CautiousInvestor's  Instablog

 

Most troubling, perhaps, is that we seem incapable of learning from our past. We have had at least one other period of extended strategic mortgage defaults, during the bailout program of the Great Depression, when the federal government's Home Ownership Lending Corp. purchased some 1 million mortgages from banks and rewrote them on more generous terms. About 200,000, or 20 percent, of those new mortgages defaulted despite the better terms. And HOLC's mortgage officers were clear what was behind the massive string of nonpayment: They classified about 65 percent of these defaults as resulting either from borrowers' "noncooperation" with HOLC or their "obstinate refusal" to pay even though, in the estimation of the loan officers, the borrowers could afford the loans. The problem grew as word spread that the government would only foreclose on people reluctantly and take years to throw people out of their homes. Most of these non-paying borrowers simply lived rent free at the government's expense.

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Is the slump in U.S. home prices bottoming out?

Shiller: The situation has definitely changed. With our numbers — the S&P/Case Shiller home price index — going up sharply. It looks like a major turnaround. We’ve been watching that for three months now, and we have some concern that it could be an aberration and temporary. But, at this point, it seems to be evident in just about every city in the U.S. That suggests it’s real. But it probably isn’t the beginning of a major boom, just because the economy is in such bad shape. There’s also a chance that it will reverse. It’s still only three months old, so it’s very hard to be sure at this point. The most likely scenario is that it won’t continue at this high rate of increase, but that it will neither go down a lot, nor up a lot.

So the index will move sideways for a while?

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With recent news that the FHA is likely to breach its congressionally mandated capital ratio of 2%, I thought it appropriate to furnish some background on this government mortgage insurer who now enjoys a 23% market share in mortgage originations owing to its low downpayment requirement of 3.5% and its "tolerance" for less than gleaming credit scores. Gazing into my crystal ball, I see the FDIC going to Treasury to draw upon its line of credit; I see CRE crushing bank balance sheets and vaporizing all illusions of stability; and taxpayers bailing out the FHA.

FHA is a mortgage loan insurer that has stepped into the rather sizable vacuum the recent housing finance market collapse created. Inside Mortgage Finance reports that its market share has jumped from a paltry 3% in 2006 to a strong 23% in the second quarter of 2009. It has become very popular especially with first-time home buyers because of its as low as 3.5% down payment requirement and more accommodating underwriting guidelines. Those parameters, actually, have to be well-liked by all borrowers.

As real estate prices have been steadily sinking in several areas, among them of course Las Vegas, FHA's increased exposure in them is also bringing more losses. Mortgage Bankers Association, or MBA, enlightens now that by the end of June 7.8% of its insured mortgages were 90 days or more late or then already in foreclosure, while a year ago that figure stood at 5.4%. The trend clearly is leading in the wrong direction.

FHA is required by Federal law to hold cash reserves a minimum of 2%, counting anticipated losses, of its insured mortgage portfolio. In 2007 the quotient was a healthy 6.4%, but took an ominous drop to around 3% last year. Another indicator that gets government housing officials and others in the know talking, some of whom are suggesting tighter controls.

The mortgage arena is today by a large measure maintained by Washington, FHA itself having a good share of it and then there is the Fed that is by far the most active buyer of Fannie Mae and Freddie Mac paper on the secondary mortgage market. FHA could be pressured into tightening oversight just to abide by the law, and the 2% minimum, and that would put more strain on any nascent nationwide real estate recovery. That in fact is already evident, as the new commissioner recently took a firm stance toward a national FHA lender, suspending its charter.     

The housing market appears to be at a turning point for the better in many regions. That should help stabilize prices and therefore rein in any further losses at FHA. It then would be able to continue operating without too many new restrictions and provide further momentum to the budding recovery that everybody is anxiously waiting for.

While the insiders on Wall Street and Washington pander about real financial regulatory reform, former Fed chair Paul Volcker yesterday hit ground zero on this hotly debated topic.

The heart of financial regulatory reform is centered on the implementation of leverage by our largest financial institutions. The leverage is exercised in a wide array of activities, both on and off-balance sheet. The capital utilized by the banks in these activities is credit that has not and will not flow directly through to the economy. Why? The banks believe that they will generate a greater return on the capital via proprietary activities rather than facilitating client business and addressing customer needs.

These proprietary activities, housed in balance sheet trading books and also in off-balance sheet SIV’s (structured investment vehicles), provided many nails in our economic coffin. While the Fed has provided the liquidity to refloat the markets (and to a lesser extent the economy), Wall Street banks are fighting hard to maintain as much of their proprietary activities as possible. Washington is largely dancing around the edges of the banks’ balance sheets in proposing financial regulatory reform. Until now. Paul Volcker hits Wall Street hard in promoting the end of the banks’ hedge fund like activities. The Wall Street Journal details Volcker’s bombshell in writing, Volcker Calls for Restricting Banks’ Risk, Trading Activity:

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I finally got around to reading the NYT and I see they finally got around to reporting on the topic at hand.

http://preview.tinyurl.com/mb6lb8