I suppose I would only add that the circle can't be broken. One must take the additional step of asking where all those dollars the Japanese and Chinese invest in mortgage-backed securities come from.
Coring out our industrial base with patently illegal trade practices?
What are the other possibilities? The stork brought them?
Of course, there are people in the United States who have made Croesus look like...well, like an illegal alien, through fees and other payoffs from mortgage-backed securities, people who have been farting through silk so long they're thinking of moving to synthetics, and these people are going to have a few choice words for Barney Frank in particular, but it is theoretically possible that, representative Democracy that we are, their voice may become more faint.
A little while back, Tanta, you mentioned a new "bad-vibes candidate for Very Bad Mortgage Day." If you were sober, you said, you might even tell us about it. Perhaps now? FED on its lifeboat rescue mission, or something else? Ala
Does anyone know if Barney Frank was deriding subprime mortgage abuse a year ago?
If congress moves at this point to tighten standards more than the market would bear, doesn't that accelerate or worsen the situation?
I'm with banker on this one. The loans were sold subject to conditions. If the conditions were not met, the loans went back to the broker. Simple enough.
If it helps any, the bondholders will suck the brokers dry soon enough, and will still be left holding a plenty big bag.
Bondholders were sold junk but it was wrapped in AAA paper.
"Bondholders" are not "mortgage-holders."
If you want to buy a mortgage loan, go to a mortgage originator and whip out your checkbook. They'll make the appointment whenever it is convenient for you. Trust me.
A bond may be backed by mortgages. (Or just about any other IOU I've ever heard of.)
Do we all know the difference between a bond and the underlying asset?
You get the AAA rating on your tranche of the security by being first in line for interest payments and last in line for losses. How, exactly, does the AAA tranche holder "get sold junk"?
Now, if you bought a BBB- or an unrated residual, well, maybe you're at some risk. But who told you it wasn't junk?
We are talking about liability for suits alleging predatory or deceptive lending practices. "Assignee liability" means that if you're making the income off the underlying loans, you have liability if those loans turn out to have been illegal.
Through the haze, I can start to see the shape of the coming apocalypse -- let's raise some tariffs to punish those patently illegal trade practices, let's void some contracts (we'll have Barney decide which ones) ex-post facto, and above all let's make it as difficult as possible to get any kind of mortgage.
I know the apocalypse is not far away when I start agreeing with Banker...
"Seems to me this would cause interest rates to skyrocket, if by increasied liability lead to diminished demand."
So what, homes might fall in price and actually become affordable again. A 40% off sale would be a good place to start IMHOP. I also own 3 of the damn things and it wouldnt bother me a bit. I knew they were liabilities when I bought them however I also paid cash.
What I couldn't quite discern from the article is whether they are looking at placing some liability on the Wall St. firms that are pooling the mortgages for securitization. IF they are going to place liability on the investors, then they also need to place it on those selling the securities. Of course, trying to impose liability on Wall St. is always difficult, as they are some of the biggest political contributors. If the Wall St. firms are excluded, it will be clear that their dollars have clearly bought them what they wanted.
Should it really be the bondholders left holding the bag?
So long as there were adequate disclosures (and the disclosures would certainly be enough to put most sane people off from buying these things) AND the credit support and enhancement requirements are enforced, then it is buyer beware.
However, to the extent that the originators/underwriters fail in their duty to ensure that the bond's requirements are met, gnawing on the butts of the bondholders in that food chain is not quite kosher.
I always though that bond ratings were based on the likelyhood of default. If so, how can predatory loans be listed as AAA, since by their very nature, they are more likely to end in default?
Also, if we are going to hold those who spread the liquidity responsible, shouldn't we start with the Fed?
This thing has no chance of passing and even if it did, it would be vetoed or declared unconstitutional. What's next? are common shareholders of mortgage lenders going to be held liable too?
Yes, well, you couldn't expect Bloomberg to clearly explain what the proposed legislation does, because that's all nerdy and shit when you can just get quotes from some dealer.
There are several model "assignee liability" laws out there. Usually, it means anyone in the assignment chain is liable. That would include any party on Wall Street who bought whole loans in order to package them into a security.
It would, unless there were some specific exclusion in the law, allow the ultimate bagholder--the bond buyer--to sue the pants off the packager if said packager did not fully disclose said potential liability risk.
The ex-post facto was a joke for "horse is out of the barn."
Having said that, this is truly a terrible idea. it's primary effect would be to keep first time home buyers from doing so. Guys like me? Do whatever you want, it has no impact. This will drill the aspiring poor and lower middle class. It is thoroughly unworkable, and unreasonable to ask bondbuyers or some interim entity to examine each underlying loan process.
How about this as a better idea if you are concerned with predatory practices. No loan originator can receive more than half their fee up front if the loan has a reset mechanism. The other half of the fee will only be paid one year after the reset occurs if the loan remians current. That approach is going to cause a whole lot less damage that the Congresscritter's approach.
Banker, can we just quit with this business about how it's all supposed to help the poor?
Predatory and deceptive lending is illegal. AGAINST THE LAW. That kind of illegal. That's what we're talking about here.
Bondholders already have credit risk of some sort. This law is about whether they can be liable for returning "ill gotten gains."
And who the hell is going to handle escrows for originator commissions for five years until the ARM resets? You think that would be cheaper than just forcing some due diligence expenses on bond buyers?
My whole point in the post is that dealing with mortgage brokers is obviously some kind of whack-a-mole game that hasn't been working. I'm perfectly ready to hear realistic proposals for further regulation of the bottom of the food chain, but, well, there's that commie thing . . .
So Tanta, are you saying that if fraud was involved in originating a mortgage that was sold by the originator to Fannie or Freddie, and I happened to buy a Fannie or Freddie securitization that included that loan in the collateral pool, I should have liability to the original borrower?
I assume the mortgage insurers would be happy to provide a service to indemnify the bondholders. Sounds like a huge growth opportunity! Better cover those shorts...
atheist, you, Fannie, the originator, and anyone else in the chain who extracted income off the deal would be jointly and severally liable. (Or whatever legal form of liability were written into the law.)
You get the AAA rating on your tranche of the security by being first in line for interest payments and last in line for losses. How, exactly, does the AAA tranche holder "get sold junk"?
Moody rated some unproven security as AAA, so it allowed Goldman to sell it to interest hungry Chinese. The Chinese believed both Goldman and Moody. Both Moody and Goldman made good money in the process.
Now back to Chinese. They worked hard to make that extra dollar. They have been blamed that they made that dollar. Now they are also blamed for believing to what was written on a wrapper. As I understand bondholders are the ones who stand to lose the most money, but the way I view it, they were deceived.
The mortgage originators, RMBS packagers and credit rating agencies are the ones to be blamed!
I must say that my worries about Fannie and Freddie are not going away with this move by Barney and Spence. But of course only a few of those 2500 accountants sorting out Fannie's affairs really know the impact of cutting mortgage streams further than the current slow down. James at econobrowser Econbrowser: More on Freddie Mac and Fannie Mae
makes a reference to a $3.7B reversal in derivative trading at Freddie (thought by many to be the brighter of the 2 outfits) for 2006...when the news was still reasonably cheerful.
Get better straw. Straw men can use only the finest, high-grade stuff.
...this is truly a terrible idea. it's primary effect would be to keep first time home buyers from doing so...It is thoroughly unworkable, and unreasonable to ask bondbuyers or some interim entity to examine each underlying loan process.
Huh? Perhaps you could rephrase that to make it sound like you come from somewhere near this solar system, because right now it sounds like bond buyers shouldn't examine the creditworthiness of the bonds they are buying.
In addition, the gratuitous comparison between yourself and first-time home buyers is, of course, specious, but it is also out of the mouth of Marie Antoinette. Is that really where you want to be?
We can't stop with the focus on those who would be hurt most, sorry. Nobody needs to handle "escrows." The loan servicer would be paid a fee by the originator for providing that information to the broker. They would then follow up on their contract with the lender. Yup, it would be a lot cheaper.
BTW, if all this is already ILLEAGAL (caps are cool huh?) then why the additional law? This approach is dumb. But it is fine since all it is is grandstanding by the Congresscritters anyway.
I assume the mortgage insurers would be happy to provide a service to indemnify the bondholders. Sounds like a huge growth opportunity!
Mortgage insurers insure against credit risk. They do not now nor have they ever volunteered to cover losses due to criminal activity on anyone's part.
Now back to Chinese. They worked hard to make that extra dollar. They have been blamed that they made that dollar.
I take it that Americans do not work hard to make that extra dollar.
I take it that there is no de facto slave labor in China and that Chinese workers get paid pennies a day because that is the fair market value of their labor.
In that case, you should be eager to move to China.
"It's not "fraud," by the way. It's predatory or deceptive practices. Those words have meaning in the statute."
So how is that any different than the IPO and research scams in the dot com era? Seems pretty similar to me, and the IBs wrote some major checks to settle.
The expectation that holders of an MBS or CDO are going to be capable or willing to evaluate their liability for the predatory activities of some 3rd rate mortgage broker strikes me as extremely unlikely. If this bill passes, someone is going to step in to examine each mortgage and indemnify the bondholders. Why not the mortgage insurers?
Unless it turns out that it's simply uneconomic to go to all the trouble, and it makes more sense to just leave the loans on a banks balance sheet in the first place. Hmmm....
So how is that any different than the IPO and research scams in the dot com era? Seems pretty similar to me, and the IBs wrote some major checks to settle.
That's right. And they want to make damned sure they never have to do that again.
If this bill passes, someone is going to step in to examine each mortgage and indemnify the bondholders.
I'm sorry, I'm not a lawyer, but I'm having a hard time with the idea that anybody can sell protection for engaging in illegal behavior, or that the solution to all this is another swap--this time a PLS: Predatory Liability Swap. That makes no sense to me, sorry.
Why shouldn't bondholders have due diligence expenses? When did everybody get a constitutional right to cost-free investments?
You realize, don't you, that the easiest way to check whether a loan is predatory or deceptive is to look at its interest rate in relationship to the current yield on a prime loan?
In one post, you sound like Marie Antoinette. Now, you want to sound like a first-time home buyer.
But I refer you to your original post: Guys like me? Do whatever you want, it has no impact.
How am I supposed to parse that?
Now, are bondbuyers supposed to examine the creditworthiness of the issuer?
If it's General Motors debt, I assume they don't look at every car, but they look at representative samples of cars (Statistics 101). Bondbuyers are not supposed to look at representative samples of the debts underlying the bonds when it comes to MBS?
It is thoroughly unworkable, and unreasonable to ask bondbuyers or some interim entity to examine each underlying loan process
Is that, or is that not, a straw man? That's saying we have to look at every car General Motors makes before we can buy a General Motors bond. That's nonsense, and no one is proposing it.
Let's move onto credit card companies and their predatory practices of ensnaring gullable citizens, straight out of college and sometimes before. Talk about foreclosures ruining peoples' lives - what about $100,000 credit card debts? Why isn't everyone enraged about this? What percentages of the population are so deeply indebted they have lost hope??? They were offered loans just like subprimers. And they took the bait.
If we're going to make sure the risk is held by the party reaping the reward, then what about the credit card companies... raising interest rates from 3.9% to 29.99% in a blink of an eye...
I wish Barney Frank would take on this issue for a change.
You realize, don't you, that the easiest way to check whether a loan is predatory or deceptive is to look at its interest rate in relationship to the current yield on a prime loan?
What about the rare predatory loan that didn't have a higher rate? No thanks, maybe I'll just stick with corporates. Oops, there goes the MBS market.
Americans are the debtors, Chinese (Russians, Arabs, etc) are the lenders. Yes, we borrow from the terrorists. OTOH the terrorists support our economy because they lent to us at low rates.
Chinese (Russians, etc) invest in American paper securities because there is nothing productive they can buy with the dollars we paid to them in exchange for valuable goods they gave to us. They were deceived by Goldmans and Moodys that the securities they were buying were high grade. It's already given that they are going to lose money on those securities. And now they liable because they believed to scoundrels.
Well, it was expected. Our congress will always blame Chinese, French or Martians. They don't contribute to our politicians.
I take it that Americans do not work hard to make that extra dollar.
Americans are the debtors, Chinese (Russians, Arabs, etc) are the lenders. Yes, we borrow from the terrorists. OTOH the terrorists support our economy because they lent to us at low rates.
Chinese (Russians, etc) invest in American paper securities because there is nothing productive they can buy with the dollars we paid to them in exchange for valuable goods they gave to us. They were deceived by Goldmans and Moodys that the securities they were buying were high grade. It's already given that they are going to lose money on those securities. And now they liable because they believed to scoundrels.
Well, it was expected. Our congress will always blame Chinese, French or Martians. They don't contribute to our politicians.
You could probably afford the damages on that one.
My quick read of the NJ law was that the damages were a free house (plus attorney's fees, etc.). One or two of those would be likely to ruin my appetite for MBS's...
High-cost home loan assignees are subject to all the claims and defenses that could be brought that the borrower could assert against the original creditor or broker.
Assignee has presumed liability exemption when they can establish that it has:
a policy against buying high-cost home loans, and
exercises reasonable due diligence in purchasing such loans.
The liability exists:
for six years following the closing of the high-cost home loan; or
for the term of the loan in cases where foreclosure has been commenced, the debt has been accelerated, or the high-cost home loan is 60 days in default.
I am not responsible for the grammar of that. The state of NJ is.
In any case, I suggest those of you worried about those low-rate high-cost loans might want to read the summary.
Hey, I am fed up with hearing about all of capital's prerogatives. When Goldman Sachs goes crying to Uncle Ben, and they will, the American taxpayer will end up footing the bill for bailing them out. Just like the S&L debacle.
Tanta, "Tell me again why this is unfair to bondholders"
Well, I don't know whether or not it's unfair, and it probably isn't, but who is to say that the A, AA or AAA paper is going to stay that way. The ratings agencies were fast asleep at the switch. Isn't it possible that the paper might get downgraded? Then what? A lot of pension funds and strictly managed fixed investment funds have a requirement that they hold only, say, AAA paper. They would by default be forced to SELL, driving the value down.
As I see it - The bodholders are the bagholders since they take a haircut when they sell.
There's too many buyers of subprime/Alt-A ABS that do not have sufficient understanding of the mortgage business or how many of the more complex mortgage products work. They don't understand all the risks. Juicy spread=BUYBUYBUY!!! It's rated investment grade! Put it in my CDO!!!
Back in the bad old days, folks would buy say carpet from a business, that business would sell the credit, and then maybe never install the carpet or sell shoddy carpet.
In the bad old days, the customer would be out the carpet and the loan, because the holder in due course of the loan would sue to recover his debt.
Then there was the thought that folks knowledgeable enough to invest in debt should be knowledgeable to know who they bought the debt from. This became law. So the holder in due course became responsible for the carpet. The result was that folks buying debt got more careful about who they bought it from.
An agreement by the two lawmakers may increase the likelihood legislation will be passed this year. The cost of borrowing would rise and curb financing for some lenders and subprime homebuyers, said David Brownlee, who oversees $14 billion as head of fixed income at Sentinel Asset Management in Montpelier, Vermont. It would also reduce opportunities for the Wall Street firms that pool the home loans as securities...
Well, if that doesn't cause the housing market to completely freeze up and the U.S. economy to fall into recession, I suppose nothing will.
Because Fannie and Freddie do not buy "high cost loans" as that is defined in these statutes for their own MBS issues. They guarantee to the buyers of their bonds that no such loans will ever back those securities.
If Fannie or Freddie happens to buy a tranche of a subprime security for its own investment portfolio, and such security contained one or more illegal predatory loans, guess what? Fannie or Freddie would be the bondholder in that case.
If the F's got uninterested in buying the top tranches of that subprime shit, because of the liability . . .
Oh, so Banker is defending the banks again, oh joy. Though you were being facetious, I actually agree this:
Theres something downright commie about making sure the risk is held by the party reaping the reward.
As the only self-described 'commie' here, I think the bondholders should eat it. If they were so stupid as to buy into the 'no housing bubble' theory thereby believing these MBS would never sour, they should get their asses handed to 'em. Let the idiot pension fund managers, FCBs and hedgies get their pedestals pulled out from under them. It's about damn time. Is it going to hurt some innocents? Of course, but this disaster is going to hurt all around the world.
The banks won't get away without pain, as they will hold enough of the bag to hurt, and what's even better, the global investment community will trust them like they did during the Depression. Fool me twice, shame on me-right? Didn't the world learn before the mistake of trusting the money lenders? Hopefully the lesson will last a little longer this time around, with some seriously ugly regulations to crimp the greed merchants thrown in for good measure.
Yes, the banks will suffer severely even with the bondholders taking it on the chin. And for quite some time.
Unfortunately for the banks and their roomfulls of PhDs, the ratio of idiot PhDs to smart PhDs is rather large in our present world. As a scientist by training, some of the dumbest PhDs I've worked with have come out of Harvard (Noooooo!!!). I'm totally serious. Of course, they think they're geniuses. [Post-docs at Harvard are a different story, as they go there for the access to funding and connections]. Think W.
Maybe I'm missing something but bondholders are holding the bag, aren't they? The covenants only protect the bondholder for repurchase on early default, but all the stuff later in the pipe that goes sour is not the responsibility of the originator, right? And if the originator chokes on too much forced repurchasing, they just go belly up and get liquidated. Meanwhile the resale value of the bond completely tanks while the income it generates deteriorates. What have I gotten wrong here?
We are not talking about who eats a defaulted loan.
We are talking about what happens if you screw a consumer by deceptive lending practices which are designed to generate mo' money for investor.
The idea is that the investor could be forced to return the mo' money. Even if the loan did not default. You are not allowed to keep usurious interest that you got someone to agree to pay you by means of deceptive practices.
I guess if a new law is passed that makes certain loans illegal, then is continuing to collect interest on those loans an ongoing criminal enterprise?
If I hold the note today, how do I determine whether it is legal or illegal? Is it a determination in a crminal or a civil court? If criminal, is there any penalty to the borrower who falsely claims that the note is illegal.
While I like the idea of extracting some flesh from everybody in the non-prime food chain, I share the concerns about after the fact legislation making a note that was "legal" yesterday "illegal" today. I agree with Tanta that with no countrol over mortgage brokers, you get a lot of bottom feeding scum in the business. Consumers cannot be expected to police the brokers.
"The only thing cheap money and creative financing did was drive up the cost of housing."
This is a good point. The central bank that claimed to have policy of being opposed to high inflation simply changed the definitions, dropped rates to the basement, held them there and let things buck.
They deserve - and, in history , will get, full 'credit'. The moral: you can lead people to liquidity but cannot make them use it in a responsible fashion.
They guarantee to the buyers of their bonds that no such loans will ever back those securities.
Yes, Yes, Yes . The vast majority of bondholders are going to want a guarantee from somebody that they aren't going to be liable for that secret mortgage broker predatory side deal.
And, that is going to increase the cost of securitized mortgage instruments. Just like the price of carpet loans went up after it turned out somebody had to check to make sure the carpet company was legit.
Somehow I doubt that the bondholder are the ones who have been making most of the money off the high interest loans. I suspect that mortgage brokers, mortgage bankers, investment bankers and credit rating agencies are the ones. Does anyone have any hard numbers? How bid is the yield on AAA trench of subprime bonds?
This all hits at the the core of "liquidity." The real reason why someone would buy a bond backed by mortgages is because of the fact that they do NOT need to know anything at all about the underlying transaction. The ability to buy and sell anonymously is "liquidity." that is the foundation of our brand of capitalism based almost entirely upon the limitation of liability for the investor which allows one investor to sell their shares to another investor without being concerned about the possibility that they may face some additional unknown liability (beyond the cost of their investment).
I would note that this "limited liability" capitalism has been created mainly to ensure "liquidity." Not because it is necessarily more efficient. After all, who would buy Dow Chemical stock if they were worried that some environmental damage caused by Dow could mean that THEY would lose their house as well as their investment in Dow. No one. However, in theory, the value of Dow should reflect this possibility of environmental damage but clearly it does not if that damage need not be paid by the shareholders.
Chinese (Russians, etc) invest in American paper securities because there is nothing productive they can buy with the dollars we paid to them in exchange for valuable goods they gave to us.
Then why are they exchanging these "valuable goods" for "worthless dollars" ?
The Chinese in particular are extremely anxious to be exploited in that way.
Obviously, America's suppliers see value in taking dollars for their goods.
And, that is going to increase the cost of securitized mortgage instruments. Just like the price of carpet loans went up after it turned out somebody had to check to make sure the carpet company was legit.
It is not more expensive to buy a GSE MBS than a subprime ABS. In fact, it's cheaper. You can buy GSE paper from discount brokerages.
They yield less than than subprime MBS. Less risk, less reward to Mr. Bondholder.
How do the GSEs manage their guarantee risk? You try getting a "high cost loan" through the GSE's delivery software. I dare you.
I mean, I say crappy things about technology from time to time, but it's amazing how those computers the GSEs use can catch an interest rate on a loan that is 500 higher than the current 60-day required net yield the GSEs post on their website. It's some fancy algorithm that picks the larger of two numbers, or some kind of rocket science math like that.
The only thing that is going to get more expensive is due diligence for someone who wants to buy a mortgage-backed security that yields 500 bps more than a GSE security does. How, like, unfair is that?
"The only thing that is going to get more expensive is due diligence for someone who wants to buy a mortgage-backed security that yields 500 bps more than a GSE security does."
Those due diligence costs will get passed on to the borrower, making the mortgage debt more expensive (and perhaps uneconomic).
I think the real estate collapse is moving into finger-pointing stage. It's definitely prudent to point your finger before someone points his finger on you.
BTW, my finger is pointing in Easy Al/Bush & Co direction.
the market will do a better job then the gov't in both the short and long term. We have seen the gov't in action the past 3 years while the subprime lending mess has been going strong. The folks providing the front end money for bonds or direct lending are cutting off the moneyflow until the risk/reward can be better understood. The same argument about subprime RE lending could be used about subpime CC or auto lending as well. Let the market both on the consumer side and lender/bondholder side do the speaking.
Translating a bit from what I've been reading Tanta, it seems that you are mainly interested in enforcing "caveat emptor" on the source of all this ill-gotten and greedy liquidity, the MBS holders and issuers, as this particular slice of the thundering investor herd was in a large part responsible for pushing the perverting of the mortgage industry as we know it to serve their profit motive, becoming one of the primary causes of the housing bubble.
And, if I may add, you seem to be doing so with all the justifiable and unholy glee of one long put upon and righteously indignant.
Frankly I agree with you that the pain should be spread up and down the food chain on this debacle. However, for all the good this will do the system, the resulting liquidity crunch will probably hurt everyone, even those not involved. I just saying a little intervention might be warranted, to prevent the scorched MBS investor/issuer/sub-prime owner fingers from turning into scorched earth for the rest of us. I'm not advocating the saving of fools from themselves, just saving us from the results and fall out of their foolish actions.
On a separate note, you wouldn't happen to be a recovering Catholic?
Nunc dimittis servum tuum, Domine, secundum verbum tuum in pace:
Quia viderunt oculi mei salutare tuum
Quod parasti ante faciem omnium populorum:
Lumen ad revelationem gentium, et gloriam plebis tuae Israel.
I agree that those who get the rewards should also shoulder the risk.
However, a better question to ask is, who gets the RISKLESS rewards?
That would be (a) the originators and (b) the Wall St. banks that package the loans. Both of these institutions make their money up front and are subsequently shielded from default risks.
Now, you might argue that the originators do in fact shoulder some risk due to the putback clauses that Wall Street puts into the deal when they buy the loans for packaging.
However, the originator can easily escape this risk by declaring bankruptcy. So what we really have here is an agency problem... shareholders in mortgage originators get stuck holding the bag, while management has of course already cashed in their bonuses, stock options, etc.
Wall Street, on the other hand, seems to carry absolutely no risk here.
As far as bondholders are concerned-- they get stuck with the default risk, as well as inflation risk (i.e. they get paid out over time).
And who are the bondholders, you ask? Well, if you have a defined benefit pension, a 401k, a money market fund, or an IRA, then look in the mirror, and you'll see a mortgage bondholder. Chances are excellent that a good chunk of that bond fund/money market fund/"diversified fund" you own (maybe even without realizing it) is, in fact, mortgage bonds.
So in the final analysis, Wall Street, of course, escapes scot free, along with the management of the origination companies. And anyone with money invested in almost any part of the financial industry gets left holding the bag.
My final point is this: why are we even bothering to discuss this issue. The entire financial system (and, in many ways, our entire governing system) is deliberately structured to systematically and gradually transfer wealth from the general population, and into the pockets of Wall Street. This is why the Federal Reserve system exists in the first place. To bother to discuss this issue on any other level is like looking at a river, and wondering why it doesn't flow uphill.
But hey, that's a topic for a different discussion.
Andrew: non sum qualis eram. That's all I've got to say.
Androus2001: I have to say that I am fascinated by the fact that we just cannot stop talking about default risk. No matter how many times I try to change the subject. I was even guilty at one point on this very thread of USING CAPS.
So why is this? Why does it seem that default risk, which we talk about often enough on this blog to have gotten ourselves reputations as obsessives about, is The One True Subject?
The fact is I know quite well what's in my 401(k). You forget that I have been the midwife to more GSE and Ginnie Mae MBS issues over the years than I can shake a stick at. Made the loans, swapped 'em for the security, serviced them, and still went out and bought the MBS with both pre-tax and after-tax dollars. I do not fear GSE MBS. I do not understand why others fear them. (GSE accounting and rate hedges make me exceptionally nervous. But since I know exactly nobobdy who argues the GSEs should be unregulated and allowed to make up their own accounting rules, I do not find it worth my while to harp on that.)
In any case, I know who will lose if my retirement account takes hits on bonds, or my neighborhood becomes a ghost town of crumbling condos and boarded-up SFDs, or my bank fails and I have to trust the FDIC to write me a check, and so on. Which is why, of course, I can't quite get over my shock when it is suggested to me that there might be scary consequences of taking away the punchbowl. As opposed to what? Letting it go on?
In any case, I am a net saver. Which makes me a lender. Which is what a bondholder is, of course.
Why do I deserve predatory yields? Why do I deserve immunity from liability for predation? In what sick morality play is the lender the innocent angel and the borrower the evil defaulter who doesn't deserve fairness? I begin to think that one reason we can't get off the subject of credit risk is that it's easier for a lot of folks to talk about people who don't pay debts rather than people who seek rents.
we're not talking about PRE-EXISTING bondholders today, we're talking about what we're going to do with FUTURE originations.
the word "bondholders" got a bunch of people mixed up. It should really be "the loan holders or loan-backed securities owners". In other words, we are including those investment banks who retain the equity tranche of a securitization, the pension fund who holds the AAA tranche, and everything in between.
I saw the following comment:
This all hits at the the core of "liquidity." The real reason why someone would buy a bond backed by mortgages is because of the fact that they do NOT need to know anything at all about the underlying transaction. The ability to buy and sell anonymously is "liquidity." that is the foundation of our brand of capitalism based almost entirely upon the limitation of liability for the investor which allows one investor to sell their shares to another investor without being concerned about the possibility that they may face some additional unknown liability (beyond the cost of their investment).
This is off-subject and irrelevant. In the future, the investors will know in advance that what they're buying contains "fraud risk". "Fraud risk" will be a new term that will be added to the already existing list (credit risk, prepayment risk, duration risk...) and the market will simply charge extra basis points for that risk.
IN OTHER WORDS, Mr. Barney Franks is suggesting the FURTHEST THING FROM COMMUNISM!!!!
He is suggesting: "let us make a market in fraud risk", "let us allow market participants to care about, and therefore, PRICE that risk, and let them trade around that risk among each other." (i.e. "we don't wanna have to an Ohio-type Dodd-type GOVERNMENT PAID bailout").
My initial reaction when I read this in the morning was that it was a bad idea, but I understand it a bit better now.
I still think the originators need to be held responsible first and foremost, because they are the ones who initiate the process, but I can't see why anyone would be OK with the bondbuyers/holders walking away clean.
As noted, when the originators go belly-up, there won't be anyone to make them whole but I can't feel sorry if there is a further price to pay for their greed.
Finally, when that law was passed in NJ we were told that it would kill the lending industry here... you can see that it did, it just took a couple of years .
Barney Frank for President. Even if he is intentionally ignoring the fact that the Fed and Banks and their attorneys passed on the risk of default to the gullible and others. Look up Goodwin Procter's PDF entitled "The Goal of Bankruptcy Remoteness. Or Google up Cadwalader's Clients and Friends Memo concerning "Interpretive Letter of The Federal Reserve and the Office of the Comptroller of the Currency Examining Various Synthetic Securities Using Credit Derivatives." My bet is that in the future more stuff than just homes will be securitized, this will make fees and other profits for some, while passing onto others the hot potato of risk.
Does that show up in national statistics as a new employed person, even though it's just one person who now has two jobs?
The household survey counts employed people. In the situation you describe your status doesn't change. You were employed and you remain employed.
In the establishment survey, they count jobs created and jobs destroyed. So it would depend on the type of second job you're taking. If you're replacing someone, it's not a new job.
Not sure why you think bondholders would get predatory yields - if there was any excess value created (stolen) from making predatory loans as opposed to "regular" subprime loans, it would be captured by the originator in the form of higher prices before the loans are sold. Bondholders would only receive excess yields if the market at the time correctly discounted this possibility. Also, if everyone who received interest is liability, where does it stop? What if the loan papers bounced around in multiple conduits, repo counterparties etc, etc, some of which may not even be around anymore.
Given that all of you have been arguing that holders of non-investment grade bonds are now screwed even without this possibility, and many blame the availability of cheap credit and tight credit spreads for causing this mess, the idea that bondholders received some sort of excess interest due to predatory lending practices to me seems somewhat unlikely. Honestly, it smells a lot like the case of Enron employees suing the company, thus the shareholders, when it was really the shareholders that got screwed over by the employees. If the loans that should not be made were made, the fault really lies with the originator and the borrower and further risk sharing or transfer mechanisms aside, the economist costs should be borne by them. And selling of whole loans into securitization vehicles has generally been understood to be a credit risk transferring mechanism by all parties, regulators included. You mentioned earlier that mortgage insurers shouldn't be held liable here - why not? Haven't they profitted from this by taking a percentage of the yield? How is that any different? If the loans were held by the originators but securitized synthetically using swaps, would that allow bondholders to be free from liability? But what's the real difference?
My personal feeling (as someone who was involved in the mortgage finance chain during the boom, though not for as long or as deeply as others here) is that criminal prosecution of those who were responsible at the origination level is the only way to go. You can't really economically analyze who benefited from this situation (almost no one who chooses to invest in these securities does so with his own money) in a legally appropriate manner and severe enough criminal penalty at the origination level would substantially discourage the practice. That is until the economic advantage draws enough shady or dumb characters into the business and the whole cycle starts again. But no amount of regulations will always protect stupid or ignorant people from signing disadvantageous contracts, which is what all this really comes down to.
The top Democrat and Republican on the House Financial Services Committee said investors in mortgage bonds should be liable for deceptive loans made by banks.
I say drag the bastards out in the street and give them a good caining while they're at it.
Very late in this conversation, but this appears to be a solution to please lawyers. Using civil courts to police "predatory" interest rates by way of damages that have to be apportioned will result in a windfall for litigators rather than benefiting anyone else. When you look at regulation, you want the lowest total cost to gain the object, because the final endgame, all costs are passed through. There are already usury laws - if the gov't wants to set rate, reset, LTV, or loan/indebtedness-to-income caps, or ban teaser rates or whatever - let them do it openly. It will still chill the market available, but it's much simpler - and cheaper - to police.
Please read what is being said. You are off-topic with this sentence:
the idea that bondholders received some sort of excess interest due to predatory lending practices to me seems somewhat unlikely
Barney Frank and Tanta are not talking about the risk-reward, contracts, valuations, decisions and transactions of the PAST. We are talking about the future. ONLY THE FUTURE.
Current holders of debt no doubt got a better deal than they "deserved" market-wise (albeit not legally). So, no, it wouldn't be nice to go after current debtholders and ask them to regurgitate this stuff.
However, if (IF) Taxpayers will be footing some sort of bill, then you need to balance out your balance sheet. In other words, by definition, it means that someone "took" money from us taxpayers. Who is it? It's the lenders.
This time it's ok because they got ripped off by wall street. But next time, let's get a real capitalist system to incorporate that risk in the securities. That's what Barney Frank is saying.
Why do I deserve predatory yields? Why do I deserve immunity from liability for predation? In what sick morality play is the lender the innocent angel and the borrower the evil defaulter who doesn't deserve fairness? I begin to think that one reason we can't get off the subject of credit risk is that it's easier for a lot of folks to talk about people who don't pay debts rather than people who seek rents.
Maybe, as Androus2001 suggests, it is time to look behind the curtain. Of course, only crackpots are curious about what is behind the curtain and most humans would rather suffer interminably than appear crazy. Nobody is prepared to confront what is behind the curtain, so the problem will continue to be ignored. The curtain will stay up until the theater burns. The power of collective denial is awe inspiring. Shock and awe indeed. Of course, even Milton Friedman thought that money shouldn't be left to central bankers. Stupid Nobel-prize winning crackpot!
Regarding the topic at hand, how many times does my money need to be washed before it is laundered clean and good?
Well, at least if there is no MBS liability then we can look forward to the THCBS bubble -- which will at least be funny.
Just make predatory or illegal lending a RICO predicate offense, and write in a private right of action against the whole food chain, brokers, originators, bondholders etc.
RICO you just need to prove conspiracy which is relatively easy to do and cha-ching get treble damages.
Yes, liability is a good step but just go whole hog.
First let me say that I am not necessarily disagreeing with you here. But I think that the real issues are getting obscured.
You imply that rentiers are making fat yields and should bear default risk. Well, I can agree with the latter (to a certain extant) but I have trouble agreeing with the former. It's pretty obvious that yield spreads have become wafer-thin. Risk is not getting compensated for in the bond markets. This is undebiable.
So let's take a closer look at the narrowing yield spreads. When prices go down, we know that supply is either rising, or demand is falling. In this case, it's pretty obvious that, thanks to Wall Street, supply of mortgage-backed securities has gone through the roof over the last 20 years. Given that Wall Street makes a nice chunk by creating these products and selling them, it certainly makes sense that they are motivated to create a bazillion of them.
Now let's take a breather for a second and ask, Cui Bono?
Well the most obvious beneficiaries, as I indicated in my earlier post, are Wall Street and executive management of the mortgage origination companies. And it is pretty obvious how the motivations of these two constiuencies have become intertwined over recent years.
The other primary beneficiaries have been the marginal borrower. Wall Street and the mortgage originators have created a powerful vacuum effect that have drawn in the marginal borrower and given them the opportunity to own a home. Now, granted, many of them will soon lose those homes, but let's face it: a few of them will figure out a way to keep their homes. And those people never would have had the opportunity in the first place.
So who loses in this equation? The investor, that's who. The massive supply of MBS's out there have helped drive yields down way out of proportion to the real risk that investors are shouldering.
And I haven't even elaborated on inflation risk, which is separate from default risk. Inflation is raging at about 10% per year, and I am perfectly willing to argue that the MBS creation mechanism is a meaningful cause of the increased inflation of late. Oh wait... you think that inflation is only 3% per year? You must have made the mistake of believing the government statistics, which are completely bogus. John Williams at Shadowgovernmentstatistics.com makes a very compelling case that inflation and unemployment are really running at virtually double-digit rates right now.
So. Barney Frank wants to get all sanctimonious about how "The investor should shoulder the risk" of the mortgage finance debacle? Well frankly it appears to me that the investor is already shouldering a massively outsized amount of the risk. Am I surprised that Barney Frank is dead wrong, again? Nope. Unless of course he is a bought-and-paid-for dupe of Wall Street, in which case he is certainly "right" as far as they are concerned!
It's pretty obvious that yield spreads have become wafer-thin. Risk is not getting compensated for in the bond markets. This is undebiable.
Your entire post, Androus, is based on market yields. The new scheme that we would be talking about would incorporate those risks in the COUPON rate (i.e. the return on face value), not on the market yield. Market yields will always fluctuate between extremes. Even within Barney Frank's new world we will have bear markets and bull markets. There will be eras of euphoria where people will declare: "Hurray! Thee are no more dishonest appraisers! Church attendance is at all all-time high!" and there will be times where people will think: "The appocalyspe has arrived! Everyone is desperate to make a buck! Appraisers and brokers are, liek the rest of society, only going to get more and more dishonest! Let us sell off those MBS!"
But again, all of this is off-topic because we're talking about the coupon rate, which is set when the securities are created, which are set after origination, which is all in the future, because this entire discussion started by Barney Frank (and Tanta) is about the future, not the past.
probert: if this is to be instituted going forward, then what prevents MBS deals from being structured in such a way that legal liability still rests with the originator? Unless you require that all parties who receive any sort of cashflow from the loans to be liable, in which case mortgage insurers will certainly be part of the suit, you can create synthetic structures to get around this. Think CDS. So, as before, if the originator blows up, borrowers won't have anyone to compensate them for those predatory loans. Legislation of this type won't do anything but result in financial engineering to get around it which would potentially incur additional costs without any corresponding benefits. Criminal prosecution has far more teeth (and has the side effect of not benefitting quite as many lawyers)
Tanta - "In what sick morality play is the lender the innocent angel and the borrower the evil defaulter who doesn't deserve fairness? I begin to think that one reason we can't get off the subject of credit risk is that it's easier for a lot of folks to talk about people who don't pay debts rather than people who seek rents."
This is another topic, but in my view that has always been one of the unseen other sides of bankruptcy law coin. The lender (just as in contract law) is held partially responsible for the loss as they are the one of the parties that is most able to the avoid of the resultant hurt. This they can do by being a teensy bit less greedy and more discriminating in who they lend to. (Whether or not that lending rises to the loanshark-esq predatory level is another question all together, I'm talking about maintaining a balanced and healthy financial system here.)
And regardless of how you come down on the recent revisions of the bankruptcy laws, no one can deny that one of the results of the changes was the changing/lessening of the sting of that particular nettle for the lender. I'm not sure that this bankruptcy change (and the MBS craze) was an entirely good thing for loan due diligence and quality.
If you pardon the bad analogy, it seems a bit like changing the balance of an ecosystem by removing a large predator from it and having an over-population explosion and crash in the prey animals result.
You imply that rentiers are making fat yields and should bear default risk. Well, I can agree with the latter (to a certain extant) but I have trouble agreeing with the former. It's pretty obvious that yield spreads have become wafer-thin. Risk is not getting compensated for in the bond markets. This is undebiable.
I am trying not to talk about default risk. Again, unsuccessfully.
So let's talk about it. Yields suck because the only way you can do a senior/sub deal and get the right rating on the senior is by putting the default risk in the sub and offering the senior holder a couple of ticks over risk-free. You tell me that these structures, this "credit enhancement," is all made possible by mortage yields of 6.00% with no prepayment penalty? C'mon. If you can't generate some yield off a bunch of poor folks paying you 13% vig, you need a competency hearing. Don't tell me you used it up to protect yourself from default risk and so therefore you didn't benefit from it.
Forgive me, but as soon as we get back to appealing to those "opportunities" for the marginal borrower in a discussion of why Wall Street should be able to avoid legal liability, I start looking for my wallet.
What I'm hearing is:
If a predatory loan is made, the originator should face criminal penalty.
If a predatory loan is purchased by an investment bank, the originator should face criminal penalty.
If a pension fund buys a security backed by predatory loans, the originator should face criminal penalty.
If the legal structures, opaque accounting, remote vehicles, and other perfectly intentionally designed overcomplexity makes it too hard for the law to find the guilty party? Well, them's the breaks, huh? I mean, we wouldn't want to have to pay any lawyers on our side, right?
There sure is enough blame to go around. From reading the posts it seems that nobody is willing to shift at least some responsibiliy to the borrower. Afterall, he's the one that defaulted on the original loan agreement. Go after the borrower's assets first, then start hitting the loan originator working all the way up the food chain.
You cannot make people shoulder risk.
They must opt to do so. If basic terms of the mortgage sytem and subsequent re-selling are changed, potential investors will simply re-evaluate and either shoulder the risk of go elsewhere.
That's why I say the simple net effect is obvious: a lot fewer mortgages will be written.
In addition, torts are still torts, fraud is still fraud and attornies will still sort out what the law 'really' means.
Tanta wrote: "If you can't generate some yield off a bunch of poor folks paying you 13% vig, you need a competency hearing. Don't tell me you used it up to protect yourself from default risk and so therefore you didn't benefit from it."
Investors don't get to capture this additional yield - loan originators do (and if they don't, wall street traders who must have effectively screwed these originators are next in line). If borrowers are paying much more in interest than their default risk as perceived by the market would warrant, those loans would sell at a significant premium, thus wiping out the advantage for those who purchase them in the secondary market. The only way investors can benefit from investing in credit is if they are better at evaluating credit than others or if the perceived credit risk of their holdings goes down over time for whatever reason.
Bearish, first of all, the definition of "predatory lending" is pretty much a borrower paying more in interest than their default risk warrants.
Strictly speaking, of course, it's not just coupon, it's fees and points. And certainly you have market participants out there paying premium for this crap. I will only observe that back in the day when I put out a rate sheet, nobody made me put a price over 102 on it. There is no law that says investors can't force those note rates down by failing to pay up for them.
But if you are suggesting to me that investors get no better yield on subprime than on prime paper, because the pricing of credit risk is perfect, you're telling me news. Why would anyone buy a security with credit risk if the yields were the same as a Ginnie II?
But even if the bondholder never sees a dime of yield over risk--that bondholder is funnelling money into the predation machine. How long will originators be able to keep all the spiff if no one buys the loans?
"Spiff." There's a word I haven't heard out loud in a long time. For how many years did some originators scoff at the idea because the market was priced perfectly? No matter. It doesn't seem to me that the GSE paper is any safer because I don't see how their assets are risk/reward coupled anymore than the risky paper was. When you test a system to destruction the flight isn't over just because you ripped off the wings.
then what prevents MBS deals from being structured in such a way that legal liability still rests with the originator?
Nothing, but again, this is off-topic... at least in my mind... maybe I am getting to the point where I'm not addressing what you're saying but here goes:
The title of this thread and Barney Frank's terminology is creating a confusion & causing ppl to talk past each other. I know the title says "bondholders", but I'm not talking about bondholders, but every tranche, including every retained tranche. And if we're talking about the originator of the loan (including even individual brokers) I still don't see how this is "gaming the system" around Barney's proposed law. Perhaps we will get to a point where lending money to a Broker/lender/originator, or perhaps, providing them with professional liability insurance, will cost more. In other words, I don't care if you financial engineer your way around it even MORE than what you suggested. The point is that under Barney's suggestion, somewhere in the engineering chain, there will be SOMEONE who will bear the risk. Right now, there is NO ONE to bear the risk, and taxpayers are being asked to chip in. This loophole will be closed forever.
What will not be closed forever is, as you say, the extra juice in MBS investor returns, or risk, or ditto for IBs, originators etc'. Any of those people might lay off THEIR risk, and at any point in the chain there may be another boom/bust cycle. After all, the 1933 securities law didn't prevent the 1990's stock market abuses did it? But that's how our society operates, we can only close loopholes one at a time, not all at once.
Nevertheless, somewhere along the chain, there will be a capitalistic process of taking on the risk of fraud/deception and reaping a reward for it. The risk/reward equation will be marketable and therefore fluctuate. It will not be a socialist process as it is now.
Tanta wrote: "Bearish, first of all, the definition of "predatory lending" is pretty much a borrower paying more in interest than their default risk warrants."
Not necessarily because you can have a situation where the loan, at the correct market rate, may not make sense at all for the borrower (as a higher default risk does not necessarily mean a higher internal discount rate - but a concept lost on a lot of people, not you Tanta, you've been illuminating this exact concept through this blog).
"But if you are suggesting to me that investors get no better yield on subprime than on prime paper, because the pricing of credit risk is perfect, you're telling me news. Why would anyone buy a security with credit risk if the yields were the same as a Ginnie II?"
No better risk-adjusted return. Not the same as pure yield or even yield after adjusting for default rates. Even you're saying: why anyone would buy such a security - because they are being compensated, on average, at the market rate for the risks. So they are not capturing any outsized gain from investing in these bonds. And even Ginnie II's are not risk-free; negative convexity is a bitch...
"Strictly speaking, of course, it's not just coupon, it's fees and points. And certainly you have market participants out there paying premium for this crap. I will only observe that back in the day when I put out a rate sheet, nobody made me put a price over 102 on it. There is no law that says investors can't force those note rates down by failing to pay up for them. "
But prices will have to go back up if other investors see that these offer an above-market level of risk-adjusted return. And investors don't see fees and points. You're demonstrating how much extra money originators are able to make with predatory subprime loans: fees, points and premiums and the level of financial incentives this creates. Investors on the other hand don't care if it's subprime mortgages or argentinian bonds.
"But even if the bondholder never sees a dime of yield over risk--that bondholder is funnelling money into the predation machine. How long will originators be able to keep all the spiff if no one buys the loans?"
Would the situation be any different if the orignator kept all the loans on its balance sheet and used credit derivatives with mortgage-like payoffs for its counterparties to hedge its portfolio? How about debt or equity funding? As long as the activity its doing is economically feasible, and predatory lending that we're discussing is better than that -it generates excess economic profit by screwing borrowers - I'm not sure if there's any way to prevent it from using any number of funding sources available through capital markets.
it generates excess economic profit by screwing borrowers - I'm not sure if there's any way to prevent it from using any number of funding sources available through capital markets.
hmmm...
Well, under that scenario, first of all, we agree that one difference is that they are knowingly taking the risk and getting paid for it, right?
Now, you have mtg source A which is making x in coupon+fees+points, and then you have mtg source B which is charging y which is greater than x, because y incorporates the risk of fraud, all else being equal. The borrower will, again, all else, beingequal, choose loan A because it costs less...
...
IF the borrower has enough sophistication.
...
In theory, it is possible that some borrowers will once again find themselves in a situation where they are abused by predatory lenders A. Now I can sort of see what you;re saying. You're arguing in favor of borrower education and/or caveat emptor...?
That actually makes sense.
But still, as long as a private party assumed the extra risks, we still have the benefit of a new non-taxpayer-bailout-solution.
probert: If I understand what you're saying correctly, then how is it different from the present situation? Originators are currently responsible for making sure that their loans do not violate existing predatory lending laws, are they not?
I have no idea what you mean by these loopholes - there are no loopholes of this kind right now. Where there are lack of predatory lending regulations, borrowers are responsible. Where there are, originators are. Loans are priced accordingly.
What was remarkable about Barney Frank's suggestion was that the legal risks associated with lending should follow the cashflows from the underlying mortgages, not that someone should hold the legal risks - someone does, right now. I don't understand your taxpayer comments either - if some borrower wants to sue someone for making a predatory loan but the originator has already gone out of business, he doesn't suddenly get to sue Uncle Sam.
Oh...Right... the end of my previous message made me realize where the error is. Most of us (at least me) are not seeking to prevent another bout of borrower abuse. You are right, it is possible to circumvent that. What we are seeking is preventing the subsequent taxpayer bailout of those abuses.
Ok gotcha... well, I thought Tanta was applauded anyone who is trying to protect the American People from things like the Ohio proposal or the Dodd bailout proposal....
I'm re-reading now...I guess somewhere I lost touch with the subject. Barney Frank obviously is talking about ABS more than anything else...and Tanta also reserved some pity for the originators.
Let's assume no legislation occurs. Then IBs would not lend to originating lenders without pricing fraud risk. And no one would want to originate fraud as frothily as they did before if it's put back to them in the way that it has (unless they somehow lay off that risk).
So now I'm actually also in favor of no legislation at all. Perhaps the marketplace can adjust itself to the situation...
And I'm not entirely sure Frank himself knows everything he's talking about. I think I'm going to re-think the entire thing again later on, and come back.
the most fascinating thing in the upcoming debacle is what happens with the guys providing insurance on these pools. i think most of the holders of these securities think of insurance as a constant, not a variable. if you've paid attention, some mortgage insurers are pushing back and not paying claims.
Bearish what the hell r u talking about?! Of course Ginnie IIs are not risk free. Neither are Treasuries! The point is they're CREDIT risk free!!! You get extra yield for the risk; that's why ginnies have an oas. you can't fund mortgages to nearly the same extent with any other source of capital than the secondary market. U want to hold all your loans and hedge the credit risk? if you held your subprime loans on the balance sheet in 2006 and hedged the credit risk you'd get worse yield than ginnie IIs!!!
Did anyone mention RICO? I tried to read the whole thread through but ended up skimming it instead.
There really is a similarity in how banks got nicked for money laundering in the drug trade... If I understand it correctly, banks have to show pretty thoroughly that they have good practices in place to screen out money launderers.
Having said that - even if they do & money is deposited that is shown to be 'illgotten' (key point is there needs to be a legal finding of wrong doing somewhere) - then the banks can lose it. But the state gets it - we don't get it.
But it only happens through court action (due process) - expensive & time consuming for both parties.
My guess is those laws are already in place - that an eager states attorney can enforce those actions now (given evidence & a finding of predatory lending).
I think it would be extremely expensive for a private party to INDIVIDUALLY force a remedy on their own particular case. The value of the home & mortgage (the damages) wouldn't begin to cover the legal costs.
However private civil class action is a possibility with or without "Barney's Law". While it might be too expensive & too hard to show damages at the individual level... it might pay to lump them all together IF you can show there was a willful & persistent trend to prey on a class of borrowers... lotsa folks, bond holders included, could be swept up in that net. Deep pocket rule applies.
In fact it would not surprise me one bit to see the eventual law restrict private civil action - especially class action - while simultaneously expanding RICO style state initiated civil action to 'recover damages'. Elliot Spitzer Att'ny General type civil action.
My guess is that will be the 'deal' that gets both GOP & Dems at the table & the President to sign it. It might be a deal worth doing.
JMHO.
Oh and did I say I have a family full of lawyers? If you like lawyers you'd love Thanksgiving at our house.
Why is it unfair to sell bondholders debt that you know can't be repaid?
Look, those mortgage brokers didn't do their job of making sure they made good loans, so they're having to eat the loans.
Instead, Tanta thinks bondholders should have to bear the cost of mortgage brokers' irresponsibility. That is pretty obviously wrong.
If you want bondholders' backing, you have to do your due diligence and make sure you're loaning money to people who can actually pay it back. What part of this could Tanta possibly object to?
More proof that reading William greider makes you dumber.
bacon dreamz: given that we're now moving beyond the notion of credit risk and into the generalized notion of risk (legal risk is not the same thing as credit risk), I'm not sure what your point is. There is no real difference between the risk of not knowing for sure when you're getting paid and the risk of not knowing how much you're getting paid. And theoretically, they are all priced so that risk-adjusted returns are similar across products. Treasuries, on the contrary, don't have any cashflow risk, only market value risk and are a fundamentally different beast. As for hedging credit risks of loans technically on balance sheet, why are you ruling out the possibility of development of liquid credit derivatives that basically pay like MBS without the transfer of underlying assets if such structures were more efficient than present MBS structures after this legislation?
Androus2001:Well frankly it appears to me that the investor is already shouldering a massively outsized amount of the risk. Am I surprised that Barney Frank is dead wrong, again? Nope. Unless of course he is a bought-and-paid-for dupe of Wall Street, in which case he is certainly "right" as far as they are concerned!
News Flash! News Flash!
Wall Street has been caught 'ripping the fucking faces off' unsophisticated "investors"!
Treat them like the used car salesmen they are and you won't be surprised by them.
This beater has been driven hard! But it is Moodys Certified and has nice rims though! Dang! This'll get the chicks!
Today bond holder are going to eat the cost of a lot of the default loans. We have the EPD and other safeguard to protect the bondholder, but what if the originator like NEW go BK? The bond holder/investor is the one that has to pay up for the problem in that scenario. Today's system is builded to make loan fast and cheap. In the process, all the steps of checking client's ability to pay, their income level, the house value are thrown out of the window in the name of making more moeny. And the bondholder are stipud enough to let it happend.
The only question that we are discussing is wether the bondholder/investor will have the offical responsibility/incentive to policy the loan process and stop these problem loans earlier in the cycle. They have the same responsibility today, except that they offload it to the originating companies thinking that they will hang around and have enough money to take care of any and all the underwriting problems. Also in the craze of chasing yield, investors don't price in the risk of default appropriately. How many time you heard the defense for low reserve by banks (BKUNA, DSL, FED, CFC, WM) is that historical data (meaning 04, 05, and 06) show them that default is going to be low. No one go back to 91 and look at those default rate at the bottom of the cycle. This kind of legislation will make the investor/bond holder think twice about offering risky mortgage to chase yield. They can still offer 30 year fixed or interest only or even stated income loans as long as they take the step to make sure borrower can make the payment, the appraisal is correct and fully disclose the loan terms.
The borrowers being 'abused' by predatory lending should go bankrupt... They are not paying attention to the contracts they sign and should rent for 7 years until they figure it out.
They are free to walk away and dump the now devalued collateral on the market and let the bondholders eat the losses.
Simple and fair I think.
Brokers are like car salesman, everyone complains about how they got 'screwed' on the deal
What I am trying to say, on the subject of GSE & Ginnie MBS, is this--and you may of course take it for what you think it's worth.
The test of a good sausage is not whether some busy office worker on the coast will buy it and feed it to her children.
The test of a good sausage is whether someone who works in the sausage-making factory will buy it and feed it to her children.
There is, of course, no theoretical reason why the sausage-maker cannot be deluded. I do my best not to be; that's all anyone can do.
I also try to be very clear about when I am talking about "sausages," and when I am talking about pigs or the sausage-making factory's accountants or shareholders or debt financing.
That is all, unless you all are hungry. Pig in a blanket, anyone?
in the same line of thinking those greedy chinese and japanese us treasury bond holders should be held responsible for the us deficit spending !! what a joke!
How do we determine how much of a government backed securities are risky? I moved my 401k from mutual funds last year and moved them into GSTIF bonds to now find out that they may be more susceptible to mortgage loans. I've attempted to find out from SSGA the makeup of the GSTIF bond fund. The answer I received was - Agency (7.3%) and Repurchase Agreements (92.7%). While this may be true, it's not the answer I was seeking. I sent another email requesting "how much of each (agency and repurchase agreements) are related to/from collaterized debt obligations, mortgages, mortgage loans, mortgage backed securities, derivatives or anything related to real estate (commercial, residential, or otherwise)." I haven't received a response yet but am expecting one by next week.
I understand there's talk of making the investors "holders of the bag", but I don't think in this case it is warranted. I am not knowingly investing in MBS and am not getting the "great" returns of MBS at 4-5%. It takes one who is on top of their investments to even realize that their government backed securities are invested in MBSs and even when they take the time to ask for the breakdown, are given vague answers.
IMF's take on the US subprime market (chapter 1):
IMF Global Financial Stability Report: Market Developments and Issues, April 2007 -- Contents
Seems to me this would cause interest rates to skyrocket, if by increasied liability lead to diminished demand. What do I know?
Seems to me this would cause interest rates to skyrocket, if by increasied liability lead to diminished demand.
And what, exactly, are low subprime interest rates doing for anyone who isn't a bondholder?
Ex-Post facto law anyone?
What's the problem with a contract being a contract?
Oh yeah, just so you don't feel let down Oh Constantly Enraged One
Theres something downright commie about making sure the risk is held by the party reaping the reward.
Who are evil bondholders? French and Chinese?
I thought it was Goldmans who pocketed the fat premium, not the bondholders. Bondholders were sold junk but it was wrapped in AAA paper. Am I wrong?
Well, well, well, well.
I am speechless.
Okay, I'm not speechless.
I suppose I would only add that the circle can't be broken. One must take the additional step of asking where all those dollars the Japanese and Chinese invest in mortgage-backed securities come from.
Coring out our industrial base with patently illegal trade practices?
What are the other possibilities? The stork brought them?
Of course, there are people in the United States who have made Croesus look like...well, like an illegal alien, through fees and other payoffs from mortgage-backed securities, people who have been farting through silk so long they're thinking of moving to synthetics, and these people are going to have a few choice words for Barney Frank in particular, but it is theoretically possible that, representative Democracy that we are, their voice may become more faint.
Tanta, you naughty girl.
I hope I live long enough to see the Dollar tank, and we all start from the begining owing Zero!!
Cause Ye Olde Greenback Ain't doing to well today.
A little while back, Tanta, you mentioned a new "bad-vibes candidate for Very Bad Mortgage Day." If you were sober, you said, you might even tell us about it. Perhaps now? FED on its lifeboat rescue mission, or something else? Ala
Bfatz,
Check the yen. The dollar is doing swimmingly against the yen.
Kind of strange isn't it? Almost like manipulation.
That carry trade sure is a strange old creature, isn't it?
Does anyone know if Barney Frank was deriding subprime mortgage abuse a year ago?
If congress moves at this point to tighten standards more than the market would bear, doesn't that accelerate or worsen the situation?
I'm with banker on this one. The loans were sold subject to conditions. If the conditions were not met, the loans went back to the broker. Simple enough.
If it helps any, the bondholders will suck the brokers dry soon enough, and will still be left holding a plenty big bag.
Bondholders were sold junk but it was wrapped in AAA paper.
"Bondholders" are not "mortgage-holders."
If you want to buy a mortgage loan, go to a mortgage originator and whip out your checkbook. They'll make the appointment whenever it is convenient for you. Trust me.
A bond may be backed by mortgages. (Or just about any other IOU I've ever heard of.)
Do we all know the difference between a bond and the underlying asset?
You get the AAA rating on your tranche of the security by being first in line for interest payments and last in line for losses. How, exactly, does the AAA tranche holder "get sold junk"?
Now, if you bought a BBB- or an unrated residual, well, maybe you're at some risk. But who told you it wasn't junk?
We are talking about liability for suits alleging predatory or deceptive lending practices. "Assignee liability" means that if you're making the income off the underlying loans, you have liability if those loans turn out to have been illegal.
Tell me again why this is unfair to bondholders.
Through the haze, I can start to see the shape of the coming apocalypse -- let's raise some tariffs to punish those patently illegal trade practices, let's void some contracts (we'll have Barney decide which ones) ex-post facto, and above all let's make it as difficult as possible to get any kind of mortgage.
I know the apocalypse is not far away when I start agreeing with Banker...
I see fewer mortgages being written for years and years and years.
"Seems to me this would cause interest rates to skyrocket, if by increasied liability lead to diminished demand."
So what, homes might fall in price and actually become affordable again. A 40% off sale would be a good place to start IMHOP. I also own 3 of the damn things and it wouldnt bother me a bit. I knew they were liabilities when I bought them however I also paid cash.
Where are you guys getting "ex post facto"? Where does it say this would be true for mortgages already originated or bonds already sold?
What I couldn't quite discern from the article is whether they are looking at placing some liability on the Wall St. firms that are pooling the mortgages for securitization. IF they are going to place liability on the investors, then they also need to place it on those selling the securities. Of course, trying to impose liability on Wall St. is always difficult, as they are some of the biggest political contributors. If the Wall St. firms are excluded, it will be clear that their dollars have clearly bought them what they wanted.
Should it really be the bondholders left holding the bag?
So long as there were adequate disclosures (and the disclosures would certainly be enough to put most sane people off from buying these things) AND the credit support and enhancement requirements are enforced, then it is buyer beware.
However, to the extent that the originators/underwriters fail in their duty to ensure that the bond's requirements are met, gnawing on the butts of the bondholders in that food chain is not quite kosher.
I always though that bond ratings were based on the likelyhood of default. If so, how can predatory loans be listed as AAA, since by their very nature, they are more likely to end in default?
Also, if we are going to hold those who spread the liquidity responsible, shouldn't we start with the Fed?
This thing has no chance of passing and even if it did, it would be vetoed or declared unconstitutional. What's next? are common shareholders of mortgage lenders going to be held liable too?
Yes, well, you couldn't expect Bloomberg to clearly explain what the proposed legislation does, because that's all nerdy and shit when you can just get quotes from some dealer.
There are several model "assignee liability" laws out there. Usually, it means anyone in the assignment chain is liable. That would include any party on Wall Street who bought whole loans in order to package them into a security.
It would, unless there were some specific exclusion in the law, allow the ultimate bagholder--the bond buyer--to sue the pants off the packager if said packager did not fully disclose said potential liability risk.
Tanta,
The ex-post facto was a joke for "horse is out of the barn."
Having said that, this is truly a terrible idea. it's primary effect would be to keep first time home buyers from doing so. Guys like me? Do whatever you want, it has no impact. This will drill the aspiring poor and lower middle class. It is thoroughly unworkable, and unreasonable to ask bondbuyers or some interim entity to examine each underlying loan process.
How about this as a better idea if you are concerned with predatory practices. No loan originator can receive more than half their fee up front if the loan has a reset mechanism. The other half of the fee will only be paid one year after the reset occurs if the loan remians current. That approach is going to cause a whole lot less damage that the Congresscritter's approach.
Tanta -
I stand corrected. Reading through the paragraph about the NJ law I got the impression it would allow claims based on pre-existing predatory loans.
Banker, can we just quit with this business about how it's all supposed to help the poor?
Predatory and deceptive lending is illegal. AGAINST THE LAW. That kind of illegal. That's what we're talking about here.
Bondholders already have credit risk of some sort. This law is about whether they can be liable for returning "ill gotten gains."
And who the hell is going to handle escrows for originator commissions for five years until the ARM resets? You think that would be cheaper than just forcing some due diligence expenses on bond buyers?
My whole point in the post is that dealing with mortgage brokers is obviously some kind of whack-a-mole game that hasn't been working. I'm perfectly ready to hear realistic proposals for further regulation of the bottom of the food chain, but, well, there's that commie thing . . .
So Tanta, are you saying that if fraud was involved in originating a mortgage that was sold by the originator to Fannie or Freddie, and I happened to buy a Fannie or Freddie securitization that included that loan in the collateral pool, I should have liability to the original borrower?
I assume the mortgage insurers would be happy to provide a service to indemnify the bondholders. Sounds like a huge growth opportunity! Better cover those shorts...
atheist, you, Fannie, the originator, and anyone else in the chain who extracted income off the deal would be jointly and severally liable. (Or whatever legal form of liability were written into the law.)
You get the AAA rating on your tranche of the security by being first in line for interest payments and last in line for losses. How, exactly, does the AAA tranche holder "get sold junk"?
Moody rated some unproven security as AAA, so it allowed Goldman to sell it to interest hungry Chinese. The Chinese believed both Goldman and Moody. Both Moody and Goldman made good money in the process.
Now back to Chinese. They worked hard to make that extra dollar. They have been blamed that they made that dollar. Now they are also blamed for believing to what was written on a wrapper. As I understand bondholders are the ones who stand to lose the most money, but the way I view it, they were deceived.
The mortgage originators, RMBS packagers and credit rating agencies are the ones to be blamed!
Damn it, get back to basics. The only thing cheap money and creative financing did was drive up the cost of housing.
Get back to a 30-year fixed and be done with it. If you do that, housing will again become affordable.
It's not "fraud," by the way. It's predatory or deceptive practices. Those words have meaning in the statute.
I must say that my worries about Fannie and Freddie are not going away with this move by Barney and Spence. But of course only a few of those 2500 accountants sorting out Fannie's affairs really know the impact of cutting mortgage streams further than the current slow down. James at econobrowser
Econbrowser: More on Freddie Mac and Fannie Mae
makes a reference to a $3.7B reversal in derivative trading at Freddie (thought by many to be the brighter of the 2 outfits) for 2006...when the news was still reasonably cheerful.
Banker,
Get better straw. Straw men can use only the finest, high-grade stuff.
...this is truly a terrible idea. it's primary effect would be to keep first time home buyers from doing so...It is thoroughly unworkable, and unreasonable to ask bondbuyers or some interim entity to examine each underlying loan process.
Huh? Perhaps you could rephrase that to make it sound like you come from somewhere near this solar system, because right now it sounds like bond buyers shouldn't examine the creditworthiness of the bonds they are buying.
In addition, the gratuitous comparison between yourself and first-time home buyers is, of course, specious, but it is also out of the mouth of Marie Antoinette. Is that really where you want to be?
What MLM said. Sorry.
No Tanta,
We can't stop with the focus on those who would be hurt most, sorry. Nobody needs to handle "escrows." The loan servicer would be paid a fee by the originator for providing that information to the broker. They would then follow up on their contract with the lender. Yup, it would be a lot cheaper.
BTW, if all this is already ILLEAGAL (caps are cool huh?) then why the additional law? This approach is dumb. But it is fine since all it is is grandstanding by the Congresscritters anyway.
I assume the mortgage insurers would be happy to provide a service to indemnify the bondholders. Sounds like a huge growth opportunity!
Mortgage insurers insure against credit risk. They do not now nor have they ever volunteered to cover losses due to criminal activity on anyone's part.
Tanta,
You have embraced the whirlwind.
Now back to Chinese. They worked hard to make that extra dollar. They have been blamed that they made that dollar.
I take it that Americans do not work hard to make that extra dollar.
I take it that there is no de facto slave labor in China and that Chinese workers get paid pennies a day because that is the fair market value of their labor.
In that case, you should be eager to move to China.
"It's not "fraud," by the way. It's predatory or deceptive practices. Those words have meaning in the statute."
So how is that any different than the IPO and research scams in the dot com era? Seems pretty similar to me, and the IBs wrote some major checks to settle.
Arbo,
Like another before you your assumptions about me are incredibly wrong. My Dad bought our first home when I was 15. I know whereof I speak on this.
The rest of your comment is similarly accurate.
Tanta
The expectation that holders of an MBS or CDO are going to be capable or willing to evaluate their liability for the predatory activities of some 3rd rate mortgage broker strikes me as extremely unlikely. If this bill passes, someone is going to step in to examine each mortgage and indemnify the bondholders. Why not the mortgage insurers?
Unless it turns out that it's simply uneconomic to go to all the trouble, and it makes more sense to just leave the loans on a banks balance sheet in the first place. Hmmm....
Do you communists believe in free lunches?
So how is that any different than the IPO and research scams in the dot com era? Seems pretty similar to me, and the IBs wrote some major checks to settle.
That's right. And they want to make damned sure they never have to do that again.
The consequences of those events to bond prices to be not underestimated, though probably not immediate.
If this bill passes, someone is going to step in to examine each mortgage and indemnify the bondholders.
I'm sorry, I'm not a lawyer, but I'm having a hard time with the idea that anybody can sell protection for engaging in illegal behavior, or that the solution to all this is another swap--this time a PLS: Predatory Liability Swap. That makes no sense to me, sorry.
Why shouldn't bondholders have due diligence expenses? When did everybody get a constitutional right to cost-free investments?
You realize, don't you, that the easiest way to check whether a loan is predatory or deceptive is to look at its interest rate in relationship to the current yield on a prime loan?
arobogast -
The question is whether the Chinese (and the Mexicans, and Indians, and...) are underpaid, or Americans are overpaid.
I've been to China twice. Those people work their asses off. I'd be tempted to starve before I worked so hard for so little.
I can tell you that the proceeds from the average refi would make you king in some of the places I visited.
Remember that late last year, Goldman Sachs broke all records for bonuses. I figured something was rotten in Denmark.
Banker,
Unresponsive. You're changing the subject.
In one post, you sound like Marie Antoinette. Now, you want to sound like a first-time home buyer.
But I refer you to your original post: Guys like me? Do whatever you want, it has no impact.
How am I supposed to parse that?
Now, are bondbuyers supposed to examine the creditworthiness of the issuer?
If it's General Motors debt, I assume they don't look at every car, but they look at representative samples of cars (Statistics 101). Bondbuyers are not supposed to look at representative samples of the debts underlying the bonds when it comes to MBS?
It is thoroughly unworkable, and unreasonable to ask bondbuyers or some interim entity to examine each underlying loan process
Is that, or is that not, a straw man? That's saying we have to look at every car General Motors makes before we can buy a General Motors bond. That's nonsense, and no one is proposing it.
For a change, let the bondholders eat cake.
To the topic of unfairness to bondholders - first, nobody plans to jail them, second, they are foreign central banks anyway.
What will happen is just some of the magic paper will turn back into pumpkin.
Let them eat PUMPKIN cake!
Well, let's not stop with subprime mortgages.
Let's move onto credit card companies and their predatory practices of ensnaring gullable citizens, straight out of college and sometimes before. Talk about foreclosures ruining peoples' lives - what about $100,000 credit card debts? Why isn't everyone enraged about this? What percentages of the population are so deeply indebted they have lost hope??? They were offered loans just like subprimers. And they took the bait.
If we're going to make sure the risk is held by the party reaping the reward, then what about the credit card companies... raising interest rates from 3.9% to 29.99% in a blink of an eye...
I wish Barney Frank would take on this issue for a change.
You realize, don't you, that the easiest way to check whether a loan is predatory or deceptive is to look at its interest rate in relationship to the current yield on a prime loan?
What about the rare predatory loan that didn't have a higher rate? No thanks, maybe I'll just stick with corporates. Oops, there goes the MBS market.
"If we're going to make sure the risk is held by the party reaping the reward, then what about the credit card companies... "
Yes! Yes! Now we're getting somewhere!
Americans are the debtors, Chinese (Russians, Arabs, etc) are the lenders. Yes, we borrow from the terrorists. OTOH the terrorists support our economy because they lent to us at low rates.
Chinese (Russians, etc) invest in American paper securities because there is nothing productive they can buy with the dollars we paid to them in exchange for valuable goods they gave to us. They were deceived by Goldmans and Moodys that the securities they were buying were high grade. It's already given that they are going to lose money on those securities. And now they liable because they believed to scoundrels.
Well, it was expected. Our congress will always blame Chinese, French or Martians. They don't contribute to our politicians.
I take it that Americans do not work hard to make that extra dollar.
Americans are the debtors, Chinese (Russians, Arabs, etc) are the lenders. Yes, we borrow from the terrorists. OTOH the terrorists support our economy because they lent to us at low rates.
Chinese (Russians, etc) invest in American paper securities because there is nothing productive they can buy with the dollars we paid to them in exchange for valuable goods they gave to us. They were deceived by Goldmans and Moodys that the securities they were buying were high grade. It's already given that they are going to lose money on those securities. And now they liable because they believed to scoundrels.
Well, it was expected. Our congress will always blame Chinese, French or Martians. They don't contribute to our politicians.
What about the rare predatory loan that didn't have a higher rate?
You could probably afford the damages on that one.
If you want responsible lenders, make lenders share the responsibility.
If you want responsible lenders, make lenders share the responsibility.
Yeah, see, that's my problem, mp. I tend to think that a "lender" is the person who lends money and gets interest back.
But that's why I keep telling my mom to stop buying me Starbucks gift cards.
You could probably afford the damages on that one.
My quick read of the NJ law was that the damages were a free house (plus attorney's fees, etc.). One or two of those would be likely to ruin my appetite for MBS's...
Democracy must be something more than two wolves and a sheep voting on what to have for dinner.
-James Bovard, Civil Libertarian (1994)
State of New Jersey
Assignee Liability
High-cost home loan assignees are subject to all the claims and defenses that could be brought that the borrower could assert against the original creditor or broker.
Assignee has presumed liability exemption when they can establish that it has:
a policy against buying high-cost home loans, and
exercises reasonable due diligence in purchasing such loans.
The liability exists:
for six years following the closing of the high-cost home loan; or
for the term of the loan in cases where foreclosure has been commenced, the debt has been accelerated, or the high-cost home loan is 60 days in default.
I am not responsible for the grammar of that. The state of NJ is.
In any case, I suggest those of you worried about those low-rate high-cost loans might want to read the summary.
Hey, I am fed up with hearing about all of capital's prerogatives. When Goldman Sachs goes crying to Uncle Ben, and they will, the American taxpayer will end up footing the bill for bailing them out. Just like the S&L debacle.
Tanta, "Tell me again why this is unfair to bondholders"
Well, I don't know whether or not it's unfair, and it probably isn't, but who is to say that the A, AA or AAA paper is going to stay that way. The ratings agencies were fast asleep at the switch. Isn't it possible that the paper might get downgraded? Then what? A lot of pension funds and strictly managed fixed investment funds have a requirement that they hold only, say, AAA paper. They would by default be forced to SELL, driving the value down.
As I see it - The bodholders are the bagholders since they take a haircut when they sell.
There's too many buyers of subprime/Alt-A ABS that do not have sufficient understanding of the mortgage business or how many of the more complex mortgage products work. They don't understand all the risks. Juicy spread=BUYBUYBUY!!! It's rated investment grade! Put it in my CDO!!!
barely, this is not, in my view, a rating issue.
The interest income off of a predatory loan, which is illegal, can be considered "ill-gotten gains."
That's what this comes down to. You want to make loans to people at 13%? You take the legal risk if that turns out to be predatory or deceptive.
You want less risk? Buy a current-coupon Fannie Mae MBS.
Back in the bad old days, folks would buy say carpet from a business, that business would sell the credit, and then maybe never install the carpet or sell shoddy carpet.
In the bad old days, the customer would be out the carpet and the loan, because the holder in due course of the loan would sue to recover his debt.
Then there was the thought that folks knowledgeable enough to invest in debt should be knowledgeable to know who they bought the debt from. This became law. So the holder in due course became responsible for the carpet. The result was that folks buying debt got more careful about who they bought it from.
"So the holder in due course became responsible for the carpet. The result was that folks buying debt got more careful about who they bought it from."
YES! YES! YES!
You want less risk? Buy a current-coupon Fannie Mae MBS.
Why is that less risky?
The current situation is the sheep complaining of too many sheep eating the seed grain after the sheepdogs have been executed.
An agreement by the two lawmakers may increase the likelihood legislation will be passed this year. The cost of borrowing would rise and curb financing for some lenders and subprime homebuyers, said David Brownlee, who oversees $14 billion as head of fixed income at Sentinel Asset Management in Montpelier, Vermont. It would also reduce opportunities for the Wall Street firms that pool the home loans as securities...
Well, if that doesn't cause the housing market to completely freeze up and the U.S. economy to fall into recession, I suppose nothing will.
Why is that less risky?
Because Fannie and Freddie do not buy "high cost loans" as that is defined in these statutes for their own MBS issues. They guarantee to the buyers of their bonds that no such loans will ever back those securities.
If Fannie or Freddie happens to buy a tranche of a subprime security for its own investment portfolio, and such security contained one or more illegal predatory loans, guess what? Fannie or Freddie would be the bondholder in that case.
If the F's got uninterested in buying the top tranches of that subprime shit, because of the liability . . .
Oh, so Banker is defending the banks again, oh joy.
Though you were being facetious, I actually agree this:
Theres something downright commie about making sure the risk is held by the party reaping the reward.
As the only self-described 'commie' here, I think the bondholders should eat it. If they were so stupid as to buy into the 'no housing bubble' theory thereby believing these MBS would never sour, they should get their asses handed to 'em. Let the idiot pension fund managers, FCBs and hedgies get their pedestals pulled out from under them. It's about damn time. Is it going to hurt some innocents? Of course, but this disaster is going to hurt all around the world.
The banks won't get away without pain, as they will hold enough of the bag to hurt, and what's even better, the global investment community will trust them like they did during the Depression. Fool me twice, shame on me-right? Didn't the world learn before the mistake of trusting the money lenders? Hopefully the lesson will last a little longer this time around, with some seriously ugly regulations to crimp the greed merchants thrown in for good measure.
Yes, the banks will suffer severely even with the bondholders taking it on the chin. And for quite some time.
Unfortunately for the banks and their roomfulls of PhDs, the ratio of idiot PhDs to smart PhDs is rather large in our present world. As a scientist by training, some of the dumbest PhDs I've worked with have come out of Harvard (Noooooo!!!). I'm totally serious. Of course, they think they're geniuses. [Post-docs at Harvard are a different story, as they go there for the access to funding and connections]. Think W.
Maybe I'm missing something but bondholders are holding the bag, aren't they? The covenants only protect the bondholder for repurchase on early default, but all the stuff later in the pipe that goes sour is not the responsibility of the originator, right? And if the originator chokes on too much forced repurchasing, they just go belly up and get liquidated. Meanwhile the resale value of the bond completely tanks while the income it generates deteriorates. What have I gotten wrong here?
What have I gotten wrong here?
We are not talking about credit risk.
We are not talking about who eats a defaulted loan.
We are talking about what happens if you screw a consumer by deceptive lending practices which are designed to generate mo' money for investor.
The idea is that the investor could be forced to return the mo' money. Even if the loan did not default. You are not allowed to keep usurious interest that you got someone to agree to pay you by means of deceptive practices.
That is the idea.
I guess if a new law is passed that makes certain loans illegal, then is continuing to collect interest on those loans an ongoing criminal enterprise?
If I hold the note today, how do I determine whether it is legal or illegal? Is it a determination in a crminal or a civil court? If criminal, is there any penalty to the borrower who falsely claims that the note is illegal.
While I like the idea of extracting some flesh from everybody in the non-prime food chain, I share the concerns about after the fact legislation making a note that was "legal" yesterday "illegal" today. I agree with Tanta that with no countrol over mortgage brokers, you get a lot of bottom feeding scum in the business. Consumers cannot be expected to police the brokers.
"The only thing cheap money and creative financing did was drive up the cost of housing."
This is a good point. The central bank that claimed to have policy of being opposed to high inflation simply changed the definitions, dropped rates to the basement, held them there and let things buck.
They deserve - and, in history , will get, full 'credit'. The moral: you can lead people to liquidity but cannot make them use it in a responsible fashion.
They guarantee to the buyers of their bonds that no such loans will ever back those securities.
Yes, Yes, Yes
. The vast majority of bondholders are going to want a guarantee from somebody that they aren't going to be liable for that secret mortgage broker predatory side deal.
And, that is going to increase the cost of securitized mortgage instruments. Just like the price of carpet loans went up after it turned out somebody had to check to make sure the carpet company was legit.
Somehow I doubt that the bondholder are the ones who have been making most of the money off the high interest loans. I suspect that mortgage brokers, mortgage bankers, investment bankers and credit rating agencies are the ones. Does anyone have any hard numbers? How bid is the yield on AAA trench of subprime bonds?
This all hits at the the core of "liquidity." The real reason why someone would buy a bond backed by mortgages is because of the fact that they do NOT need to know anything at all about the underlying transaction. The ability to buy and sell anonymously is "liquidity." that is the foundation of our brand of capitalism based almost entirely upon the limitation of liability for the investor which allows one investor to sell their shares to another investor without being concerned about the possibility that they may face some additional unknown liability (beyond the cost of their investment).
I would note that this "limited liability" capitalism has been created mainly to ensure "liquidity." Not because it is necessarily more efficient. After all, who would buy Dow Chemical stock if they were worried that some environmental damage caused by Dow could mean that THEY would lose their house as well as their investment in Dow. No one. However, in theory, the value of Dow should reflect this possibility of environmental damage but clearly it does not if that damage need not be paid by the shareholders.
Chinese (Russians, etc) invest in American paper securities because there is nothing productive they can buy with the dollars we paid to them in exchange for valuable goods they gave to us.
Then why are they exchanging these "valuable goods" for "worthless dollars" ?
The Chinese in particular are extremely anxious to be exploited in that way.
Obviously, America's suppliers see value in taking dollars for their goods.
And, that is going to increase the cost of securitized mortgage instruments. Just like the price of carpet loans went up after it turned out somebody had to check to make sure the carpet company was legit.
It is not more expensive to buy a GSE MBS than a subprime ABS. In fact, it's cheaper. You can buy GSE paper from discount brokerages.
They yield less than than subprime MBS. Less risk, less reward to Mr. Bondholder.
How do the GSEs manage their guarantee risk? You try getting a "high cost loan" through the GSE's delivery software. I dare you.
I mean, I say crappy things about technology from time to time, but it's amazing how those computers the GSEs use can catch an interest rate on a loan that is 500 higher than the current 60-day required net yield the GSEs post on their website. It's some fancy algorithm that picks the larger of two numbers, or some kind of rocket science math like that.
The only thing that is going to get more expensive is due diligence for someone who wants to buy a mortgage-backed security that yields 500 bps more than a GSE security does. How, like, unfair is that?
Last sentence of last post needs to read "security backed by mortgages that yield."
Nunc dimwittedness.
"The only thing that is going to get more expensive is due diligence for someone who wants to buy a mortgage-backed security that yields 500 bps more than a GSE security does."
Those due diligence costs will get passed on to the borrower, making the mortgage debt more expensive (and perhaps uneconomic).
It's some fancy algorithm that picks the larger of two numbers, or some kind of rocket science math like that.
Its not a matter of half adders, XOR, NAND, OR, AND gates, Fortran, Java, or plug boards.
Its getting someone to tell what the heck to do.
The algorithm of the human mind.
I think the real estate collapse is moving into finger-pointing stage. It's definitely prudent to point your finger before someone points his finger on you.
BTW, my finger is pointing in Easy Al/Bush & Co direction.
"And, that is going to increase the cost of securitized mortgage instruments. "
Well, Hell, yeah! Hey, diligence isn't free, is it?
I like it.
TMR is moving. Good company, cheap stock.
TMR - SharpCharts Workbench : StockCharts.com
the market will do a better job then the gov't in both the short and long term. We have seen the gov't in action the past 3 years while the subprime lending mess has been going strong. The folks providing the front end money for bonds or direct lending are cutting off the moneyflow until the risk/reward can be better understood. The same argument about subprime RE lending could be used about subpime CC or auto lending as well. Let the market both on the consumer side and lender/bondholder side do the speaking.
Ron Paul
The Federal Reserve Monopoly over Money
The Federal Reserve Monopoly over Money
Translating a bit from what I've been reading Tanta, it seems that you are mainly interested in enforcing "caveat emptor" on the source of all this ill-gotten and greedy liquidity, the MBS holders and issuers, as this particular slice of the thundering investor herd was in a large part responsible for pushing the perverting of the mortgage industry as we know it to serve their profit motive, becoming one of the primary causes of the housing bubble.
And, if I may add, you seem to be doing so with all the justifiable and unholy glee of one long put upon and righteously indignant.
Frankly I agree with you that the pain should be spread up and down the food chain on this debacle. However, for all the good this will do the system, the resulting liquidity crunch will probably hurt everyone, even those not involved. I just saying a little intervention might be warranted, to prevent the scorched MBS investor/issuer/sub-prime owner fingers from turning into scorched earth for the rest of us. I'm not advocating the saving of fools from themselves, just saving us from the results and fall out of their foolish actions.
On a separate note, you wouldn't happen to be a recovering Catholic?
Nunc dimittis servum tuum, Domine, secundum verbum tuum in pace:
Quia viderunt oculi mei salutare tuum
Quod parasti ante faciem omnium populorum:
Lumen ad revelationem gentium, et gloriam plebis tuae Israel.
Tanta,
I agree that those who get the rewards should also shoulder the risk.
However, a better question to ask is, who gets the RISKLESS rewards?
That would be (a) the originators and (b) the Wall St. banks that package the loans. Both of these institutions make their money up front and are subsequently shielded from default risks.
Now, you might argue that the originators do in fact shoulder some risk due to the putback clauses that Wall Street puts into the deal when they buy the loans for packaging.
However, the originator can easily escape this risk by declaring bankruptcy. So what we really have here is an agency problem... shareholders in mortgage originators get stuck holding the bag, while management has of course already cashed in their bonuses, stock options, etc.
Wall Street, on the other hand, seems to carry absolutely no risk here.
As far as bondholders are concerned-- they get stuck with the default risk, as well as inflation risk (i.e. they get paid out over time).
And who are the bondholders, you ask? Well, if you have a defined benefit pension, a 401k, a money market fund, or an IRA, then look in the mirror, and you'll see a mortgage bondholder. Chances are excellent that a good chunk of that bond fund/money market fund/"diversified fund" you own (maybe even without realizing it) is, in fact, mortgage bonds.
So in the final analysis, Wall Street, of course, escapes scot free, along with the management of the origination companies. And anyone with money invested in almost any part of the financial industry gets left holding the bag.
My final point is this: why are we even bothering to discuss this issue. The entire financial system (and, in many ways, our entire governing system) is deliberately structured to systematically and gradually transfer wealth from the general population, and into the pockets of Wall Street. This is why the Federal Reserve system exists in the first place. To bother to discuss this issue on any other level is like looking at a river, and wondering why it doesn't flow uphill.
But hey, that's a topic for a different discussion.
Andrew: non sum qualis eram. That's all I've got to say.
Androus2001: I have to say that I am fascinated by the fact that we just cannot stop talking about default risk. No matter how many times I try to change the subject. I was even guilty at one point on this very thread of USING CAPS.
So why is this? Why does it seem that default risk, which we talk about often enough on this blog to have gotten ourselves reputations as obsessives about, is The One True Subject?
The fact is I know quite well what's in my 401(k). You forget that I have been the midwife to more GSE and Ginnie Mae MBS issues over the years than I can shake a stick at. Made the loans, swapped 'em for the security, serviced them, and still went out and bought the MBS with both pre-tax and after-tax dollars. I do not fear GSE MBS. I do not understand why others fear them. (GSE accounting and rate hedges make me exceptionally nervous. But since I know exactly nobobdy who argues the GSEs should be unregulated and allowed to make up their own accounting rules, I do not find it worth my while to harp on that.)
In any case, I know who will lose if my retirement account takes hits on bonds, or my neighborhood becomes a ghost town of crumbling condos and boarded-up SFDs, or my bank fails and I have to trust the FDIC to write me a check, and so on. Which is why, of course, I can't quite get over my shock when it is suggested to me that there might be scary consequences of taking away the punchbowl. As opposed to what? Letting it go on?
In any case, I am a net saver. Which makes me a lender. Which is what a bondholder is, of course.
Why do I deserve predatory yields? Why do I deserve immunity from liability for predation? In what sick morality play is the lender the innocent angel and the borrower the evil defaulter who doesn't deserve fairness? I begin to think that one reason we can't get off the subject of credit risk is that it's easier for a lot of folks to talk about people who don't pay debts rather than people who seek rents.
Some of you are very confused!
Let's recap:
I saw the following comment:
This all hits at the the core of "liquidity." The real reason why someone would buy a bond backed by mortgages is because of the fact that they do NOT need to know anything at all about the underlying transaction. The ability to buy and sell anonymously is "liquidity." that is the foundation of our brand of capitalism based almost entirely upon the limitation of liability for the investor which allows one investor to sell their shares to another investor without being concerned about the possibility that they may face some additional unknown liability (beyond the cost of their investment).
This is off-subject and irrelevant. In the future, the investors will know in advance that what they're buying contains "fraud risk". "Fraud risk" will be a new term that will be added to the already existing list (credit risk, prepayment risk, duration risk...) and the market will simply charge extra basis points for that risk.
IN OTHER WORDS, Mr. Barney Franks is suggesting the FURTHEST THING FROM COMMUNISM!!!!
He is suggesting: "let us make a market in fraud risk", "let us allow market participants to care about, and therefore, PRICE that risk, and let them trade around that risk among each other." (i.e. "we don't wanna have to an Ohio-type Dodd-type GOVERNMENT PAID bailout").
That's what he's saying.
Forgive me father for I have flamed.
Okay, that's off my chest.
I have a very serious question.
Seriously
Here's the situation. I have a mortgage, or some other obligation that costs money, and I discover that my income from my job doesn't really cover it.
So...I go out and get another job.
Does that show up in national statistics as a new employed person, even though it's just one person who now has two jobs?
Does anyone know the answer to that?
Very curious...
My initial reaction when I read this in the morning was that it was a bad idea, but I understand it a bit better now.
I still think the originators need to be held responsible first and foremost, because they are the ones who initiate the process, but I can't see why anyone would be OK with the bondbuyers/holders walking away clean.
As noted, when the originators go belly-up, there won't be anyone to make them whole but I can't feel sorry if there is a further price to pay for their greed.
Finally, when that law was passed in NJ we were told that it would kill the lending industry here... you can see that it did, it just took a couple of years
.
By the way, to follow up on probert's post, please consider that Barney Frank is co-sponsoring with a Republican.
What's going on here is that both of them see the GSE's taking a huge fall and the taxpayer picking up the pieces...and neither of them likes it.
Yeah, I know all about the $300 billion.
It won't be enough, and besides it's taxpayer money.
This is all about the GSE's. They're not risk free, at least not from the perspective of Frank and Bachus.
That's the key.
Barney Frank for President. Even if he is intentionally ignoring the fact that the Fed and Banks and their attorneys passed on the risk of default to the gullible and others. Look up Goodwin Procter's PDF entitled "The Goal of Bankruptcy Remoteness. Or Google up Cadwalader's Clients and Friends Memo concerning "Interpretive Letter of The Federal Reserve and the Office of the Comptroller of the Currency Examining Various Synthetic Securities Using Credit Derivatives." My bet is that in the future more stuff than just homes will be securitized, this will make fees and other profits for some, while passing onto others the hot potato of risk.
There must be a CR chart in here somewhere: the more risk one bears, the greater one's ability to 'self-correct' in the market.
Does that show up in national statistics as a new employed person, even though it's just one person who now has two jobs?
The household survey counts employed people. In the situation you describe your status doesn't change. You were employed and you remain employed.
In the establishment survey, they count jobs created and jobs destroyed. So it would depend on the type of second job you're taking. If you're replacing someone, it's not a new job.
Tanta,
Not sure why you think bondholders would get predatory yields - if there was any excess value created (stolen) from making predatory loans as opposed to "regular" subprime loans, it would be captured by the originator in the form of higher prices before the loans are sold. Bondholders would only receive excess yields if the market at the time correctly discounted this possibility. Also, if everyone who received interest is liability, where does it stop? What if the loan papers bounced around in multiple conduits, repo counterparties etc, etc, some of which may not even be around anymore.
Given that all of you have been arguing that holders of non-investment grade bonds are now screwed even without this possibility, and many blame the availability of cheap credit and tight credit spreads for causing this mess, the idea that bondholders received some sort of excess interest due to predatory lending practices to me seems somewhat unlikely. Honestly, it smells a lot like the case of Enron employees suing the company, thus the shareholders, when it was really the shareholders that got screwed over by the employees. If the loans that should not be made were made, the fault really lies with the originator and the borrower and further risk sharing or transfer mechanisms aside, the economist costs should be borne by them. And selling of whole loans into securitization vehicles has generally been understood to be a credit risk transferring mechanism by all parties, regulators included. You mentioned earlier that mortgage insurers shouldn't be held liable here - why not? Haven't they profitted from this by taking a percentage of the yield? How is that any different? If the loans were held by the originators but securitized synthetically using swaps, would that allow bondholders to be free from liability? But what's the real difference?
My personal feeling (as someone who was involved in the mortgage finance chain during the boom, though not for as long or as deeply as others here) is that criminal prosecution of those who were responsible at the origination level is the only way to go. You can't really economically analyze who benefited from this situation (almost no one who chooses to invest in these securities does so with his own money) in a legally appropriate manner and severe enough criminal penalty at the origination level would substantially discourage the practice. That is until the economic advantage draws enough shady or dumb characters into the business and the whole cycle starts again. But no amount of regulations will always protect stupid or ignorant people from signing disadvantageous contracts, which is what all this really comes down to.
The top Democrat and Republican on the House Financial Services Committee said investors in mortgage bonds should be liable for deceptive loans made by banks.
I say drag the bastards out in the street and give them a good caining while they're at it.
Very late in this conversation, but this appears to be a solution to please lawyers. Using civil courts to police "predatory" interest rates by way of damages that have to be apportioned will result in a windfall for litigators rather than benefiting anyone else. When you look at regulation, you want the lowest total cost to gain the object, because the final endgame, all costs are passed through. There are already usury laws - if the gov't wants to set rate, reset, LTV, or loan/indebtedness-to-income caps, or ban teaser rates or whatever - let them do it openly. It will still chill the market available, but it's much simpler - and cheaper - to police.
Bearish,
Please read what is being said. You are off-topic with this sentence:
the idea that bondholders received some sort of excess interest due to predatory lending practices to me seems somewhat unlikely
Barney Frank and Tanta are not talking about the risk-reward, contracts, valuations, decisions and transactions of the PAST. We are talking about the future. ONLY THE FUTURE.
Current holders of debt no doubt got a better deal than they "deserved" market-wise (albeit not legally). So, no, it wouldn't be nice to go after current debtholders and ask them to regurgitate this stuff.
However, if (IF) Taxpayers will be footing some sort of bill, then you need to balance out your balance sheet. In other words, by definition, it means that someone "took" money from us taxpayers. Who is it? It's the lenders.
This time it's ok because they got ripped off by wall street. But next time, let's get a real capitalist system to incorporate that risk in the securities. That's what Barney Frank is saying.
Bearish, let me just re-explain something: legally I agree with you, financially i disagree with you.
Why do I deserve predatory yields? Why do I deserve immunity from liability for predation? In what sick morality play is the lender the innocent angel and the borrower the evil defaulter who doesn't deserve fairness? I begin to think that one reason we can't get off the subject of credit risk is that it's easier for a lot of folks to talk about people who don't pay debts rather than people who seek rents.
Maybe, as Androus2001 suggests, it is time to look behind the curtain. Of course, only crackpots are curious about what is behind the curtain and most humans would rather suffer interminably than appear crazy. Nobody is prepared to confront what is behind the curtain, so the problem will continue to be ignored. The curtain will stay up until the theater burns. The power of collective denial is awe inspiring. Shock and awe indeed. Of course, even Milton Friedman thought that money shouldn't be left to central bankers. Stupid Nobel-prize winning crackpot!
Regarding the topic at hand, how many times does my money need to be washed before it is laundered clean and good?
Well, at least if there is no MBS liability then we can look forward to the THCBS bubble -- which will at least be funny.
Just make predatory or illegal lending a RICO predicate offense, and write in a private right of action against the whole food chain, brokers, originators, bondholders etc.
RICO you just need to prove conspiracy which is relatively easy to do and cha-ching get treble damages.
Yes, liability is a good step but just go whole hog.
Tanta,
First let me say that I am not necessarily disagreeing with you here. But I think that the real issues are getting obscured.
You imply that rentiers are making fat yields and should bear default risk. Well, I can agree with the latter (to a certain extant) but I have trouble agreeing with the former. It's pretty obvious that yield spreads have become wafer-thin. Risk is not getting compensated for in the bond markets. This is undebiable.
So let's take a closer look at the narrowing yield spreads. When prices go down, we know that supply is either rising, or demand is falling. In this case, it's pretty obvious that, thanks to Wall Street, supply of mortgage-backed securities has gone through the roof over the last 20 years. Given that Wall Street makes a nice chunk by creating these products and selling them, it certainly makes sense that they are motivated to create a bazillion of them.
Now let's take a breather for a second and ask, Cui Bono?
Well the most obvious beneficiaries, as I indicated in my earlier post, are Wall Street and executive management of the mortgage origination companies. And it is pretty obvious how the motivations of these two constiuencies have become intertwined over recent years.
The other primary beneficiaries have been the marginal borrower. Wall Street and the mortgage originators have created a powerful vacuum effect that have drawn in the marginal borrower and given them the opportunity to own a home. Now, granted, many of them will soon lose those homes, but let's face it: a few of them will figure out a way to keep their homes. And those people never would have had the opportunity in the first place.
So who loses in this equation? The investor, that's who. The massive supply of MBS's out there have helped drive yields down way out of proportion to the real risk that investors are shouldering.
And I haven't even elaborated on inflation risk, which is separate from default risk. Inflation is raging at about 10% per year, and I am perfectly willing to argue that the MBS creation mechanism is a meaningful cause of the increased inflation of late. Oh wait... you think that inflation is only 3% per year? You must have made the mistake of believing the government statistics, which are completely bogus. John Williams at Shadowgovernmentstatistics.com makes a very compelling case that inflation and unemployment are really running at virtually double-digit rates right now.
So. Barney Frank wants to get all sanctimonious about how "The investor should shoulder the risk" of the mortgage finance debacle? Well frankly it appears to me that the investor is already shouldering a massively outsized amount of the risk. Am I surprised that Barney Frank is dead wrong, again? Nope. Unless of course he is a bought-and-paid-for dupe of Wall Street, in which case he is certainly "right" as far as they are concerned!
Androus2001,
(sorry Tanta if I leapfrog you here)
It's pretty obvious that yield spreads have become wafer-thin. Risk is not getting compensated for in the bond markets. This is undebiable.
Your entire post, Androus, is based on market yields. The new scheme that we would be talking about would incorporate those risks in the COUPON rate (i.e. the return on face value), not on the market yield. Market yields will always fluctuate between extremes. Even within Barney Frank's new world we will have bear markets and bull markets. There will be eras of euphoria where people will declare: "Hurray! Thee are no more dishonest appraisers! Church attendance is at all all-time high!" and there will be times where people will think: "The appocalyspe has arrived! Everyone is desperate to make a buck! Appraisers and brokers are, liek the rest of society, only going to get more and more dishonest! Let us sell off those MBS!"
But again, all of this is off-topic because we're talking about the coupon rate, which is set when the securities are created, which are set after origination, which is all in the future, because this entire discussion started by Barney Frank (and Tanta) is about the future, not the past.
I do not fear GSE MBS. I do not understand why others fear them.
"Be afraid... be very afraid."
probert: if this is to be instituted going forward, then what prevents MBS deals from being structured in such a way that legal liability still rests with the originator? Unless you require that all parties who receive any sort of cashflow from the loans to be liable, in which case mortgage insurers will certainly be part of the suit, you can create synthetic structures to get around this. Think CDS. So, as before, if the originator blows up, borrowers won't have anyone to compensate them for those predatory loans. Legislation of this type won't do anything but result in financial engineering to get around it which would potentially incur additional costs without any corresponding benefits. Criminal prosecution has far more teeth (and has the side effect of not benefitting quite as many lawyers)
Tanta - "In what sick morality play is the lender the innocent angel and the borrower the evil defaulter who doesn't deserve fairness? I begin to think that one reason we can't get off the subject of credit risk is that it's easier for a lot of folks to talk about people who don't pay debts rather than people who seek rents."
This is another topic, but in my view that has always been one of the unseen other sides of bankruptcy law coin. The lender (just as in contract law) is held partially responsible for the loss as they are the one of the parties that is most able to the avoid of the resultant hurt. This they can do by being a teensy bit less greedy and more discriminating in who they lend to. (Whether or not that lending rises to the loanshark-esq predatory level is another question all together, I'm talking about maintaining a balanced and healthy financial system here.)
And regardless of how you come down on the recent revisions of the bankruptcy laws, no one can deny that one of the results of the changes was the changing/lessening of the sting of that particular nettle for the lender. I'm not sure that this bankruptcy change (and the MBS craze) was an entirely good thing for loan due diligence and quality.
If you pardon the bad analogy, it seems a bit like changing the balance of an ecosystem by removing a large predator from it and having an over-population explosion and crash in the prey animals result.
No problem, probert. You go!
You imply that rentiers are making fat yields and should bear default risk. Well, I can agree with the latter (to a certain extant) but I have trouble agreeing with the former. It's pretty obvious that yield spreads have become wafer-thin. Risk is not getting compensated for in the bond markets. This is undebiable.
I am trying not to talk about default risk. Again, unsuccessfully.
So let's talk about it. Yields suck because the only way you can do a senior/sub deal and get the right rating on the senior is by putting the default risk in the sub and offering the senior holder a couple of ticks over risk-free. You tell me that these structures, this "credit enhancement," is all made possible by mortage yields of 6.00% with no prepayment penalty? C'mon. If you can't generate some yield off a bunch of poor folks paying you 13% vig, you need a competency hearing. Don't tell me you used it up to protect yourself from default risk and so therefore you didn't benefit from it.
Forgive me, but as soon as we get back to appealing to those "opportunities" for the marginal borrower in a discussion of why Wall Street should be able to avoid legal liability, I start looking for my wallet.
What I'm hearing is:
If a predatory loan is made, the originator should face criminal penalty.
If a predatory loan is purchased by an investment bank, the originator should face criminal penalty.
If a pension fund buys a security backed by predatory loans, the originator should face criminal penalty.
If the legal structures, opaque accounting, remote vehicles, and other perfectly intentionally designed overcomplexity makes it too hard for the law to find the guilty party? Well, them's the breaks, huh? I mean, we wouldn't want to have to pay any lawyers on our side, right?
There sure is enough blame to go around. From reading the posts it seems that nobody is willing to shift at least some responsibiliy to the borrower. Afterall, he's the one that defaulted on the original loan agreement. Go after the borrower's assets first, then start hitting the loan originator working all the way up the food chain.
You cannot make people shoulder risk.
They must opt to do so. If basic terms of the mortgage sytem and subsequent re-selling are changed, potential investors will simply re-evaluate and either shoulder the risk of go elsewhere.
That's why I say the simple net effect is obvious: a lot fewer mortgages will be written.
In addition, torts are still torts, fraud is still fraud and attornies will still sort out what the law 'really' means.
Tanta wrote: "If you can't generate some yield off a bunch of poor folks paying you 13% vig, you need a competency hearing. Don't tell me you used it up to protect yourself from default risk and so therefore you didn't benefit from it."
Investors don't get to capture this additional yield - loan originators do (and if they don't, wall street traders who must have effectively screwed these originators are next in line). If borrowers are paying much more in interest than their default risk as perceived by the market would warrant, those loans would sell at a significant premium, thus wiping out the advantage for those who purchase them in the secondary market. The only way investors can benefit from investing in credit is if they are better at evaluating credit than others or if the perceived credit risk of their holdings goes down over time for whatever reason.
Bearish, first of all, the definition of "predatory lending" is pretty much a borrower paying more in interest than their default risk warrants.
Strictly speaking, of course, it's not just coupon, it's fees and points. And certainly you have market participants out there paying premium for this crap. I will only observe that back in the day when I put out a rate sheet, nobody made me put a price over 102 on it. There is no law that says investors can't force those note rates down by failing to pay up for them.
But if you are suggesting to me that investors get no better yield on subprime than on prime paper, because the pricing of credit risk is perfect, you're telling me news. Why would anyone buy a security with credit risk if the yields were the same as a Ginnie II?
But even if the bondholder never sees a dime of yield over risk--that bondholder is funnelling money into the predation machine. How long will originators be able to keep all the spiff if no one buys the loans?
"Spiff." There's a word I haven't heard out loud in a long time. For how many years did some originators scoff at the idea because the market was priced perfectly? No matter. It doesn't seem to me that the GSE paper is any safer because I don't see how their assets are risk/reward coupled anymore than the risky paper was. When you test a system to destruction the flight isn't over just because you ripped off the wings.
then what prevents MBS deals from being structured in such a way that legal liability still rests with the originator?
Nothing, but again, this is off-topic... at least in my mind... maybe I am getting to the point where I'm not addressing what you're saying but here goes:
The title of this thread and Barney Frank's terminology is creating a confusion & causing ppl to talk past each other. I know the title says "bondholders", but I'm not talking about bondholders, but every tranche, including every retained tranche. And if we're talking about the originator of the loan (including even individual brokers) I still don't see how this is "gaming the system" around Barney's proposed law. Perhaps we will get to a point where lending money to a Broker/lender/originator, or perhaps, providing them with professional liability insurance, will cost more. In other words, I don't care if you financial engineer your way around it even MORE than what you suggested. The point is that under Barney's suggestion, somewhere in the engineering chain, there will be SOMEONE who will bear the risk. Right now, there is NO ONE to bear the risk, and taxpayers are being asked to chip in. This loophole will be closed forever.
What will not be closed forever is, as you say, the extra juice in MBS investor returns, or risk, or ditto for IBs, originators etc'. Any of those people might lay off THEIR risk, and at any point in the chain there may be another boom/bust cycle. After all, the 1933 securities law didn't prevent the 1990's stock market abuses did it? But that's how our society operates, we can only close loopholes one at a time, not all at once.
Nevertheless, somewhere along the chain, there will be a capitalistic process of taking on the risk of fraud/deception and reaping a reward for it. The risk/reward equation will be marketable and therefore fluctuate. It will not be a socialist process as it is now.
Tanta wrote: "Bearish, first of all, the definition of "predatory lending" is pretty much a borrower paying more in interest than their default risk warrants."
Not necessarily because you can have a situation where the loan, at the correct market rate, may not make sense at all for the borrower (as a higher default risk does not necessarily mean a higher internal discount rate - but a concept lost on a lot of people, not you Tanta, you've been illuminating this exact concept through this blog).
"But if you are suggesting to me that investors get no better yield on subprime than on prime paper, because the pricing of credit risk is perfect, you're telling me news. Why would anyone buy a security with credit risk if the yields were the same as a Ginnie II?"
No better risk-adjusted return. Not the same as pure yield or even yield after adjusting for default rates. Even you're saying: why anyone would buy such a security - because they are being compensated, on average, at the market rate for the risks. So they are not capturing any outsized gain from investing in these bonds. And even Ginnie II's are not risk-free; negative convexity is a bitch...
"Strictly speaking, of course, it's not just coupon, it's fees and points. And certainly you have market participants out there paying premium for this crap. I will only observe that back in the day when I put out a rate sheet, nobody made me put a price over 102 on it. There is no law that says investors can't force those note rates down by failing to pay up for them. "
But prices will have to go back up if other investors see that these offer an above-market level of risk-adjusted return. And investors don't see fees and points. You're demonstrating how much extra money originators are able to make with predatory subprime loans: fees, points and premiums and the level of financial incentives this creates. Investors on the other hand don't care if it's subprime mortgages or argentinian bonds.
"But even if the bondholder never sees a dime of yield over risk--that bondholder is funnelling money into the predation machine. How long will originators be able to keep all the spiff if no one buys the loans?"
Would the situation be any different if the orignator kept all the loans on its balance sheet and used credit derivatives with mortgage-like payoffs for its counterparties to hedge its portfolio? How about debt or equity funding? As long as the activity its doing is economically feasible, and predatory lending that we're discussing is better than that -it generates excess economic profit by screwing borrowers - I'm not sure if there's any way to prevent it from using any number of funding sources available through capital markets.
it generates excess economic profit by screwing borrowers - I'm not sure if there's any way to prevent it from using any number of funding sources available through capital markets.
hmmm...
Well, under that scenario, first of all, we agree that one difference is that they are knowingly taking the risk and getting paid for it, right?
Now, you have mtg source A which is making x in coupon+fees+points, and then you have mtg source B which is charging y which is greater than x, because y incorporates the risk of fraud, all else being equal. The borrower will, again, all else, beingequal, choose loan A because it costs less...
...
IF the borrower has enough sophistication.
...
In theory, it is possible that some borrowers will once again find themselves in a situation where they are abused by predatory lenders A. Now I can sort of see what you;re saying. You're arguing in favor of borrower education and/or caveat emptor...?
That actually makes sense.
But still, as long as a private party assumed the extra risks, we still have the benefit of a new non-taxpayer-bailout-solution.
probert: If I understand what you're saying correctly, then how is it different from the present situation? Originators are currently responsible for making sure that their loans do not violate existing predatory lending laws, are they not?
I have no idea what you mean by these loopholes - there are no loopholes of this kind right now. Where there are lack of predatory lending regulations, borrowers are responsible. Where there are, originators are. Loans are priced accordingly.
What was remarkable about Barney Frank's suggestion was that the legal risks associated with lending should follow the cashflows from the underlying mortgages, not that someone should hold the legal risks - someone does, right now. I don't understand your taxpayer comments either - if some borrower wants to sue someone for making a predatory loan but the originator has already gone out of business, he doesn't suddenly get to sue Uncle Sam.
Oh...Right... the end of my previous message made me realize where the error is. Most of us (at least me) are not seeking to prevent another bout of borrower abuse. You are right, it is possible to circumvent that. What we are seeking is preventing the subsequent taxpayer bailout of those abuses.
I'm against any sort of bailout as well - probably more so than most here. I'd rather face a severe recession.
Ok gotcha... well, I thought Tanta was applauded anyone who is trying to protect the American People from things like the Ohio proposal or the Dodd bailout proposal....
I'm re-reading now...I guess somewhere I lost touch with the subject. Barney Frank obviously is talking about ABS more than anything else...and Tanta also reserved some pity for the originators.
Let's assume no legislation occurs. Then IBs would not lend to originating lenders without pricing fraud risk. And no one would want to originate fraud as frothily as they did before if it's put back to them in the way that it has (unless they somehow lay off that risk).
So now I'm actually also in favor of no legislation at all. Perhaps the marketplace can adjust itself to the situation...
And I'm not entirely sure Frank himself knows everything he's talking about. I think I'm going to re-think the entire thing again later on, and come back.
the most fascinating thing in the upcoming debacle is what happens with the guys providing insurance on these pools. i think most of the holders of these securities think of insurance as a constant, not a variable. if you've paid attention, some mortgage insurers are pushing back and not paying claims.
Bearish what the hell r u talking about?! Of course Ginnie IIs are not risk free. Neither are Treasuries! The point is they're CREDIT risk free!!! You get extra yield for the risk; that's why ginnies have an oas. you can't fund mortgages to nearly the same extent with any other source of capital than the secondary market. U want to hold all your loans and hedge the credit risk? if you held your subprime loans on the balance sheet in 2006 and hedged the credit risk you'd get worse yield than ginnie IIs!!!
keep the comments coming! soon it will be a record for most comments ever!!! Tanta brings it out of us (even if they're off topic)!!
Did anyone mention RICO? I tried to read the whole thread through but ended up skimming it instead.
There really is a similarity in how banks got nicked for money laundering in the drug trade... If I understand it correctly, banks have to show pretty thoroughly that they have good practices in place to screen out money launderers.
Having said that - even if they do & money is deposited that is shown to be 'illgotten' (key point is there needs to be a legal finding of wrong doing somewhere) - then the banks can lose it. But the state gets it - we don't get it.
But it only happens through court action (due process) - expensive & time consuming for both parties.
My guess is those laws are already in place - that an eager states attorney can enforce those actions now (given evidence & a finding of predatory lending).
I think it would be extremely expensive for a private party to INDIVIDUALLY force a remedy on their own particular case. The value of the home & mortgage (the damages) wouldn't begin to cover the legal costs.
However private civil class action is a possibility with or without "Barney's Law". While it might be too expensive & too hard to show damages at the individual level... it might pay to lump them all together IF you can show there was a willful & persistent trend to prey on a class of borrowers... lotsa folks, bond holders included, could be swept up in that net. Deep pocket rule applies.
In fact it would not surprise me one bit to see the eventual law restrict private civil action - especially class action - while simultaneously expanding RICO style state initiated civil action to 'recover damages'. Elliot Spitzer Att'ny General type civil action.
My guess is that will be the 'deal' that gets both GOP & Dems at the table & the President to sign it. It might be a deal worth doing.
JMHO.
Oh and did I say I have a family full of lawyers? If you like lawyers you'd love Thanksgiving at our house.
oops, i should have said "spread" not "oas".
"Tell me again why it's unfair to bondholders."
Why is it unfair to sell bondholders debt that you know can't be repaid?
Look, those mortgage brokers didn't do their job of making sure they made good loans, so they're having to eat the loans.
Instead, Tanta thinks bondholders should have to bear the cost of mortgage brokers' irresponsibility. That is pretty obviously wrong.
If you want bondholders' backing, you have to do your due diligence and make sure you're loaning money to people who can actually pay it back. What part of this could Tanta possibly object to?
More proof that reading William greider makes you dumber.
bacon dreamz: given that we're now moving beyond the notion of credit risk and into the generalized notion of risk (legal risk is not the same thing as credit risk), I'm not sure what your point is. There is no real difference between the risk of not knowing for sure when you're getting paid and the risk of not knowing how much you're getting paid. And theoretically, they are all priced so that risk-adjusted returns are similar across products. Treasuries, on the contrary, don't have any cashflow risk, only market value risk and are a fundamentally different beast. As for hedging credit risks of loans technically on balance sheet, why are you ruling out the possibility of development of liquid credit derivatives that basically pay like MBS without the transfer of underlying assets if such structures were more efficient than present MBS structures after this legislation?
Androus2001:Well frankly it appears to me that the investor is already shouldering a massively outsized amount of the risk. Am I surprised that Barney Frank is dead wrong, again? Nope. Unless of course he is a bought-and-paid-for dupe of Wall Street, in which case he is certainly "right" as far as they are concerned!
News Flash! News Flash!
Wall Street has been caught 'ripping the fucking faces off' unsophisticated "investors"!
Treat them like the used car salesmen they are and you won't be surprised by them.
This beater has been driven hard! But it is Moodys Certified and has nice rims though! Dang! This'll get the chicks!
Today bond holder are going to eat the cost of a lot of the default loans. We have the EPD and other safeguard to protect the bondholder, but what if the originator like NEW go BK? The bond holder/investor is the one that has to pay up for the problem in that scenario. Today's system is builded to make loan fast and cheap. In the process, all the steps of checking client's ability to pay, their income level, the house value are thrown out of the window in the name of making more moeny. And the bondholder are stipud enough to let it happend.
The only question that we are discussing is wether the bondholder/investor will have the offical responsibility/incentive to policy the loan process and stop these problem loans earlier in the cycle. They have the same responsibility today, except that they offload it to the originating companies thinking that they will hang around and have enough money to take care of any and all the underwriting problems. Also in the craze of chasing yield, investors don't price in the risk of default appropriately. How many time you heard the defense for low reserve by banks (BKUNA, DSL, FED, CFC, WM) is that historical data (meaning 04, 05, and 06) show them that default is going to be low. No one go back to 91 and look at those default rate at the bottom of the cycle. This kind of legislation will make the investor/bond holder think twice about offering risky mortgage to chase yield. They can still offer 30 year fixed or interest only or even stated income loans as long as they take the step to make sure borrower can make the payment, the appraisal is correct and fully disclose the loan terms.
The borrowers being 'abused' by predatory lending should go bankrupt... They are not paying attention to the contracts they sign and should rent for 7 years until they figure it out.
They are free to walk away and dump the now devalued collateral on the market and let the bondholders eat the losses.
Simple and fair I think.
Brokers are like car salesman, everyone complains about how they got 'screwed' on the deal
Rob Dawg:
What I am trying to say, on the subject of GSE & Ginnie MBS, is this--and you may of course take it for what you think it's worth.
The test of a good sausage is not whether some busy office worker on the coast will buy it and feed it to her children.
The test of a good sausage is whether someone who works in the sausage-making factory will buy it and feed it to her children.
There is, of course, no theoretical reason why the sausage-maker cannot be deluded. I do my best not to be; that's all anyone can do.
I also try to be very clear about when I am talking about "sausages," and when I am talking about pigs or the sausage-making factory's accountants or shareholders or debt financing.
That is all, unless you all are hungry. Pig in a blanket, anyone?
in the same line of thinking those greedy chinese and japanese us treasury bond holders should be held responsible for the us deficit spending !! what a joke!
CR, Tanta: What about government backed bonds? There is an unknown risk there as well.
http://www.viewfromsiliconvalley.com/id313.html
How do we determine how much of a government backed securities are risky? I moved my 401k from mutual funds last year and moved them into GSTIF bonds to now find out that they may be more susceptible to mortgage loans. I've attempted to find out from SSGA the makeup of the GSTIF bond fund. The answer I received was - Agency (7.3%) and Repurchase Agreements (92.7%). While this may be true, it's not the answer I was seeking. I sent another email requesting "how much of each (agency and repurchase agreements) are related to/from collaterized debt obligations, mortgages, mortgage loans, mortgage backed securities, derivatives or anything related to real estate (commercial, residential, or otherwise)." I haven't received a response yet but am expecting one by next week.
I understand there's talk of making the investors "holders of the bag", but I don't think in this case it is warranted. I am not knowingly investing in MBS and am not getting the "great" returns of MBS at 4-5%. It takes one who is on top of their investments to even realize that their government backed securities are invested in MBSs and even when they take the time to ask for the breakdown, are given vague answers.