by Gary North /
DIGG THIS -
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 this 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 re*****sment 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 re*****sed 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
relation****ps you have built with your customers and your communities.
Local banks got out of the 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 *****sed 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 im****tant 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.
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. 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.
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 sup****t 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
re****ting 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 sup****t 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 re****t 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 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
im****tant 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.
March 8, 2008
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