Real Homes of Genius: Today we Salute you Artesia. Half-off Sales Going on in Southern California. Federal Reserve new Pawnshop Function.
The rally on Wall Street yesterday was the largest one-day jump in 5 years. Was the rally based on healthy economic news? No. Was the major increases based on a housing market turning around? No. The rally was based on the notion that the Fed was going to start exchanging Treasurys for mortgage-backed securities. So what exactly occurred yesterday? In essence, the Fed has decided to become Wall Street’s pawnshop:
“The program will lend up to $200 billion of Treasurys to primary dealers, a group of 20 big investment firms, for a 28-day term. The firms can put up as collateral mortgage-backed securities issued by Fannie Mae and Freddie Mac, which generally are seen as safe because of an implicit government guarantee.
But in an unusual move, AAA-rated mortgage securities issued by banks will also be accepted. Many investors have shied away from these mortgage-backed securities because they fear defaults in the underlying assets will erode the value.”
California is still facing massive budget short falls as are many other states. Does nothing to address the now ever increasing job losses. I love how many folks were crowing about lifting caps not being such a big deal. This is exactly why it is a big deal. The lifting caps was to allow as many loans to be refinanced that were actually garbage, slap a AAA rating on them or funnel them into the GSEs, and then hand them off to the Fed for something of actual value. The reason there is no market for this stuff is because many of these loans aren’t worth the paper they are printed on. The slippery slope argument comes to mind here. It should now be utterly apparent why there was such a persistent fight to keep the rating agencies from downgrading anything because now, all that needs to be done by these investment firms is to roll up to the Fed and exchange toxic mortgage sludge for something of actual value. Take a wild guess what this is going to do to our dollar and the overall economy? This is a flat out bailout principally geared at Fannie Mae and Freddie Mac. The mortgage market in the US is huge. It is roughly $11.2 trillion in size and Fannie Mae and Freddie Mac hold $5.61 trillion of this amount. What’s worse, is that Fannie Mae itself has approximately $133 billion in subprime or subprime like loans on its books. Interesting how this number fits nicely with the $200 billion pawnshop plan. I will now remove my tinfoil hat.
*Hat designed to ward off future bailouts and also can be used for Jiffy Popcorn.
So let us now look at some potential examples of what kind of mortgages will be funneled into this glorious pawnshop now known as the Federal Reserve. Today we salute you Artesia with our Real Homes of Genius Award.
Two for the Price of One
What if I told you that you would be able to purchase two homes for the price of one if you were to wait for slightly over a year? Sounds too good to be true? Maybe this rings like a real estate late night infomercial and you’re expecting someone in a Hawaiian shirt to tell you how you will never have to work another day in your life and have a nice tan too. Who said you couldn’t have everything in life? The above 836 square foot home is exactly this kind of deal. This 2 bedroom 1 bath home located in Artesia is now selling for an incredible $180,000. Now where does the deal come in you may be asking? Well let us look at the sales history on this place:
Sale History
12/22/2006: $363,000
09/11/2006: $260,000
06/26/1970: $2,000
So in a little over one year, the price has been slashed in half. Now, you can buy two places like this for the price of one. Of course this place is a short sale but what ever happened to that note that accompanied the sale for $363,000? Keep in mind that the original sale, given the price falls into the conforming loan limit range even before the caps being raised, may well have placed this home into a government backed loan. Now, the market is setting the price so the $180,000 price is now the true value of the home assuming it sells at that price. Yet that original note doesn’t vanish into thin air. Now, many mortgage holders that own these mortgages, can stop by their local government sponsored pawnshop and exchange the mortgage-backed security for nice and exchangeable US Treasurys. Isn’t that grand? Yes, the market on the street is telling us that the value of the home is only $180,000 but I wonder what the good people at the Fed will be handing out to the investment firms? Here is another issue that isn’t really being discussed. Are they going to pay the face value of the note? Let us assume this was a 5 percent down purchase, will the government hand over to the investment firms $344,850 worth of Treasurys?
Clearly there are many nuances that simply need to be worked out. In addition, the firms need to pay back the money after the 28 days are over. Now riddle me this, if they can only sell a place like this for $180,000 and owe the government back $344,850 plus interest accrued, where in the world are they going to come up with the additional $164,850? These mortgage-backed securities are bundled but that doesn’t mean that they are disconnected from the underlying asset. After all, the entire reason we are in this mess is because the underlying asset was over inflated. Therefore, it is important to understand how the Fed is going to value these MBS exchanges. Clearly many of these firms are not going to be able to pay back their exchange because the reality is, many of the homes will not come remotely close to yielding the initial face value of the mortgage unless homes appreciate by 20 percent this year. My guess is the Fed will continue to roll over payment and give forbearance to many of these investment firms. These are the same firms that are beating current owners/servicers over the head to pay their mortgage. Is that price disconnect going to improve in the next few months? Of course not. All this does is pushes the day of reckoning a day further and ultimately does not help 95 percent of the population.
The program will start on March 27 so we’ll see how it goes. Nothing has happened yet. But this has the same chance of helping the overall economy just as much as all the other failed bailout, whoops, I mean liquidity measures that have occurred over the past year. Until our leaders have the courage to let many of these firms go under for flat out unscrupulous lending practices and allow the market to adjust, we are going to continue to see things like this. Contact your Congress person and let your voice be heard. Nothing wrong with some of these proposals including the OTS negative equity certificates or allowing judges to do cram-downs. But these are things that will hurt lenders and the few power brokers on Wall Street so of course they are off the table and didn’t garner any traction. But what isn’t off the table is making the Fed the new pawn shop of America.
Today we Salute you Artesia with our Real Homes of Genius Award.
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11 Responses to “Real Homes of Genius: Today we Salute you Artesia. Half-off Sales Going on in Southern California. Federal Reserve new Pawnshop Function.”
Nice hat Doctor! I’ve got one too, but mine is made of silver. I love how people even a year ago said you can’t live in stocks/money, but you can live in a house and be it your investment for life.
Some of those people are now stuck for life living in these overpriced shacks. Things still suck here in Orlando. A group of thugs beat someone with a baseball bat when he refused to give them a dollar! Things are just peachy here in the good ole USA!
Keep up the good work. Long live Ron Paul/Peter Schiff/Doctor Housing Bubble!
Viva la mexico………..I mean USA!!!!!!
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A Loan or a Giveaway?
Wednesday March 12, 12:25 pm ET
By Dirk van Dijk, CFA
Yesterday the Fed announced that it will start a new program to lend $200 billion to the primary dealers. It was a move that made the market very happy. This is sort of like the term auction facility (TAF) that it has, which was significantly increased last week.
What it is is sort of complicated, but I will try to simplify it as much as I can. The key difference is that while the TAF is geared towards banks — which as depository institutions, the Fed has to be a lender of last resort to — the new program, the TSLF, is aimed at the big investment banks (IB’s) like Goldman (NYSE: GS – News) and Bear Stearns (NYSE: BSC – News).
Essentially what the Fed is doing is allowing the IB’s to borrow T-notes and Bills and put up mortgaged-backed securities (MBS) as collateral. The MBS’s do not have to be backed by the government or the GSE’s, but have to be rated AAA. But in today’s market, what does AAA mean?
There is a haircut on the amount that the Fed will lend, but the precise amount of the haircut has not been disclosed. However, in principal, it works something like this: the IB puts up $1 billion in MBS and in return gets $900 million of Treasury bills in return. The IB can then go and sell or borrow against the T-bills to raise cash. The loan is supposed to be for 28 days, which incidentally will be past 3/31, when the 1st quarter ends. This helps the IB’s from having to recognize that the MBS on their books are not worth anything close to face value.
It is very unlikely that the money will be repaid 28 days from now; it will simply be rolled over. There is a huge risk that these ‘AAA’ MBS’s remain on the Fed’s books for good.
One of the big questions is: Is the haircut big enough to reflect the true value of the MBS? Think of it this way — if someone were to offer a non-recourse loan to you using your ten-year-old Ford Taurus — and base the amount of the loan not on blue book, but to a 10% discount for what you bought it new — is that a loan or a giveaway?
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Currently, MBS’s are not trading very much. The market has turned as illiquid as the Sahara. Quite frankly, it’s not that there are no bids, but that the holders of these MBS’s just do not like the prices that are being offered.
These assets are still being valued on the bank’s balance sheets based on models of what they ‘should’ be worth. If they sold $1 million of them at the prices people are currently willing to pay, they would have to write the remaining $1 billion they hold on their balance sheet down to that level.
That would make the bank insolvent, so they must keep the fantasy alive. Is there a good proxy for what the true value of these MBS’s is in the market? Yes — it is found in the credit default swaps market, roughly the price that it costs to insure these bonds against default. These are known as the ABX indexes. The implied price for AAA mortgage bonds of 2007 origination is now below $0.60 on the dollar.
Does this make sense (after all these are AAA, right)? Well this little item that came across the Bloomberg wire yesterday should answer that question:
‘Even after downgrading almost 10,000 subprime mortgage bonds, Standard & Poor’s and Moody’s (NYSE: MCO – News) Investors Service haven’t cut the ones that matter most: AAA securities that are the mainstays of bank and insurance company investments.
‘None of the 80 AAA securities in ABX indexes that track subprime bonds meet the criteria S&P had even before it toughened ratings standards in February, according to data compiled by Bloomberg. A bond sold by Deutsche Bank AG (NYSE: DB – News) in May 2006 is AAA at both companies even though 43 percent of the underlying mortgages are delinquent.
‘Sticking to the rules would strip at least $120 billion in bonds of their AAA status, extending the pain of a mortgage crisis that’s triggered $188 billion in writedowns for the world’s largest financial firms. AAA debt fell as low as 61 cents on the dollar after record home foreclosures and a decline to AA may push the value of the debt to 26 cents, according to Credit Suisse Group (NYSE: CS – News)…
‘The 20 ABX indexes are the only public source of prices on debt tied to home loans that were made to subprime borrowers with poor credit histories. About $650 billion of subprime bonds are still outstanding, according to Deutsche Bank. About 75 percent were rated AAA at issuance…
‘Within one AAA index, the $79 million Deutsche Bank bond, known as ACE 2005-HE-7 A2D, is rated AAA by S&P and Moody’s even though 18 percent of its loans are in foreclosure, 15 percent of the properties have been seized by lenders and about 10 percent have been delinquent for more than 90 days. When the bonds were created, Moody’s and S&P required capital support to cover a loss rate of no more than 7 percent for all three loss categories combined. Fitch doesn’t rate the debt.’
Gee, 43% of the underlying mortgages are delinquent — including 18% in foreclosure and 15% already in the hands of the lenders — and it’s still rated AAA by S&P and Moody’s. Why should anyone take any of their credit ratings seriously? Well, the Fed is, and is willing to use it as collateral with only a small haircut. Arms-length transaction or a flat-out bailout of the big boys on the street? …”
Great post, on my site I take a look at a specifc security that wuold qualify as collateral in this new plan and if you really want to feel sick to your stomach take a look.
http://www.venicesurfreport.com/2008/03/boring-but-important-financial-post.html
I guess this is why they call Los Angeles “LA LA land”
Here’s the thing. If this was the Secretary of Energy, instead of Ben Bernanke, and, to increase the Strategic Petroleum Reserve, he was offering to pay, not the market price for oil, but a price 20-40% higher to the largest US oil firms for their crude, how long would it be before he would be forced to resign or be indicted? Here with have a public official using public funds to purchase assets he KNOWS he could purchase for considerably less to benefit private corporations. Where is the outrage?
How long will treasuries hold their value when 200 Billion worth are being exchanged for something that’s worthless? I guess Mr. B can’t stand anything to keep its value.
If you think about it, a tinfoil hat is generally less than half a sphere….more of an upside-down parabola…doesn’t that focus the beams?
I think I see the trick here:
“The firms can put up as collateral mortgage-backed securities issued by Fannie Mae and Freddie Mac…”
The banks are learning a lesson from their jingle mail customers. Put up the MBS as collateral, let the loan default and the Fed gets to keep the collateral. Isn’t how things often work at pawn shops too?
>If you think about it, a tinfoil hat is generally less than half a sphere….more of an upside-down parabola…doesn’t that focus the beams?
LOL, that was along the lines of my thought too. I saw that and said, “that tinfoil hat won’t work!” and then I thought again and laughed. If you are going tinfoil, it might as well be stylish… or is it robinhoodish? I wasn’t sure on that point too.
I like that the bailout seems to be hastening the collapse of the hedge funds as (I presume) an unintended consequence of offering treasuries in exchange for securities. _There’s_ a group of people I can’t generate any sympathy for.
That house really reminds me of some of the junk in East Palo Alto. They are dropping quite a bit too, some in the 40 to 50% range. They all have spiky fences because it is a dangerous area.
Hey DHB, you better keep that hat, if it’s aluminum it will probably be worth over 100$ by the time Bernanke is done with the economy. I just read a story from the LA Times. (http://www.latimes.com/business/la-fi-homes14mar14,0,696694.story?ref=patrick.net) and not once did the reporter or the so called financial experts mentioned that the problem with the southland housing is that it is still unaffordable. They never mentioned income as being an important factor in the housing bubble. What the hell is wrong with these people? Are they blind? Are they deaf? Are they stupid? The government has no concern for the Middle Class and Lower MC. Actions speak louder than words. Thanks
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