Category / Mortgages

Sausage makers like sausages January 31, 2014 at 9:53 am

An important catch from Tracy Alloway at FT alphaville, this: Ing-Haw Cheng and colleagues looked at how the personal portfolios of mid-level staff involved in the securitisation industry in 2006 did, and found that they were even worse than the ordinary’s Joes’. Why? A job environment that fosters “groupthink, cognitive dissonance, or other sources of over-optimism” perhaps?

From the abstract:

We find that the average person in our sample [of mid-level insiders] neither timed the market nor were cautious in their home transactions, and did not exhibit awareness of problems in overall housing markets. Certain groups of securitization agents were particularly aggressive in increasing their exposure to housing during this period, suggesting the need to expand the incentives-based view of the crisis to incorporate a role for beliefs.

Answering the call for private capital November 15, 2013 at 7:10 pm

Matt Levine, unexpectedly, is too generous. He suggests that the Fairholme Capital Management proposal to privatize Fannie Mae and Freddie Mac is pretty good. Not so much, Matt, unless you like the idea of the state handing billions of dollars to a bunch of hedge funds for no readily obvious reason. What Frannie needs is a whole bunch of new capital: not the $52B of Fairholme’s proposal, but hundreds of billions. This is because we simply cannot tolerate a repeat of 2008, so the new companies *must* be able to stand on their own feet, even in a severe downturn. My gut feel starting point is $200B of total capital for New Frannie as a whole, but I could be persuaded higher.

How can we get there? First, the pref holders should be converted into equity then massively diluted in stages – no single IPO could raise that much without a huge discount, so it makes sense to privatize New Frannie gradually. Perhaps one company per FED district would work: start with Kansas New Frannie, say, covering Colorado, Kansas, Nebraska, Oklahoma, Wyoming, and some corners of other states, capitalised at $12B, and work up to the bigger districts from there.

It is worth point out, BTW, that having the New Frannies be insurance companies represents a significant regulatory arbitrage, as Fairholme well know: the capital it would require for the same business if they were banks would be much higher. Indeed, whatever the status of the New Frannies, deeming them all systemic and imposing a supplemental leverage ratio would not be a bad plan.

Quantifying the subprime lies October 26, 2013 at 8:54 am

From Piskorski et al., a lovely idea:

We contend that buyers received false information about the true quality of assets in contractual disclosures by intermediaries during the sale of mortgages in the $2 trillion non-agency market. We construct two measures of misrepresentation of asset quality — misreported occupancy status of borrower and misreported second liens — by comparing the characteristics of mortgages disclosed to the investors at the time of sale with actual characteristics of these loans at that time that are available in a dataset matched by a credit bureau. About one out of every ten loans has one of these misrepresentations. These misrepresentations are not likely to be an artifact of matching error between datasets that contain actual characteristics and those that are reported to investors. At least part of this misrepresentation likely occurs within the boundaries of the financial industry (i.e., not by borrowers). The propensity of intermediaries to sell misrepresented loans increased as the housing market boomed, peaking in 2006. These misrepresentations are costly for investors, as ex post delinquencies of such loans are more than 60% higher when compared with otherwise similar loans. Lenders seem to be partly aware of this risk, charging a higher interest rate on misrepresented loans relative to otherwise similar loans, but the interest rate markup on misrepresented loans does not fully reflect their higher default risk. Using measures of pricing used in the literature, we find no evidence that these misrepresentations were priced in the securities at their issuance. A significant degree of misrepresentation exists across all reputable intermediaries involved in sale of mortgages. The propensity to misrepresent seems to be largely unrelated to measures of incentives for top management, to quality of risk management inside these firms or to regulatory environment in a region. Misrepresentations on just two relatively easy-to-quantify dimensions of asset quality could result in forced repurchases of mortgages by intermediaries up to $160 billion.

Can the US mortgage market be privately funded? October 6, 2013 at 9:13 am

Naked Capitalism links to testimony given to the Senate Banking Committee testimony by Georgetown law professor Adam Levitin. Levitin makes an interesting claim that private sources of residential mortgage funding

will be able to support no more than $500 billion of annual housing finance; [while] the US housing finance market needs anywhere between $1.5 trillion and $4 trillion in annual financing, depending on interest rate conditions.

Part of Levitin’s claim is based on the unusually high quality nature of post-crisis US RMBS deals:

The average mortgage size in these deals was nearly $825,000, over four times the national average. These deals were backed by ultra-prime collateral: the average loan-to-value (LTV) ratio on these deals was 65%, and only 0.5% of the mortgages had an LTV of above 80%.

I don’t find this particularly persuasive as one could make the claim that there is crowding out by the GSEs. Levitin does make the interesting point though that

The fully prepayable 30-year fixed-rate mortgage is a uniquely American and uniquely consumer friendly product that furthers economic stability and monetary policy. The 30-year FRM is the crown jewel of the American housing finance system. Its long amortization period lowers mandatory monthly payments. The fixed rate shields households from inflation and facilitates stabile household budgeting. The ability to prepay enables consumers to take advantage of improved rate environments and to pay down the mortgage faster if they have excess funds. And the prepayment feature greatly facilitates Federal Reserve monetary policy by enabling lower interest rates to easily translate into greater disposable income for consumers and increased consumer spending in the real economy. 30-year FRMs underwritten with full documentation did not blow up in the housing bubble. Any restructuring of the system should start with the question of how to ensure the widespread availability of the 30-year FRM.

History indicates that the private market will not produce 30-year FRMs in any volume.

Now, even if you believe Levitin that the private label market’s dislike* of 30 year fixed rate deals means that they will not supply sufficient funding for them, it is not obvious that the answer to the preserve the 30 year FRM at all costs. No other country has a residential mortgage market based on such long term fixed rate loans. Perhaps the US could look to the experience of others and possibly conclude that the 30 year FRM shares risk inequitably between borrower and lender. Five year FRMs are much more manageable for the lender and scarcely† less useful for the borrower. Rather than sanctifying a mortgage structure that can only survive with taxpayer subsidy, perhaps the key to US mortgage market reform is finding something that works for borrowers and lenders?

*This dislike is based on the large, not-fully-hedgeable prepayment risk of these deals. Mortgage prepayment models are not accurate, so you don’t know exactly how the loans will prepay, especially given that prepayment rates depend on default rates. This imprecision means that you don’t know whether a prepayment hedge of a private label RMBS will work.

†The WAL of a typical 80% LTV 30 year FRM is around 7 years in normal markets, so asking the borrower to take on average 2 years worth of rate risk does not seem unreasonable.

Where should US mortgage risk be held? July 24, 2013 at 7:04 am

From the most recent 10-Qs:

  • Fannie Mae mortgages on B/S, $3T.
  • Freddie Mac ditto, $1.5T, plus $500B ‘mortgage related investments’.

So, very roughly, Freddie and Fannie have between them $5T of US mortgages: they also finance roughly 90% of new US resi mortgages.

Now what is very clear is that if you wanted to wind down the two agencies, you would need a home for a lot of mortgages. What percentage of the total mortgage stock outstanding? Roughly half it seems: a quick and dirty calculation from the flow of funds data suggests that there are $10T total US home loans. So where are trillions of dollars of loans going to go? Bank balance sheets are constrained, and we know what happened the last time the MBS market expanded dramatically (although of course this time it could be different).

It’s a dilemma. Fannie and Freddie are simply to big to wind down on less than a multi-decade basis, without a firm plan for what will replace them, how that thing(s) will be funded, and what consequences that will have for US housing market.

In this context, then, Freddie’s plan to issue agency MBS which pass on some of the default risk – structured agency credit risk securities – is interesting. Perhaps the answer to the Fannie/Freddie problem isn’t to wind down the agencies, but rather to reduce the amount of risk they have, by passing more of it on. Read in that context, there is a lot resting on STACR 2013-DN1.

What seems to be happening is that STACRs are Libor floater mezz tranches, with Freddie keeping the senior and equity tranches. Mezz tranches, of course, were an artificial market pre-crisis (in that they were seldom bought by real money purchasers: rather they went into CDOs of ABS) so it will be really interesting to see where the clearing price is on these risks*.

*If anyone knows what the spread was on these M1 and M2 STACRs, I’d appreciate a comment. I’m hearing roughly L+340 and L+715, which feels rich.

m-REIT questions and answers July 10, 2013 at 3:10 pm

Q. What’s does negative convexity mean for most US MBS?
A. As rates go up, the bond’s duration lengthens, so it gets less valuable faster than a standard fixed rate bond.

Q. What’s an m-REIT?
A. A leveraged vehicle that invests in US MBS

Q. So an m-REIT is a leveraged negative convexity play?
A. Yep.

Q. What could possibly go wrong?
A. Well, m-REITs are down 19% in a couple of months without really big moves for one thing.

PRA sense, EBA analysis February 27, 2013 at 5:42 pm

The FT tells us

Lord Turner told the Commission on Banking Standards that new banks would be allowed to start up with core capital equal to as little as 4.5 per cent of their assets, adjusted for risk.

The Prudential Regulation Authority, which takes over bank supervision from the FSA in April, would give new lenders some time – perhaps three years – to get their core capital up to 7 per cent. Their management would not be allowed to pay bonuses or dividends until they hit the higher threshold.

This is of course entirely consistent with Basel 3: 4.5% is the minimum, and between 4.5 and 7 you can’t pay divys or bonuses. So the UK is using all the flexibility that Basel gives them.

What really brings this into focus, though, is a passage later in the same story:

Small banks and new entrants must use a residential mortgage risk weight of 35 per cent – the key input for capital requirements – but some UK banks that use models have cut that number to 5 per cent

In other words, that is a 4.5% capital ratio based on standardised RWAs, not on IRB RWAs. The smaller or newer guys are not getting absolutely lower capital, just a little compensation for not having IRB models (or the history to prove that they are well-calibrated). As the EBA points out, IRB models can be manipulated to produce rather low capital requirements, making a 7% (or 10%) ratio easy to achieve.

The ‘top down’ analysis conducted using the existing supervisory reporting data from 89 European banks across 16 countries confirms material differences between banks in the calculation of the Global Charge (GC) defined as the sum of RWAs (unexpected losses) and the expected losses (EL).

The analysis conducted so far suggests that:

– 50% of the differences in terms of GC between banks mainly stem from the approach for computing RWAs in use (standardised vs IRB) as well as from the composition of each bank’s loan portfolio. In other words, these are differences that relate to the structure of a bank’s balance sheet as well as to its reliance on the different regulatory approaches for assessing and measuring risks (referred in the report as A-type differences).

– The remaining 50% stem from the IRB risk parameters applied thus reflecting each bank’s specific portfolio and risk management practices.

I wonder how much of this IRB-driven variation would go away if there was a 15% RW floor on mortgages.

What did Lehman’s Eurosystem collateral turn out to be worth? February 25, 2013 at 10:07 am

From the Bundesbank:

Frankfurt-based Lehman Brothers Bankhaus AG settled its monetary policy transactions with the Eurosystem via the Bundesbank… In September 2008 … liabilities vis-à-vis the Bundesbank stood at €8.5 billion. These liabilities originated exclusively from monetary policy refinancing operations, for which LBB had pledged a total of 33 securities, chiefly highly complex instruments… Since autumn 2008 the Bundesbank has gradually resolved the pledged securities, in some cases having to restructure them. In 2012, Diversity and Excalibur*, the two largest positions in the LBB collateral portfolio, were sold, amongst other assets. The process of winding down the pledged securities is now complete.

The situation after more than four years of resolving collateral is as follows. With proceeds from sales as well as interest and redemption payments totalling €7.4 billion.

In other words, LBB’s collateral turned out to be worth 84 cents on the dollar, after accounting for haircuts; and it took four years to get that much.

*Diversity and Excalibur where European CMBS deals. See here and here for further details.

Deflating a Swedish bubble February 20, 2013 at 12:11 pm

Sweden has made a countercyclical move. Bloomberg tells us:

Sweden’s financial regulator says it’s ready to tighten restrictions on mortgage lending to stop banks feeding household debt loads after a cap imposed during the crisis failed to stem credit growth… The [Swedish] FSA is ready to enforce a cap limiting home loans relative to property values to less than the 85 percent allowed today, [director general of the FSA] Andersson said. Banks may also be told to raise risk weights on mortgage assets higher than the regulator’s most recent proposal, he said.

Coming as it does on top of Switzerland’s use of a countercyclical buffer, and noises from Australia on measures to deflate the housing bubble there, this is interesting. We are starting to see countercyclical regulatory policy in action.

Countercyclical theory and practice February 14, 2013 at 6:20 am

The Swiss are imposing a 1% countercyclical buffer due to real estate market overheating. This is probably sensible. But it does come in the same week that I read

There is little evidence that the credit to GDP gap, the ratio of credit to GDP or credit growth are factors affecting the incidence of crises in OECD countries

In other words, the key factor that Basel III suggests should be used to determine whether to impose a countercyclical buffer is of no use as a crisis predictor. What is, pace Switzerland, is house price growth.

Pot pourri December 18, 2012 at 6:16 pm

A mixture today:

From a Bloomberg story as part of their America’s Great Payroll Giveaway series:

“There’s a mythology promulgated by people in administration that you have to pay competitive salaries to attract the best people,” said Benjamin Ginsberg, political science professor at Baltimore-based Johns Hopkins University and author of a book detailing how universities are adding administrators even as state funding drops. “In point of fact, no one can show there is any relationship between what these people are paid and the quality of the work they do.”

From a story in the Securities Lending Times on CCP ownership:

Research firm Finadium interviewed major CCPs worldwide to find out how they view the role of collateral for both risk management and as a potential competitive lever in the marketplace.

Its subsequent report—CCPs and the Business of Collateral Management—was released on 15 November.

Stock, options and futures exchanges own 60 percent of recognised CCPs, said the report. “This ownership structure makes CCP activity part of the strategic direction of the exchange itself; decisions made at the exchange level trickle down as opposed to CCP decisions trickling up.”

Boards of industry representatives or outside parties run the remaining 40 percent.

“These ownership structures complicate the process of categorising the intentions of the CCP community; some CCPs operate truly as utilities for the benefit of their users while others are inclined towards market growth through acquisitions and new product development. Further, many exchanges including the CME, ICE and London Stock Exchange are competitive, publicly traded entities, putting their fully owned CCP functions in a competitive position as well.”

From Jesse Eisinger’s new article on US mortgage finance:

…with little planning and paltry public discussion, the government has almost completely taken over the American home mortgage market. Banks and other for-profit financial services companies lend money to homeowners, but without the guarantees and other support the government provides, the housing market would barely be functioning now.

Fannie Mae and Freddie Mac, the taxpayer-controlled housing giants, guaranteed 69 percent of new mortgages in the first nine months of the year, up from about 27 percent share in 2006, according to Inside Mortgage Finance. Meanwhile, the Federal Housing Authority and the Department of Veteran’s Affairs currently back another 21 percent of mortgages, up from just 2.8 percent in 2006. Altogether, 9 of every 10 new mortgages are backed by the U.S. taxpayer, up from three in 10 in 2006, when the government share hit a decade-low, according to the publication.

From a BIS working paper Global safe assets by Pierre-Olivier Gourinchas and Olivier Jeanne:

…a convincing link can be established between macroeconomic shortages of safe assets and some of the most disturbing features of our recent global financial history… a natural way to eliminate the financial instability arising from the asset scarcity consists in supplying public safe assets. In turn, the safety of public asset may require a monetary backstop. We show that this backstop can increase significantly the safety of public securities, with minimal or no consequences in terms of price stability.

Bank spreads vs corporate spreads September 14, 2012 at 7:13 am

FT alphaville had this as their chart of the day:

Bank vs Corporate spreads

Now, there is a lot going on here including deleveraging, corporate cash hoarding, bank use of collateral (reducing the assets available in bankruptcy to support senior debt holders), increasing mortgage quality, and changes in bank resolution & regulation. Still, it’s an interesting chart.

Securitization as a state sponsored enterprise September 10, 2012 at 2:40 pm

Amir Bhinde, writing in Bloomberg, has an interesting post which makes a few points. To begin, he makes the case that the growth of securitization was heavily influenced by state sponsorship:

The securitization revolution that really stifled traditional banking was led by Fannie Mae and Freddie Mac. The government-sponsored agencies paid banks a fee for originating mortgages that conformed to certain criteria, sparing banks the expense of in-depth analysis and losses from bad loans. Fannie and Freddie sold securitized bundles of the mortgages by suggesting they were as safe as Treasury bonds. Regulators then encouraged banks to buy the securities. Capital requirements for the residential mortgages that a bank kept on its books were more than twice those for mortgage-backed securities that had AA or AAA ratings.

This is broadly accurate; the GSEs were the parents of securitization, and (for reasons not wholly unconnected with the Pfandbrief market), RMBS are cheap for regulatory capital purposes.

The Bloomberg article then criticizes securitization for its reliance on ‘a few abstract variables’, and certainly we have seen that there is more to mortgage risk than stated income, LTV, FICO, and DTI. That said, if honestly sourced, these variables often do quite a good job at predicting the risk of a securitization. Often, though, is perhaps not good enough.

Amir’s next suggestions are more controversial:

To fundamentally reform the financial system, we need to end state sponsorship of securitization.

First, the federal government must stop guaranteeing mortgage securities. If lawmakers feel impelled to divert credit to homebuyers, the Small Business Administration’s approach of offering partial guarantees for housing loans would do less harm. Let the private sector securitize the loans if it can.

Second, banks should be required to evaluate the creditworthiness of every individual or business they directly or indirectly lend to, rather than outsourcing credit analysis to ratings companies or relying on reductionist statistical models. Allowing banks to buy securitized assets with only superficial knowledge of the ultimate borrowers is folly.

There are two issues here.

A correctly functioning government guaranteed (or for that matter covered) bond market provides a useful source of safe assets. That safety is worth more to investors than the cost to the state. What you do with the lower tranches – and who pays for them – is a different story*, but at least for the top tranches, securitization is performing a useful service for investors as well as borrowers.

The second problem is how credit is extended. Like it or not, the large banks have more or less killed off the loan officer in favour of statistical models for most retail and SME credit extension, not just for the securitized piece of it. If you want to go back to the prelapsarian world of local credit for local people, then banking is going to get a whole lot more expensive.

*Whether the state should subsidize home ownership or not, and by how much, is essentially a political rather than a financial question.

JPM’s surplus liquidity problem… May 19, 2012 at 8:11 pm

…was huge. Really huge. The FT reports that JPM’s CIO

has built up positions totalling more than $100bn in asset-backed securities and structured products – the complex, risky bonds at the centre of the financial crisis in 2008.

These holdings are in addition to those in credit derivatives which led to the losses and have mired the bank in regulatory investigations and criticism…

The unit made a deliberate move out of safer assets such as US Treasuries in 2009 in an effort to increase returns and diversify investments. The CIO’s “non-vanilla” portfolio is now over $150bn in size.

Just when you thought it couldn’t get any worse. They own

more than £13bn (or 45 per cent) of the total amount of UK RMBS that has been placed with investors since the market re-opened in October 2009,” the BBA said.

Systemic, moi?

Interest rate risk in the banking book – a little bit hidden? April 24, 2012 at 11:01 am

A typically histrionic post on Naked Capitalism about interest rate risk in the banking book gave me pause for thought. (Don’t you wish there was a browser plugin that could turn down a website automatically; it would substitute ‘unexpected inconvenience’ for ‘hidden time bomb’ for instance… Also, NC, for reference, the duration of a bond does not increase ‘exponentially’ as the coupon rate falls.)

Their point is that at some point rates in the US will likely rise, and that this will have an impact on bank earnings. That’s true. The direct impact however is both minor and well-disclosed. Here for instance is the relevant table from Citi’s 2011 annual report, showing the impact of 100 bp move in rates.

Citi IR in the BB

These disclosures are mandated in Basel 2, and clearly the numbers are not material for Citi.

Note too that this disclosure should include both behavioural effects on mortgages and their hedges, so that you will see some convexity for large rate shocks in the mortgage book (which a bank might well hedge with caps or swaptions, for instance). These behavioural effects include prepayment behaviour and fixes of mortgages with front end floating periods that flip (or can be converted) to fixed. To get a feel for the convexity, I would also like to see Citi disclose the impact of a 200 bps move.

What is also not there, and what may be an issue, is the impact of rates on the credit risk in mortgages. Rising rates cause extension in mortages and that in turn means that the borrower is on risk for longer. In a poor credit environment with a foreclosures still going at a good rate, being on risk for longer is a bad thing. The estimated increase in provisions under the different rate scenarios would therefore be another useful additional disclosure. Still, ‘rate risk = hidden time bomb’ feels seriously overblown to me.

It ain’t over yet April 22, 2012 at 6:09 pm

NPR reports:

More U.S. homes are entering the foreclosure process, setting the stage for a surge in properties repossessed by lenders this year.

The number of homes that received first-time foreclosure notices rose 7 percent in March from the previous month, foreclosure listing firm RealtyTrac Inc. said Thursday.

The US housing market is not out of the woods yet, with the usual suspects (CA, UT, NV, AZ, FL, MI and IL) doing particularly badly. On average, 1 in every 662
housing units received a foreclosure filing in March 2012 but it was more like 1 in 300 in the worse affected states.


Let’s try to get along February 16, 2012 at 7:16 am

A minor spat in the finance blogosphere – no one died. This is hardly news I know. But for me this fight is unnecessary; both parties have some of the truth. John Cochrane first – his tagline is

As long as some firms are considered too big to fail, those firms will take outsized risks.

That seems pretty reasonable. His account of the mechanism at work around the Lehman failure has a measure of truth about it too:

After the Bear Stearns bailout earlier in the year, markets came to the conclusion that investment banks and bank holding companies were “too big to fail” and would be bailed out. But when the government did not bail out Lehman, and
in fact said it lacked the legal authority to do so, everyone reassessed that expectation. “Maybe the government will not, or cannot, bail out Citigroup?” Suddenly, it made perfect sense to run like mad…

Buttressing this story, let us ask how—by what mechanism — did Federal Reserve and Treasury equity injections and debt guarantees in October eventually stop the panic? An increasingly common interpretation is that, by stepping in, the government signaled its determination and legal ability to keep the large banks from failing. That too makes sense in a way that most other stories do not. But again, it means that the central financial problem revolves around the expectation that banks will be bailed out.

I might quibble with that ‘central’, but certainly too-big-to-fail is a problem, and certainly it needs to be resolved.

Next, Economics of Contempt, who lays into Cochrane. They choose instead to emphasise the liquidity aspects of Lehman’s failure:

…the end result is that LBIE’s [Lehman’s main London entity’s] failure caused hundreds of billions in liquidity to suddenly vanish from the markets. It also caused other hedge funds to pull their money out of their prime brokerage accounts at Morgan Stanley and Goldman (the two biggest prime brokers), since they were now scared that they wouldn’t be able to access their funds if either of the prime brokers failed…

And there was absolutely nothing minor about the run on the money markets. One of the biggest money market mutual funds, the Reserve Primary Fund, “broke the buck” because of losses on Lehman commercial paper. This caused a massive run on money market mutual funds, with redemptions totaling over $100bn.

This is perfectly fair, and indeed the liquidity aspects of the crisis are rather less well understood than the solvency ones, so EoC is right to discuss them. Having another angle does not justify calling Cochrane’s piece ‘mind-boggling nonsense’ though.

Now, I do think that Cochrane goes astray in his account of the TARP, but I don’t think he is being duplictious, and he does show some sympathy for the complexity of the policy choices the authorities faced after Lehman. He’s good on the fragility of some of the structures such as ABCP conduits used to fund mortgages, and on the ‘huge initiative of mostly pointless regulation that would move derivatives and cds onto exchanges, regulate hedge funds, force loan originators to hold back some credit risk, and so forth’.

Give both of them a read, Cochrane and EoC. They both have worthwhile things to say. There’s plenty of crisis to go around, with no need for a fight.

What is Fannie good for? January 24, 2012 at 7:19 am

Papagianis and Swagel writing on Bloomberg view about Fannie Mae and Freddie Mac argue that the US government should

recognize budgetary reality and put the firms’ liabilities on the government balance sheet and include their spending in the federal budget.

They are probably right. I certainly think that if an entity enjoys a government guarantee on its debt, then it should be on the government’s balance sheet. Indeed, you could make an argument that Fannie and Freddie’s problems were at least partly due to having private shareholders (which in turn was a 1954 trick to keep them off balance sheet).

Anyway, let’s ignore whether Fannie and Freddie should exist, and assume that they do. What function can they perform?

You could argue as follows.

  1. A credit spread contains (at least) a liquidity premium, compensation for default, and a return on the equity needed to support unexpected risk.
  2. Non mark to market holders are only exposed to default risk, assuming they are well enough funded and capitalized to hold to term.
  3. Therefore, a non-mark-to-market government guaranteed player in the mortgage market does not need to make as a high a return as private capital and thus can charge less for mortgages.
  4. If you believe that home ownership is a societal good (something I do not intend to get in to here), then having such an entity would by extension be good too.
  5. But, seen in this light, it is really clear that government has the risk that the aggregate credit spread paid on mortgages is not sufficient to support experienced credit losses, and the profit if indeed the credit spread charged is more than sufficient. It is in the position of an equity investor as well as a debt guarantor (and so should consolidate).

What these entities do then – indeed what any mortgage insurer does – is attempt to monetize the difference between the spread you can charge on the mortgage and the compensation needed for default risk. This only works, of course, given that they do not need to mark their portfolios to market…

Caja ha ha? February 16, 2011 at 12:08 pm

A reader whose knowledge of Spain and Spanish banking is much greater than mine commented regarding the previous post:

[There is ] a clash of cultures – specifically those of international capital and Spanish regional banking.

The conflict comes into play in the way that equity-for-debt real estate would be dealt with. In the Spanish context of a pre-20th century love of property, the strategy is a no-brainer. The homes they take in lieu of loans have a really low cost of carry (possibly competitive with physical gold) and they are concrete apartments that don’t deteriorate much. And they will sell, eventually. The 30% provision mandated by the BdE should suffice in most cases and would do the trick were Spain still an isolated exotic kind of place.

The capital market people won’t see it that way at all. Aside from the matter of bank accounting standards, they are confusing properties with bad loans. This won’t change.

(I will happily put a link in to your blog, Spanish expert, if you wish.)

I don’t disagree with any of this. The Caja might represent a perfectly reasonable business model. (I have my doubts, but I know far less about the issue than the writer quoted.) But they do not represent a good business model for a modern European bank. Even without factoring in the low ROE of this business model, you can’t fund it without deposits as anything else has too much liquidity risk. But then deposits vs. mortgages is a strategy that has been prone to boom-and-bust cycles over the years. Equity holders ought to hate this kind of play because the earnings are so volatile even under accrual. Perhaps that’s the equity holder’s problem – they have unrealistic expectations of both bank ROE and bank equity risk – but even if the model has a low risk of ultimate insolvency, I still don’t get the joke.

Is it over? Part 3 February 7, 2011 at 9:27 pm

Look at all those non-recourse states:

Underwater mortgages by state.jpg