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Wednesday, January 05, 2011

SIGTARP for Lazy Reporters

SIGTARP is an acronym for Special Inspector General for the Troubled Asset Relief Program. SIGTARP is responsible for oversight and auditing of the various programs. The reports are available here on the SIGTARP website.

In retrospect, we should have paid more attention to the "TARP" acronym. In particular, the homeowners' portions have performed very badly and probably have caused some homeowners to lose their homes, and many other homeowners to lose more financially than they otherwise would have lost. I cannot consider this a success.

I am currently reading the October quarterly report, available here as a pdf of only 338 pages. What's not to love? You get the SIGTARP seal and you save money on the latest bestselling novel.

I am particularly interested in the small business and homeowners sections. It ought to be illegal for government entities to make their pdfs uncopyable. After all, the public paid for the text and has a right to copy the bleeping text.

Since I cannot copy the bleeping text, I recommend at least reading pages 166 through 177. There is more in the March 2010 audit report about the failures of this program. That one is only 60 pages.

In general the audits are the best reading. In particular, the audit on the selection of fund managers for the Bond, James Bond crony capitalism maneuver is a must-read. Hint one: Treasury promptly suspended the obligation to raise private capital. This audit too is published so that one cannot copy it, apparently to prevent lazy reporters from doing anything with it. The official name of this thing is PPIP (Public Private Investment Program).

Because I was and am so irritated by this entire program, I intend to retype the whole effing thing on this blog. For lazy reporters, so they can copy it.

If any lazy reporter runs across this post, here's some teasers:
A) Initially Treasury published five "anticipated criteria" with its application:









These criteria were used to screen out a whole bunch of applications, but somehow the nine who got money did not necessarily meet these requirements.

Regarding the 500 million in private capital to be raised, the actual way the applications were evaluated (according to Treasury) was that this requirement was passed as long as the applicant did not say it couldn't raise 500 million in private capital. One of the applications passing said it would endeavor to raise 250 million in private capital.

The 10 billion in eligible assets currently under management was changed to 1 billion in total assets under management by the evaluation committee, although this was never publicized.

When push came to shove, seven of the nine successful applicants failed to raise the 500 million in private capital within the required time.

I am amazed that no one has looked at this process. It is "dubious" to say the least, and the way in which it was carried out made it even more dubious.

Comments:
I just finished reading Bush's book. It has some mea culpas about how unprepeared the Treasury and the FED were for the financial crisis. They were taking shots in the dark. Their biggest mistake was to save Bear Stearns and let Lehman fail. That smacked of favoritism and panicked the markets.

They originally hoped to get other financial entities to partner with them in buying some of the underwater MBSs. They hoped that wopuld take pressure off the financial stocks that were being killed by the shorts and were unable to raise new capital. This report shows that that obviously failed.

So, it was quickly on to just giving money (by buying preferred shares) to financials to increase confidence. Because that was what this was - a complete collapse of confidence. Though the infusion of capital helped, stability was not achieved until FSAB and the SEC dropped the mark to market requirement for MBSs and similar illiquid paper.

The MBS problems are slowly being worked off. Huge losses with some financial institution failures have and will continue to occur, but they can be written down and worked out over a period of several years. That is what is happening in the background right now.

Low interest rates and stabilization of finacial equity prices have allowed the banks, etal to raise capital and begin the process of working off the bad debt and paying back the TARP money.

Was it a mess? Yes, but what better procedure could have been put in place? To allow the whole system to freeze up and go in the crapper would have been far worse.

As to the efforts to put a bottom under home prices - it has been a near complete failure. My opinion is that the banks have not wanted to modify the mortgages, preferring foreclosure (the devil they know) to taking losing mortages and losing even more on them (the devil they don't know). Many people who deserved to have their mortgages modified were turned down or gave up because of the interminable documentation process and poor coordination of same. (The process takes at least a year. Ridiculous!) The government could have and could still increase demand for foreclosed homes by providing tax incentives to people who buy homes and turn them into rentals. There is so-called vulture capital out there ready to move when it appears the market has bottomed or the odds of making a profit have been increased with tax incentives. But the Obama governmment won't do that because, even though it would be good for the economy, someone might make a profit off of someone else's misfortune.

Thanks for doing the grunt work on reading this report, MOM. We all know the FED and Treasury have been operating in uncharted waters and have made a plethora of questionable moves. Hopefully, this report might be a guide for avoiding such in the future.
 
If the documentis not password protected you can change the doc.pdf parameters so you can copy

Look under the little lock/Secure icon at the top . .
 
To allow the whole system to freeze up and go in the crapper would have been far worse.

Not allowing price discovery IS freezing up the system.

Nothing is worse than policy that encourages continued malinvestment.
 
Charles said, "Not allowing price discovery IS freezing up the system."

There was no way to discover prices on illiquid MBSs that were constructed of many different mortgages. Only the mortgage sevicers knew whether individual mortgages were performing. No one KNEW what was in the MBSs. Therefore, all, botht the good and the bad, were bid down to 22 cents on the dolar. A price that was nowhere near the true value of the mortgages. Even if every mortgage in an MBS went into default, the underlying properties were still there and I know of no real estate market where prices have gone down 78%. Even with a total default the value should have been somewhere near 50 cents on the dollar. You cannot value an illiquid instrument like an MBS in an auction market unless there is some way of knowing for each MBS what the quality of the mortgages are, how many of the mortages are performing, and what geographical markets the mortgages are in. As far as I know that information is not available and there is no mechanism planned to make it available. That is why the FASB and SEC are allowing financial companies to carry the MBSs at a value arrived at by the percentage of income derived from performing mortgages. Not perfect, but it has calmed the stormy seas.

Securitization of mortgages has turned out to be much trickier than auto loans or credit card loans although there may be problems in those areas that we don't know about yet.

Where the real problems lie, and are smoldering like a spark on the forest floor, are in the Credit Default Swaps (CDSs). They are insurance that has been written on loans that, if the loans default, can never be paid. I cannot understand why the practice is still allowed, because they are, in the words of Warren Buffet, instruments of mass financial destruction. They were (and probably still are) the major problem at AIG.

But the Dodd/Frank financial reform bill fixed everything so, the coast is clear. Right? LOLs.
 
MOM:
I use Freeware PDF Unlocker 1.0.4 for such annoying pdf problems. I've unlocked the SIGTARP doc and would be happy to email it to you (I think your time is worth a lot!). If you'd like me to do so, please email me at jonathan_saundersATyahooDOTcom.
-jon
 
Jon - thank you very much!

Since I need to read and use a lot of these, I downloaded the program myself and it worked very well.

I thought you might be getting too many "Dear Jon" letters from me for your peace of mind....

Again, thanks.
 
Jimmy - the auto/CC stuff has hit bottom (a very deep one for CC) and are slowly struggling upward.

You're not grasping why some of the investment grade tranches were at 22%. It's a long explanation.
 
Jimmy,

I think you're making a math mistake somewhere in there. Property values didn't drop because the loans stopped performing, the loans stopped performing because the property values dropped.

The 50% drop in values includes property owned free and clear. With a 50% drop in property values, a greater than 50% drop in MBS value is to be expected. My guess is that would mean 40 cents on the dollar at best, so 30 cents doesn't seem all that out of line. And since the market expects some further erosion of house prices, 22 cents on the dollar doesn't seem out of line.

In other words, a 78% drop in MBS value equates to roughly an overall 60% expected drop in property values. If MBS values dropped the exact same percentage as property values, they would be risk-free instruments.
 
Charles,
You are right about the drop in property values causing the defaults in loans. However, one reason why the MBS was considered to be such a good investment was therte was tangible property standing behind every loan. The error was that no one believed values would drop more than 6%.

The other thing is that, at the worst, we have had only 14% of loans default. Who came up with the idea that 100% of loans would default?

Consider this math:
Let us assume at least a 10% down payment on a group of 100 houses with a price of $100,000, resulting in 100 mortgages of $90,000. If every property in that MBS loses 50% of its value, that means the properies are now worth $50,000 each. The mortgages were for $90,000 so the lender is potentially out $40,000 on each property if the loan defaults. That is a 44% loss. Meaning that, if all 100 loans default, the MBS should be worth about 56 cents on the dollar. What we know is that none of the MBSs had 100% defaults and values dropped less than 50% even in the worst markets. Let's take a case where 75% of the loans defaulted and the lender had to resell the 75 properties at $50,000 each. That is a 31% loss on the MBS meaning it should be worth 69 cents on the dollar.

It is my understanding that last year (2010) 9.85% of all mortgages were in default. Maybe there were some really awful MBSs that had 50%or higher mortgage defaults, but I don't think it is possible to make the assumption that all MBSs were in that category. Nevertheless, the mark to market program resulted in a 22 cents on the dollar valuation for all MBSs; a patently ridiculous valuation. That is why mark to market was finally dropped in February of
2009. I don't believe it is any coincidence that finacial securities have been reasonably stable since March of 2009.

The problems were caused, as you said, by:"Approximately 80% of U.S. mortgages issued to subprime borrowers were adjustable-rate mortgages.[1] After U.S. house prices peaked in mid-2006 and began their steep decline thereafter, refinancing became more difficult. As adjustable-rate mortgages began to reset at higher rates, mortgage delinquencies soared." That's from wikipedia. It needs to be said that 80% of problem mortgages were in California, Las vegas, Arizona, and Florida. Not only were people trying to buy too much house, but there was a lot of speculation going on. I was in Naples Florida at the height of the boom. There were large subdivisions of $500,00 and up homes being built. Prices were escalating and it was a common practice to buy a lot as soon as a subdivision opened, then sell the house at a profit as soon as it was completed. I had friends who had been doing that and made a lot of money. Some speculators were buying three and four homes at a time. When interest rates went up and demand cooled, it was like pushing over a row of dominoes. The government is now trying to stop the dominoes from falling to fight deflation. However, they have failed because they are unwilling to harness the profit motive. Investors will start buying the foreclosures when they see a better than average chance to profit.

The other thing that makes valuing an MBS without detailed information about what is in the portfolio is that the crisis was very geographically specific. Property values in New York City have increased after a small drop in 2009. Property values in Seattle are down only 18-20% since 2008. Those who keep screaming that the sky is falling everywhere are the ones hoping to benefit from lower prices. Great fortunes were made in the 80s when people bought packages of loans from the Resolution Trust Corporation, who sold them at just about any price to willing investors. I think there are people who are hoping for a repeat.
 
Charles,
You are right about the drop in property values causing the defaults in loans. However, one reason why the MBS was considered to be such a good investment was therte was tangible property standing behind every loan. The error was that no one believed values would drop more than 6%.

The other thing is that, at the worst, we have had only 14% of loans default. Who came up with the idea that 100% of loans would default?

Consider this math:
Let us assume at least a 10% down payment on a group of 100 houses with a price of $100,000, resulting in 100 mortgages of $90,000. If every property in that MBS loses 50% of its value, that means the properies are now worth $50,000 each. The mortgages were for $90,000 so the lender is potentially out $40,000 on each property if the loan defaults. That is a 44% loss. Meaning that, if all 100 loans default, the MBS should be worth about 56 cents on the dollar. What we know is that none of the MBSs had 100% defaults and values dropped less than 50% even in the worst markets. Let's take a case where 75% of the loans defaulted and the lender had to resell the 75 properties at $50,000 each. That is a 31% loss on the MBS meaning it should be worth 69 cents on the dollar.

It is my understanding that last year (2010) 9.85% of all mortgages were in default. Maybe there were some really awful MBSs that had 50%or higher mortgage defaults, but I don't think it is possible to make the assumption that all MBSs were in that category. Nevertheless, the mark to market program resulted in a 22 cents on the dollar valuation for all MBSs; a patently ridiculous valuation. That is why mark to market was finally dropped in February of
2009. I don't believe it is any coincidence that finacial securities have been reasonably stable since March of 2009.

The problems were caused, as you said, by:"Approximately 80% of U.S. mortgages issued to subprime borrowers were adjustable-rate mortgages.[1] After U.S. house prices peaked in mid-2006 and began their steep decline thereafter, refinancing became more difficult. As adjustable-rate mortgages began to reset at higher rates, mortgage delinquencies soared." That's from wikipedia. It needs to be said that 80% of problem mortgages were in California, Las vegas, Arizona, and Florida. Not only were people trying to buy too much house, but there was a lot of speculation going on. I was in Naples Florida at the height of the boom. There were large subdivisions of $500,00 and up homes being built. Prices were escalating and it was a common practice to buy a lot as soon as a subdivision opened, then sell the house at a profit as soon as it was completed. I had friends who had been doing that and made a lot of money. Some speculators were buying three and four homes at a time. When interest rates went up and demand cooled, it was like pushing over a row of dominoes. The government is now trying to stop the dominoes from falling to fight deflation. However, they have failed because they are unwilling to harness the profit motive. Investors will start buying the foreclosures when they see a better than average chance to profit.

The other thing that makes valuing an MBS without detailed information about what is in the portfolio is that the crisis was very geographically specific. Property values in New York City have increased after a small drop in 2009. Property values in Seattle are down only 18-20% since 2008. Those who keep screaming that the sky is falling everywhere are the ones hoping to benefit from lower prices. Great fortunes were made in the 80s when people bought packages of loans from the Resolution Trust Corporation, who sold them at just about any price to willing investors. I think there are people who are hoping for a repeat.
 
Jimmy, your numbers are badly off.

First, far more than 14% of loans have defaulted. In the last quarter, banks reported 10.98% of loans being delinquent (annualized); there are many more which have already passed out of the delinquent bucket. See here.

Second, your numbers for recoverable property values are way off.

Third, you are not accounting for lost interest.

Fourth, you are not accounting for foreclosure costs.

Fifth, you are not accounting for losses on loans which are modified to prevent foreclosure.

Sixth, you are not accounting for losses on good loans which refi out to lower interest rates.

When I have time, which won't be today, I will try to write more of this up for you. I do not like to see such nonsense written on this blog, especially by an astute and intelligent commenter.
 
MOM, You undoubtedly know a good deal more aout how the MBSs work than I do. I would appreciate a straight forward explanation of how they are structured and how they can show 78% losses when no where in the system have we had, according to your figures, only 14%of all loans go bad. Were all the bad loans in the MBSs? I am aware that some markets in California and Florida may have gone down by as much as 40%, but that is a small segment of the total market. The damage on average has been much less - depending on location.

I am willing to recant all if you can remove the scales from my eyes.
 
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