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Tracking the consumer evolution of financial services

Archive for the ‘sub prime’ Category

“If the chain of title of the note is broken, then the borrower no longer owes any money on the loan” | Subprime redux

I have been reading John Mauldins weekly emails for a while and I gain tons of insight through it.  Tonights note including quotes from David Kotok at ( almost made me fall off my chair.  Like everyone I have heard that US banks are pressing pause on foreclosures and there was some talk of fraudulent foreclosure notices with what I thought I heard about shortcuts.  The issue is much deeper.

The Subprime Debacle: Act 2 | John Mauldin

"Homeowners can only be foreclosed and evicted from their homes by the person or institution who actually has the loan paper…only the note-holder has legal standing to ask a court to foreclose and evict. Not the mortgage, the note, which is the actual IOU that people sign, promising to pay back the mortgage loan.

"The whole purpose of MBSs was for different investors to have their different risk appetites satiated with different bonds. Some bond customers wanted super-safe bonds with low returns, some others wanted riskier bonds with correspondingly higher rates of return.

"So somewhere between the REMICs (Real-Estate Mortgage Investment Conduits, a special vehicle designed to hold the loans for tax purposes) and MERS (Mortgage Electronic Registration System), the chain of title was broken”

In simple terms the mortgages placed with Freddie Mac/ Fannie Mae, were broken up into tranches where each mortgage was no longer whole … bits went into high grade securities, and bits went into junk bonds.  This was the attraction of the new vehicles with different rates of return.  In order to maintain chain of ownership between borrower and (original) lender the use of REMIC and MERS was designed to do that.

It failed.  The chain of ownership was broken between the borrower and the holder of the note.  That break in the chain says that the borrower no longer owes any money on the loan.  The issue of transparency has always been there with Mortgage Backed Securities MBS).  This goes much further than transparency.  The question is one of legality in creation of MBS and the methodology that supported them.

If you want to read the whole thing, sign up here.

This is huge.  This is why Ally Financial (formerly GMAC), JP Morgan Chase, and Bank of America have suspended mortgage foreclosures.  They run the risk of all the foreclosure actions being declared null and void.  This story is about to get big. 

Written by Colin Henderson

October 16, 2010 at 21:10

Posted in sub prime, subprime

Canada banking sector is avoiding the troubles in US and UK

The press is all doom and gloom at the moment.  Not without reason, but the causes and implications are getting blurred.  So I did a simple analysis comparing three stock markets, their fall since mid 2007, and the relative importance of the banking sector in that fall.  The results suggest that it does depend where you live.  There is an all out banking crisis in the US and UK, based on market sentiment.


us can uk comparison 

Somehow Canadian banks are not regarded with such fear as the others.  This no doubt partly due to the early work of Purdy Crawford and the Federal Governments efforts last year to manage the $35bn in ABCP.  In retrospect this was a far-sighted move (Fall 2007).  In a very complex manouvre, they carved the $35bn held by smaller banks and investment houses into tranches that were backed by hastily arranged lines of credit from the Banks.  In any event the outcome was an orderly shift away from certain bank or investment house bankruptcies.

Written by Colin Henderson

October 5, 2008 at 13:21

America in hock | who is responsible?

A particularly telling graph of US consumer debt / GDP.  The rise from 1995 is almost exponential!  ‘

America in hock

A cut in overall lending would be a complete reversal of trend. Morgan Stanley reckons that total American debt (ie, the gross debt of households, companies and the government) has risen inexorably since 1980 to more than 300% of GDP (see chart), higher than it was in the Depression. Consumers, in particular, were encouraged to borrow by low unemployment and interest rates and (until last year) rising asset prices. Their debt jumped from 71% of GDP in 2000 to 100% in 2007, a bigger increase in seven years than had occurred in the previous 20.


in hock

Question de jour, given North America is in election time;  is this the Governments’ fault?  Who is responsible for the outcome of this new debt load? 

PS … no prizes for answers, but I’d love to see the debate in context of the $700 bn bailout that will inevitably be approved before NYSE opens Monday.

Written by Colin Henderson

September 27, 2008 at 22:25

Posted in sub prime, US

What should Banks be required to do to bring confidence back

Smithers raises an interesting concept here.  He offers that Banks should value their loans on the balance sheet at market value.  Today loans are shown at face value on Banks balance sheets.  The reduction based on market value would have a dramatic effect on Bank capital, and take many from being highly levered to being hyper levered, or bankrupt. 

However he misses the point that Banks already do this in effect by taking allowances for bad debts, and there are substantial reserves in place in most conservative Banks.  However its clear that those reserves are not adequate, and there are different levels of conservatism exhibited amongst Banks.

It goes against normal accounting practise that books assets at cost, but Banks are clearly in need of a different approach that will bring credibility and confidence.  It will take more than accounting, but this is one step in the right direction. 

Financial crisis: what the US authorities should do

The authorities should require banks to value their assets at these levels and to make conservative reserves against future losses. Banks would then fall into one of three categories:

(i) those with adequate capital for regulatory purposes, who would need to take no action

(ii) those with inadequate regulatory capital, who would be required to raise new equity and would be capable of raising it from private sources and

(iii) those that would need the injection of preferred capital by the government as proposed by Charles Calomiris

Written by Colin Henderson

September 21, 2008 at 04:04

Posted in sub prime

Resolution Trust FAQ |

Here is a nice crisp synopsis of Resolution Trust that will be responsible for managing the $700 million in bad loans.  RTC was set up to unwind $394 Bn of bad loans following the Savings and Loan failures in the 1980’s.  There were 747 S&L failures in that period.  America has a history of Bank failures. 

Here is the synopsis at

The RTC provided two functions. It shuttered many of the failing institutions, which wound up totaling 747. The total amount of assets equalled $394 billion. It then liquidated those assets over a period of time until it was folded back into another federal agency — the Federal Deposit Insurance Corporation (FDIC).

According to analysis by the FDIC, the total amount incurred by the taxpayer came to $75.6 billion, while the private sector absorbed just $7.1 billion. The taxpayer covered more than 90% of the cost of the bailout. The FSLIC also accumulated losses. The total tab to the taxpayer as of 1999 came out to $123 billion, or about 81% of the total costs.

It appears they had decent success.  The new tab this time around is only double the amount at $700 Bn … not much if you say it really fast.  Given there has been nearly 20 years elapsed, in real terms this failure may in fact be a similar amount.  In retrospect, if this brings back confidence to US Banks, it will be the best way out of a bad situation. 

The key though is that the remaining Banks must be required to alter their approaches and focus on balance sheet strength, not quarterly shareholder satisfaction.  It is time to revisit the bank model of low capital, high profits and dividends.  Its time to treat Banks as if they were normal companies, and all the financial measures that come with that accountability. 

Written by Colin Henderson

September 20, 2008 at 16:45

Posted in sub prime, US

Lessons from Japan that are not being heeded

No need to get extreme just yet, but its interesting to reflect on previous bubble situations, and Japan is a good example.   During the period 1986 – 1990 Japan experienced an extreme bubble based on stock and property values.  Chatting with my wife, who lived through that bubble, there are distinct parallels.  In other words they experienced North America 2000 plus 2007 yet simultaneously.

Prices were highest in Tokyo’s Ginza district in 1989, with choice properties fetching over US$1.5 million per square meter ($139,000 per square foot). Prices were only slightly less in other areas of Tokyo. By 2004, prime “A” property in Tokyo’s financial districts had slumped and Tokyo’s residential homes were a fraction of their peak, but still managed to be listed as the most expensive in the world. Trillions were wiped out with the combined collapse of the Tokyo stock and real estate markets.

The easily obtainable credit that had helped create and engorge the real estate bubble continued to be a problem for several years to come, and as late as 1997, banks were still making loans that had a low guarantee of being repaid. Loan Officers and Investment staff had a hard time finding anything to invest in that would return a profit.

Meanwhile, the extremely low interest rate offered for deposits, such as 0.1%, meant that ordinary Japanese savers were just as inclined to put their money under their beds as they were to put it in savings accounts.

There are interesting lessons here, that point to possible scenarios for North America as it unwinds itself from the current situation.  Economists  will argue that the scenarios are different and that the outcomes will be different, yet we know some aspects are always true.  The following chart from Wikipedia indicates the exponential increase in property prices lately.  Common sense suggests this isn’t sustainable.


1890                                                            1960                                        2005


BloggingStocks back in July commented on bubbles offerring five different types. 

  1. Securitisation – If a bank sells a loan rather than keeping it on its books, it does not care whether the borrower pays back the loan. Now that the securitisation market is dead, banks can’t sell the loans they originate so they pay more attention to whether the borrower can repay.
  2. Leverage – During the boom, the typical investment bank and hedge fund had $1 of capital for every $32 in assets, meaning that it borrowed the other $31. This level of borrowing expands profits when the bubble is expanding and magnifies the losses during a contraction. If these financial institutions had more of a cushion of capital, they would not need to look to taxpayers to bail them out of their business mistakes.
  3. Fear of getting left behind – During an expansion, financial institutions look at their peers and they wonder why they are not doing as well.
  4. Young staff – When the bubble pops, financial institutions fire the people who made the loans and originated the deals. Many of the people they fire have the experience to understand what went right and what went wrong.
  5. Heads-I-win, tails-you-lose pay – As I have pointed out here and here, financial institutions pay people for the volume of business they bring in. This encourages them to close as many big deals as they can and to ignore the quality of those deals. When the deals go bad, nobody asks them to fork over their multi-million dollar bonuses to cover the losses of the deals they originated.

This is a terrific assessment.  Securitisation is all about the sub-prime crisis, and the lack of transparency between the eventual lender and the original borrower.  Leverage is why the Banks are unable to weather the subprime crisis without help.  Points 3. 4. and 5. are pretty much how the Banks got into this situation in the first place. 

Bottom Line … these are tough times, and everyone is an expert.  The final result will undoubtedly be something that no-one anticipated, and we are just seeing the beginning today.  

Written by Colin Henderson

September 16, 2008 at 00:41

Posted in sub prime

Citi, Merrill, UBS involved in buy back of $20 Bn in ‘misrepresented’ securities

In a truly remarkable turn of events Citi is essentially guilty of mis-representing the value in $7.5Bn in securities sold to investors. Merrill Lynch and UBS are also involved. The amounts ($20 Bn) and the names involved are simply staggering.

Clearly additional information is needed to better understand but the SEC has clearly taken a tough enforcement stance here. The fast and loose days are over for Banks. / Companies / Financial services – Citigroup and Merrill in $20bn ARS agreements

In a key settlement with state and federal regulators, Citi agreed to buy back within three months $7.5bn of ARS held by individual investors and small businesses. ARS are long-term debts issued by municipalities and others whose interest rates are set at bank-backed auctions

The bank neither admitted nor denied wrongdoing but paid a $100m fine
to settle claims from regulators that it had misrepresented ARS as
liquid, cash-like securities.

Under the deal, Citi pledged fully to compensate small investors who
sold ARS at a loss after February 12, when the market collapsed. Citi,
which agreed to the deal within days of being threatened with a lawsuit
by Andrew Cuomo, the New York attorney-general, said the measures would
result in a $500m pre-tax loss.

After the Citi deal, Merrill announced it would offer to buy back ARS
it had sold to some 30,000 retail clients. There are $12bn of holdings
but Merrill said it expected there to be $10bn by the time it begins
the buyback in January 2009.

Written by Colin Henderson

August 7, 2008 at 19:43

Posted in sub prime

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