Tuesday, September 29, 2009

Subprime Housing Mess 2.5

Why is this version 2.5? Because we should have learned.  This one is brought to you with the usual actors only this time they are sitting in slightly different chairs.

The Buyer is the same as before, but instead of exceedlingly loose credit standards, the consumer is helped along by an $8,000 first time home buyer tax credit.

The Provider of the loans is not Wall Street this time, but good old Uncle Sam.  From WSJ Opinion (2009 September 29)

The reason for this financial deterioration is that FHA is underwriting record numbers of high-risk mortgages. Between 2006 and the end of next year, FHA's insurance portfolio will have expanded to $1 trillion from $410 billion. Today nearly one in four new mortgages carries an FHA guarantee, up from one in 50 in 2006. Through FHA, the Veterans Administration, Fannie Mae and Freddie Mac, taxpayers now guarantee repayment on more than 80% of all U.S. mortgages. Sources familiar with a new draft HUD report on FHA's worsening balance sheet tell us that the default rates have risen most rapidly on the most recent loans, i.e., those initiated or refinanced in 2008 and 2009.

All of this means the FHA is making a trillion-dollar housing gamble with taxpayer money as the table stakes. If housing values recover (fingers crossed), default rates will fall and the agency could even make money on its aggressive underwriting. But if housing prices continue their slide in states like Arizona, California, Florida and Nevada—where many FHA borrowers already have negative equity in their homes—taxpayers could face losses of $100 billion or more

So who is buying the mortgages? The very banks in trouble, with a little 'encouragement' from the FDIC. (WSJ, September 10,2009)

Holding Ginnie bonds help banks look better because federal bank-capital  guidelines give the Ginnie securities a "risk weighting" of 0%. That means banks don't have to hold any cash in reserve to protect against losses. By contrast, securities backed by Fannie Mae and Freddie Mac, the two mortgage giants seized by the government, carry a 20% risk weighting, meaning some cash needs to be set aside to hold them, even though most banks and investors think there is scant risk of Fannie or Freddie securities defaulting. Privately issued mortgage-backed securities can receive risk weightings of 50%, while many other types of debt carry 100%.
Because of the different risk weightings, bankers say they are selling relatively safe assets like Fannie securities and replacing them with Ginnie securities. The move doesn't shrink banks' balance sheets or remove their troubled assets. But it reduces their total assets on a risk-weighted basis. That is important because risk-weighted assets are the denominator in some key ratios of bank capital.
"With the pressure for capital, that's really made the Ginnie Maes more attractive," said John C. Clark, chief executive of First State Bank in Union City, Tenn. The bank's holdings of Ginnie securities jumped to $66 million at June 30 from less than $4 million a year earlier.
Like some peers, First State bankrolled those purchases partly with taxpayer dollars that were intended to stabilize the banking industry and jump-start lending. The 32-branch bank used a "significant portion" of the $20 million it received through TARP to buy Ginnie securities, Mr. Clark said. Mr. Clark credits the strategy with helping First State preserve its capital ratios even as loan defaults swelled to $9.5 million on June 30 from $1.6 million a year earlier. During the same period, its total risk-based capital ratio climbed to 11.3% from 10.7%. That gave First State some breathing room above the 10% ratio regulators require for banks to be deemed "well capitalized."
So my friend, whom I'll call Mr. Green and is a banker:  I have my eyes on some nice short term GNMA mbs paper.  (Fortunately your last name makes Mr. Green easier, otherwise I'd use a different color)  Let us load you up on the GNMA's and forget commercial lending.  Good rates, no 'risk' and you can be out to the links even earlier!  As a nice bonus your risk based capital ratios will improve as well.  I can even provide some additonal low cost margin leverage on my end as well.  The banking regulators and your boss will love you!  </end sarcasm>

Unfortunately this party will end like the last one, but we all will be paying the bill again and it will be much larger.  Too late, the bills are already coming due:  Calculated Risk (September 18,2009) -- FHA Cash Reserves will drop below requirement

Ironically, the Federal Reserves focus on purchasing mortgage backed securities from GNMA, Fannie Mae, and Freddie Mac compresses the spread between mortgages and treasury rates.   An artifcially compressed spread crowds out any private market competition, forcing more loans into the gentle loving arms of Uncle Sam.

If I sound a bit annoyed in this post, you are correct.  Collectively we are not learning from our very recent mistakes.

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