the sustainability of defined benefits pension plans.  There are three major advantages of a defined benefit plan.  It provides security.  The person who has paid into the plan knows exactly want the financial benefits will be and can do some financial planning accordingly. The person also know exactly how long he or she has to work to be eligible for the benefits.  And, finally, the person knows that the pension is covered by the Pension Benefit Guaranty Corporation.

We know that some public employee pension plans are better administered than others, but the opponents of defined benefit plans are eager, enthusiastic even, about publicizing the problems of some as the characteristics of all.  This is evident in the ALEC assault on public pension funds, all 45 pages of it which blatantly calls for defined benefit plans to be morphed  into “properly defined alternatives, such as defined contribution, cash balance, and hybrid plans.”  Read: The Next Big Money Pot for Wall Street.

Creeping Financialism

The ALEC advocates and associates are only too pleased to discuss the delights of the defined contribution plans.  Most often they are couched in friendly wording such as “you can manage your own plan,” which sounds like “freedom.”  It also sounds like a 401(k).   What they aren’t anxious to publicize is that 401(k) plans have been a bust.

“The 401(k) plan was never meant to be a mainstream pension plan and is a poor substitute for one. It’s a voluntary program that was intended to supplement retirement savings –  one of those quirky little options in the byzantine tax code that employers seized upon as a way to save money while pretending that they were doing the right thing by their employees.” [Forbes]

That’s putting it about as bluntly as possible.  Oops! The 401(k) was never intended to be the main source of retirement funds, and it’s a poor substitute for a defined benefit plan.

“Authors like Helaine Olen have been right on the mark in saying that the financial services industry and employers are all too eager to tell us how little we’re saving, yet don’t serve as honest brokers in maximizing our retirement savings. That would require cutting fees, eliminating middlemen, increasing employer contributions and getting rid of the fee structure that is based on assets under management. And above all, the most dangerous part of this equation: Educating employees on how to invest cost- and risk effectively.”  [Forbes]

And for all this – while the fund administrators collect the fees, hire middlemen, and thrive under the fee structure – the public employee is asked to give up any and all financial privacy, learn to be a financial manager, and forget about the security a defined benefits plan offers. All this so that Wall Street will secure the next Big Money Pot.  And it’s already started.

Creepy Financialists

The unease felt by public employees about their future financial security isn’t merely the result of escalating fiscal paranoia; it’s very real. The Rhode Island Case describes what happens when crony capitalism merges with Wall Street wealth addiction when state treasurer Gina Raimondo issued forth :

“Nor did anyone know that part of Raimondo’s strategy for saving money involved handing more than $1 billion – 14 percent of the state fund – to hedge funds, including a trio of well-known New York-based funds: Dan Loeb’s Third Point Capital was given $66 million, Ken Garschina’s Mason Capital got $64 million and $70 million went to Paul Singer’s Elliott Management. The funds now stood collectively to be paid tens of millions in fees every single year by the already overburdened taxpayers of her ostensibly flat-broke state. Felicitously, Loeb, Garschina and Singer serve on the board of the Manhattan Institute, a prominent conservative think tank with a history of supporting benefit-slashing reforms. The institute named Raimondo its 2011 “Urban Innovator” of the year.

The state’s workers, in other words, were being forced to subsidize their own political disenfranchisement, coughing up at least $200 million to members of a group that had supported anti-labor laws.” [Rolling Stone]

Worse still, the states that were supposed to be making defined contributions didn’t seem to be taking the process very seriously.

Chris Tobe, a former trustee of the Kentucky Retirement Systems who blew the whistle to the SEC on public-fund improprieties in his state and wrote a book called Kentucky Fried Pensions, did a careful study of states and their ARCs. While some states pay 100 percent (or even more) of their required bills, Tobe concluded that in just the past decade, at least 14 states have regularly failed to make their Annual Required Contributions. In 2011, an industry website called 24/7 Wall St. compiled a list of the 10 brokest, most busted public pensions in America. “Eight of those 10 were on my list,” says Tobe.

Among the worst of these offenders are Massachusetts (made just 27 percent of its payments), New Jersey (33 percent, with the teachers’ pension getting just 10 percent of required payments) and Illinois (68 percent). In Kentucky, the state pension fund, the Kentucky Employee Retirement System (KERS), has paid less than 50 percent of its ARCs over the past 10 years, and is now basically butt-broke – the fund is 27 percent funded, which makes bankrupt Detroit, whose city pension is 77 percent full, look like the sultanate of Brunei by comparison.” [Rolling Stone]

However, nothing stops the administrators of the Annual Required Contribution plans from drawing their salaries. Nothing stops the hedge fund managers and wealth managers from earning their money, and nothing stops the hedge funds, wealth funds, and bankers from getting nice bonuses from playing with these new Big Money Pots.

2013 also brought the disclosure of other pension swindles.  A report on North Carolina’s pension plan yielded the most opaque atmosphere surrounding a supposedly transparent pension system, with the Wall Street characters benefiting from the opacity:

“Today, TSERS assets are directly invested in approximately 300 funds and indirectly in hundreds more underlying funds, the names, investment practices, portfolio holdings, investment performances, fees, expenses, regulation, trading and custodian banking arrangements of which are largely unknown to stakeholders, the State Auditor and, indeed, to even the (State) Treasurer and her staff,” he reports. “As a result of the lack of transparency and accountability at TSERS, it is virtually impossible for stakeholders to know the answers to questions as fundamental as who is managing the money, what is it invested in and where is it?” [Salon]

How are the investors in the system (the state, the locality, the employees) supposed to act as “free” administrators of their own pension plans when they can’t discover who is managing the money, what investments have been made, and where the money is?  Much less ask what fees are being paid to the money managers of the new Big Pot?  In the initial example above, Rhode Island, state treasurer Raimondo couldn’t answer the question about the amount paid in fees.

President George W. Bush famously tread on the third rail of American politics, privatizing Social Security in 2005, and just as famously backed away from the precipice.  It seems that Americans have not forgotten what is supposed to be a “mainstream pension plan.”   If continued symbolic acts continue to be promoted by the Cato Institute and if there continue to be the likes of Iowa senator-elect Ernst who call for a hybrid plan in which younger workers are allowed to put a portion of their Social Security into a Retirement Savings Account (read: Wall Street Money Pot) we can’t declare the nation free of schemes to privatize Social Security.  If a state treasurer in Rhode Island who promoted the defined contribution plan in her jurisdiction can’t find out how much is being raked in by money managers, then how do we expect our average “younger worker” to effectively track his or her retirement account.

Thus we can look forward to more proposals for Hybrid Plans – which augment the Big Money Pot, and Defined Contribution Plans – which can’t be tracked and make a mockery of the entire concept of transparency, and more assaults on public employees who might be victims of the latest Great Burglary of their pension systems.  Elections do have consequences, and the last mid term election put more than $100 billion in public pension funds in the hands of financialists turned politicians.

1 Comment

Filed under Economy, financial regulation, Politics, public employees, Republicans

The Great Balancing Act: US on the high wire

High Wire ActThe previous post was, in essence, a set up for this one.  Those looking for illustrative examples of radical economic philosophy will find none better than the musings of Nevada Representatives Amodei (R-NV2) and Heck (R-NV3).   When radical economics combine with radical politics the resulting admixture is toxic, and dysfunctional.  Witness the 12% approval rating for the Congress. [HuffPo]

So, why is the economic theorizing beloved by our two Tea Party darlings from the Silver State to be categorized as “radical?”

#1. It turns classical economic theory on its head.  Traditional economic theory asserts that an equilibrium price, and optimal market function,  can be determined when supply and demand for goods or services converge.  To give undue attention to one side or the other of the equation is asking for trouble.  Since the perpetration of the Supply Side Hoax, the “job creators” (corporate executives) have been attended to like medieval monarchs, with the Congress bowing, scraping, and otherwise engaging in obsequious behavior before members of the CEO class.   In sum, the Supply Side economics offered by the radical Republicans of the 21st century is little more than a political agenda masquerading as an economic theory. (1)

#2.  It eviscerates the guiding principal set forth in the founding documents of this nation which contends that we do better as a country when we take an interest in our communal welfare, and economic interests.  The preamble to the U.S. constitution notes that one of our foundational principles is the notion we should “promote the general welfare,” not that we should promote the interests of the rentier class, or any other specific class for that matter.  One of the first charges leveled at King George III was that he had “refused his asset to laws, the most wholesome and necessary for the public good.”  (Declaration of Independence) Note that the criticism wasn’t that the monarch had not attended to the good of “some” but of “all.”

In order to make this country work politically, as well as economically, we need to balance the needs and interests of business and labor.  Capital and commerce. Consumers and manufacturers.  When things get out of balance, things go wrong.  Achieving a balance between competing interest demands compromise.  However, when the Republicans in Congress assert their demand that they will not enact any modifications to the debt limit until the President and the Democrats in the Senate agree to repeal the Affordable Care Act and Patients Bill of Rights, accept the Ryan Budget, and privatize Medicare — the unwillingness to compromise produces nothing but manufactured gridlock.  Those who advocate no comprise in the face of opposition to their own exclusive agenda are functioning as anarchists — promoting no government as a solution to any governance.  (2)

Radical Theory Applied to Practical Reality Yields Poor Results

I’ve lost count of the number of times I’ve used the term “aggregate demand” in economic related posts.  However, when the situation becomes unbalanced and the needs of the top 1% of the American public are given greater consideration than those of the other 99% we have a situation in which there are few positive long term results.

Unalleviated promotion of the demands of the 1%, especially in the financial sector, helps to create economic consequences such as an increase in income disparity.  This is NOT to argue for some scheme of income re-distribution imposed by the federal government, but for a market based re-distribution based on the traditionally accepted principles of standard economics — including attention to the necessity of increasing our aggregate demand.

Increasing income disparity means that fewer households control more wealth, and hence have more spending “power.”  It is possible to have a warehouse load of vehicles, BUT the U.S. annually  manufactures some 15,797,864 cars and trucks (as of 2012) [WardsAuto  XL download] and 1% of the population obviously isn’t going to make a dent in this inventory without some significant assistance from the middle class.   The American middle class is less able to contribute to the aggregate demand than it was prior to the last Recession:

“Median household income in the country is nearly $4,000 less than what is was back in 1999. Things have gone from great to terrible since then, and this change has certainly played out in the nation’s median household income number. In September of 1999, the national unemployment rate was 4.2%; in September of 2011, the national unemployment rate was 9.1%.” [Manuel.com]

There are all manner of explanations for this situation, from various positions on the political spectrum.  For the radical right the explanation is to be found in the “high” corporate tax rates and regulation of financial transactions (the politics of prosperity for some and austerity for all).  For the left the explanation often incorporates the nefarious influence of the 1%.  Easy rationalizations miss an essential question.

What does our allocation of interest, energy, and resources tell us about our attention to our economic health?

There is one sector of our economy which has experienced significant growth — finance.  The NBER published a paper in 2007 offering an explanation for this increase:

“The share of finance in U.S. GDP has been multiplied by more than three over the postwar period. I argue, using evidence and theory, that corporate finance is a key factor behind this evolution. Inside the finance industry, credit intermediation and corporate finance are more important than globalization, increased trading, or the development of mutual funds for explaining the trend. In the non financial sector, firms with low cash flows account for a growing share of total investment. […] I find that corporate demand is the main contributor to the growth of the finance industry, but also that efficiency gains in finance have been important to limit credit rationing. Overall, the model can account for a bit more than half of the financial sector’s growth.”  (emphasis added)

Some definitions are in order, for example what’s “credit intermediation?”   The simplest way to describe this is to say that intermediation is the transfer of funds from the ultimate source to the ultimate user.   Our banks “intermediate credit” when they borrow from depositors to make loans to creditors.

Corporate finance runs a gamut of fiscal operations.  However, the standard expression relates to how does a corporation manage its capital investment decisions?  Decisions would be made such as should the company raise funds by the equities route, by issuing debt (bonds), and so forth.

If the NBER report is essentially correct, then the increasing transfers of funds, and the increasing role of corporate finance transactions are driving the increase in the growth of the financial sector.  So what?

The “so what” question may be answered, at least in part, by observing the increasing role of securitization of assets (Remember: One man’s debt is another man’s asset), and manufacturing of financial products in the “intermediation” process.   There’s a cautionary note from a 2009 IMF report (pdf)

“Mobilizing illiquid assets and transferring credit risk away from the banking system to a more diversified set of holders continues to be an important objective of securitization, and the structuring technology in which different tranches are sold to various investors is meant to help to more finely tailor the distribution of risks and returns to potential end investors. However, this “originate-and-distribute” securitization model failed to adequately redistribute credit risks, in part due to misdirected incentives. Hence, it is important in restart ing securitization to strike the right balance between allowing financial intermediaries to benefit from securitization and protecting the financial system from instability that may arise if the origination and monitoring of loans is not based on sound principles.”

What the polite phrasing of the IMF document is trying to say may very well be — “all the fancy ways the investment houses tried to reduce the risk to investors in various schemes aren’t going to be much help IF the underlying assets aren’t very good in the first place.” So, why did the system freeze up in 2007-2008?  Insert “avarice,” or good old fashioned “greed” in the place of “misdirected incentives,” and we have a situation in which all the financial products dreamed up by the “market makers” couldn’t erase the hard cold fact that many of the mortgages and other credit instruments which were securitized into ever more elaborate packages weren’t any good in the first place.

If we’re spending too much of our attention, energy, and finances on manufacturing financial products which are supposed to spin dross into gold for investment houses and major banks,  then we’re not paying attention to the sectors of our economy which need more attention, more energy, and more financing.

All analogies break down at some point, but for illustrative purposes only contemplate what might happen to an individual who owns a home with a set of broken steps to the front porch.  These steps are a risk for the homeowner.  However, instead of fixing the broken stairs the homeowner buys an extra insurance policy to offset his risk, then the benefits of the policy may be securitized, the security may be further offset with hedges, bets, and other derivatives — and in all the revenues generated and all the fees and commissions collected everyone appears to forget that the entire financial contraption is built upon a set of broken stairs.   When the steps collapse, as they inevitably must, the policy must pay out, along with those who bet against the policy being paid out and those who bet on the policy in favor of the  benefits being paid…. and so it might go.

The moral of this hypothetical is that if we are paying more attention to devising ways to mitigate risk, and manufacturing more financial products to do so, and we are not attending to correcting the faulty underlying assets — then we ought not complain when the house of cards falls in a heap at our feet.

Further, if we are studiously attending to generating revenue from the transfer of risk among credit intermediaries and corporate finance offices, then we are consequently paying less attention to our education system, our infrastructure, our manufacturing and business lending operations, and our fundamental  banking soundness.  Further, as more finance is sucked into the Shadow Banking system, the very real one is in danger of being neglected.

Worse still, according to the Economic Policy Review, the emphasis on the shadow system isn’t leveling off:

“Looking ahead, the authors contend that despite efforts to address the excesses of credit bubbles, the shadow banking system will likely continue to play a significant role in the financial system for the foreseeable future. Furthermore, increased capital and liquidity standards for traditional banking entities are “likely to increase the returns to shadow banking activity” partially because reform efforts have done “little to address the tendency of large institutional cash pools to form outside the banking system.”

This really doesn’t give much hope that financial institutions and major corporations will be excited about investments in manufacturing, infrastructure, or work force concerns, at least not in the foreseeable future.

Increasing aggregate demand, and thereby increasing our GDP, requires more earning power in the wallets of more residents and citizens.  The shadow banking system is not designed to take into consideration the credit needs of American car buyers — only to securitize and minimize (and then bet on) the credit worthiness of the underlying loans.   If banks made “good” home and auto loans then there would be less need to offset risks — which need not stop the shadow system from continuing to bet on the prospects of default anyway.

Finance and The Family Wallet

Looking back at the mess created by the Mortgage Meltdown of ’08, several observers were wont to ask — Why did the banks make those shaky loans in the first place?  And, no, it wasn’t because they “had to” because of the consumer finance laws — they made them because the loans could be originated quickly then securitized even faster. Once securitized the financial sector could manufacture  products to paper over the risks to the bankers — here came the hedges, bets, derivatives, swaps, etc. — and if the revenue generated from the manufacturing of those paper products could be greater than the loss from the loan default — then where was the incentive to make good and proper loans?  Someone wasn’t looking at those faulty front porch steps?

That was then, this is now and those who are playing derivative games with the underlying assets originally residing the family wallet aren’t taking kindly to being regulated, to being required to be more transparent, to being litigated against because of their manipulations.  Some more attention needs to be paid to that crucial line from the IMF report: “Hence, it is important in restarting securitization to strike the right balance between allowing financial intermediaries to benefit from securitization and protecting the financial system from instability that may arise if the origination and monitoring of loans is not based on sound principles.”

Balance

There’s that word again — we need some balance between competing interests (capital and commerce, labor and ownership) and balance requires — demands — compromise.  Those standing on the ramparts of their own idiosyncratic battlements of ideological purity, refusing to compromise with the dreaded Other, are jeopardizing not only the political life of this nation but the economy of the country as well.

(1) For more on this topic see: The Trickle Down Hoax, AmericanThinker, July 15, 2012.  The Political Genius of Supply Side Economics, Financial Times, July 25, 2010. (registration required) Supply Side Economics Explained, Reign of Error, September 23, 2005.  The Six Biggest Hoaxes in History, Huffington Post, May 23, 2013.

(2)  See also: Gridlock and Harsh Consequences, New York Times, July 7, 2013.  Gridlock in Congress, CNN, May 21, 2012.  Five Reasons Gridlock Will Seize Congress Again, Washington Post, January 4, 2013.   Congress Shows Few Signs of Ending Gridlock, Bloomberg News, July 8, 2013.

Comments Off on The Great Balancing Act: US on the high wire

Filed under Economy, Politics

Bubble Bubble Here Comes Trouble? REO to Rental Securitization

Three WitchesBubble: The real estate experts in Las Vegas, NV were happy to report the Shadow Inventory of foreclosed homes in the region wasn’t as high as expected as of January 20, 2013. [LVRJ]  Nevada’s anti-robo-signing law (AB 284) is part of the reason, and some homes are still on the market because they aren’t in salable condition.  Before we get entirely too pleased with ourselves…

There are homes that will be included in the Shadow Inventory in the next two years; homes which will be in default and Nevada may be able to circumvent the foreclosure statistics  increases by using short sales.

Bubble:  There are several motivations for purchasing real estate, one of which is to transform unsold residences into rental properties, as in the following example from last December:

“Home prices fell 62 percent from 2006 to early 2012—the steepest drop in any U.S. metropolitan area—yet Vegas is again enticing buyers. The number of homes listed for sale has dropped to a 1.5-month supply, down from the four-month stock that’s typical in the area, says Jeremy Aguero, principal at Applied Analysis, a Las Vegas research and advisory firm. One reason for the inventory squeeze: Investors such as Blackstone Group (BX), GTIS Partners, and Haven Realty Capital are buying deeply discounted homes in bulk to rent out at a profit.”  [BusinessWeek]

The good news is that (a) more rental properties are available, (b) some of the excess inventory is off the market, so that (c) home prices could rebound and those “under-water” on their mortgages might see a bit of relief.   Again, before we become too cheerful, there’s another reason to invest in foreclosed properties which if not carefully monitored could lead to another Bubble.

Toil: There’s more to the story than Blackstone’s interest in getting into the rental business in Nevada.    Blackstone’s also been active in southern California:

“In all, major investors have raised between $6 billion and $9 billion to buy single-family homes, according to a recent analysis by investment bank Keefe, Bruyette & Woods. The goal is to bring corporate scale and efficiency to what has historically been a mom-and-pop, single-family-home rental business.” [LATimes]

What we have here is Wall Street moving in on Main Street.  Renting residences used to be primarily a Mom & Pop operation.  But, Mom & Pop don’t have between $6 and $9 billion to buy up residential real estate.  Now we tread into “market efficiency” territory.  There are some variant perspectives on what “efficiency” really means.

When we speak of efficiency as a component of Economies of Scale, the Black Rock venture looks like the application of operational efficiency to the old Main Street individual homeowner model of residential rental markets.  There are Internal economies of scale (the company is so big that it can buy in bulk usually at a discount not available to smaller concerns) and External economies in which the company is so big it can get preferential treatment from governments or outside sources to reduce taxation, get roads and utilities provided, etc. in an environment in which a small business or individual cannot successfully compete.

The initial view is that Blackstone is taking advantage of its capacity to be operationally efficient — it can buy up residential real estate in Nevada and southern California at prices heavily discounted by foreclosure processes or perhaps even short sales.

Trouble: What we don’t need is a real estate market which is “operationally efficient” to such an extent that we create yet another Bubble.  So, let’s read further into the Los Angeles Time’s article:

“These firms are also exploring ways of packaging rental income streams into securities, similar to the way mortgages were bundled during the boom years. Those mortgage bonds — often packed with risky home loans that produced mass defaults — turned into the toxic assets that helped bring down major banks during the financial crisis.”  (emphasis added)

There are some breaches in this model.  Real estate is a labor intensive business, if we think in terms of home maintenance, home marketing, and all the associated jobs which must be performed to rent and receive income from a block of home purchases.  Profit margins depend on rental income, and will the rental income stream support acceptable levels of profitability given the labor intensive nature of the housing market?   What happens to the business model if high competition for properties drives prices up beyond the  original cost estimates?  What happens if the profitability margin in the “revenue stream” doesn’t meet expectations?

Now we have to consider the other “Efficiency.”  The rental income will be securitized.  Packaged into bonds. The bonds will be sold in financial markets, and the efficient capital market theory tells us “the price of an asset reflects all relevant information that is available about the intrinsic value of the asset.” [EconLibrary]  What determines the value of the bonds?

What’s “relevant information?”  Do we include the rating assigned to the bonds by the rating companies?  We’ve seen this movie before and it didn’t end well.  In fact, the ratings companies seem to have gotten a bit of religion on the subject of slapping high grade investment ratings on questionable products:

“Ratings companies began commenting last year on how they would approach assessing potential securities backed by rental homes, a market fueled by the foreclosure crisis they helped create by granting inflated grades to mortgage bonds.

Moody’s said in August that items including a dearth of historical data on the business could make it difficult for issuers to obtain the grades they seek.

In its report today, Moody’s said it wouldn’t offer its “highest ratings” to deals backed by “equity” structures, rather than individual mortgages, also because they would offer less protection against “unauthorized sales” of homes and new liens. [Bloomberg, Jan. 2013]

Do we include the timeline in our calculation of the bond value?  Last November Blackstone opined that it had a two year window in which to buy up financially fragile properties, [Bloomberg] so are properties purchased in the 3rd year likely to be less profitable, and thus have a lower return for investors than properties purchased in the first two?  If the bonds are manufactured as they were during the Housing Bubble (mixtures of good and bad loans which blew up when housing demand and prices collapsed) then what is the “intrinsic value” of the assets (bonds)?  Will the bond packages include combinations of rental income from markets in which prices are going up, and from regions where the market is still depressed?   If so, then what is the actual “value” of the bond? How many markets have to see increased home prices before the admixture of cheaper and more expensive rentals in securitized assets gets “top heavy?”

Enter all the usual suspects.  Blackstone got an increased loan from Deutsche Bank this month to “underpin” its long term financing of the new REO to Rental securities.  What we know so far about this:

The new Deutsche Bank loan, upsized to US$2.1bn, includes an
original US$600m warehouse facility in addition to investments
from eight other banks and securities investors.

At least 20 banks and investors looked at participating in
the loan, and some passed because their charters would only
allow them to participate in bond deals and not bank loans.

Securitization specialists with knowledge of the deal said
Deutsche Bank expanded the size of the facility in order to
accommodate Blackstone’s increased commitment to purchasing
distressed single-family homes with the goal of renting them
out.  [ChiTrib]

Think of that warehouse as a paper storage facility in which all those rental agreement are stack up, only to be divided up, restacked, and used to back bonds issued by Blackstone.   We’ve seen this movie before too — it didn’t end well in its last incarnation.

Not to put too fine a point to it — but, are we about to get into the same “valuation” debacle about the actual value of sliced, diced, tranched, and securitized assets we witnessed in 2007-2008?

Double, double toil and trouble;
    Fire burn, and caldron bubble.

If we get ourselves into this mess again it’s going to take more than newt’s eyes, fillets of fenny snakes, frog toes, bat’s wool, and dog tongues to extricate ourselves.

Comments Off on Bubble Bubble Here Comes Trouble? REO to Rental Securitization

Filed under Economy, housing, Nevada economy

If You Aren’t Pulling The Wagon, Don’t Complain About The Load: Foreclosures in Nevada

Another day, another glossy flyer from Grover Norquist in my P.O. box reminding me that the President supposedly promised to staunch the foreclosure flood in Nevada.  Better information and analysis can be found in the Las Vegas Sun article on the faltering foreclosure reduction plans in the Silver State.  The article makes some important points, and falls nicely into the Must Read List.

One of the advantages of blogging is that there is no length limit to articles, and some areas can be explicated in greater specificity.  No surprise, here come’s additional information on the securitization issues related to the foreclosure processes.

Wonk Alert

Not only were banks administratively unprepared to deal with failing home loans, the system devised in the Securitization Boom wasn’t helpful either.  The New York Times produced some of the better graphics to illustrate what was going on during the Housing Bubble.

At this point we should recall that those mortgages being pooled were not being held by the banks that issued them.  First, some weren’t even properly registered.  The MERC mess was created by bankers who didn’t think county recorders were working fast enough to satisfy the financier’s demand for more mortgages to pack into the pools.  [DB]

“The mortgage industry created MERS to allow financial institutions to evade county recording fees, avoid the need to publicly record mortgage transfers and facilitate the rapid sale and securitization of mortgages en masse,” Mr. Schneiderman said. By creating this “bizarre and complex end-around of the traditional public recording system,” Mr. Schneiderman’s lawsuit asserts, the banks saved $2 billion in recording fees.” [NYT]

It might have saved the banks some $2 billion in recording fees, but when it became obvious some of those hybrid adjustable rate monstrosities were going into default, one thorny question arose — Who owned the mortgage? When trying to determine how to re-negotiate an individual mortgage it is helpful to know who owns it.  On the other end of the scale, investors who purchased mortgage backed securities were told that all the loans were just fine and dandy — some, specifically Bear Stearns, told investors the firm would repurchase defective loans — that wasn’t what happened. [NYT]

Now let’s look at the next step in the diagram.  The mortgage backed securities shown in the first part of the diagram were used to create another layer of investment products called CDOs.   This isn’t as much of a problem for the homeowner facing the possibility of robo-signing and ‘who owns the mortgage’ MERC related issues, but it does illustrate how the faulty or defective  mortages contaminated the system when pumped into Wall Street Casino.

One Size Doesn’t Fit All

In addition to the problems associated with the Securitization Boom, homeowners faced a situation in which not all regional housing markets were created equally.  David McGrath Schwartz’s article mentions this crucial point.  One map from 2010 illustrates the point:

The “hottest” real estate markets in the Housing Bubble were those most likely to see the creation of the now infamous no-doc hybrid adjustable rate mortgages which were designed from the outset to encourage refinancing NOT repayment.   However, federal statutes must address national problems, so the initial programs were devised with the national — not the Nevada — issues in mind.

HAMP:  “The program was built as collaboration with lenders, investors, securities, mortgage servicers, the FHA, the VA, FHLMC, FNMA, and the Federal Housing Finance Agency, to create standard loan modification guidelines for lenders to take into consideration when evaluating a borrower for a potential loan modification.”  [source]   Problems for Nevada emerged immediately.  Many home loans in the state weren’t part of any of the eligible agencies.  Some didn’t meet the first lien qualification standard.  How to calculate the >31% of available income became problematic.   Worse still the American Bankers Association in conjunction with the Mortgage Twins (Fannie & Freddie) were adamant in their objections to any mention of reducing the principal of the loans to prevent homeowners from going any further underwater.  [ Examiner]

The notion of bankers being unwilling to accept any reduction in the principal in order to prevent foreclosures doesn’t seem to make sense, unless we remember that the banks didn’t have enough skin in the game.  Too many banks securitized too many mortgages while retaining too little ownership of them.

HARP:  The Home Affordable Refinance Program — “To be eligible, you must have a mortgage owned or guaranteed by Fannie Mae or Freddie Mac, sold to those agencies on or before May 31, 2009. The current loan-to-value ratio on the mortgage must be greater than 80 percent. Having a mortgage that was previously refinanced under the program disqualifies you from the program. Borrowers cannot not have missed any mortgage payments in the past six months and cannot have had more than one missed payment in the past 12 months.” [WaPo]

Here we go again — if the loan was owned or guaranteed by one of the mortgage twins, then a homeowner would be eligible.   If not — good luck.

“This is a big deal because, although the Fannie Mae-Freddie Mac-FHA triumvirate controls more than 90% of today’s new mortgage originations, that wasn’t the case from 2001-2007. Last decade, non-GSE lending was a major part of the U.S. housing market.

For example, Alt-A mortgages accounted for 27.5% of mortgage originations in 2005. Today, each of these homeowners is locked out from HARP. HARP 3.0 would allow these Alt-A customers to (finally!) refinance their home loans.”  [TMR]

HARP 3.0 is still on the drawing boards.  The situation as of June, 2012?

Although at least one Senate Republican shows interest in a plan to expand the Home Affordable Refinance Program, the outlook for Congressional action remains doubtful and House Democrats are pushing the Federal Housing Finance Agency to make further HARP changes administratively. During a Senate Banking, Housing and Urban Affairs Committee hearing last week on legislation to expand HARP, Sen. Bob Corker, R-TN, said he was open to the proposal. “I hope that we’ll have a real mark-up on this bill,” he said.”  [IMF]

A HARP 3 bill was introduced by Senators Boxer (D-CA) and Menendez (D-NJ) in September 2012.  S.3522 “Responsible Homeowner Refinancing Act of 2012,”  was placed on the Senate’s legislative calendar on September 12, 2012 and no action has been taken since.

In short, the two major programs have been limited because (1) of the opposition of banks and the mortgage finance industry to any suggestion that the principal of the mortgages be reduced; and, (2) the fact that a full 27% of the mortgages issued during the Housing Bubble were not from government guarantors over whom the Federal government has any current jurisdiction.

Instead of bemoaning the slow pace and limited reach of home mortgage modification in Nevada, we should be demanding that the 112th Congress take action on bills like Menendez’s S. 3522 which would expand the reach of federal services to those holding non-GSE  or FHA loans.

Comments Off on If You Aren’t Pulling The Wagon, Don’t Complain About The Load: Foreclosures in Nevada

Filed under 2012 election, banking, Economy, financial regulation, Foreclosures, housing, Nevada economy, Nevada politics