The Obvious About Bank Profits
October 16th, 2009By David Goldman
Bank of America’s unexpectedly large loss differs from the unexpectedly large gain at J. P. Morgan only in tertiary ways. The expected pattern was better fixed-income trading results combined with deterioratng credit books. With about 20% of the US workforce un- or underemployed, it is hard to imagine any other result. A higher default rate for consumer loans is to be expected. But what about the surge in trading profits?
Subprime AAA Securiites (So-Called), 2007 Vintage
The price of so-called toxic waste has surged, despite the fact that the cash flows from the toxic waste are just as dicey as the consumer loan book. Shown above are securitized AAA securities backed by 2007 vintage (that is, bottom of the barrel) subprime home-equity loans Why is their price so high? Because the Federal Reserve continues to buy huge amounts of mortgage backed securities, and because the Treasury and Fed are providing ultra-cheap, non-recourse financing for banks (through Public-Private Investment Partnerships) to buy these securities.
At the beginning of the year, I stressed over and over again that with a minimum of regulatory forbearance, the big banks would NOT go bankrupt: they had sufficient cash flows left to wring out of the toxic waste to keep one nostril out of the water. Now we have the opposite problem: the Federal Reserve and Treasury have helped the banks create a mini-bubble in what used to be called toxic waste (remember, that was the stuff that was supposed to be taken off the banks’ books so that they could resume lending to business?).
Of course the banks show an increase in fixed income trading profits! WIth cheap financing from the government, they made markets for very yieldy securities bid-only. Prices went through the ceiling. You only had to stand still and hold a suitcase-full of these securities in order to show trading profits during the third quarter.
Of course, those profits are a one-time, unrepeatable exercise; they are likely to lead to losses in the future (except to the extent that the banks can sucker their customers back into PPIP-backed toxic waste fund); and loan book losses will continue to pile up.
I bought the banks too early, at the beginning of the year, and sold too soon, in early September. Nonetheless the trade worked out. I’m not playing any more.
October 16th, 2009 at 8:15 am
David,
What do u think of MY solution to this subprime mess. The PPIP offers 95% non-recourse loans to investors who buy PAPER assets and shift them around. This really does NOTHING to deal with the actual problem of what to do with these homes, how much they r worth etc. There is also this attempt to postpone the inevitable and trying to keep homeowners in homes they cant afford. This is completely ludicrous.
MY soulution would be to provide real estate entrepreneurs, small and large, with good credit and a 33% deposit, loans to buy these assets at say a 4-5% LONG TERM interest rate. Believe me, these buyers will figure out EXACTLY how much these homes r worth and bid accordingly. And the cheap financing would even encourage the vultures to pay up a bit since they will be getting this cheap financing. This would actually DEAL with the problem of the underlying assets and as such would fix the problem of evaluating the securities behind these properties. In effect, the toxic securities would be exchanged for AAA government backed bonds but with a haircut. OK, maybe it will be a Marine style haircut, but nonetheless we would have REAL values. And we could move on.
The downside is soooo much lower than this PPIP. With a 33% deposit on properties that have already come down as much as 50%, the government would have REAL collateral. Unlike in PPIP.
There r many good deals in the real estate market now. But the problem is the financing is just not there. U can still get cheap fianancing on a private home u cant afford. But an investment property based on solid fundamentals such as cash flow, has a much higher rate. This whole concept is idiotic.
In an old Spengler column, u suggested making profits on any home purchased for cash tax free. not a bad idea either. But i like mine better as it reaches more people and effectively allows triple the number of homes to be purchased. Maybe either or…or BOTH. I would appreciate ur thoughts on this.
Thenachash
PS: I NEVER understood gold (Expensive to buy/sell/deliver/assay/store, no dividends etc) U explained it perfectly! Thanks
October 21st, 2009 at 10:08 pm
Why should the government provide cheap financing for housing, and not for building nuclear power plants? I’d rather do this on the tax side to increase the risk-taking propensity of speculators. Subsidized credit always is a slippery slope.
October 22nd, 2009 at 4:29 pm
Thanks for ur reply. The government DOES provide cheap financing for housing. But only if u want to occupy a home u cant afford. If u buy as an investment with sound fundamentals these days u still pay a MUCH higher rate. Nuclear power plants CAN get subsidized interest thru Municipal Finance and industrial developement bonds. Not that Im ruling out cheap financing for nuclear power plants either!
My point is that the govt IS financing all these other schemes, TARP, PPIP etc. All paper manipulations! Why not get to the source of the problem, namely all these unsold homes? And the cheap financing I was refering to was basically the same rates that FNM and FDE charge owner occupants who cant afford the homes they live in. And with 33% collateral on already decimated prices I think the downside is very low for the govt. My point of financing w/33% as opposed to paying cash would basically allow MORE homes to be sold.
Remember the ultimate problem here is noone knows how to value these securities because noone knows the underlying value. Real Estate investors know what the value is and it will be related to the cash flow of the homes. The govt IS in the home loan buisiness with King Barrack underwriting like 80% of the mortgages these days. Why not lend to well qualified investors w/33% collateral instead of lesser qualified homeowners for 20% collateral. 33% is A LOT of money for the investor to risk. Its not the people who bot w/33% down who r on the ropes right now. Its those no money down investors who all went belly up.