Should Federal Bailout Policy Be Coordinated?

Here’s a silly question. When the Chairman of the Federal Reserve’s Board of Governors and the Secretary of the Treasury speak, do their colleagues listen? 

I don’t know. But if I tell you why I’m confused, then perhaps you’ll be able to tell me where I ran aground. 

[Note: Those not in the mortgage business may have a tough time following this post. To help those of you that are not, or anyone that does not know what an “APM” is, read the special “Background Section” that appears at the bottom of this article before continuing.] 

On 15 Oct 2008, Chairman Bernanke spoke in New York. His topic - Stabilizing the Financial Markets and the Economy. A portion of his talk dealt with TARP, and brief excerpts of his comments appear below.

• The Troubled Asset Relief Program (TARP) … will allow the Treasury … to undertake two highly complementary activities.
• First, the Treasury will use the TARP funds to help recapitalize our banking system by purchasing non-voting equity in financial institutions…
• Second, the Treasury will use some of the [bill’s] resources … to purchase troubled assets from banks and other financial institutions, in most cases using market-based mechanisms. Mortgage-related assets … will be the [program’s] focus…
• With time, the provision of equity capital to the banking system and the purchase of troubled assets will help credit flow more freely, thus supporting economic growth.

Source: Chairman Ben S. Bernanke, Stabilizing the Financial Markets and the Economy, 15 Oct 2008.

About a month later, Treasury Secretary Henry Paulson announced that the Treasury, Fed, and the FDIC had re-examined the relative benefits of purchasing illiquid mortgage-related assets (the second TARP item in Chairman Bernanke’s speech), and concluded that this was not an effective way to use TARP funds.

However, even as Secretary Paulson set aside TARP’s original “troubled asset” purchase program on 12 Nov, he reaffirmed Chairman Bernanke’s focus on strengthening banks’ capital positions and balance sheets.

So why then did HUD issue APM 08-23 on 7 Nov, about three weeks after Chairman Bernanke spoke, and less than one week before Secretary Paulson reconfirmed the importance of bank capital in the bailout process? 

As noted below (see “Background Section”) APM 08-23 makes it more (not less!) difficult to resecuritize delinquent GNMA loans that are bought out of GNMA pools.

Let me be blunt. If the goal of the “Bailout” effort is to direct additional capital to the banking system - to “help credit flow more freely” - why would you make it more difficult, now, to generate capital through the GNMA buyout process? 

To put it another way, if the government is “bailing”, why are some Federal agencies acting as if they are trying to sink the “boat”?  

Early on, many focused on the difficulty that TARP administrators would have in setting a price that was “just right”: 

• Overall, the trick [with respect to the purchase of troubled assets] is for the government to walk a fine line between offering a sufficiently attractive price to the securities’ holders so that trading can be rejuvenated while also avoiding paying so much that taxpayers recover too little money on the securities’ ultimate resale…  

• ”If you end up paying too little to these institutions, … you’re not giving them the support that they need,” …[one Senator] told government officials … ”If you end up paying too much, then there’s no upside potential for the taxpayer … And the details of how you find the right balance here are the ones that … all of us need to understand better.”  

Source: S. Marcy, BNA Accounting Policy and Practice - Bailout Bill Offers Few Clues for Valuing Assets for US Purchase, 3 Oct 2008.

However, it is not unusual for government entities to allow for mortgage-related transactions at prices that differ from market. In fact, it is a well-established component of the GNMA buyout process, in which buyouts occur at par. Furthermore, the price differential, between the buyout price and the market value, is what generates the returns from an efficiently managed GNMA buyout program.

Here’s a modest proposal:

If it is important to direct more capital into banks, then let’s start by withdrawing APM 08-23, and revert back to the GNMA repurchase policy that prevailed prior to 7 Nov 2008.

Let’s encourage the increase of bank capital by withdrawing, or rolling back, APM 02-24. APM 02-24, like APM 08-23 referenced above, makes it very difficult to conduct an effective GNMA buyout program.

Or maybe I’m just confused.

Background Section

1. Reperforming Loans

• A reperforming mortgage loan is one that is contractually delinquent but that consistently makes monthly payments. The loan may be characterized by "rolling delinquencies."
• In this case, the loan becomes delinquent and the borrower subsequently resumes making monthly payments but is unable to pay overdue amounts.
• The overdue amounts continue to "roll" forward as an ongoing delinquency. Although such a loan may have regained payment stability, it remains contractually delinquent.
• Reperforming loans pose greater credit risk than "clean" prime-quality mortgage loans, but they pose less prepayment risk. 
• Borrowers on reperforming loans have few, if any, refinancing opportunities because of their delinquencies. When they can refinance, it usually is into a sub-prime mortgage loan.

2. Non-Performing Loans 

• A non-performing mortgage loan is one that is in default and on which the borrower has ceased making payments.  

• In effect, a non-performing loan represents the right to the eventual proceeds of the foreclosure on or other disposition of the underlying mortgaged property.  

• Sometimes a servicer can resolve a non-performing loan with techniques other than foreclosure. Examples include forbearance, taking a deed in lieu of foreclosure or helping the borrower to sell the property.  

• Sometimes a servicer may offer cash payments to motivate a defaulting borrower to surrender the property (i.e., a so-called "cash for keys" strategy).  

• In any such case, the objective is the same: to maximize the net recovery on the loan as quickly as possible. In choosing the best strategy, a servicer must be able to accurately assess both the value of the underlying property and the time required for the whole foreclosure/liquidation process.

 3. APM & Participants

• APM: Abbreviation for “All Participants Memorandum.”
• APM Numbering Method: YY-SS, where the first two digits refers to the year that an APM was published (example “02” for 2002), and the last two digits refers to the sequence number of the APM for that year.
• Participants: Any entity that participates in the Ginnie Mae MBS securitization process. This includes those involved in the origination of mortgage loans, the pooling of these loans into securities, and the servicing of the loans. It also includes the investors that purchase the mortgage-backed securities.
• Issuers: Entities that pool eligible mortgage loans and securitize these pools into Ginnie Mae MBS.
• Servicers: Entities that collect borrowers’ monthly loan payments, apply payments to accounts, advance funds, administer escrows, submit accounting reports, and absorb foreclosure losses that are not covered by FHA/VA settlements.

4. APM 02-24 and APM 08-23

• APM 02-24:  APM issued by Ginnie Mae in 2002 that made it difficult for servicers to buyout “reperforming” FHA/VA loans out of Ginnie Mae MBS pools.
• APM 08-23:  APM issued by Ginnie Mae in 2008 that established additional delinquency requirements for bought out loans that are resecuritized into Ginnie Mae MBS.

 

Disclosure: No positions.

Comments

[Robert Nabloid:]

Federal Bailout policy shouldn't exist because bailouts shouldn't exist. I don't get bailed out if I screw up. I go bankrupt if I screw up. Why can't they? Most companies that big do survive bankruptcy and emerge healthier, leaner and better able to compete. During a bankruptcy, the debtor's write down the amount they are owed and the shareholder's lose most of their investment - which thanks to the big stock declines, has sort of happened anyways...

The government should only insure depositor's funds, which it already does. If a bank goes broke, the people who have money in the accounts will be reimbursed... If a bank screws up, let it fail. Period. Not all banks screwed up, just a few really big ones that have close ties to the Federal Reserve and then they get bailed out for taking on leverage and lending to people they shouldn't have. It was pretty easy to see this coming a long time ago... Sure it's easy to say that now, looking back, but I said it years ago... looking forward. It wasn't rocket science.

Other than that, let the banks that didn't get into trouble, flourish. Stop rewarding the risky banks that act like they are "too big to fail" and willingly take on excessive risk.

2008 Nov 17 05:52 PM

[Joshua Lacey:]

We must not as a nation forget the role the high cost of our dependence on foreign fuel played in the demise of our automakers. The exorbitant cost of gas the past year has done serious damage to our economy and society. We need to take lessons from our mistakes.WE also need to get out from under the grip our dependence on fore gin oil has on us. Why not take some of these billions and invest in America becoming energy independent. Driving an electric car would cost the equivalent of 60 cents a gallon. The electricity could be generated by solar or wind power. Green technology would create millions of badly needed new jobs. What America needs is a green revolution. It is time for us to move forward with alternative energy. I just read Jeff Wilson's new book The Manhattan Project of 2009. I highly recommend this book to anyone who is concerned about the downward spiral of our economy and it's effect on our society and would like to see our country become energy independent! themanhattanprojectof2...

2008 Nov 17 05:57 PM

[carey_jim:]

The only people who listen to them are their immediate subordinates.

Their jobs depend on it.

2008 Nov 18 01:22 PM