One of the dead bodies in plain sight that generally goes unremarked upon in polite company is the buyers’ strike in the securitization market. Issuance of private label (as in non-government guaranteed) residential mortgage backed securities has collapsed, with government entities insuring 96.5% of all home mortgages in the first quarter 2010. The commercial mortgage bond market is a shadow of its former self.
One could take the view that the moribund state of the private mortgage securitization market is a side effect of the government’s aggressive efforts to prop up the housing market. In other words, the terms private uninsured investors would require are sufficiently far away from what the authorities are willing to offer that they are not competitive.
Would that that were true, but the state of play is even worse. Starting in 2004, many traditional “real money” private mortgage investors began pulling back. In 2005, derivatives players started colonizing the residential mortgage market, with disastrous effects. Private RMBS were increasingly sold not to arm’s length investors, but to collateral managers of CDOs (who got funding from dealers), and to conduits.
The problem, fundamentally, is one the Fed recognized in 2008: banks needed to raise a tremendous amount of equity. From an April post:
John Dizard, in “Fed plan is spoilt by its backing of hypocrites,” returns to a notion he has brought up in some recent Financial Times articles, namely, that the amount of funds that banks need to rebuild their balance sheets is so large that it cannot be obtained without some form of government sponsorship. Note that that does not necessarily imply explicit payments or subsidies; it could take the form of calling in favors (assuming we have any left), guarantees, or other forms of intervention.
Dizard provides more support for his view by dissecting the Fed’s plan to save the finance business. And what is that plan? Banks must raise $200 billion in the next two quarters.
Dizard treats this fantasy with more dignity than it warrants, puncturing the notion that this goal is even remotely attainable. Moreover, that delusion presupposes that financial concerns are even willing to seek more equity right now. Many are asserting that they don’t need more dough, thank you very much, because sales of stock-linked paper would be highly dllutive. Hhhm, wonder if this point of view has anything to do with the prevalence of option-based incentive comp. It couldn’t possibly, since pliant boards will no doubt re-issue the options at more favorable strike prices. Dizard also points out that shrinking balance sheets to conform with shrunken capital bases isn’t very workable either.
Dizard uses this discussion to make a broader, more disturbing observation: despite the nasty dose of reality inflicted by the markets, regulators and central bankers are still co-opted by the industry and are acting as enablers rather than seeking real solutions, no doubt because they might inflict pain on their charges.
Yves here. Fast forward to 2010. Central bankers seem unwilling to confront some fundamental problems, all of which point to the politically unacceptable conclusions:
1. Chris Whalen of Institutional Risk Analytics contends that large banks, in real, risk adjusted terms, are destroying value. That means they must do a combination of cut pay, which is the biggest expense (which no one at these organizations is even remotely prepared to consider), and/or shrink their balance sheets so as to improve their returns on capital
2. Securitization volumes increased in significant measure due to bad practices: poor due diligence, misratings, the ability to camouflage risk and dump it on unsuspecting parties. Some of the once-critical outlets for risk, namely AIG and the monolines, have been blown up, plus investors have smartened up and are unlikely to be fooled a second time, at least on anything remotely approaching what took place in the bubble years. But all the things that investors want, such as better underwriting standards, having parties in the securitization pipeline retain a meaningful piece of the deals, would make the economics of securitization much less attractive.
So the result is a much smaller securitization market, with much more costly credit.
The real problem is that this is the end state after credit excesses: a return to healthier practices means more costly, less readily available debt. As Gillian Tett describes in the Financial Times today, the authorities stepped in to prevent that outcome, yet appear unwilling to accept the fact that there is no going back to status quo ante, circa early 2007, nor should they want that outcome.
From the Financial Times:
In the first seven years of the past decade, the securitisation sector expanded at a stunning pace…But since the onset of the financial crisis, these markets have collapsed…
So far, few non-bankers have really noticed this collapse, largely because governments have stepped into the breach, papering over the gaping hole. In the US, for example, the Federal Reserve has bought $1,250bn of mortgage-backed securities. In Europe, the Bank of England and ECB have gobbled up mortgage-backed bonds, and other securitised assets, via repo deals. Before 2007, eurozone banks sold more than 95 per cent of their securitised products to private sector investors; now it is under 5 per cent – with the rest going mostly to the ECB.
The crucial question is: how long will this pattern continue? Unsurprisingly, all western central banks are deeply uncomfortable about the fact that they, in effect, have replaced, or become, the securitisation sphere. They are thus looking for exit strategies and urging the banking industry to restart the securitisation machine…
In 2007, when bankers were guzzling champagne, a large source of the demand for securitised bonds came from quasi “invented” buyers – that is, banks and bank-funded vehicles that were developing investment strategies to take advantage of regulatory and rating agency loopholes, fuelled by artificially cheap loans.
Cheap funding has since vanished and governments are determined to close all those loopholes. As a result, those invented buyers have disappeared.
That need not spell the end of securitisation, per se. After all, there are still real money investors out there, such as pension funds, which could buy securitised bonds. But if these real investors reappear, they will demand much better returns. That means the market will be smaller in future, and funding costs will rise.
That leaves G20 leaders with an unpalatable choice: either the government continues to replace the securitisation market indefinitely, to maintain credit growth, or it must adjust to a world where credit is far more rationed and costly. That first option is hated by most central bankers. However, the second is disliked by most politicians, too.
Yves here. So far, political expediency is clearly prevailing.
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I’m currently on my knees, praying that PennyMac will go belly up this year; actually this week would be nice, but, there are some fat greasy squid-pigs pumping funds into this filthy garbage barge:
http://www.marketwatch.com/story/blackrock-highfields-back-distressed-mortgage-fund-pennymac
>> Private National Mortgage Acceptance Company, LLC, or “PennyMac,” will be run by a group of mortgage industry veterans led by Stanford Kurland, the former chief operating officer and president of Countrywide Financial , the largest mortgage originator in the U.S.
BlackRock and Highfields said PennyMac will raise capital from private investors and use the money to buy loans from financial institutions that want to cut their mortgage exposure. The firm will then work with borrowers to re-organize the mortgages and re-sell them later for a profit.
==> May they all reap what they so richly deserve …. They sound like a group of mafia butchers.
Not so. Mafia butchers have standards.
One last thing:
==> Re: “former chief operating officer and president of Countrywide Financial , the largest mortgage originator in the U.S.”
> Apparently this guy is proud to have been involved with the criminal organization which was called Countrywide, and apparently instead of going into hiding like a snake, he wants your money, because Countrywide didn’t steal enough, and for some reason, like a rat with a tail on fire, he swam away from the burning ship, where his buddies didn’t make out as well:
==> On June 4, 2009, the U.S. Securities and Exchange Commission charged former CEO Angelo Mozilo with insider trading and securities fraud, and former COO David Sambol and former CFO Eric Sieracki with securities fraud for failing to disclose Countrywide’s lax lending standards in Countrywide’s 2006 annual report…. etc., etc….
In September 2007, after months of negative publicity and the announcement of a reduction of 20% of its workforce,[52] Countrywide launched a public relations campaign aimed at demoralized employees. Employees were expected to sign a pledge to “demonstrate their commitment to our efforts” and “to tell the Countrywide story to all”. Those who signed the pledge received a green rubber Protect Our House wristband…
>> What about neckbands for these retards at PennymaCrooks?
See: All the dreams we held so close seemed to all go up in smoke
Let me whisper in your ear:
Angie, Angie, where will it lead us from here?
“…either the government continues to replace the securitisation market indefinitely, to maintain credit growth, or it must adjust to a world where credit is far more rationed and costly. That first option is hated by most central bankers. However, the second is disliked by most politicians, too”.
I think the second option – costly credit – will be the one that will win out. The current push to Govt. “austerity” looks to me like a strategy to raise rates. There are a lot of people out there who would like to invest at higher rates, including a lot who want to be made whole after losses in the GFC. They need higher rates, and I think they’ll get them. Ultimately, Govts. respond to investors more than they do to debtors.
In other words, the terms private uninsured investors would require are sufficiently far away from what the authorities are willing to offer that they are not competitive.
Would that that were true, but the state of play is even worse. Starting in 2004, many traditional “real money” private mortgage investors began pulling back. In 2005, derivatives players started colonizing the residential mortgage market, with disastrous effects. Private RMBS were increasingly sold not to arm’s length investors, but to collateral managers of CDOs (who got funding from dealers), and to conduits.
When I muse on how much has really been stolen through the Bailout, I try to think of what would be the right metric for how much each cent should be valued.
One possibility would be to prorate all the trillions at the rate Goldman had to pay Buffett in fall 2008. But that number would have to be modified upward by the TBTF premium (e.g. as calculated by the CEPR), since Buffett invested after the Bailout began.
I suppose another possible measure would be how much MBS really cost according to the market, “the terms private uninsured investors would require”.
That need not spell the end of securitisation, per se. After all, there are still real money investors out there, such as pension funds, which could buy securitised bonds. But if these real investors reappear, they will demand much better returns. That means the market will be smaller in future, and funding costs will rise.
So let me get this straight. Two monumental problems – the existence of securitization in itself, and the way pension funds have been taken hostage by the terrorist “markets” – are said to be slowly mitigating themselves, and yet the FT considers it a constructive possibility that the one problem can try to perpetuate the other by doubling down on itself?
It really is clear: There’s no redemption for any part of this system. We need a complete clean break.
This certainly would explain the disturbing fact that only 28,000 homes were sold last year. A declining housing market in the US will lead to further retrenchment of consumer spending, already struggling with high debt. High private and high public debt will support raising interest rates, although I’m not sure there’s any rate high enough to compensate risk, when there’s no leadership from any quarter to begin the long road to economic recovery, no plan, just the exit strategies of the many politicians, corporate and financial interests who intend to retire to the villas and countrysides or simply continue life unimpeded by the distress of the masses and reflect upon what might have been had the baser nature of man not prevailed in modern civilization.
The central banks are the Last Buyers–but they have infinite (in theory) capital with which to do it, and an ideology which permits them to do it. When and if they stop is a matter of Will, and should be gamed that way.
Hmmmmm …
The newer, CONTROL driven Pernicious Greed, now has the older, PROFIT driven Vanilla Greed, firmly by the balls. And they squeeze. Hard!
Or so it APPEARS …
But amazingly … there is NO real policy reform …
Is that lack of policy reform intentional? Or is it just caused by bumbling policy makers that reflect the same ‘well meaning’ kind of bumbling like that of smiling and lovable master bubble blower, deregulator, Al Greenspan?
Is the invisible propaganda hand — the hand that orchestrates the deflective duopoly theater of Republican vs Democrat — also orchestrating the similarly deflective Pernicious Greed vs Vanilla Greed show, with its theme of; “Oh its all soooooo complex, frustrating and soooooo hard to fix!”, and, its deeper hidden theme; to create perpetual conflict in the masses so as to drastically cut their consumption and create a two tier ruler and ruled world with the ruled in a perpetual conflict with each other?
Is this the final bubble pop? The big vacuum? The great suck?
Is this the real game — Downward Divisive Designer Deflation?
After a while if it looks like a duck …
TSTS! Too Sleazy To Save!
Deception is the strongest political force on the planet.
Yves,
Can you reconcile the apparent disconnect between “having parties in the securitization pipeline retain a meaningful piece of the deals” and a Volcker rule that, in my (admittedly, likely faulty) interpretation essentially would, in spirit, prohibit such activity?
Are Volcker and “skin in the game” mutually exclusive?
Why… after 3 yrs of TARP and such, has “contends” not progressed towards more certain conclusions & language?
I read everything Whalen writes, for some time now. AFAIC, he’s among a few “John the Baptist” voices telling the truth about stuff. His statements on these matters are far more certain than you imply, and far more to the point.
Worse, AFAIC, this has been evident for a loooong, loooong time. And US finance/econ is so far up to it’s ass in delusion (fraud… lies… inability to grasp reality) that moving piles of money here and there does nothing other than… well, move piles of money here & there.
We have a dysfunctional economy, fueled largely by dysfunctional citizenry informed by these wizards of finance Whalen refers to. It’s a circular feedback loop, and there’s little evidence I see that influence exists to thwart the corrosion.
It’s stunning to me that reaction to these housing #’s is like an “ah-ha” moment. Feds have move piles of $$ around, but nothing… nothing fundamental to finance/investment/economic planning has changed: it’s exactly the same as through the obscured bubble years that got us here.
I’m curious Yves… what do you think readers of this “news” conclude? What correction/change… solutions are implied in this? Or, as it seems to me, is this just another point-in-time observation & metric along the way of accelerating slide to collapse? Which is, BTW, a couple years after the fact (TARP birth, w/predicatble results then).
If we agree as a society that currencty is tender for value, yet the keepers of that currency pervert it beyond any reasonable relationship to underlying goods/services (destroying value), what do people expect?
Yves,
sorry to go off topic, but have you read the extraordinary article by Jim Sinclair on Minyanville about BP’s critical role in the banking/credit system.
If what he says is correct, it is a HUGE story. I have not had time to verify any of it.
Thanks,
Lee S.
Monday,
Thanks. Very interesting… worth exploring. Proven oil reserves ARE money in the bank. Bank Petroleum [BP?]
Here’s the site:
http://www.minyanville.com/businessmarkets/articles/bp-bankruptcy-bp-bankrupt-bp-bankruptcy/6/24/2010/id/28903
But prior to say 1980 or so, they were not accounted for as such…and Mr Pickens, amongst others saw the undervaluation, and has thus become wealthy.
“So the result is a much smaller securitization market, with much more costly credit.”
This must explain why mortgage rates are so high now.
Indeed…
Simple arithmetic will suffice:
Ultra-leveraging, which gave us all those debt-financed billionaires and trillionaires, now requires ultra-deleveraging.
Sorry to have to state the obvious (and great post, BTW).
“The real problem is that this is the end state after credit excesses: a return to healthier practices means more costly, less readily available debt.”
Whoa. Whoa. Whoa. Why do you label that a problem?
Every day, I’m looking at these absurd loans initiated in 2005-2006 destined for CMBS. The kind of refinancing deals that I saw in hotels and apartments were *crazy*. There *should* be less readily available debt. Yes, I understand we need credit to have a fully functioning economy. Humans also need water to live. They can also drown if they drink too much.
This is the way it should be (and always have been). Credit should be difficult (but not impossible) to obtain.
30 years of easy credit and NINJA loans followed by 30 years of AUSTERITY in which the cream has already been skimmed off. The teat must be sucked dry with children weaned at birth because capital is on strike.
Was ATLAS SHRUGGED really that hard to understand or just too hard to believe?
7 years of fat, seven years of lean…hav we not seen this dream before?
“The perfect storm”.
There is no trust or faith in the market place.
The government has handed huge gobs of almost free money to the banks, but they are not motivated to lend. Unless the banks can show tripple digit returns on this “free money” they can find no reason to lend. Private lenders have been ‘educated’ that the mortgage market is not safe!
Therefore we have this:
http://theeconomiccollapseblog.com:80/archives/the-coming-u-s-real-estate-crash
> There is no trust or faith in the market place
Exactly. And the lack of meaningful reform/regulation/self-reflection means there won’t be any trust or faith.
The market is acting exactly as it should. Having been screwed by American-style corporatism, it won’t return until honest dealings are available.
Housing is down because housing does not respect it’s customers.. KB Home just Google “KB Home Sucks”. KB will ignore your complaints. The Board of Directors does not care about the quality or the reputation. KB Home only interested in quick profits at your expense and time – with the cheap materials and undocumented workers at this job site. They will undervalue your home just to suit their short term business objective. There is no Lemon Law for your new home in these United States so you’re stuck with it. The housing industry is not regulated. Years later they will still be in your home trying to fix what should have been done correctly in the first place. The Corporate greed still running high in America – it’s called KB Home. BTW Bruce Karatz the former CEO of KB faces up to 60 years in prison when he gets sentenced September 2010. Leslie Moonves is on KB Home’s board and runs CBS, wonder why KB Home does not appear on 60 minutes? Ask you salesperson about Bruce Karatz and his stock manipulation. The rats are jumping ship from KB Home, Wendy Shiba General Council and secretary stepping down shortly after Ron Burkle’s resignation as Board Member. KB Home does not publish their warranty online? They have a FTC Consent order, it states if you are not 100% satisfied they will buy your home back within one year. How many have they bought back? ZERO! The Mozila trial didn’t start yet, what’s the deal? More time to play GOLF with Friends of Mozila? KB Home Countrywide mortgage, became Countrywide…Then Bank of Italy became… Bank of America.