If Banks MUST keep their CDSs here's a way to remove the risk of another housing bubble

[Bill USA]

Amend Dodd-Frank law governing trading of CDSs on any home mortgage - such that - if the originator of the mortgage wants to securitize (aka: "Flip&quot the mortgage he MUST first sell a CDS on that mortgage to the homeowner - the individual paying on the mortgage. That way, if the mortgage goes into default - the mortgage originator has to pay off on the CDS - to the home-owner.

That way if Wall Street banks want to package mortgages in Collaterized Debt Obligations and sell CDSs on them, let them! At least the homeowner is protected from the mortgage originator writing a irrationally high risk mortgage. The mortgage originator isn't going to write a mortgage he feels he might have to pay off on (through the CDS) if it goes into default. This is a way to stop the writing of bad (irrationally high risk) mortgages - by predatory lenders (who wrote questionable mortgages just to flip them) - right from the start.


Banks Face New Checks on Derivatives Trading

In one victory for the derivatives industry, regulators agreed to apply the swap-dealer designation only to firms that arrange more than $8 billion worth of swaps contracts annually, up significantly from an initial proposal of $100 million. The plan could excuse some energy companies and large regional banks from registering.

Even so, the rule still captured the biggest banks in the world, requiring them to register as swap dealers by Dec. 31 of last year. The designation requires that banks, among other things, adopt internal risk management controls, bolster disclosures to trading partners and meet certain record-keeping requirements.

The banks must also turn over in real-time the data from their trading book. The disclosures, posted on the Web site of the Depository Trust and Clearing Corporation, a data warehouse, include the volume, time and price of each derivatives trade. The trades involve interest rate swaps and credit indexes, including the index where JPMorgan Chase suffered its recent multibillion-dollar trading loss.

The spreadsheet, regulators say, presents the public with its first window into the swaps market. While the public is blocked from viewing the identity of the trader, regulators have access to that information.
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[truedelphi]

1. That would be wonderful wonderful wonderful.

Not holding my breath.

And I really believe that where the bubble happens to be right now is in student loan monies. Every other commercial on Prime Time TV (and any other time TV, for that matter) is how you can go to Cyber Tech University, for a mere $ 22,000 a year. No more commuting, just sign up. A college "specialist" is waiting to take you r application. If you can't afford it - why, there is "free money," to pay the hefty tuition just for your asking.

I really think that the Big Time Banking fraudsters are gambling on the student loans monies the way they used to gamble on the sub prime mortgages.

[Bill USA]

2. you've got that right. The blizzard of such commercials shows there's money to be made and

like the predatory lenders, many of these "educational institutions" don't give a damn if they are providing anything of value to the students. I think these kinds of major Con-jobs should be made capitol crimes.

[1StrongBlackMan]

26. And such commercials at the other end ...

"Hey Graduates of Cyber-Tech U ... Got your unaccredited mega-Computer Techie certificate, paid for with loans? Can't pay them back? We can help you! (555) ASC-AM02."

[truedelphi]

43. A thinking person can only imagine the "help"

Those companies really offer to the debtor.

[unblock]

3. does the dodd-frank 5% risk retention rule address your concern?

or are you looking for something larger than 5%? or something to address credit default swaps in particular?

[Bill USA]

4. 5% is a joke. My idea would end th predatory lender scam of writing bad mortgages only to flip them

[Chan790]

5. No practice but the total cessation of mortgage lending will do that.

Banks write mortgages with the best terms for them possible with the intention of flipping them for a simple reason that cannot be fixed...

because they want to sell mortgages because it's profitable while they have no desire to hold the debt because they don't want to have their deposit assets tied up that way. If it was a breakeven proposition, they'd still do it...though they'd probably look for another means to monetize them first.

[Bill USA]

8. banks wrote mortgages and kept them on their books - for decades before securitization came along

[FBaggins]

12. That's what caused the depression.

Retail banks can't hold a 30-year asset unless it's callable - otherwise they have no liquidity.

So when the banks needed cash at the start of the Depression, they called in those loans (which meant that you paid off your mortgage right away or went into default and lost your home). People who had never missed a payment were suddenly forced to come up with a bunch of cash. Nobody was lending... so IF they had the money in savings (more often back then), they went to withdraw it from their bank... which caused THAT bank to have a liquidity crisis and call in THEIR loans.

[Bill USA]

16. securitization of mortgages didn't exist before 1970 -

http://financialservices.house.gov/media/pdf/110503cc.pdf

Statement of Cameron L. Cowan
Partner Orrick, Herrington, and Sutcliffe, LLP
On behalf of the American Securitization Forum
Before the Subcommittee on Housing and Community Opportunity
Subcommittee on Financial Institutions and Consumer Credit
United States House of Representatives


[FONT SIZE="+1"]"Securitization is the creation and issuance of debt securities, or bonds, whose payments of principal and interest derive from cash flows generated by separate pools of assets. It has grown from a non-existent industry in 1970..."[/FONT]

[FBaggins]

20. That's not relevant to your claim.

Your statement was that banks kept mortgages on their books prior to these securities coming along. That's simply incorrect. They sold them to Fannie/Freddie/etc. They just didn't package them into MBSs and sell them into the marketplace themselves.

[Bill USA]

34. Fannie and Freddie started buying mortgages in the 1980's. Securitization of mortgages was going

along okay until Morgan Stanley invented the Credit Default Swap in 1997. Then, Phil Gramm, at the behest (not unremunerated) of Wall Street banks, made trading in CDS by banks unregulated (he slipped the Commodities Futures Modernization Act in as a rider to the Omnibus Spending Bill 2000 in the waning days of the last Clinton administration. Nobody even knew they were voting for the CFMA as they voted to fund the Government for the next year.). The CFMA made trading in CDSs legal AND UNREGULATED. CDSs made CDO tranches of high risk/return much more marketable as the CDSs would insure the investing fund that if his tranche went south the CDS he was holding would pay off and he would not lose his money! (that's the way it was supposed to work).

This made the securitization of high return (subprime) mortgages a hot market to be in (higher return with 'no' risk of loss of your investment, oh boy!). Wall street wanted all the subprime mortgages predatory lenders could flip. Wall Street banks leaned on credit rating agencies (S&P, Moody's) to give their CDOs ridiculous ratings to make them an easier sell (at better prices) to investors. Investors saw a chance to make higher returns without any additional risk - because they also bought a CDS to cover their investment in the high risk CDO. It was great fun. The party really got going about 2004 or so. It lasted about 4 more yrs and then it all blew up.


... but mortgages were written before securitization came along. But securitization is not a bad thing in itself. When the mortgage originator is able to off-load all the risk of a given mortgage, that incentivizes bad behavior. CDSs also makes selling high risk CDOs more marketable and this all needs to be regulated but especially the mortgage originator should not be allowed to off-load all the risk of a given mortgage.

[FBaggins]

39. I don't know where you got that idea... it's simply wrong.

They were created during the depression for the explicit purpose of buying mortgages.

[Bill USA]

46. I was thinking of "mortgage securitization" which began in the 1970's by Fannie Mae

Even then, securitization didn't really get going in terms of significant volume, really until the 1980's. When CDSs were invented in 1997 they were used to help sell CDOs with subprime mortgages and then (after the Commodities Futures Modernization Act was passed in 2000 making trading in CDSs by banks legal and unregulated) securitization really took off.

YOu are right Fannie Mae began back in 1938 (Freddie Mac began business with passage of the Emergency Home Finance Act of 1970). my point was that Securitiztion itself worked okay since the 80's (when significant volumes were being sold). It was when the unregulated use of CDSs 'lit a fire under' the marketing of Subprime CDOs that the problems emerged. Banks found this a very lucrative trade and didn't want rating agencies ruining the party - so the 'made sure' they got the proper unrealistic credit ratings of their moneymaking subprime CDOs from S&P and Moody's.


http://en.wikipedia.org/wiki/Mortgage-backed_security

Ginnie Mae guaranteed the first mortgage pass-through security of an approved lender in 1968.[16] In 1971, Freddie Mac issued its first mortgage pass-through, called a participation certificate, composed primarily of private mortgages.[16] In 1981, Fannie Mae issued its first mortgage pass-through, called a mortgage-backed security.[17] In 1983, Freddie Mac issued the first collateralized mortgage obligation.[18]
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[Bill USA]

17. all banks hold only a fraction of their total loaned $s in liquid assets. Any bank suffering a "run"

.. without some entity like the Fed Reserve to provide them with extra liquidity would not be able to pay all their account holders if they all came in demanding to withdraw all their money.


http://en.wikipedia.org/wiki/Causes_of_the_Great_Depression

During the post-Civil War period and continuing into the early 20th century, the US and Europe had generally adopted a government-mandated gold standard. The U.S. economy during this period went through a number of cycles of boom and bust. The depressions often seemed to be set off by bank panics, the most significant occurring in 1873, 1893, 1901, 1907, and 1920.[5] Before the 1913 establishment of the Federal Reserve, the banking system had dealt with these crises in the U.S. (such as in the Panic of 1907) by suspending the convertibility of deposits into currency. [font size="3"]Starting in 1893, there were growing efforts by financial institutions and business men to intervene during these crises, providing liquidity to banks that were suffering runs. During the banking panic of 1907, an ad-hoc coalition assembled by J. P. Morgan successfully intervened in this way, thereby cutting off the panic, which was likely the reason why the depression that would normally have followed a banking panic did not happen this time. A call by some for a government version of this solution resulted in the establishment of the Federal Reserve[/font].[6]

But in 1928–32, the Federal Reserve did not act to provide liquidity to banks suffering runs. In fact, its policy contributed to the banking crisis by permitting a sudden contraction of the money supply. During the Roaring Twenties, the central bank had set as its primary goal "price stability", in part because the governor of the New York Federal Reserve, Benjamin Strong, was a disciple of Irving Fisher, a tremendously popular economist who popularized stable prices as a monetary goal. It had kept the number of dollars at such an amount that prices of goods in society appeared stable. In 1928, Strong died, and with his death this policy ended, to be replaced with a real bills doctrine requiring that all currency or securities have material goods backing them. This policy permitted the US money supply to fall by over a third from 1929 to 1933.[7]

When this money shortage caused runs on banks, the Fed maintained its true bills policy, refusing to lend money to the banks in the way that had cut short the 1907 panic, instead allowing each to suffer a catastrophic run and fail entirely. This policy resulted in a series of bank failures in which one-third of all banks vanished.[8] According to Ben Bernanke, the subsequent credit crunches led to waves of bankruptcies.[9] Friedman said that if a policy similar to 1907 had been followed during the banking panic at the end of 1930, perhaps this would have stopped the vicious circle of the forced liquidation of assets at depressed prices. Consequently, the banking panics of 1931, 1932, and 1933 might not have happened, just as suspension of convertibility in 1893 and 1907 had quickly ended the liquidity crises at the time.”[10]

[FBaggins]

21. Also irrelevant... There are degrees of liquidity.

A revolving line of credit with a variable rate can be repriced as market rates change. A five-year loan can be balanced against a five-year CD and remove market risk from the equation. Banks go to great lengths to manage assets and liabilities so that they have roughly comparable sums maturing at any given time.

That 5-year car loan may not be "liquid" in terms of surviving a "run", but that's not the point. It isn't excessively risky for the bank to make that 5-year car loan at 5%... because even if rates reprise upward quickly, there's a 5-year CD at 1.5% that's funding that loan. I remember when rates were falling in the late 80s and there were people who had five-year CDs paying double-digit interest rates... even though the banks were lending money at 7%. It would seem as though they were losing their shirts... but those CDs had been balanced years earlier against comparable-term assets at 14%. The net interest margin (where banks used to make their living) wasn't badly damaged as long as the A/L management was done properly.

Of course that's overly simplified, but the point is that they can't lock up hundreds of thousands of dollars on a potentially 30-year asset - because they can't balance it against a corresponding liability. Banks wouldn't do that... unless (like a long-term CD that you can still redeem if needed) they can "call" the loan back in if they need to. That's why the government created Fannie/Ginnie/Freddie.

Banks that made mortgages prior to the depression were allows to "call" them even if the customer never missed a payment. When those runs started (and the government wouldn't lend them liquidity), they called in those loans. Some people could pay them off (it was a known risk so fewer people borrowed unless they could afford to pay it off), but even those people were just withdrawing money from other banks (exacerbating the cycle). Those who couldn't pay lost their homes... which made things even worse as it of course caused home values to fall... and the banks couldn't sell the homes nearly fast enough to recoup the liquidity that they needed.

[Bill USA]

29. of course now the Federal Reserve provides liquidity to banks needing it. The fact remains banks

can get along without CDSs... as they did before CDSs were invented.

[FBaggins]

30. Why change the subject?

That doesn't have anything to do with your errant claim that banks held mortgages up until they started securitizing.

The fact remains banks can get along without CDSs... as they did before CDSs were invented.

It "remains" because it wasn't challenged. Of course they can. What's missing is an understanding of how they were used vs. how they should be used... in exactly the same way that many people misuderstand what other derivates do.

If a company uses derivatives to hedge a position that they actually hold... then it decreases overall risk. If they use them as bets (that is... as uncovered positions), then they increase risk (and should not be allowed with depositor funds).

[Bill USA]

31. the point is the large banks aren't interested in CDSs used properly as hedges of risk. What really

interests them is using CDSs improperly - to magnify profits by taking on more risk which CDSs magically make disappear (until AIG collapses).

This is precisely the thinking on the part of banks which created the Credit Catastrophe - 2008.

If we could count on bankers to use CDSs only as hedges of risk there would be nothing to worry about. But bankers are people. And it is a common weakness of humans to think they can 'pull off' what others before them always thought they could pull off - assume lots of risk - make your score - and then get out. But people never 'get out'. They want to hit the 'table' or the market for one more 'score'. Ergo, the Credit Catastrophe of 2008. I'm not saying bankers are different. I'm saying they are people, a portion of whom always think they can gamble - take on excessive risk - and win - time and time again. This is a human weakness and that's why we need regulations and close monitoring of what is going on.

Change the subject - what I want to do is make the possibility of using CDOs (of high risk - read: subprime - mortgages) untenable. If you remove the ability to 'play with' subprime, high risk mortgages by reckless securitizations of them (which using CDSs makes possible - "Not to worry, if the CDO tranche I'm selling you goes south - this CDS will save your ass. Ya see - more return without the risk! What a deal!"

[font size="3"]
How Wall Street Defanged Dodd-Frank[/font]
(emphases my own)
http://www.thenation.com/article/174113/how-wall-street-defanged-dodd-frank?page=full

Battalions of regulatory lawyers burrowed deep in the federal bureaucracy to foil reform.



~~
~~

[font size="3"]Perhaps no part of Dodd-Frank matters more than the CFTC’s battle to implement derivatives reform. Certainly the big banks wouldn’t argue that point: no product peddled by Wall Street has proved as lucrative in recent years, especially for the country’s most elite firms. Just five banks—Goldman Sachs, JPMorgan Chase, Citigroup, Morgan Stanley and Bank of America—account for more than a 95 percent share of a derivatives market that has been generating an estimated $40 billion to $50 billion in annual revenues.[/font] Because derivatives have been traded on dark (i.e., unregulated) markets, this “oligarchy” of five, says Darrell Duffie, a finance professor at Stanford’s Graduate School of Business and the author of How Big Banks Fail and What to Do About It, has been able to charge exorbitant rates to the wide range of businesses and government entities that buy them—profit margins that are sure to plummet if Dodd-Frank is fully implemented, Duffie says. That alone would justify the huge sums spent on lobbying to gut Dodd-Frank, a reflection of the banks’ unflinching resolve to protect the billions of dollars in derivatives profits they book every year. “If you look at the energy and ferocity and the dollars the financial sector put on the table, it was overwhelmingly directed at derivatives,” says Michael Barr, the former Treasury official.

This is why derivatives—and by extension, the CFTC—should matter to the rest of us as well, at least if we want to reduce the odds that the banks will again blow up the global economy anytime soon. It was derivatives, after all—all those credit default swaps, collateralized debt obligations and other exotic financial instruments that most of us would learn about in newspaper infographics offered only after the fact—that were the main culprit in the collapse of insurance giant AIG. They were also the main problem in the failures of Lehman Brothers and Bear Stearns, and nearly took down the other big banks as well.

Price manipulations of basic commodities such as oil and grains through derivatives are another target of Dodd-Frank, which instructs the CTFC to create “position limits”—caps on the portion of a market that financial speculators can own. The need for this check on financial speculators has never been clearer than in recent years, given the wild fluctuations in the price of oil in 2008, when a barrel of crude rose to $145 before whipsawing back to $37 in early 2009, and a spike in the price of wheat and other basic grains that caused rioting around the world.

The push to regulate a new breed of ever more complex derivatives goes back to the 1990s. The catalyst was the central role these instruments played in the financial collapse of Orange County, California, which in 1994 became the largest municipal entity ever to declare bankruptcy. Those in favor of derivatives reform would find their champion in Brooksley Born, who headed the CFTC under Bill Clinton. Think of most derivatives as a bet on the price of something going up or down—an interest rate, say, or mortgage defaults. Her agency was already in the business of regulating the futures markets for commodities such as corn and soybeans, Born argued, so why not add this new breed of financial derivatives to the CFTC’s portfolio? But this was in the Clinton era, when Democrats worked overtime to win the affections of Wall Street, and Wall Street knew that transparency would only spoil a good thing. Clinton’s top economic advisers, including Treasury Secretary Robert Rubin and Lawrence Summers, the deputy who would take his place in 1999, overruled Born and worked with Congress to pass what became the Commodity Futures Modernization Act of 2000, which had the effect of deregulating much of the derivatives market along with basic commodities like oil. Just eight years lat
(more)

[FBaggins]

42. Sorry... you remain confused in this whole thing

Yes... CDSs were initially created as a hedge for risk.

But they weren't purchased by banks to protect bad mortgages that they were making. They were purchased by the investors that held mortgage backed securities. Yes... many of those were also "banks", but not the bank that was making the original loan.

Residential-Mortgage-backed securities were really just a small piece of the CDS market and weren't a big part of the housing bubble. Your premise assumes things that just aren't true.

CDSs are going away (the market has already declined by at least half)... and that doesn't have a thing to do with a bank's willingness to make a loan (good or bad). The things that will help avoid banks making intentionally bad loans are better regulation and transparency... things that are well along already.

[Bill USA]

49. Please note this quote from the OP......

[font size="3"].."if Wall Street banks want to package mortgages in Collaterized Debt Obligations and sell CDSs on them, let them!"

note the word: "SELL" in the phraze: "sell CDSs on them"

Does this not convey that I am saying that the Banks did ... and still want to .... SELL Credit Default Swaps to investors - in Collaterized Debt Obligations ??????

.. is this language not clear???

..you say: "Residential-Mortgage-backed securities were really just a small piece of the CDS market and weren't a big part of the housing bubble."

Actually, it doesn't matter to me what part of the Credit Crash residential houseing was - that's the part I care about, because that's the part that relates to those with houses that crashed in value. I'd like to see that doesn't happen again.

I suppose you are referring to the Synthetic CDOs consisting of CDSs against other CDOs - of Mortgage Backed Securities. This should be outlawed obviously because there is no economic purpose for it. It's just people betting on the viability of other CDOs. IF it was up to me, these derivatives would be illegal. But my OP is focused on protecting the home owners (and commercial property owners too. businesses should not be ripped off either.) Synthetic CDos is another, disgusting topic, worthy of its own thread.


But of course, if you have sensible mortgages packaged into viable CDOs - would there be so much gambling on those securities? Gambling occurs where there is a difference of opinion - backed up with money - on a given outcome. With CDOs made up of rational risk mortgages, would there be that many synthetic CDOs written on CDOs of that quality, with a better reckoning of the risk of default on them?

[Bill USA]

36. "change the subject"? CDSs were originally created as hedges to risk..

as you state in 30.--

"If a company uses derivatives to hedge a position that they actually hold... then it decreases overall risk."

which is why I wrote comment 29: "now the Federal Reserve provides liquidity to banks needing it" ... thus with the Fed they don't have to have CDSs to deal with risk.

So why do they want them (CDSs)? ... to take on more risk, in the never-ending hope of making a killing - by making high returns and 'beating' the risk with CDSs.

..

[FBaggins]

40. And that's not the subject on this piece of the debate.

It was your errant claim that banks wrote mortgages and kept them on the books for decades before securitization came along. You continue this error with your recent claim that fannie didn't start buying mortgages until the 80s.

The fact is that mortgages changes fundamentally with the great depression... from callable loans to up-to-30-year loans that could not be called unless the borrower defaulted. From that point on, banks were selling the vast bulk of their mortgages. There has been no period where banks were writing what we now think of mortgages... but weren't selling them. Because... as you have been told multiple times, they have no appetite for a 30-year asset that can't be offset by comparable liabilities.

[Bill USA]

48. I am focussed on the securitization of mortgages - and in particular with CDSs used to sell subprime

CDOs. Yes, you are right that Fannie Mae started buying mortgages back in '38. But the securitization of mortgages began in the 1970s - and really more like the 1980s if you are talking about when significant volumes were achieved in securitized mortgages.

As you have pointed out, banks were sellling mortgages to Fannie Mae long before securitization of mortgages began - and in particular before CDSs were used to sell subprime CDOs. So why not just do things as they were for so many years - without the CDSs? - or with the mortgage originator flipping a mortgage selling the first CDS to the homeowner. That way the homeowner can be protected - so far as the equity he has in the property - and let the banks and investors do what they may. ... Of course, my intent here is that with the mortgage originator being liable to pay off the CDS (to the extent of the equity homeowner has in property), if the mortgage goes into default - guess what - the mortgage originator will magically not write bad or unreasonably risky loans (at least he will make an honest effort to NOT write overly risky loans).! If there is money to be made flipping mortgages and he can off-load all the risk - you are asking for trouble.


I am well aware of commercial banks distaste for tieing up money in long term mortgages. But let's not forget - if you are talking about liquidity - that not ALL the 30 yr mortgages held by a bank are 30 yrs 'out'.. They are of various 'maturities', some are 30 ys, some 15 yrs, 10 yrs, 5 yrs ... and less. They are not ALL 30 yrs out. I understand banks wanting to put their depositors money into more profitable investments. That's fine as long as not too much off-loading of risk occurs.

I think securitization is fine, but when you get CDSs involved and the mortgage originator doesn't retain an adequate amount of liability then you can (and therefor - will) get into trouble.


re: Securitization.....

Statement of Cameron L. Cowan
Partner Orrick, Herrington, and Sutcliffe, LLP
On behalf of the American Securitization Forum

Before the Subcommittee on Housing and Community Opportunity Subcommittee
on Financial Institutions and Consumer Credit United States House of Representatives
[hr]

~~
~~
[font size="3"]
Securitization is the creation and issuance of debt securities, or bonds, whose payments of principal and interest derive from cash flows generated by separate pools of assets. It has grown from a non-existent industry in 1970 to $6.6 trillion as of the second quarter of 2003.

~~

Mortgage-Backed Securities

The first mortgage-backed securities arose from the secondary mortgage market in 1970. Investors had traded whole loans, or unsecuritized mortgages, for some time before the Government National Mortgage Association (GNMA), also called Ginnie Mae, guaranteed the first mortgage pass-through securities that pass the principal and interest payments on mortgages through to investors.

~~
~~

Growth in the pass-through market inevitably led to innovations especially as originators sought a broader MBS investor base. In response, Fannie Mae issued the first collateralized mortgage obligations (CMO) in 1983.

[Bill USA]

35. what relevance does your recitation of various term loans have to your cmnt 12 where you said:

[font size="3"]"Retail banks can't hold a 30-year asset unless it's callable - otherwise they have no liquidity. "[/font]

what does talking about the fact that bnks make loans of various periods accomplish when your point was that banks holding 30 yr loans must close if a run occurs because they can't call their all their 30 yr loans.

in 17. I pointed out that the Fed can provide liquidity to a bank in trouble - which should mean to anybody that it is NOT TRUE that - banks have NO OTHER recourse for needed cash than to call in their 30 yr loans. (as you stated above) They have the Federal Reserve.

if that is not relevant to you ... I can't do anything for you.

[FBaggins]

41. There are TWO primary reasons they don't want to hold mortgages.

Liquidity and asset/liability management.

First of all... liquidity is important - and that isn't changed by your claim that the fed can provide liquidity. Banks have had access to the discount window for decades... but never wanted to use it because (is used in any significant quantity) it showed that the bank was in trouble. That's the same reason that a number of good banks that never got involved in the shenanigans that crumbled so many other... still were forced to take the TARP bailout. Because the bad banks knew that if they took it and others didn't... everyone would know which banks were about to go under... and that would be the death of them.

They CAN get liquidity from the fed... but that just keeps them from going under. It doesn't keep their stock price from falling to pennies. Note that the key measure of a bank's health in the critical stress testing is their liquidity position and their calculated liquidity in a speculated future downturn.

The second reason is at least as important (and was the subject of #12). No bank can afford to take the risk of loaning money at a fixed rate over a 30-year period... because they can't bring in deposits at a fixed rate for that term. That A/L "bucket" would be unbalanced and they would have an unacceptable interest-rate risk. Can you imagine them making a 30-yr mortgage today at 3.5% only to find that interest rates rise over the next five years and they're paying double that on their CDs?

[Bill USA]

44. the most important factor in banks not getting into trouble is to write mortgages that do not

involve excessive risk. Yes, absolutely banks do NOT want to make a practice of running to the discount window. Better to lend with proper recognition of risk. Re liquidity, fortunately banks do not lend ALL their money out for a terms of 3 decades.

[FBaggins]

45. Close enough.

That's the key to all things banking. They exist to asses and properly price for risk. They can take on greater risk... assuming that the pricing is appropriate for that risk.

Which doesn't really impact the thread any. There's still no connection between whether or not they have to sell a CDS to the borrower and whether or not they are willing to intentionally write a bad mortgage.

[Bill USA]

47. well, except that in the 2004-2008 timeframe the CDS did make it a lot easier to sell subprime CDOs

because .. you know this ...the CDS was supposed to protect the investor's investment in case of default of the CDO (or portion thereof purchased). This did open up the possibility of making beauceou bucks selling securitized mortgages of doubtful creditworthiness (with credit rating agencies cooperation).

BTW, Re Longer term loans - e.g. 30 yrs - let's not forget that not ALL of a banks Long term loans are 30 yrs 'out'. Only a part of that part of their portfolio is 30 yrs old. Some of them are 20 yrs, 10yrs and 5 ys and less. So, again, not ALL their typical 30 yr mortgages are 30 yrs 'out'.

[Chan790]

13. Right...and now they're no longer willing to.

How do I know this? Because I worked for a major US bank as a licensed banker for the worst 2 years of my life.

We don't want to hold mortgages. Full Stop. That's the whole thing.

Securitization is secondary...it's a "solution" that justifies what you were already going to do. If you don't want to hold mortgages...you go about finding a way to divest the mortgages.

Since you can find a way to monetize them too, Hallelujah!

[Bill USA]

18. Mortgage debt outstanding - Federal Reserve - Board of Governors report

http://www.federalreserve.gov/econresdata/releases/mortoutstand/current.htm

[Chan790]

19. I'm not sure I see your point.

The fact that the Federal Reserve tracks Mortgage Debt Outstanding in no way mitigates the fact that BoA, Chase, Citi, SunTrust, Wells Fargo, et al. have no real desire to hold mortgages in any great quantity. They just want to sell mortgages...they make their money upfront on mortgage fees, not over the term of the loan from the interest being paid on the debt.

We bundle them and sell them because it frees up assets to generate revenues elsewhere...Gramm-Leach-Bliley isn't helping certainly. It gave free-rein to invest assets on deposit and boost the bottom-line...those vehicles are more profitable than holding mortgages and encouraged us to hold even less in mortgage debt relative to what we bundle and dump into investment markets.

All of which brings us back around to where we started...the only way you're going to get banks to stop selling their mortgages in the form of derivatives and securities is to forbid them from doing so, which would strongly encourage them to stop lending. They no longer need to make personal loans, business loans or mortgages to generate revenues; they have far more profitable things they can do with funds on deposit that also provide greater liquidity and allows them to pay lower interest rates to depositors since the bank is no longer locked into long-term lending agreements requiring long-term positions and deposits on hand.

[Bill USA]

32. not trying to stop them from securitizing. I just want to make sure that at the beginning -

the mortgage securitized is worth investing in - as a security (CDO).

[Bill USA]

37. LOL. you said (13) "and now they're no longer willing to." and ....

"We don't want to hold mortgages. Full Stop. That's the whole thing."

in 18. I gave you a link to a Fed report which shows "major Financial Institutions" holding over $4 Trillion in mortgage debt.

[font size="3"]If you really "can't see my point" Anyone would have to say that you are exhibiting a classic case of ...[/font]

..... [font size="4"]hysterical blindness[/font].

[unblock]

7. oh, dodd-frank is a joke but your idea of paying the homeowner to default isn't?

[Bill USA]

10. CDS would be paid only tothe extent of the equity the homeowner has in the home. see link:

http://www.democraticunderground.com/?com=view_post&forum=1016&pid=94741

[FBaggins]

6. Could you clarify?

It sure reads as if a defaulting borrower would benefit from that default.

Why would anyone pay a mortgage payment again?

[Bill USA]

9. I knew someone would ask this. First of all he has to pay for the CDS - which costs money..

Nobody would buy a house just to default on the mortgage - ruins your credit for one thing. Plus, it wouldn't be a profitable venture when you consider the cost of buying the CDS from the mortgage originator. The CDS would be written so that the banker pays off to the extent of the equity the homeowner has in the home NOT the market value. The idea is, it would basically stop the writing on bad (high risk of going into default) mortgages - just to flip them. No banker is going to write a bad mortgage if he knows he's going to have to pay off on the CDS when it fails.

[FBaggins]

11. You're kidding... right?

Nobody would buy a house to default on the mortgage because it would ruin his credit?

For a multi-hundred-thousand-dollar profit... I'd bet there are no end to the number of people who would be willing to pay for the default swap and dump the loan. Just look at the number of people who are willing to walk away from their mortgage for a tiny fraction of that amount (and still take the credit score hit).

Plus, it wouldn't be a profitable venture when you consider the cost of buying the CDS from the mortgage originator.

Sorry... that's not even close to true. You're getting a free house for a premium that's a tiny fraction of the home price (plus a hit on your credit score that you'll never care about... because you don't need to apply for credit - having no mortgage payment)

The idea is, it would basically stop the writing on bad (high risk of going into default) mortgages - just to flip them.

That was pretty effectively stopped years ago when so many of them went out of business because of it... along with clawbacks of bonuses and fees on such fraudulent sales.

[Bill USA]

14. please note the quote from the comment 9.

[font size="4"]"The CDS would be written so that the banker pays off to the extent of the equity the homeowner has in the home NOT the market value."[/font]

[FBaggins]

22. That still doesn't leave you with a workable solution.

First of all... it wouldn't deter the bank from making the bad loan, because if that swap fee supported the amount being covered (think of it as insurance... though it's a little different), then the bank could just take that fee and buy their own insurance for the same coverage. Still no risk that they'll have to pay more than they otherwise would (and thus no deterent to bad behavior).

Also... it doesn't really change anything if it's limited to the amount of the homeowner's equity. That belongs to the homeowner anyway. If they have a 150k mortgage on a 200k home and default on the loan... they still get back whatever is left over after the foreclosed home is sold. The vast majority of bad-debt foreclosures in the recent crash didn't have any equity in the home. They had put down little-to-nothing to buy the home (in some cases, negative equity on purchase) and the market declines made the situation worse.

Now you're left with a new way for the bank to make a profit on the deal... since they're getting a fee on a CDS that they never have to pay out.

[Bill USA]

24. "make a profit on the deal"? .. how much after paying more for his insurance on a riskier loan. NOt

a great, or particularly remunerative, way to run a bank. NOt a likely business plan or one that would attract a lot of adherents.

[Bill USA]

15. "pretty effectively stopped."?? LOL! It won't happen again?: Subprime Lending is Back -- link

Subprime lending execs back in business five years after crash

Five years after the financial crisis crested with the bankruptcy of Lehman Brothers Holdings Inc., top executives from the biggest subprime lenders are back in the game. Many are developing new loans that target borrowers with low credit scores and small down payments, pushing the limits of tighter lending standards that have prevailed since the crisis.

Some experts fear they won’t know where to stop.

The Center for Public Integrity in 2009 identified the top 25 lenders by subprime loan production from 2005 through 2007. Today, senior executives from all 25 of those companies or companies that they swallowed up before the crash are back in the mortgage business. Most of these newer “non-bank” lenders are making or collecting on loans that may be too risky to qualify for backing by the U.S. government. As the industry regains its footing, these specialty lenders represent a small but growing portion of the market.

The role of big subprime lenders in teeing up the financial crisis is well documented.

Lawsuits by federal regulators and shareholders have surfaced tales of predatory lending, abusive collection practices and document fraud. A commission charged by Congress to look at the roots of the crisis said lenders “made loans that they knew borrowers could not afford and that could cause massive losses to investors in mortgage securities.”
(more)

[FONT SIZE="+1"] "pretty effectively stopped"?? YOU'RE KIDDING ... RIGHT??[/FONT]

[FBaggins]

23. Sorry... you're still confused.

The fact that some institutions are making subprime loans isn't evidence that "it's happening again".

Subprime loans aren't the problem. If they're priced appropriately for the risk involved (for both borrower and investor), then they present no systemic risk. What contributed to the collapse was that the subprime loans were priced too low and were packaged and sold (and even rated by S&P etc) as better-quality paper.

You should look up the recent Truth-in-Lending regulation modifications on "qualified mortgages" and "ability to repay". There's quite a bit of additional protection in there keeping the predatory lenders from repeating their misdeeds. Making a subprime loan does not now mean that they have the option of "flipping" them for a profit leaving an investor who has overpaid for an asset that was riskier than advertised.

[Bill USA]

25. thanks for the little history lesson on the Financial crisis. I'm 'not without' knowledge of the

the causes of the Crisis. IF S&P and Moody' had been doing their job the Crash would likely not happened as all the mortgages would have been properly valued witha realistic risk assessment at the base. But you still needed to stop predatory lenders from making irrationally risky loans.

Dodd - Frank has tightened up on loan standards for "Qualified Mortgages" but still allows financialization of mortgages with a whole 5% retention of the risk by the mortgage originator flipping the loan.

Here's another article on the return of subprime lending that "isn't happening" http://www.bloomberg.com/news/2014-01-29/subprime-called-safer-makes-comeback-as-nonprime-mortgages.html

BTW: 'happening again" does not mean we are back in 2007-2008 as far as loaned dollar amounts. But things have to start somewhere. Saying it isn't happening is nonsense when subprime loans and securitization is starting again. Yes, if loans a properly valued that will make a big differerence - so long as they are properly valued as to risk when securitized. But, I believe they said nothing was wrong (with the way things were being operated) before. There is a need for redundancy where big profits can be had, or are perceived as being possible. Rules have a way of being out-maneuvered.

Are these article written in invisible ink? - but I can see them?

[MFrohike]

27. How would this help?

If the originator goes under, which occurred a lot in the last decade, what good is that CDS to the homeowner? Even if there's the a transferable interest in the CDS, so that anyone could buy/sell it and assume the position of the obligor, the homeowner is still exposed to the risk of their poor decisions.

It'd probably be more effective to apply the insurable interest rule to CDS to remove the ridiculous gambling aspect of them.

[Bill USA]

33. if you take away the opportunity to make a fast buck (by flipping a bad mortgage) - this has a way

of making it much less likely that untenable mortgages (written only so they can be flipped) are written - and flipped.


.. the very fact that the banker types (above) are so vigorously arguing this wouldn't work - provides confirmation that it would. If they bankers are arguing against it, you are probably onto a good thing.

[MFrohike]

38. I'm a bit confused

What does a CDS have to do with a ban on selling loans? Those are two separate and pretty unrelated issues.

There's nothing wrong really with selling mortgages for securitization. The GSEs bought and securitized them for decades without a problem. The primary issues were really the sheer volume of money coming from institutional investors that made corruption in this market attractive and the complete, unquestioning willingness of the financial sector to get in and loot as fast as possible. While I suspect that less liquid capital markets is probably desirable, I don't know if this is the way to do it.

[jmowreader]

28. Better idea: national usury rate

South Dakota had a decent idea when it eliminated its usury rate: the usury rate was lower than the cost of money, so no one was lending. Problem is, removing the rate allowed the banks to take risks no sane person would in the pursuit of the almighty buck.

Set the rate as follows: prime rate mortgages LIBOR plus 100 points, subprime plus 250, short term ("car&quot loans plus 300, credit cards plus 500...all those are as of the date the money was borrowed.