Archive for May, 2008
RGE Monitor Event on the US Economy, the Risks of a Systemic Banking Crisis and the Outlook for Financial Intermediaries
Recently RGE Monitor organized a panel discussion in New York that was attended over 150 private and financial sector professionals. In addition to myself five other independent leading experts of the banking and financial intermediaries spoke at this event: Chris Whalen of Institutional Risk Analytics, Josh Rosner of Graham Fisher, Alex Pollock of the American Enterprise Institute, Martin Mayer who is now a guest scholar at Brookings, and Sylvain Raynes of R&R Consulting.
Here is a summary of the views presented in this event…
The Financial Times had a three part (15 minutes) video interview with me last week. You can find this interview on the FT Video site or on YouTube: Part 1 is here Part 2 is here Part 3 is here I discuss the outlook for the US economy, housing and mortgages; the prospects for policy [...]
The RGE Monitor community is expanding and now including a broad range of external collaborators who regularly blog on the RGE Monitor group blogs. I provide below a summary of such contributions that have been posted in the last week until Thursday; more have been published today Friday. If you freely register to read my [...]
It looks increasingly likely that the deal of Bank of America (BAC) buying Countrywide (CFC) may collapse: according to many banking experts once BAC does its due diligence on this deal it will become obvious that Countrywide is effectively bankrupt (negative equity) and saddled with a mountain of litigation and potential liabilities whose size are likely to be extremely large and uncertain. The point that is becoming clear is that BAC will be better off paying the modest break-up fee and walk away from a deal that sucks in every dimension. So if CFC goes bankrupt (its bank subsidiary into a FDIC receivership and the holding company into Chapter 7 liquidation) what will be the systemic implication of the biggest banking bust in US history? Remember that CFC originated almost 20% of all mortgages in the US in the last few years. So the collapse of the biggest mortgage lender will have massive and systemic ripple effects in financial markets.
Let us consider in more detail why Countrywide will go bust and what will be the systemic consequences of such massive bankruptcy…
The most severe financial crisis in decades has not only damaged the balance sheet of financial institutions. It has also severely affected their P&L, i.e. the process of generating revenues and profits.
In the old “originate & hold” model (before securitization) financial institutions made money from the investment income of holding the credit risk of loans and mortgages. But in the brave new world of securitization where you “originate & distribute” the credit risk rather than hold it on balance sheet an increasing fraction of the income of financial institutions was coming from the fees and commissions involved in this securitization process. This food chain of fees on top of fees is now broken: securitization of mortgages, that was running at the annual rate of $1,000 billion in January of 2007, was down 95% to an annual rate of $50 billion by January of 2008. So the process of generating fees and commissions is broken.
Let’s consider in more detail this loan origination and securitization chain for residential mortgages, commercial real estate mortgages and leveraged loans financing LBOs…
Broad Support Among Economists and Experts of the Goal of Providing Mortgage Debt Relief to Distressed Borrowers
My latest note supporting the Frank-Dodd proposal for mortgage debt relief has caused some vituperative reactions among some of the readers of this forum: some accused me of being a Socialist/Marxist (too bad I am a centrist economist who believes in market economies where governments provide the necessary public goods); some suggested I am supporting the Democrats’ plan as a way to seek a job in the next administration (sorry but I have not been involved in any form in any presidential campaign, have no intention of going back to policy in D.C. and I already have two full time jobs being an academic and running an economic consultancy); and so on….
Very few reflected on the substance of this proposal and its strong economic logic that would benefit borrowers, lenders and even the government as the fiscal cost of no action (a systemic banking crisis that would trigger a costly fiscal bailout of banks given deposit insurance) is much higher than the potential modest fiscal cost of this proposal.
The story is simple: many homeowners are underwater (have negative equity in their homes) and/or are unable to service their mortgage payments. Given that mortgages are mostly non-recourse loans millions of such homeowners will walk away from their homes and/or end up into an avoidable foreclosure. Freezing reset of interest rate on mortgages is not enough; when economic agents are unable to pay (insolvent) debt relief is both unavoidable and necessary. A disorderly workout of unsustainable debts make everyone – borrowers, lenders and the government – worse off.
Unfortunately for the critics of this proposal the experts who are supporting it are very broad and ranging from Democrats to Republicans, from folks to the left of the center and others to the right of the center or outright conservative. And the latest news is that Senator Dodd is on the verge of reaching an compromise with Senate Republicans on a slightly modified version of his plan.
Here is below a sample of the views of a number of leading economists and experts who are either directly supporting the Frank-Dodd proposal or supporting its core idea of providing debt relief to those mortgage borrowers who are deserving it via a reduction of the face value of the unsustainable debt payments…
Why the Frank-Dodd Proposal for Resolving the Mortgage Crisis Makes Sense and Why the Threatened Veto of This Legislation by the White House is Reckless
The Barney Frank and Chris Dodd proposal for an effective ‘nationalization’ of a good part of the distressed mortgages is the only sensible proposal that would start to tackle the vicious circle of falling home prices, rising defaults and foreclosures and growing mortgage losses for financial institutions.
It does indeed represents a “nationalization of mortgages as the financial institutions that would be willing to reduce the face value of their mortgages by 15% of the current (lower) market value of the home property and let home owners refinance at this lower debt level at a more affordable mortgage rate (effectively converting variable rate mortgages into fixed rate mortgage) would have the new mortgage balance guaranteed by the FHA (or some other government agency). It is nationalization because it is equivalent to a plan where the government buys these mortgages outright at the same discount of the current market value of the property and then refinances home owners into a mortgage of lower principal value and with a more affordable fixed rate interest rate.
Why is this effective nationalization of mortgages necessary and desirable to start resolving the severe mortgage crisis? Let us discuss in more detail the logic of this proposal…
Following the great success and popularity of the Latin America EconoMonitor and the Europe EconoMonitor RGE Monitor has just launched three new group blogs: the Global Macro EconoMonitor, the Finance & Markets Monitor and the Asia EconoMonitor. Starting today May 9th a large group of academic economists, experts, former and current policymakers and market practitioners [...]
In the last few day I have been at the Asian Development Bank meetings in Madrid and then visited Hong Kong and China. I have presented my view on the severity of the US recession and its potential effects on economic growth in China and Asia. Will this region decouple from the US economic contraction? [...]
In his most recent excellent column Martin Wolf presents his seven principles of financial regulation. In this column Wolf cites a recent paper I wrote where I presented ten fundamental issues in reforming financial regulation and supervision. I am very sympathetic to Wolf’s seven principles that in many ways are consistent with the views that [...]