Posted on 02/28/2008 9:42:39 AM PST by AdamSelene235
Banking is one of our economy's most important players, financing the aspirations of everyone from homeowners to private-equity titans. Since last summer, the weakening collateralized debt market has mired the banking industry in one of the stickiest spots it's seen in decades. So when Fed chairman Ben Bernanke was faced with the possibility that panic in the banking industry might turn an ugly problem into an outright catastrophe, he sprung into action in ways we've never seen.
A bit of background Banks must keep specific amounts of cash on hand, called required reserves, to ensure that they can meet customers' withdrawal requirements. Money flows in and out every day at different levels, so when some banks fall behind, those with deeper pockets loan money out and cover the difference. Bank of America (NYSE: BAC) can lend to Washington Mutual (NYSE: WM), JPMorgan (NYSE: JPM) can cover Wachovia (NYSE: WB), and so on, until everyone is squared up at the end of the day. It's like the corporate version of a hippie commune.
But when money gets really tight, and lending between banks falls short, the Fed steps in and acts as a lender of last resort. It loans banks money through what it calls the discount window, albeit at a higher rate than banks charge each other. It really is last resort, because relying on the Fed for money is the equivalent of asking your parents for a loan; it doesn't exactly instill confidence in your financial well-being.
Uncle Ben to the rescue! When banks hit a logjam in December, Bernanke faced quite a bind. Interbank lending slowed as market uncertainly grew, yet banks were reluctant to use the discount window, for fear that the banking industry's health as a whole would be called into question. Their options were running low. Bernanke's solution: the term auction facility.
Term who? The term auction facility, or TAF, isn't too different than the standard discount window. It just allows the Fed to lend predetermined amounts of money, and let the banks bid on the interest rate. Most importantly, it doesn't come with the stigma of the discount window, which threatened further panic.
The Fed wasn't shy about how much money it was willing to front. A recent article in the Financial Times revealed that banks borrowed around $50 billion from the TAF as of mid-February. That's a lot of money, even for big banks. The latest round of loans, earlier this month, totaled $30 billion at 3%.
That 3% number is quite peculiar. It's the same amount as the Federal Funds Rate -- the rate at which banks lend to one another -- but lower than the discount rate the Fed would typically charge.
It's all coming together Waaaait a minute. If the TAF and the Fed Funds rate are identical, why aren't banks just lending to each other, like they always do? The TAF isn't saving banks any money over the interbank market, so why the hassle?
For one thing, the TAF lets banks use their battered CDOs as collateral against loans that would get laughed out of the interbank market. Perhaps banks have cut back lending to each other because they know that their fellow banks' CDO collateral is much like their own: impossible to accurately value.
When participants in the private interbank market refuse to lend to each other because they know the collateral backing those loans is questionable, what does that say about the Fed? Sure, the money is being "loaned," and you can call it "adding liquidity." But when the Fed takes on risk for a price the private market doesn't deem adequate, you're looking at a government bailout.
Shhh! Don't awake the sleeping giant Since last fall, banks like Citigroup (NYSE: C) and Bear Stearns (NYSE: BSC) have announced numerous bailouts from Sovereign Wealth Funds. Just weeks ago, President Bush signed into law a government stimulus package to bolster the economy. While these actions have been heavily publicized, the TAF remains behind the scenes. What gives?
Regardless of how overblown real estate values became, a large part of the breakdown in debt markets stems from investors' lack of confidence. Just as jubilation pushed CDOs to astronomical heights, fear could just as easily push them down to laughably low depths. Emotions often overrule even the most obvious statistics, and Bernanke hardly wants to inject the market with more fear than it already contains.
By using the TAF, Bernanke was able prevent added panic and simultaneously keep the banking system sound. Nonetheless, he -- and hence, the general public -- swallowed the risk banks had built up over the years. Did he do the right thing? I certainly think so; it's scary to think where banks would be today without such measures. All the same, actions like Bernanke's only shed further light on how wobbly the banking sector has become.
So, what are implications of this to the US taxpayer?
from Fannie Mae’s 10Q:
“For example, we recently introduced a new HomeSaver Advancetm initiative, which is a loss mitigation tool that we began implementing in the first quarter of 2008. HomeSaver Advance provides qualified borrowers with an unsecured personal loan in an amount equal to all past due payments relating to their mortgage loan, allowing borrowers to cure their payment defaults under mortgage loans without requiring modification of their mortgage loans. By permitting qualified borrowers to cure their payment defaults without requiring that we purchase the loans from the MBS trusts in order to modify the loans, this loss mitigation tool may reduce the number of delinquent mortgage loans that we purchase from MBS trusts in the future and the fair value losses we record in connection with those purchases.”
^^^^^^^^^^^^^^^^^^
So, it appears that Fannie is just re-writing mortgages as “personal loans” to people in default, all to keep from having to reflect that the “asset” on their books is essentially worthless.
The implications to taxpayers? Taxpayers will be buying lots and lots and lots of overpriced houses and relieving bank balance sheets of nonperforming debt.
Just wow.
Tremendous article! Thanks for posting!!!
It is too bad that the US Govt didn’t put 150B in the SS Trust Fund..and then have the SS TRust Fund INVEST that money in our own banks. The SS Trust Fund would then be really earning something. Instead they are sending the money to China via the public and WallmartBestBuy.
So now we have other countries owning our banks..and our Govt bonds..great work BushCongresscritters.
Nope. Per the article, the personal loan amount is equal to the value of missed payments, not the value of the mortgage.
Best part of the article saved for the very last paragraph.
I have not seen hardly any mention of the role that Rule 157 plays in this mess. It is easily googled. In short, it requires portfolio assets to be placed in one of three classes for purposes of placing a value on them. In laymen’s language, the three classes are 1) mark the asset’s value to the price an active market places on them (mark to market); 2) mark the assets value according to a model that can be substantiated; 3) mark the value according to a guess that management will sign off on.
This rule came into effect November 15, 2007.
In our lawsuit-happy and risk-averse world, this meant that the instant that CDOs of sub-prime mortgages were suspected of having been mis-rated in quality by the rating agencies, they could no longer be considered Triple A quality, and so they no longer qualified to be held in portfolios that had that quality requirement.
This meant they were ‘toxic’ to the portfolio and had to be dumped, but since this was what every other manager of AAA portfolios was doing, the market ceased to function, and nobody could sell anything.
The simple fix would be to suspend FASB 157 to allow a transition, but again, I have not seen any discussion of this in any financial news.
Now this problem has spread to other types of debt instruments. This week’s stoppage in the news is student loans. Until this can be repaired, some of the usual funding and trading conduits and markets are not functioning. Lowering the reserve requirements allows banks to take up the slack.
Having said that, the Federal Reserve (a private corporation that has ZERO ownership by the US government) has few tools to deal with this situation. Any circumstance that allows money to be “borrowed into circulation” is literally inflation of the currency; it is counterfeiting of private wealth, and even though it quickly causes the “appearance” of prosperity, it eventually manifests itself in mal-investment and the normal boom-bust of the business cycle.
The only real “stimulus” that is “sustainable” (a concept the Left only wants to scold us about when it advances something they like), is to reduce the destruction of wealth. Since government is the A Number One destroyer of wealth in our economy, a drastic cut in government spending is the one answer, that is of course unless we can force someone to invent some wonderful new way to greatly increase worker productivity.
Sorry, that is not how things work. The SS Trust fund is made of low interest paying U.S. debt. It is unconstitutional for the U.S. government to invest in private industry, such as banks. Plus, the Chinese gave us strong dollars for long term debt that they will get pennies on the yuan for if they try to sell them...brilliant.
Excellent post. How's this for a wonderful new way to greatly increase worker productivity...decrease corporate taxation, such as the double taxation of dividends...
Bookmark
The effect of the referenced action wil be to transfer the arrearages of mortgage loans into personal loans, leaving FNM directly on the hook for the arrearages. All conventional lending recognizes that secured, eg; mortgage loans are supposedly more secure than personal, unsecured loans. That’s precisely why mortgages are in the 6% range and credit cards are anywhere from 8% to 20+%. Magically transferring the arrearages “somewhere else” makes the mortgage loan look current, when it is clearly not, and makes the mortgage loan more salable. This is nothing but another case of “hide the salami”. I incorrectly characterized these actions as “rewrites” and you’re correct, they are anything but.
Confirms the truth that the problem in banking was not that the cost of money was too low, but that banks simply were scared and didn’t trust each other anymore.
Confirms this is NOT just another typical downturn in the economy, but a bonafide liquidity crises.
Confirms why merely cutting the FED funds rate hasn’t worked to stimulate the economy and isn’t going to work to stimulate the economy.
This is why the banks are failing...
FROM THE DESK OF MR HAMMAD ISMAIL
BILL AND EXCHANGE MANAGER
BANK OF AFRICA)
OUAGADOUGOU
BURKINA FASO WEST AFRICA
Dear Friend,
I hope this meets you in good health. My name is Mr Hammad Ismail, the manager of bill and exchange at the foreign remittance department of bank, BANK Of Africa(B.O.A) here in Ouagadougou, Burkina Faso.
In my department we discovered an abandoned sum of Ten Million, Five Hundred Thousand United States Dollar US$10.5m dollars in an account belonging to one of our foreign customer.Who died alongside with his entire family on Monday, 31 July, 2000 in a plane crash in paris. Please visit this site that is one of the evidence the directors brought in other to swallow the money at the end of the day, http://news.bbc.co.uk/1/hi/world/europe/859479.stm
Since we got information about his death, we have been expecting his next of kin to come over and claim his money because we can not release it unless some body applies for it as next of kin or relation to the deceased as indicated in our banking guidlings and laws but unfortunately we learnt that all his supposed next of kin or relation died alongside with him at the plane crash leaving nobody behind for the claim.
It is therefore upon this discovery that I decided to make this business proposal to you and release the money to you as the next of kin or relation to the deceased for safety and subsequent disbursement since nobody is coming for it and I don’t want this money to go into the bank treasury as unclaimed bill.
The banking law and guidline here stipulates that if such money remained unclaimed after seven years, the money will be transfered into the bank treasury as unclaimed fund. The request of foreigner as next of kin in this business is occassioned by the fact that the customer was a foreigner and a Burkinabe cannot stand as next of kin to a foreigner.
I agree that 40% of this money will be for you as a respect to the provision of a foriegn account ,10% will be set aside for expenses incurred during the business and 50% would be for me.
Thereafter, I will visit your country for disbursement according to the percentage indicated Therefore, to enable the immediate transfer of this fund to your desiggnited bank account ,you must apply first to the bank as a relation or next of kin of the deceased with a text of application that I will send to you,so I will like you to send to me your private telephone and fax number for easy and effective communication and location where the money will be remitted.
Upon receipt of your reply, I will send to you by fax or email the text of the application. I will not fail to bring to your notice that this transaction is hitch-free and that you should not entertain any atom of fear as all required arrangements have been made for the transfer. You should contact me immediately as soon as you receive this letter.
Reply me with this email please: mr_hammad001@yahoo.com
Trusting to hear from you immediately.
Yours faithfully.
Mr Hammad Ismail
BILL AND EXCHANGE MANAGER
Ya.com ADSL 24h + Llamadas Nacionales y Locales 24h - desde 9,95 €/mes+IVA.
FASB 157’s mark-to-market provision, combined with a quiet, but carefully orchestrated circle-jerk by a few of the big banks, could have quite a salutary effect on the ailing credit market. If it went too far, it would cause problems, but if it were orchestrated by people who imposed discipline in limiting the trade prices to plausible approximations of real post-credit crisis values, it could actually help by eliminating the current artificial depression of prices.
It's so hidden it's right there in the 10Q. FNM is on the hook for the unsecured amount, but it's their decision that it's better business, provided that the borrowers are qualified, than having to repurchase the mortgages from the MBS trusts.
Then it is likewise their decision to mischaracterize the nature of the securities they have on their books and which they bundle and resell into the secondary market. A buyer in arrears on their mortgage loan is practically by definition NOT qualified for a personal loan, but if you’re happy with this complete sham and fantasy by a company who couldn’t produce financial statements for 3-1/2 years, a condition which would result in exchange delisting for ANY other listed company, then by all means, enjoy.
Bump!
The FED is purposely and rapidly devaluing every dollar you and I own. It is taxation without Congressional approval, and thus worse. It is silent taxation without the gun to our heads. Worst of all, a small cabal of unelected FED officials vote to pick your pocket and mine of our hard earned wealth in order to bail out Wall Street bankers and the stock market.
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