Greatest Scandal Since Watergate?

David Brooks says Fannie Mae is a huge political scandal that isn't getting enough attention.

[T]he Fannie Mae scandal is the most important political scandal since Watergate. It helped sink the American economy. It has cost taxpayers about $153 billion, so far. It indicts patterns of behavior that are considered normal and respectable in Washington.

I agree. I'd like to see more attention paid to the nexus of politicians, lobbyists, and financial industry executives. In the meantime, the so-called GSA's should be completely privatized. Whatever benefit they're providing the mortgage business is outweighed by their potential for risk and corruption.

But it's interesting how Brooks brings up Bachmann at the end of his column. He warns Washington insiders that they need to police themselves, or someone like Bachmann will be elected to do it for them. It's almost like he thinks she's some sort of bogeyman: "You better watch out, or Michelle Bachmann's gonna eat your face!"

Underwater Banks

Jack Shafer tweets an MSNBC article on underwater banks. After Q2 '09, only 3.6% of FDIC-insured banks had troubled loan values exceeding capital and reserves. But that number has been increasing steadily since 2007.

Guess the crisis isn't quite over.

Roots of the Lending Crisis

Kenneth Anderson at Volokh Conspiracy links a WSJ op-ed by Stan Liebowitz on zero-money-down mortgages. Liebowitz writes...

What is really behind the mushrooming rate of mortgage foreclosures since 2007? The evidence from a huge national database containing millions of individual loans strongly suggests that the single most important factor is whether the homeowner has negative equity in a house -- that is, the balance of the mortgage is greater than the value of the house.

Anderson later updates his post with a response from Barry Ritholtz, who argues that while 100% LTV mortgages are a problem, subprime and alt-A mortgages are still the real culprit. He summarizes thus...

A more comprehensive 40,000 foot view would note that 100% LTV is a symptom of the larger problem of a) abdication of lending standards, caused by b) enormous demand for securitized loans, enabled by c) rating junk as AAA, in order to satisfy the demand for higher-yielding, non-junk paper, all of which traces its roots to d) Greenspan’s ultra low interest rates.

(via Insta, David Bernstein)

Treasury to Regulate Derivatives

Good, someone needs to regulate them. Anne Flaherty of AP reports Pres. Obama wants Treasury to take the job. This was a major flaw in 1999's Gramm-Leach-Bliley Act, which partially repealed 1933's Glass-Steagal Act. The Glass-Steagal part was fine, removing the barrier between retail and investment banks. Turning the Fed into a "superregulator" overseeing all financial transactions was also a good move. But explicitly exempting security swaps and their derivatives was a very, very bad move. Equally bad was the decision to leave out tighter mortgage standards.

Sen. Gramm and Pres. Clinton have defended GLB, saying it didn't have anything to do with the current financial crisis. They're wrong. By refusing to restrict lending standards, and by refusing to regulate credit default swaps and their derivatives, the stage was set for both the biggest financial boom in recent memory and also the biggest disaster.

So regulation is overdue. But there are some questions to ask before proceeding. First, why Treasury? Why not the Fed? Second, how will this affect securitization? Much of the financial world depends on securitization: slow it down and you slow down global finances. (BTW, I'm not saying that's necessarily bad.)

Third, do we really need to regulate all derivatives? The melt-down sprang almost exclusively from consumer loan derivatives (the notorious credit default swaps and CDO's). I haven't heard that other derivative types (commodities, equities) have caused nearly as much of a problem.

(h/t Insta, who doesn't like the thought of Geithner being in charge of this.)

Bank of America: Stable or Not?

This Bloomberg article confuses me.

1. Federal regulators didn't like BoA's earnings and dividends, worrying BoA wouldn't be able to raise capital.
   
2. Regulators suggested cut their dividend from $.32 to $.05 per share.
   
3. The Fed pressured BoA to buy Merrill-Lynch, which they did in December.
   
4. BoA lost $1.79B in Q4 '08.
   
5. Merrill lost more than $15B.
   
6. I don't know how much of that gets attributed to BoA's books, but it must be more than $1.79B.
   

It looks to me like BoA was on track to profit in Q4, and the Merrill acquisition pulled them down. If so, then BoA didn't really need a bailout at all. So some questions:

1. If regulators were worried about BoA's stability, why pressure them to buy Merrill and take on more instability?
   
2. If BoA hadn't bought Merrill, would they have needed any TARP money?
   
3. Why not just prop up Merrill directly? I understand the desire to appear "capitalist", but nationalizing Merrill strikes me as less intervention than TARP.
   

Clearly I'm missing something.

Mortgage Delinquencies Up Again

Reuters reports 7 percent of mortgages are more than 30 days past due, as reported by Equifax. The article doesn't mention the other credit agencies.

Equifax also reports 39.8 percent of sub-prime mortgage have fallen past due, up 23.7 percent from year.

Whoa, wait a minute: forty percent of sub-primes are delinquent?! And that's up 24 percent from last year? That means one in six sub-primes were delinquent in Q1 '08. How was this not a major problem? Why didn't we hear about it? How could anyone think sixteen percent delinquency was anything but a bad risk? And yet the GSE's, Countrywide, AIG, and the rest of the financial industry were trading derivatives of these loans as AAA investments!

Is anyone asking about this now? In all the talk about financial regulation, what's being done about sub-primes?

Edit: Fixed a spelling error in the title (grr).

Summers Overlooks "Frightening" Trades

Really interesting article at TPM about Iris Mack, a former quantitative analyst at Harvard Management Corp., which manages Harvard U.'s huge endowments. She didn't like the way HMC's money managers were trading derivatives, and complained in writing to then-Harvard President Larry Summers. She was accused of making unsubstantiated accusations and subsequently fired. He now serves as Director of the National Economic Council, and provides key economic advice to President Obama and Treasury Secretary Geithner.

(Edit: h/t Insta.)

AIG and the Financial Bounce

The DJI bounced up again today, almost to 7400. Financial stocks, including Citigroup and Bank of America, continue to do well.

As far as I know, Citi and BoA haven't accounted for their success. For all I know they could in fact be following a high-risk path to profitability.

But I just thought of another explanation. We know AIG made billion dollar payments to domestic and foreign banks. Neither Citi nor BoA have been mentioned as counterparties, but this BusinessWeek article does list Merrill Lynch, which is now part of BoA. The article goes on to point out that much of these payments will likely be passed on to other domestic banks.

Adam Lerrick, a fellow at the American Enterprise Institute, argues that viewing AIG's counterparties as the final beneficiaries of the government bailout is overly simplistic and probably not correct. It would not be unusual for the banks named in the report to have turned around, Lerrick says, and written a second round of contracts with yet other banks, quite possibly different U.S. players such as Merrill Lynch. In today's financial system, Lerrick argues, it would be impossible to be certain that the taxpayer bailout didn't eventually come largely back to supporting other U.S. firms.

If that's true (and I have no reason to doubt it), then I wonder how much of the financial sector's recent profitability derives from these AIG payments, which come from taxpayer-funded bailouts? And if these payments are driving Citi's, BoA's, and others success, can that really be called a profit? Or is it just "give a bank a bailout, and they'll profit for a quarter"?