Some Investors Fault Plan to Aid Home Borrowers

Wall Street Journal ^ | 1 December 2007 | DEBORAH SOLOMON, JAMES R. HAGERTY and LINGLING WEI

[shrinkermd]

As much as $362 billion in U.S. subprime home mortgages with adjustable interest rates are due to reset at potentially higher rates in the coming year, according to Banc of America Securities, risking a wave of defaults by borrowers unable to afford the new monthly payments. That in turn could exacerbate a wave of write-offs by investors who now own those mortgages. Losses related to bad mortgages already have reached the tens of billions of dollars and have led to turmoil in the world's financial markets.

Fears that the problems could accelerate have led the U.S. Treasury and the mortgage industry to develop a plan that would postpone the higher rates for some borrowers.

The success of the plan, details of which are still under discussion, may hang on the many investors in securities backed by mortgages. A coalition of lenders negotiating with the administration includes investor representatives, but the securities are held world-wide and it would be impossible to get everyone's approval. A deal could also spark lawsuits from investors who believe they're being cheated out of their money.

Unlike in years past, when just a bank and a borrower were involved in a mortgage, today's loans have been bundled together, sliced into securities and sold to investors. That has created problems for officials trying to help borrowers, because so many parties are involved.

Alan Fournier, a fund manager at Pennant Capital Management LLC, Chatham, N.J., predicted that the plan being pushed by the Treasury Department will prolong the pain of the housing slump. He said it would merely delay inevitable foreclosures for some people who can't afford their homes, while allowing holders of mortgage-backed securities to put off marking down their assets

[DaGman]

"He said it would merely delay inevitable foreclosures for some people who can't afford their homes, while allowing holders of mortgage-backed securities to put off marking down their assets"

In other words, ease into a crash rather than hit one abruptly.

[palmer]

I'm glad that we are now in agreement that the market sets interest rates.

Me too. Now all we need to agree on is what factors the markets use to set rates:

1. Borrowers demand for money
2. Lenders supply of funds to loan
Also lenders willingness to take risks (short term holding cash at zero versus risk of default), lenders perception of future rates, borrowers perceptions, which leads to lenders and borrowers perceptions of being able to refinance at more favorable rates.

The spike up in spread in groanup's link came from a sudden unwillingess to loan at low rates. At the same time treasuries dropped in anticipation of future Fed rate cuts. Borrowers bid 3 month yields lower being fairly sure that they would refinance at yet lower rates in the future. The reserve banks were able to set lower rates since they could use those loans as collateral for even lower rate short term loans from the Fed. The low rates ripple out from there although unevenly with fluctuations.

[Toddsterpatriot]

Me too.

Excellent!

Now all we need to agree on is what factors the markets use to set rates:

Okay.

1. Borrowers demand for money

Yes.

2. Lenders supply of funds to loan

Yes.

Also lenders willingness to take risks (short term holding cash at zero versus risk of default), lenders perception of future rates, borrowers perceptions, which leads to lenders and borrowers perceptions of being able to refinance at more favorable rates.

You bet.

The spike up in spread in groanup's link came from a sudden unwillingess to loan at low rates.

Or to loan at all.

At the same time treasuries dropped in anticipation of future Fed rate cuts.

I think you meant Treasuries rose.

Borrowers bid 3 month yields lower being fairly sure that they would refinance at yet lower rates in the future.

You mean they stopped borrowing? Or are you talking about Treasury yields?

The low rates ripple out from there although unevenly with fluctuations.

Ripple out where? To longer term loans? Longer term Treasuries? Not sure what you're saying.

[nomorelurker]

self ping to keep up with this mess

[AndyJackson]

Actually, this is an interesting argument. For instance, one prominent economist has a peer reviewed article on How the Federal Reserve controls the money supply.

On the other hand, the Federal Reserve Board itself claims that it the Fed no longer implements changes in monetary policy by controlling the growth rate of the money supply, the monetary aggregates are still monitored by economists as an indicator of future economic activity. The reason stated is "[T]he relation between the growth in money and the growth in nominal GDP, known as ‘velocity,’ 3 can vary, often unpredictably, and this uncertainty can add to difficulties in using monetary aggregates as a guide to policy. Indeed, in the United States and many other countries with advanced financial systems over recent decades, considerable slippage and greater complexity in the relationship between money and GDP have made it more difficult to use monetary aggregates as guides to policy. In addition, the narrow and broader aggregates often give very different signals about the need to adjust policy. Accordingly, monetary aggregates have taken on less importance in policy making over time.”

Unfortunately, it appears that Greenspan, and now Bernanke have foresaken any consideration of just how much the money supply has expanded, as the following chart showing "zero-maturity" money demonstrates.

Greenspan's critics have lambasted him for paying no heed to the asset inflation that arose from this bubble in the money supply. Greenspan's point of view is well summarized in a recent statement: "Greenspan added that during his tenure as Fed chairman from 1987 to 2006 “we didn’t have to be concerned about a weak dollar at the time.” He said central banks should concentrate on alleviating the economic fallout from burst asset bubbles because they had few methods to prevent them and lean against the wind.” “There doesn’t seem to me that there is very much evidence that we can do much about them....irrespective if we could identify them, we could not do much to defuse them."

[AndyJackson]

Lenders supply of funds to loan

Which is established by banking reserves. As everyone here understands, the Federal Reserve does engage in open market operations to expand or contract banking reserves, which directly expands or contracts the amount of money that a bank can lawfully lend.

[Woodman]

I don’t see how they could. The investors bought securitised package that bears interest, there is not guarantee how much it would earn do to prepayments and defaults. So it would be difficult to prove that you should be getting a certain return.
If the investors could sue in this situation, It would mean that if I bought Federated Group, I could sue them for not stocking enough UGG boots for Christmas and not making as much money as they could.

[palmer]

Yes, I meant treasuries rose. Yields went down in anticipation of lower short term yields. The ripple effect I was referring to was the banks that can put up longer term debt as collateral for short term loans from the Fed. The ripple is out to banks and ultimately other borrowers at the lower rates.

But your question brings up another point which is lenders are likely to go longer term under these conditions such as myself. If I were locking in a CD right now, I would try to get a longer term knowing that the Fed will lower. The effect of that is less short term money to lend (i.e. higher rates) which the Fed is trying to offset, and more long term money to lend which lowers long term rates.

[palmer]

The reserve requirements fluctuate a bit which is one mechanism the Fed has as you suggest. But over time the reserve requirements have plummeted from about 25% in the 60’s to about 6% or less today. The consequences are a less effective tool and a contribution to the large increase in overall debt (measured against GDP or other comparisons).

[airborne]

...according to Banc of America Securities...

Any relation to Bank of America, the guys who were handing out credit cards to illegal immigrants carte blanche, with no Social Security numbers or addresses?

[AndyJackson]

But over time the reserve requirements have plummeted from about 25% in the 60’s to about 6% or less today

I am not talking about reserve requirements as in percentage, which the Fed does not change very frequently. I am talking about actual reserves (money on deposit with the Fed or vault cash held in reserve). That is what the Fed actually manages.

[shrinkermd]

Yes, good point. But is it supply and demand or “eagerness” to either supply or demand that is the crucial variable?

[shrinkermd]

Thanks! I understand more than I thought was possible.

[palmer]

Supply and demand and real and controlled to an extent by the Fed. Eagerness to supply or demand is basically from two variables, future economic expectations and future Fed cut expectations. I think the Fed cut expectations are a bit stronger right now due to the subprime (and spreading) meltdown. OTOH, the rest of the economy is decent.

[palmer]

Thanks, I didn’t realize that.

[expat_panama]

"...reserve requirements have plummeted from about 25% in the 60’s to about 6% or less today. The consequences are a less effective tool and a contribution to the large increase in overall debt..."

The fed has a bunch of different reserve requirements (feds reserve req. list here); here's one plot--

 

but they don't have that percentage that you talked about; a link would be a big help in following what you're saying, especially if you're not getting the data from the fed.  Same for when you talked about "the large increase in overall debt", whether you meant private debt, public debt, total (gov't, business, private, financial, etc.) debt...

[AndyJackson]

Current reserve requirements are Federal reserve requirements.

[expat_panama]

Current reserve requirements are Federal reserve requirements.

That's not what we're working with. 

That link says

Type of liability	Requirement
	Percentage of liabilities
$0 to $9.3 million	0
More than $9.3 million to $43.9 million	3
More than $43.9 million	10

and palmer said in post 69 "25% in the 60’s to about 6% or less today".   We need to know where he got his numbers.  If they came from the Fed then there should be a link.  If they were made up by some third party then this won't be anything we need to concern ourselves with.

[expat_panama]

 Federal reserve requirements.

Just above the table is a link to a report with historical data at the end, and apparently reserve requirements haven't been slashed from 25% to 6% in forty years like palmer said, but rather they've been fairly constant around 10% over the entire 88 year time range.

[AndyJackson]

Just to be clear, we are not arguing about the Federal Reserve Data. I posted the reserve requirement because nowhere does 6% appear.