Bank expert Chris Whalen has a little bombshell in his current newsletter. It’s so obvious that it should not only have occurred to me but pretty much everyone on the real estate beat. And that begs the question why no one has even mentioned it.
One of the actors in the subprime/Alt A market was private mortgage insurers. For those of you lucky enough to be unfamiliar with this concept, PMI is insurance paid for by the borrower for the benefit of the lender. The effect of PMI is to insure the property value on highly levered transactions. Lenders were quite happy to lend up to 80% of appraised value based on semi-decent income; it was considered unlikely before the crisis that home values would fall all that much in a specific geography even in a recession. But for the amount in excess of 80%, the lender wanted extra protection. In steps the PMI insurer. If the borrower wants to make only a 10% downpayment, he would need to get a PMI policy to insure down to the 80% risk that the lender was prepared to shoulder. (Update: note that the insurable event is a default on the loan, not a change in property value).
Given the prevalence of PMI insurance, their thin capitalization, and the big wipeout in home values, they should be as dead as the monolines. But they aren’t. That’s because they are engaging in insurance fraud, namely, refusing to pay out legitimate claims.
And perversely, as Whalen tells us, they are getting quite a bit of help from Fannie and Freddie not making claims at all. Why not? Well, if the GSEs did put in claims, the PMIs would quickly go bust and Fannie and Freddie would report losses. So the failure to put in claims is yet another variant of “extend and pretend”. But in this case, there’s good reason to believe the numbers are very large:
Both investors and Congress need a lot more details about the purchases of defaulted loans by Fannie and Freddie. We need to know exactly how many dud loans have migrated back to the GSEs, what their loan loss reserve is, how much of that loan loss reserve is “covered” by the MIs and how much “capital” the MIs have against these exposures. The GSE are letting dead loans sit on their books in part to avoid recognizing the losses, an event that would drive many of the MIs into bankruptcy. If you look at how slow the process of final loss recognition by Fannie and Freddie is proceeding, then you’ll understand why the publicly disclosed loss rates reported by Fannie and Freddie have been falling.
Instead of demanding insurance payments, the GSEs are doing everything in their power to keep the MIs looking like going concerns so that they can count the MI “receivable” as a good asset. This is why the GSEs direct LTV based LLPAs to the MIs, to keep some cash flowing their way, and…
If there was a proper mark-to-market on the MIs (like all proper insurance/reinsurance businesses do), then the MIs would be massively insolvent. The GSEs would have to take another huge amount of capital from Treasury. Geithner and the GSEs are trying to avoid it, and to date are getting away with it. Sad to say, nobody at the FHFA seems to have a clue about this issue. But we understand that a certain independent minded committee chairman on Capitol Hill is preparing for hearings on this monumental act of fraud against the taxpayer, not to mention the holders of GSE debt.
Now the losses on the underwater PMI (or MI as Whalen prefers to call it) are only one part of the picture. An even uglier part of the equation is the dead loans still being carried at face value:
As the GSE warehouse of delinquent and defaulted loans grows by billions of dollars each month, there is still no demand for payment from the MIs by the FHFA. As we noted in an earlier comment, we figure that there is as much as $200 billion in defaulted loans sitting on the books of Fannie and Freddie at cost — that is, close to par value
Loss severities are now running at 70%. They are only going to rise as housing prices are forecast to fall further in most markets and more borrowers are fighting foreclosure, which increases the cost of foreclosing. But if you take Whalen’s $200 billion top estimate and take a conservative 70% in loss severities, that gets you to $140 billion in unreported losses at the GSEs. So an estimate of north of $100 billion seems plausible.
Whalen also tells us how the latest round of stress tests are even more divorced from reality than the first iteration:
….we review the Fed’s latest stress test exercise and discuss what it means for the banking industry and the US economy. While the US central bank did not provide results for specific institutions, the assumptions in the Comprehensive Capital Analysis and Review (CCAR) are more instructive than the Big Media seems to notice. Indeed, a close reading of the CCAR document provides a compelling argument for why the Fed should not be supervising financial institutions.
For example, the Fed has a down 6% for housing prices in its “stressed scenario,” but that is about where we are now. Incredibly, the central bank also has a down 5% for HPI [housing price inflation] in 2012, again in a “stressed” scenario. This implies that the Fed’s “normal” estimate for HPI is positive for 2011-2012? Hello?
I’ve said it repeatedly, but it seems I can never say it enough: the financial power that be have long ago ceased being in the business of anything remotely connected with reality. They honestly seem to believe if they can get enough people to believe their propaganda, reality will come to conform to it.
In my entryway, I have some Rockwell Kent prints, namely, his Apocalypse series, on display (yes, I’m sure readers will regard that as fitting). One, which didn’t strike me as particularly apocalyptic when I bought them, is called “Degravitation” and shows Wall Street people flying to the sky. Maybe I can sell copies to the Fed and Treasury as motivational pictures, since it does seem to depict the business they are really in.
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You will see pretty much the same thing if you examine the financial statements of any insurance company, bank, large corporation. Assets are marked to fantasy. Liabilities are underreported. Footnotes are indecipherable. Business continues because cash keeps flowing in and more importantly sucking out to the enrichment of prevaricating suits. There is very little point in analyzing overweening dishonesty. You cannot get toothpaste back in the tube. Human life requires that the food keep coming in and the trash keep going out. Work cannot be stored but finance is the music in the game of musical chairs around which all work is organized. What is the operative premise? Credulity. Real people exchange real effort for fiat money and the game continues. The victims are those who expect to store yesterday’s effort in financial assets none of which any longer has value, although most of them continue to have a price, at least for now.
Agreed. I think this is rather old news, except I would suspect that ONLY $100 billion might be a softball low number.
There was a valid reason why Mr. Kellerman committed suicide awhile back, after being appointed acting CEO at one of those (sorry, forgot which one), and I don’t think it was for personal reasons, as Mr. K was supposed to have been an honorable man.
“””I’ve said it repeatedly, but it seems I can never say it enough: the financial powers that be have long ago ceased being in the business of anything remotely connected with reality. They honestly seem to believe if they can get enough people to believe their propaganda, reality will come to conform to it.””
From Deep Survival by Laurence Gonzales
“””We all make powerful models of the future. The world we imagine seems as real as the ones we’ve experienced. We suffuse the model with the emotional values of past realities. And in the thrall of that vision we go forth and take action. If things don’t go according to the plan, revising such a robust model may be difficult. In an environment that has high objective hazards, the longer it takes to dislodge the imagined world in favor of the real one, the greater the risk. Adaptation is important; the plan is not. It’s a Zen thing. We must plan. But we must be able to let go of the plan, too.
Psychologists who study survival say that people who are rule followers don’t do as well as those who are of independent mind and spirit.”””
How prevalent was PMI? My experience buying a house in 2002 was that mortgage brokers and lenders would do anything possible to get borrowers out of having to pay PMI. Don’t have a 20% down payment? No problem, we’ll do an 80/10/10 with a 10% piggyback second mortgage and a 10% down payment. Can’t even come up with the 10% in that scenario? No problem, we’ll work with the seller to help finance the downpayment by monkeying with the selling prices. I’d imagine things had gotten even worse by 2005 or so.
PMI was often rolled into the purchase price, an upfront payment, no doubt in excess of the NPV of the payments over the expected life. That had the effect of making it partly tax deductible to the borrower. It was made tax deductible on a supposedly temporary basis starting in 2007. It was extended through 2010, not sure re 2011.
Interesting – where’s Ralph Nader when you really need him?
I could imagine someone bringing a claim in a state court about deceptive trade practices – on the theory that the MIs and the lenders now have a quiet agreement that highly inflated mortgage insurance premiums could be charged and tacked onto the loan the sucker (ahem, excuse me, borrower) was taking out.
But the lenders and the MIs now know that such “insurance” is now in fact just a bogus charge – claims will never be paid b/c claims will no longer be made.
How much longer until the entire machinery of the real estate market seizes up, I wonder?
Yves, I can tell you that the poster, DP is 100% correct in that PMI went out the window by 2002 and banks started routinely avoiding PMI by providing a piggyback equity loan for whatever money was needed above 80% of the purchase price. I didn’t know why they were doing it, but I personally attended many closings in NY, where the parties are typically represented by attorneys, throughout the 1990s and 2000s and that is the way it was done. I only saw PMI on FHA or VA loans after the early 2000s. At the time I figured the lenders figured they may as well make the money on the interest rather than letting the PMI companies make money on the premiums.
Now, I realize that they were packaging those seconds and selling them up the securitization chain just like the firsts. I imagine, since the seconds had higher interest rates, they could sell the MBS issued with a higher yield and make more money on the backend. I think this also had to do with great demand for such securities at the time, just as underwriting went out the window in order to keep the mortgage assembly line to securitization chain going.
Oops, the poster I was referring to was RuetheDay. Also, I suppose there could have been a dichotomy between scenarios where the first was intended to be sold to Fannie/Freddy as opposed to the first being sold into a private label securitization. I really don’t know if that was the case, but it might be. After all, private label picked up a huge share of the market during that time period.
It also seems that many of the private label securitization trusts contained credit default swaps against the mortgages contained therein, so I suppose, they could have figured why insure the mortgages twice?, ie once at the individual loan level and then again at the pooled trust level?
I’m just speculating, but I know the briefs in the Ibanez case did disclose that there were credit default swaps (that paid off) contained in the trust that their mortgage supposedly made its way into.
My understanding is that they provided a very small ammount of coverage in the subprime and ever less in the alt-a market during the bubble. At some level THEY were the ones looking at losses, rather than palming the risk off on clueless bond purchasers as happened with those second mortgages. But I wouldn’t be surprised if they continued to cover a pretty good percentage of the relatively sane mortgages the F&F would be willing to purchase.
Good thinking Rue….but there are different kinds of PMI. The majority of instances are exactly what you are thinking of- the MI is used to cover any financed amount over 80% at the loan level, which the borrower needs to pay for. In this case, an 80/10/10 or 80/20 would circumvent that need.
But you also have LPMI. Many of these loans- even the 80/10/10s- were sold in securities, for which the issuer obtained additional MI on the entire security (“wrap”) to cover any potential losses. This was particularly common on Non-Conforming deals. So even of there is no MI payed by the borrower, there may be exposure on the deal side as well.
Maybe the idea is that, once there is no more extend and pretend for Fannie and Freddie, the propaganda Wurlitzer then will be able to spin the necessary failure/bailout as definitive PROOF that the poor people who took out big loans really did CAUSE our financial Fukushima.
Maybe. Too cynical?
Three things are no longer possible in this culture:
1) being too cynical;
2) being too skeptical of TPTB; and
3) parody–reality always outpaces it.
it seemed sort of clear when the GSEs announced the buyouts in jan/feb 2010 that the MIs would be beneficiaries.
but i’m also a little confused by the logical flow of the argument here. do the GSEs ever make direct claims to the MIs? i thought the servicer made the claims to the MIs, then the MIs either paid or looked to rescind coverage (or OK a loan mod, etc). if the MI rescinds, then it gets sent back to FNM/FRE and normally pushed back to originator for rep/warr.
i haven’t gone through the GSE filings/financials. what am i missing?
Thanks Yves! Did not have room to talk about the connection between private MI and CDOs. We’ll get to that. Keep an eye on this Qualified Residential Mortgage process. The MIs are desperately trying to carve out a new role in the post-crisis housing sector.
Yves–
I’d be interested to know whose responsibility it actually is to submit the claims to MIs: GSEs or the servicers? I would suspect the servicers, because if these loans were sold in MBS (or futher into CDOs), the servicer would submit the claim, not the investor.
Further, what has happened to the cash flows from these defaulted mortgages? I suspect we’re talking about FNM/FRE retained loans? If GSEs are carrying them at face value, you’re talking about delinquencies far north of 90 days, some north of a year…
Teeing up in the litigation queue: the National Credit Union Administration.
http://online.wsj.com/article/SB10001424052748703410604576217023625225138.html?mod=WSJ_hp_LEFTWhatsNewsCollection
WSJ
MARCH 23, 2011
Banks Hit for Credit Union Ills
By LIZ RAPPAPORT
Federal regulators are blaming Wall Street’s biggest firms for the collapse of five institutions at the heart of the nation’s credit-union industry and are seeking to recoup tens of billions of dollars in losses on securities that doomed the five.
In one of the broadest accusations that Wall Street helped cripple financial institutions during the crisis, the National Credit Union Administration, or NCUA, has threatened to sue several investment banks unless they refund over $50 billion of mortgage-backed securities sold to the five institutions, called wholesale credit unions.
The NCUA is accusing Goldman Sachs Group Inc., Bank of America Corp.’s Merrill Lynch unit, Citigroup Inc. and J.P. Morgan Chase & Co. of misrepresenting the risks of the bonds to wholesale credit unions, which loaded up on the bonds in their role of investing on behalf of retail credit unions, according to people familiar with the situation.
[…]
The NCUA’s hardball move is one of most aggressive steps yet by the U.S. government against the Wall Street securities factory that turned millions of mortgages into bonds, helping to inflate the housing bubble, whose collapse resulted in economic damage throughout the world.
HFactor,
You are pretty close. What the article really said is that
the Us Economy is definitely SOGGY toast.
Our financing/banking/underwriting/securitization processes for the past 15 years have created a situation where most of the large banks are insolvent and the guarantors and investors behind them can not cover the losses.
As early as 2002 I was stating back in Indiana that Fannie Mae was buying ‘bad HUD loans’ in order to meet certain benchmarks of low in income loans in order to trigger larger bonuses for then Fannie head, Franklin Raines. He, along with others were determined that the American people would not know that the losses are staggering (that is 9 years ago folks) because it would have pushed stock values down and led to the possibility of the government needing to take over the management of Fannie.
I was speaking out trying to get someone to listen to the national impact such behavior would have–to no avail. On NPR I discussed this with Tavist Smiley as an issue with national implications. The Fannie Mae economist denied the
they were hiding larges losses; I insisted they were.
Now history tells us that I was right and as a direct consequence Fannie Mae is now a ward of the country. What is so incredibly sad is that they (Fannie and Freddie) could have been reined in back then before they cost the country bu-billions and they are yet to cost us gu-billions more.
I could go on and on but I won’t.
They are now our children and we have to take responsibility for their irresponsible behavior.
Hence, we are unfortunately, bound to be really, really SOGGY toast.
Have the best day you an, given the state of the nation.
Mildred
Thanks Mildred….I’ve just finished reading ‘The Price of Loyalty’ about Sec. of Treasury Paul O’neills two years in Bush administration 2000-2002. (This is my second time reading the book/read it when it first came out ’04’)…..in it he writes about a economic cabinet meeting where Greenspan BLOWS UP and states ‘Capitalism is Broke’ in America(and world). This was after both O’neill and Greenspan(GOOD FRIENDS) found out that not only was Enron NOT an isolated incident BUT the way MANY MANY of the ‘BIGS’ (Banks,mutinationals) were ‘doing business’!!! Fast forward to Nov. 10′ interview with O’Neill where he clearly states NOTHING has changed and he’s not sure if ANYTHING can reverse it….BUT America’s day of ‘reckoning’ is CLOSE!!! ‘Day of Reckoning’???? …is that the CRASH of our economy and what will that LOOK LIKE????? (I know a LOADED question to ask!) THANKS!!!
Mildred, thanks for your efforts. I am sure you are receiving multiple job offers due to you fore-sight. Surely Elizabeth Warren and numerous “regulatory” agencies are clamoring for your insights. I know I got tons of calls from those who heard my (correct) predictions.
I’m a layperson who had trouble understanding this article but from what I did understand, does it say that the Economic Future of this country is TOAST???
I agree with Whalen. Big bank financial statements are a fantasy.
Yves stated “That’s because they are engaging in insurance fraud, namely, refusing to pay out legitimate claims.”
Since this post doesn’t explain where, when, how the PMI’s are refusing to pay out legitimate claims (fraud), perhaps someone can direct me to a website or blog that can provide greater detail on this issue. Maybe another post from Yves with more detail?
Otherwise a great post for bringing Whalen’s article to our attention on failure of the GSE’s to make claims on PMI’s.
That’s in part of the Whalen post I didn’t quote directly. But this is the predictable result when parties write insurance and are undercapitalized. The monolines understood that and tried to avoid taking any risk (as in their ratings were meant to be rating agency arbitrage, for instance, providing guarantees to good credit quality municipalities because it was cheaper for them than getting a rating). But if you provide guarantees beyond what your capital will support, and you take real risk, your options are going bust or denying legitimate claims (some people will fight you in court but a lot won’t).
Thank you. Yes, first the monolines and then the PMI’s. I guess the title insurers will be next up on denying legitimate claims on defective titles resulting from the foreclosure fraud.
I thought Whalen produced a very interesting take on the MI’s and GSE’s. Brings to light many questions, some that had crossed my mind and many that hadn’t. However, Yves blog suggests that MI companies or insuring against a drop in value of a property.
“If the borrower wants to make only a 10% downpayment, he would need to get a PMI policy to insure against the possibility that the value of his house might fall below the 90% he had borrowed against it, down to the 80% risk that the lender was prepared to shoulder.”
This is incorrect. They insure against default on the loan and that amount is from any LTV higher than 80.01%. They do not make any claims about or if a property declines in value…
Your explanation of PMI accords with my understanding. In normal times — say, back even ten years ago — PMI was something of a gold mine for the concerned financial institutions.
Sorry, this was not worded precisely, but the intent of the insurance was to insure exposure over 80% property value, and in context, it is clear the event they were concerned about was default. A borrower can typically drop his PMI if either pays his loan balance down to 80% of appraised value OR the property appreciates so that his loan balance is equal to or less than 80% of the property value. The concern was about the amount of recovery in the event of default, that the lender would wind up with losses on a high LTV loan.
The post does state that the insurance covers the excess of the borrowed amount. Nowhere does it say the trigger for a claim would be a fall in property value. But I will clarify the post.
Our elites have been building kleptocracy for the last 35 years. It’s not like this bit of the financial system is corrupted and that part isn’t. It’s all crap, just in different ways. When Geithner took the loss limits off the GSEs, it was clear they were going to be the designated garbage can. Of course, their accounting is fantasy. Whose isn’t? All of them are lying. They will lie until reality, a collapse or a revolution, intervenes just as they will loot until one or both of these events occurs.
I am going to say it anyway. So, your Oligarchs employ The US (through Congress and The Presidency) to ‘extend and pretend’. This is not about the banking sector. This is about their power they wield through the banking.
And their wealth. That is right. They want to keep what the would lose. And they upped the ante by rigging the system and getting their employees in Congress and The Presidency to put the burden on you, the American public.
They screwed the pooch so bad that the pooch bit back. And, instead of taking the medicine for the rabies. They passed it on to you. They are carriers of a disease. And, they are exploiting it.
We all know the truth. The verdict is in. We have had since 2007 to realize it. Now, we just need to quit pretending. The Oligarchs, due to their egos and desires, will take us all down if they don’t get to stay the masters over their slaves.
The Oligarchs have the deal mostly done. Not all the way, of course. We live in a society with some semblance (perverted as it is) of ‘Rule of Law’. And some little people keep getting in the way and actually trying to apply the rules.
You have two choices: You are with them. Or you are against them. Being with them means staying a slave. Being against them… well, that remains to be seen what happens.
Just remember. They so-called masters will take this world down with them. After all, if they can’t have it, neither should you.
A RE-POST:
Thanks Mildred….I’ve just finished reading ‘The Price of Loyalty’ about Sec. of Treasury Paul O’neills two years in Bush administration 2000-2002. (This is my second time reading the book/read it when it first came out ‘04′)…..in it he writes about a economic cabinet meeting where Greenspan BLOWS UP and states ‘Capitalism is Broke’ in America(and world). This was after both O’neill and Greenspan(GOOD FRIENDS) found out that not only was Enron NOT an isolated incident BUT the way MANY MANY of the ‘BIGS’ (Banks,mutinationals) were ‘doing business’!!! Fast forward to Nov. 10′ interview with O’Neill where he clearly states NOTHING has changed and he’s not sure if ANYTHING can reverse it….BUT America’s day of ‘reckoning’ is CLOSE!!! ‘Day of Reckoning’???? …is that the CRASH of our economy and what will that LOOK LIKE????? (I know a LOADED question to ask!) THANKS!!!
It’s ridiculous how much bullshit Wall Street is willing to shovel onto this country in order to avoid taking a loss on anything.
Everyone wanted to bet big and hedge and hand out loans like candy, but now no one has the balls to just admit they made horrible business decisions and pay up.
Capitalism was god, and god is dead.
Jeezzz, 100B$? What’s that, 1 month of deficit?
Wake me up when the loss is at least half-a-T.
That’s a very good point. You demostrated strategic thinking :-)
‘the GSEs are doing everything in their power to keep the MIs looking like going concerns so that they can count the MI “receivable” as a good asset’
M to Fantasy valuation of MBSs is epidemic!
Extend and Pretend games have been going on with no real challenges!
The charade continues!
You might want to add Kent’s “It’s Later Than You Think, or Wake Up America” to your collection.
http://clubs.plattsburgh.edu/museum/rka_print.htm
— And thank you for all of your efforts to help America wake up.
Subprime severity rates are running about 70% (72.2% in Q4 10 according to TCW, a fund group that is a big player in MBS), but severity rates are lower for Alt-A (58.2%) and Prime (44.9%). As somebody pointed out earlier, the portfolios of Fannie and Freddie were more heavily skewed toward Prime than Alt-A and subprime. And delinquency/default rates in Prime are a fraction of those for Alt-A and Subprime.
Not to say that Fannie and Freddie aren’t disasters, but applying a 70% severity rate to their problem loans seems excessive.
There is reason to think that the FC process in a lot of localities has moved faster on properties with more equity. And I’d hazard that we are going to see another 10% fall in RE with a very big backlog, plus more borrowers fighting. And if borrowers fight FCs at all, you can quickly get to 200% plus loss severities. Those two factors combined can easily add 15% to the loss severities you see now. An attenuated FC process (due to the need to resolve documentation problems pre fling) also adds to losses (the more the servicer advances in interest, the more he takes back out when the FC finally happens).
Put it more simply, there’s good reason to think the GSEs are sitting on the loans with the potential to have really bad loss severities. And you still get to $100 billion with $200 billion of defaults and 50% loss severities.
F&F are great example on why gov’t should stay out of the housing business. It’s hard to stay objective when your playing on the same time.
What is a credible estimate of the total hidden losses in the US? Perhaps more than one trillion. Perhaps less than five.
Try 6-10 trillion. Easy.
If 1% of the 600+ trillion in over the counter derivatives are losses, that gets you 6 trillion. Since the counter-parties are largely the insolvent money center banks, 10-30 trillion is not out of the question, including systemic effects.
I misread this… “the dead loans still being carried at FARCE value:”
Still works.
So what?
That’s just one and a half Madoff as far as losses go. Considering that Fannie and Freddie are two big *institutions*, they should really be ashamed it’s so little.
It is acceptable, but sad, that the stupid and blind can’t see or understand the implications of a Naked Emperor riding an Elephant in the same room.
As intelligent sighted people it is amazing that Americans are still missing the implications and continue to allow it to happen without comment while the guy cleaning up the poop left behind is arrested for having contraband elephant poop…
Hopefully Americans will see the truth and ask why the emperor is naked and riding an elephant in the first place… http://diligencegroupllc.net/
American Homeowner
-AH