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Monday, August 20, 2007

Everything Goes Splat?

I'm having a quiet, ladylike nervous breakdown.

AFAICS, everything's gone splat. Unless the Fed fiats some buckaroo reserve value instruments in the form of Treasury instruments (the gold of the current era), TAPS is playing. And we'll need the Amazing Grace too.

There are just about no takers for non-Fannie loans in the marketplace right now; in another week the thing will have locked up tight.

H.3 Aggregate Reserves. In two weeks (Aug 1 - Aug 15) excess depository reserves moved from 1574 million to 9346 million. Surplus vault cash went from 14154 to 20271. I assume some is sitting in coffee cans and safes also; hopefully not too much.

I assume the better psychiatrists will be booked up too, so let me recommend Isle Wars Pro by Soleau Games. The shareware version is free, and there is something about conquering the world a few times with your morning coffee that steadies the nerves.

With all these excess reserves, maybe some of these banks will go back to lending the old-fashioned way...just make the loans and hold them themselves, rather than securitize them.

Ya think?
David, there are duration issues for some types of loans, especially mortgages. The smaller the institution is, the more quickly it needs to be able to roll or sell debt off. Otherwise interest rate changes create an interest margin problem. Of course another problem with lending all your money out on loans of long duration is that the profitable ones (higher interest rates) will refi out when rates go down. So the ones you get stuck with are the ones less creditworthy when the loans become really profitable. Because of this you always need to be rolling your portfolio. If you write long loans during periods of low interest rates, they'll never refi and then when rates go back up you will be stuck paying more to service the loan and on deposits than you get back.

So having an interbank or financial market for debt instruments of longer durations is very important.

No institution that holds debt can afford to get all its money tied up in debt with long durations.

So yes, one would expect tightening terms to offer some banks opportunities to lend where they could not compete recently. But liquidity issues actually exist for debt made by an institution and held by that institution. To the extent that money is taken out of financial markets and deposited at smaller banks, it will be removed from the non-agency mortgage market if there is not a good debt market in which those banks can invest. They need stable secure instruments that are marketable.

Also there are collateralization issues for banks. Because they still had a good chunk of the home equity/HELOC market, and because many of those were seconds, I expect them to take big losses on those loans in some areas.

In the current market it is very hard for most banks to be competitive at car loans, etc. They cannot afford to go second lien. The best way for smaller banks to ride out this storm is to originate VA, FHA, FNMA.

And then there's the dig-out business. This often involves consolidating debt first, and holding a first lien mortgage for six months to a year to establish payment/get the borrower stabilized. Then you originate it to an agency and get the borrower a decent rate, plus get your money back to do it again.
And here I've been quietly and calmly going insane, I could have had a ladylike nervous breakdown! Ok, truth be told, I do good to balance a checkbook. After a job transfer in 03, a realtor informed me that I didn't need any money to buy a house, do a 80/20 loan and not pay PMI... it's all good! So it's kind of became a hobby of sorts, watching this fiasco, apartment living is very boring HA! And most of it I can muddle through and figure out, but where did the excess reserve come from?
Meaning that you listened when your mother asked "If everyone else jumped off a cliff, would you too?"

Ah, yes, the voice of quiet sanity pops up.

People are withdrawing money from funds and instruments that they perceive as risky and depositing it at the banks, where it is insured.

The problem is that we need to keep that money in circulation. To do that we need safe lending instruments that are liquid (you know you can buy and sell them any time). So what is essentially a shortage of tradable reserve instruments could lock that money in place, which is absolutely what we don't want to happen. It's kind of like having clogged financial arteries.

We will see how treasuries settle today.
MOM..thanks for the comprehensive response. The duration point is of course an important one.

What did banks do back in the olden days before securitization and government involvment in the markets?...I know they required much higher down payments, but I wonder how they dealt with the problem of matching durations of assets & liabilities, especially.
Oh yes, SUDDENLY there's risk! How silly of me, thanks for explaining it!
Anon - yep, the suddenness of perception is awesome, isn't it.

But as for the individuals who are withdrawing funds, many of them weren't playing the game. Like you. Like me. Said no thanks, that doesn't make any sense. But how would the doctors and nurses and engineers and teachers and bus drivers, etc, realize how this would affect the whole credit system?

If we are to believe our esteemed Board of Governors, this was all unforeseeable because these lovely innovative underwriting efficiencies were totally, brilliantly risk-free and pure blessings to borrowers. I don't know about you, but every once in a while I see flashes of red before my eyes. Striving for the ladylike, otherwise I would just be writing "Today, the bleeping bleep de bleep...."
David - you can do things like participation agreements, etc. The larger a pool and geographic spread you have, the lower the overall risk and the higher a CLTV you can reasonably underwrite.

Banks have to avoid having too much exposure to any one entity, too.
Unfathomable! No one could have seen it coming! The jungle, it just came alive and took the housing market down! Flashes of red is an understatement, for an instant yesterday I wanted some of the bleeping bleepety bleeps to have to live in an apartment for a few years. It's so childish but I wanna tree!!!
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