Gary North’s REALITY CHECK
Gold’s price:
www.GaryNorth.com/snip/300.htm
To subscribe to this letter:
www.snipurl.com/subscribenow
Issue 734 March 7, 2008
BERNANKE ON THE MORTGAGE MARKET HOUSE OF CARDS
The worst is not behind us. The worst is yet to come.
I have this on the highest authority — from the man who
has openly admitted that his organization has no solutions
to offer except month-old data on the extent of the housing
crisis.
When the public at last figures the out, there will be
financial blood in the streets.
When I first read Ben Bernanke’s March 4 speech, I was
amazed at how gloomy he was in full public view. He
concealed this gloominess with academic bloviation, which
is his version of Greenspan’s FedSpeak. But if you pay
attention to what he says, you can find out much of what he
is thinking. This was not true with Greenspan.
Bernanke spoke on the need for banks to reduce
interest rates for busted home owners. This indicates just
how scared he is. To argue for a rewriting of millions of
contracts to favor debtors is one more example of the
asymmetric nature of mortgages. Lenders lose; debtors win.
His long, tedious, and thoroughly academic speech
revealed an academic economist whose career has not yet hit
the inevitable brick wall: the unforgiving realities of
capital markets, contracts, and an economic crisis. He may
still believe that footnotes will save his reputation.
They won’t.
He is presiding over a stock market decline that
threatens to turn into a collapse. Yet he pretends that
being a boring professor in public will somehow calm
international stock markets. It won’t.
Greenspan was incoherent. Bernanke is boring. His
rhetorical strategy in his speeches is to drone on and on
about what is now obvious to all of his listeners. He
thereby avoids concentrating on looming disasters that are
not yet obvious to his listeners. But, unlike Greenspan,
he eventually does hint at what is not yet obvious. I slog
through his speeches in search of those hints.
Bernanke’s public strategy for the last six months has
been to offer a series of detailed analyses of how the
horses got out of the barn. He has no clue as to how to
get them back in.
REDUCING PREVENTABLE MORTGAGE FORECLOSURES
The mortgage market, as we all know, is the heart of
the current problem. It is a gigantic carry trade market,
and it always has been. Mortgage lenders are borrowed
short and lent long, which is the essence of the carry
trade. Now this trade has been disrupted because what
should have been obvious in 2005: the inability of subprime
borrowers to pay off their loans. This has become public
knowledge. The mortgage lenders cannot raise the short-
term capital necessary for the game to go on as before.
Here is what is obvious to most investors at this
point.
Over the past year and a half, mortgage
delinquencies have increased sharply, especially
among riskier loans. This development has
triggered a substantial and broad-based
reassessment of risk in financial markets, and it
has exacerbated the contraction in the housing
sector. In my remarks today, I will discuss the
causes of the distress in the mortgage sector and
then turn to the key question of what can be done
in this environment to reduce preventable
foreclosures.
This newly reassessed risk is based on a discovery,
namely, that Greenspan’s ludicrously loose monetary
policies, 2000-2003, have led to a housing bubble crisis.
But Bernanke will never admit this in public.
He is now in search of new suppliers of pools of
capital who are willing to rush in and bail out the
mortgage lending market. Who wants to be first? Nobody.
But the crisis will get much worse if lenders don’t enter
this market to provide loans for visible deadbeat
borrowers. This must be done very soon.
If the deadbeats walk away from their homes, and if
new lenders are not found to fund replacement owners,
America will experience hundreds of billions of dollars of
property equity decline by the end of 2009. He will not
say this directly, but this is the problem. Squatters and
the weather will take over occupancy.
Who, then, should rush in where angels fear to tread?
Local banks, says Bernanke. They did not create the
crisis, but they must solve it.
Although I am aware, as you are, that community
banks originated few subprime mortgages,
community bankers are keenly interested in these
issues; foreclosures not only create personal and
financial distress for individual homeowners but
also can significantly hurt neighborhoods where
foreclosures cluster. Efforts by both government
and private-sector entities to reduce unnecessary
foreclosures are helping, but more can, and
should, be done. Community bankers are well
positioned to contribute to these efforts, given
the strong relationships you have built with your
customers and your communities.
Local bankers got out of the home mortgage market two
decades ago, after the savings & loan debacle took its
toll. Government-guaranteed mortgage lenders entered,
pooling trillions of dollars of mortgages based on a broad
geographical base of loans from around the country. This
was done in the name of asset diversification. It also cut
costs of local monitoring. The statisticians assessed the
risk, and nobody was hired locally to monitor the loans and
collect monthly payments. So, local banks took commissions
for originating loans locally and then passed the loans on
to Fannie Mae and Freddie Mac.
Local banks went into commercial real estate instead.
Their banks are now at risk. The Comptroller of the
Currency, John Dugan, on January 31 gave a speech to the
Florida Bankers Association. He made this unsettling
observation.
Over a third of the nation’s community banks have
commercial real estate concentrations exceeding
300 percent of their capital, and almost 30
percent have construction and development loans
exceeding 100 percent of capital.
Here in Florida, as in other states where housing
is so important to local economic growth, the
concentration levels are more pronounced. Over 60
percent of Florida banks have CRE loans exceeding
300 percent of capital, and more than half have
C&D loans exceeding 100 percent of capital.
www.GaryNorth.com/snip/511.htm
When the commercial real estate market begins to fall
in the recession, as it will, local banks will have their
hands full. Where will they get the capital to head off
foreclosures in the residential estate market?
So, no one is available locally to monitor the empty
houses or screen replacement home owners. The cost of
monitoring is rising. The number of people locally to do
the job has declined.
Bernanke now thinks that local banks are ready,
willing, and able to take over their old tasks. But how?
No one has been trained to do this for 20 years. The
people with these skills have retired. The local banks got
cut out of the mortgage market except as loan originators,
which economic idiots could do, and did.
Why would any local bank step in now? Not to get
rich, surely. Only to keep from getting poorer in a
national banking crisis. Here is Bernanke’s message:
“Heads, you lost; tails, you will lose even more. Step
right up! This way to the guillotine!”
Then he went into his now-famous “Let me give you a
history of the foul-up instead of offering a solution”
routine. Or, as I have often described it, blah, blah,
blah.
MORTGAGE DELINQUENCIES AND FORECLOSURES
Here is what we all know. So, he calls it to our
attention.
Mortgage delinquencies began to rise in mid-2005
after several years at remarkably low levels.
The worst payment problems have been among
subprime adjustable-rate mortgages (subprime
ARMs); more than one-fifth of the 3.6 million
loans outstanding were seriously delinquent at
the end of 2007.1 Delinquency rates have also
risen for other types of mortgages, reaching 8
percent for subprime fixed-rate loans and 6
percent on adjustable-rate loans securitized in
alt-A pools. . . .
Boring. Useless. Irrelevant. In other words, a
Ph.D. academic economist’s career strategy. “Bore them
into submission.” It won’t work.
It’s going to get worse, he says. Yes, he says this
in a boring way. Pay attention anyway. Watch for key
phrases, such as this one: “some further declines in house
prices are likely.” They surely are!
Delinquencies and foreclosures likely will
continue to rise for a while longer, for several
reasons. First, supply-demand imbalances in many
housing markets suggest that some further
declines in house prices are likely, implying
additional reductions in borrowers’ equity.
Second, many subprime borrowers are facing
imminent resets of the interest rates on their
mortgages.
Ed McMahon used to ask Johnny Carson, “How bad is it?”
Bernanke plays the role of Carson, but without the humor.
In 2008, about 1-1/2 million loans, representing
more than 40 percent of the outstanding stock of
subprime ARMs, are scheduled to reset. We
estimate that the interest rate on a typical
subprime ARM scheduled to reset in the current
quarter will increase from just above 8 percent
to about 9-1/4 percent, raising the monthly
payment by more than 10 percent, to $1,500 on
average. Declines in short-term interest rates
and initiatives involving rate freezes will
reduce the impact somewhat, but interest rate
resets will nevertheless impose stress on many
households.
In other words, we have not yet begun to see the
carnage in the subprime market. The problem is
refinancing. No one wants to lend strapped, stressed
debtors any more money.
In the past, subprime borrowers were often able
to avoid resets by refinancing, but currently
that avenue is largely closed. Borrowers are
hampered not only by their lack of equity but
also by the tighter credit conditions in mortgage
markets. New securitizations of nonprime
mortgages have virtually halted, and commercial
banks have tightened their standards, especially
for riskier mortgages. Indeed, the available
evidence suggests that private lenders are
originating few nonprime loans at any terms.
This situation calls for a vigorous response.
Ah, yes, the ever-popular “vigorous response.” And
what has the FED’s response been? To deflate. The
financial press has not yet caught on. The FED has not
inflated. It has deflated.
www.GaryNorth.com/public/3118.cfm
What additional vigorous response does Bernanke have
in mind? Administered how? How fast? With who in charge?
Using what for money? At whose expense?
Here comes neighborhood blight, like a thief in the
night. Here comes the collapse of collateral for millions
of bonehead loans.
At the level of the individual community,
increases in foreclosed-upon and vacant
properties tend to reduce house prices in the
local area, affecting other homeowners and
municipal tax bases. At the national level, the
rise in expected foreclosures could add
significantly to the inventory of vacant unsold
homes–already at more than 2 million units at
the end of 2007–putting further pressure on
house prices and housing construction.
He said steps are underway to solve this problem. He
gives no proof of how these steps can work or if they are
working now. He said: “Policymakers and stakeholders have
been working to find effective responses to the increases
in delinquencies and foreclosures.” Oh, yeah? So what?
There is a big and growing problem. This problem was
created by loose money policies under Greenspan and by
national mortgage lending agencies (GSE’s). But the
economic hit will be taken locally. “Troubled borrowers
will always require individual attention, and the most
immediate impacts of foreclosures are on local communities.
Thus, the support of counselors, lenders, and organizations
with local ties is critical.” But where are these local
agencies? What incentives do they have to step in?
In short, forget about the busted borrowers. What
about the troubled lenders? Busted and troubled lenders?
Who is going to finance borrowers who have no credit, no
extra money, and no jobs in a recession?
“O course, care must be taken in designing solutions.”
Spoken like a true academic. What care? Administered by
whom? “Solutions should also be prudent and consistent
with the safety and soundness of the lender.” Like what,
for instance?
Bernanke then droned on and on about the Federal
Housing Administration’s plans, as if the FHA had money to
solve the problem, as if the FHA were involved in this
massive pile of bad mortgage loans. The FHA is a
peripheral player, yet this is the main government agency
in the housing loan market. So, he talked about the
toothless FHA. This indicates that the government has no
tools or plans to intervene. But what else could he have
done? He dared not admit that the government has
insufficient money and leverage to solve this crisis.
He then called for a vague “loss-mitigation
arrangements.” Like what? Administered by whom locally?
At whose expense? With losses to be borne by whom?
In cases where refinancing is not possible, the
next-best solution may often be some type of
loss-mitigation arrangement between the lender
and the distressed borrower. Indeed, the Federal
Reserve and other regulators have issued guidance
urging lenders and servicers to pursue such
arrangements as an alternative to foreclosure
when feasible and prudent.
Guidelines? That was what the mortgage industry
needed ten years ago.
The response system is running out of time, yet
foreclosure costs are high — thousands of dollars per home
– and the courts are jammed. Meanwhile, an empty house
falls in value within weeks, as crackheads or weather take
their toll.
You want to know what is coming? This: gigantic
equity losses. Yes, Bernanke is boring. Read him anyway.
The financial media are not reporting on this.
Loss mitigation is made more attractive by the
fact that foreclosure costs are often
substantial. Historically, the foreclosure
process has usually taken from a few months up to
a year and a half, depending on state law and
whether the borrower files for bankruptcy. The
losses to the lender include the missed mortgage
payments during that period, taxes, legal and
administrative fees, real estate owned (REO)
sales commissions, and maintenance expenses.
Additional losses arise from the reduction in
value associated with repossessed properties,
particularly if they are unoccupied for some
period.
He was talking about abandoned homes and equity
losses. This is happening already. This is not a maybe.
This is a sure thing. The loss of equity will undermine
the loans. Look at his estimate: 50% of principal balance.
A recent estimate based on subprime mortgages
foreclosed in the fourth quarter of 2007
indicated that total losses exceeded 50 percent
of the principal balance, with legal, sales, and
maintenance expenses alone amounting to more than
10 percent of principal. With the time period
between the last mortgage payment and REO
liquidation lengthening in recent months, this
loss rate will likely grow even larger.
Moreover, as the time to liquidation increases,
the uncertainty about the losses increases as
well.
Who is going to write new loans at anything like
today’s home prices? Nobody who is not already stuck with
the bad loan. But these lenders are running short of
capital.
I love the man’s use of language. Consider the words
“limited” and “considerable.” He seeks to convey calm.
The reality of what he is describing does not point to calm
in the mortgage markets anytime soon.
The low prices offered for subprime-related
securities in secondary markets support the
impression that the potential for recovery
through foreclosure is limited. The magnitude
of, and uncertainty about, expected losses in a
foreclosure suggest considerable scope for
negotiating a mutually beneficial outcome if the
borrower wants to stay in the home.
Can any of this actually work? He used the phrase
“less likely.” I agree entirely.
Unfortunately, even though workouts may often be
the best economic alternative, mortgage
securitization and the constraints faced by
servicers may make such workouts less likely.
So, how bad is it? Very bad and getting worse. The
default rate is rising.
Despite this progress, delinquency and default
rates have risen quickly, and servicers report
that they are struggling to keep up with the
increased volumes. Of course, not all delinquent
subprime loans can be successfully worked out;
for example, borrowers who purchased homes as
speculative investments may not be interested in
retaining the home, and some borrowers may not be
able to sustain even a reduced stream of
payments. Nevertheless, scope remains to prevent
unnecessary foreclosures.
Scope remains. I see. Scope. When I hear “scope,” I
think of a mouthwash that covers bad breath.
He made it plain: borrowers will be allowed to escape
their debts. Once again, the asymmetry of the mortgage
market becomes visible. Borrowers win. Lenders lose.
Lenders and servicers historically have relied on
repayment plans as their preferred loss-
mitigation technique. Under these plans,
borrowers typically repay the mortgage arrears
over a few months in addition to making their
regularly scheduled mortgage payments. . . .
Loan modifications, which involve any permanent
change to the terms of the mortgage contract, may
be preferred when the borrower cannot cope with
the higher payments associated with a repayment
plan.
Lenders are balking at writing down principal.
Surprise! Surprise! If they write it down, they have to
record this in their books as a loss. They don’t want to
do this. They prefer to conceal the loss with negotiated
rates.
Lenders tell us that they are reluctant to write
down principal. They say that if they were to
write down the principal and house prices were to
fall further, they could feel pressured to write
down principal again. Moreover, were house
prices instead to rise subsequently, the lender
would not share in the gains.
Then what can be done? Fannie Mae and Freddie Mac
must come to the rescue. But with what? They are under
siege. Their credit ratings are held up in the same way
Wile E. Coyote was held up when he overshot the ledge of a
cliff. He has looked down, but he is still hanging in mid-
air. We await the inevitable fall.
The government-sponsored enterprises (GSEs),
Fannie Mae and Freddie Mac, likewise could do a
great deal to address the current problems in
housing and the mortgage market. New
capital-raising by the GSEs, together with
congressional action to strengthen the
supervision of these companies, would allow
Fannie and Freddie to expand significantly the
number of new mortgages that they securitize.
With few alternative mortgage channels available
today, such action would be highly beneficial to
the economy. I urge the Congress and the GSEs to
take the steps necessary to allow more potential
homebuyers access to mortgage credit at
reasonable terms.
CONCLUSION
The man droned on for another four pages of text. All
of it boiled down to this: the FED has no solution. All
that the FED can do is share data. As a professor,
Bernanke believes in data. As a the head of the FED, he
has no answers, but he has lots and lots of data to share.
I would like to comment briefly on Federal
Reserve System efforts to reduce preventable
foreclosures and their costs on borrowers and
communities. The Federal Reserve can help by
leveraging three important strengths: our
analytical and data resources; our national
presence; and our history of working closely with
lenders, community groups, and other local
stakeholders. A major thrust of our efforts is
sharing relevant and timely data analysis of
mortgage delinquencies with community groups and
policymakers to efficiently target resources to
areas most in need.
If you think the FED can solve the mortgage crisis,
it’s time to re-think your understanding of the FED.
Bernanke has confirmed Franklin Sanders’ aphorism: “The
Federal Reserve has only two policy tools: inflation and
blarney.”
Bernanke is running low on blarney.
Loading ...
