Subprime historians can try to trace back the first subprime pool of loans that was successfully sold in the secondary market with AAA blessing from the credit rating agencies. That must have been around 2002 to 2003. Once proven as a viable channel to dump large amounts of bad debt to the sheer infinite pool of unsuspecting investors who relied solely on the rating agencies, just a few minor players came to dominate the entire mortgage market at first by offering loans with no regards to qualifications. Legitimate lenders had to decide whether to participate in this scam or be crowded out of the market completely. In the end only one major lender, Wells Fargo, decided not to play the game.
The subprime story is not over yet. Today the entire residential real estate market is dominated by one super subprime company that goes by the name of B&G Mortgage.
B&G of course stands for Bernanke and Geithner. Ironically, B&G were not founders of the company. With not a trace of real estate, housing or mortgage experience, they just happened to walk into the co-CEO positions and proceeded to change real estate as we knew it. B&G mortgage is not for profit, in fact it is anti-profit. It has no clear objective. It has no strategy for operation. It has no exit plan. It is the mountain blocking the road to real estate recovery.
B&G Mortgage is not publicly listed, but public ownership is mandatory. We all are forced to pay the price.
Meet the principals of B&G Mortgage Co. after a hearty meal.
(Photo via puppetgov.com)
Mr. B. is manipulating mortgage interest rates. With Herculean effort, he has driven mortgage rates down to their current lows. Unfortunately for Mr. B., this no longer has any stimulative effect. The market is taking these low rates for granted today. Home prices are perched precariously on the edge, while sales volume continues to decline. Mr. B. can always say "if not for me, it would have been much worse" and declare success. In reality, if mortgage rates were to move up to, say, over 5%, the real estate market would collapse instantaneously.
If mortgage rates simply remain at their current low levels, the refinancing activity will end while sales will continue on their steady downward course.
If the objective is to re-inflate the real estate market, the only choice Mr. B. has is to launch another round of 'QE', similar to his purchase of residential MBS [mortgage backed securities, ed.] in 2009/10. How much lower must mortgage rates drop in order to have an effect, and at what cost to the Federal Reserve's balance sheet?
As for Mr. G., monumental government interventions have only exacerbated the problems and brought about the current state of utter hopelessness. Wasteful ideas such as the tax credit have proven to have even less effect than a band-aid. Giving tax refunds to builders so they can build more future REO's ['real estate owned' – owned involuntarily by the banks after foreclosures, ed.] was about as stupid and corrupt as we have come to expect from Washington.
By absorbing all the losses, delaying foreclosures and using other forms of interventions, he is passing the burden to taxpayers while benefiting bondholders and those who are not paying their mortgages. It has been three years since the Treasury took over Freddie and Fannie. What comes next? Is it time for principal reduction? Are they really going to rent the REO's to borrowers? Are they really expecting borrowers who aren't paying their mortgages to pay rent, either voluntarily or involuntarily? Stay tuned, because Mr. G. is rumored to be launching a new and improved round of government intervention in the immediate future.
The destruction of the free market in real estate by B&G Mortgage is absolute. There is no private label that dares to compete with it. Put yourself in the position of an MBS investor. On one side you have a private label (PL) issuer and on the other side you have B&G mortgage securities. Let us just compare a few of the major differences.
Default risk: With PL, the investors have to analyze the underlying mortgages and assess the potential losses in the event of a default. With B&G, Mr. G. with his very deep pockets has said he will guarantee all loans.
Foreclosure risk: With PL, the investors have to calculate the loss severity in the event of default and foreclosure. The government has declared war on the foreclosure process, changing the rules at will. Not only would PL investors need to absorb this risk, it has become impossible to quantify this risk. B&G takes all those worries off investors.
Interest rate risk: B&G's securities are basically the equivalent of a Treasury note with an even benchmark to compare it to. PL's securities on the other hand may fluctuate wildly. What should be the initial spread between a PL security and a B&G security? By how much is this spread expected to fluctuate?
Mr. B. and Mr. G. have repeatedly complained about the fact that lenders are not lending. Who can possibly lend under these circumstances? Who would borrow from a private lender, presumably for a higher rate, if he can qualify for a B&G loan? Therefore the big bad banks are only too happy to let Mr. B. and Mr. G. carry the torch, while they benefit from making fees off originating and servicing the loans. They are more than willing to pass through all the loans to B&G Mortgage and let the taxpayers unknowingly assume all the associated risks.
In summary, the real estate world of B&G Mortgage is neither stable nor sustainable. Mr. B. and Mr. G. have exerted extreme effort just to bring the market to its current condition. Much more will be required to maintain this level, not to mention trying to boost the real estate market.
What is the current condition? On the default and foreclosure front, there is not a trace of improvement. Per the latest data:
4.1 million loans are 90 days delinquent or in foreclosure with another ~2.2 million that are <90 days delinquent.
Do not misunderstand these terminologies. The average number of days for a "90 days delinquent" loan is actually 397 days and the average number of days for a "foreclosure" is 599 days, as of July 2011. All these loans are so far gone that there is really only one solution – foreclose.
If you look at all the real estate indicators, such as the Case Shiller Index or new and existing home sales, there is not one that is even faintly encouraging. Most importantly, employment is nowhere near the level that could support a robust real estate recovery. In this current round, do not look for a real estate recovery to lead job creation. There is an excess supply of millions of homes and builders are still building more, compounding the problem.
The data are usually pretty useless, but they serve a good illustrative purpose here.
Rates have been going down to the ridiculously low level of 4.32%. Even that low rate is not attracting all those phantom buyers supposedly on the side lines. I've got news for the housing bulls: the sidelines are empty. Everyone who can refinance has already done so or is in the process of doing so. This week the percentage of refinances declined from 79.8% to 77.8%, resulting in a decrease of 9.6% of the index on a seasonally adjusted basis. If rates were to move back up to, say 5%, there would be ZERO refinancing applications and the applications index could well drop by 50% or more.
With the housing crisis, there is a golden opportunity to correct many past mistakes and rebuild the foundation of the real estate market for a better tomorrow.
Unfortunately, with B&G Mortgage, I think we will only see further destruction.
by Pater Tenebrarum
Indeed, as Bruce Krasting reports, rumors of the next major intervention in the housing market are already percolating.
In the meantime, here are the most recent Case-Shiller Index charts:
Case-Shiller National Home Price Indices as of August 30 – click for higher resolution.
Case Shiller Index level vs. its year-on-year percentage change. On a national level, home prices are back to where they were in 2003, the beginning of the bubble's 'parabolic' stage – click for higher resolution.
Fixed-rate mortgage interest rates, 15 and 30 years – click for higher resolution.
Lastly, readers can download a wide-ranging summary of the latest US residential real estate indicators published by S&P here (pdf). As Ramsey says, none of the data look particularly encouraging.
As we have often noted, the housing bubble must count as one of the greatest malinvestment episodes of the entire post WW2 era. It was a long time in the making – today people generally blame the ratcheting down of interest rates by the Greenspan Fed following the bursting of the tech bubble for its gestation and it is certainly true that this policy egged the bubble on and initiated its 'parabolic phase'.
As Ramsey notes above, this is also the time to which we can trace back the hey-day of the issuance of ever more complex sliced-and-diced CDO's (collateralized debt obligations) and related structured finance products, which greatly facilitated the marketing of sub-prime mortgage debt to investors bound by strict mandates that allowed them to buy only the most highly rated securities. Greed (the famous 'hunt for yield'), an overly accommodative central bank, Wall Street's inventiveness and the irresponsible connivance of the credit rating agencies combined to create the ingredients for one of the biggest financial and economic disasters ever.
However, one must not lose sight of the fact that long before the bubble 'took off', its foundations had been laid by the misuse of the GSE's [government sponsored enterprises, ed.] as 'reliquification conduits' during previous financial crises, such as the Asian/Russian crisis of 1997/1998. Almost no-one remembers it today, but a small handful of market observers predicted the eventual failure of Fannie Mae and Freddie Mac already back in late 1990's (!). It was blindingly obvious even at that early stage that one day the extreme leverage of these institutions would be their undoing and that the 'implicit' treasury guarantee would become an 'explicit' one.
The late 1990's/early 2000d's were also the time when the Fed first loosened its collateral rules and began to accept agency securities in its open market operations. For this reason alone it was obvious that tax payers would eventually be on the hook, no matter how many times the US treasury department insisted that there was 'no government guarantee' for GSE debt.
People should also not forget the role of politicians who were constantly bribed by the GSE's with campaign contributions in order to steer regulation in a direction that undermined free competition, fostered the growth of the bubble and was 'bonus-friendly' for the CEO's of these institutions. Under cover of 'providing affordable housing' to 'underprivileged classes', politicians and the GSE's ensured that the bubble attained ever greater heights of absurdity.
In the end many jokingly remarked that all that was required from a borrower to get approval for a gigantic mortgage loan was the ability to 'fog a mirror'. Reality soon overtook satire however, as even recently deceased people began to receive approvals for mortgages in mid six-figure amounts in their mail – without ever having asked for them while they were still alive. In fact, even being dead for 19 years and residing in Jamaica didn't necessarily keep one from being approved for a mortgage exceeding $500,000. We wonder who owns the 'senior CMO tranche' today that contains that particular mortgage.
No wonder people aren't so eager to agree to a settlement with the banks that would cost the banks a tiny fraction of what they were able to funnel to themselves over the past few years as a result of the Fed's ongoing war on savers, while precluding any future claims against them.
As an aside to all this, S&P continues to bless sub-prime mortgage products with AAA ratings, as Bloomberg reports – a rating it does not even bestow on the US government anymore.
“Standard & Poor’s is giving a higher rating to securities backed by subprime home loans, the same type of investments that led to the worst financial crisis since the Great Depression, than it assigns the U.S. government.
S&P is poised to provide AAA grades to 59 percent of Springleaf Mortgage Loan Trust 2011-1, a set of bonds tied to $497 million lent to homeowners with below-average credit scores and almost no equity in their properties. New York-based S&P stripped the U.S. of its top rank on Aug. 5, saying Washington politics were making the country less creditworthy.
Treasuries gained about 1.95 percent and U.S. borrowing costs have fallen to record lows as investors repudiated the downgrade, according to Bank of America Merrill Lynch indexes. S&P has awarded AAAs to more than $36 billion of securities in the U.S. this year that were created by bankers who continue to gather thousands of loans, bundle them into bonds of varying risk and pay ratings firms a fee to assign credit rankings.
“Everybody has been led to believe over the years that AAA means AAA means AAA across the board,” Gregory W. Smith, the general counsel for the $41 billion Public Employees’ Retirement Association of Colorado, said in a telephone interview on Aug. 24. “Anybody that didn’t learn in the 2008 crisis that doesn’t apply should find another line of work.”
Money managers are lending to the government at rates that, in some cases, are about a third of what they demand to hold top-rated mortgage notes, four months after Congressional investigators said S&P helped spur the longest economic contraction since the 1930s by assigning inflated grades to the bonds from 2005 through 2008.
More than 14,000 securitized bonds in the U.S. are rated AAA by S&P, backed by everything from houses and malls to auto- dealer loans and farm-equipment leases, according to data compiled by Bloomberg.”
As we often say on such occasions, you couldn't make this up.
Watch for an update on the euro area in these pages after the close of trading on Thursday. From a parliamentary commission in Greece lamenting that government's fiscal situation has considerably worsened instead of getting better, to Italy eagerly abandoning the last vestiges of 'austerity' in the face of the now slightly lower bond yields it enjoys following the ECB's intervention, the euro area just keeps being a fount of ever more bizarre news flow. In addition to the usual mixture of comedy and tragedy we also have a few data points well worth considering, especially in the context of the ongoing banking system crisis in euro-land. Nothing is resolved, so we expect major turbulence to return with a vengeance in the fall.
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