Chris Whalen is the best bank analyst on the planet. He doesn’t hold back. He was right before the 2008 crisis and he is right now. This article is very detailed and a little hard to follow, but he is basically saying that Wall Street and Timmy Geithner are conducting a huge ponzi coverup to give the appearance of stability in the mortgage market. It is a complete fraud. Fannie and Freddie, which you own, have $200 billion of bad loans on their books. You can add that to the National Debt figure because you will be taking the losses.
A Crime Called Private Mortgage Insurance
Why does it turn out that every single time we have a major “unforeseeable event,” it turns out to have been not only foreseen, but warned against, — and those warnings were widely ignored by the people in charge?
“Earthquake/Nuclear Accident Warnings Ignored by Japan”
The Big Picture
This week in The IRA Advisory Service, we review the Fed’s latest stress test exercise and discuss what it means for the banking industry and the US economy. While the US central bank did not provide results for specific institutions, the assumptions in the Comprehensive Capital Analysis and Review (CCAR) are more instructive than the Big Media seems to notice. Indeed, a close reading of the CCAR document provides a compelling argument for why the Fed should not be supervising financial institutions.
For example, the Fed has a down 6% for housing prices in its “stressed scenario,” but that is about where we are now. Incredibly, the central bank also has a down 5% for HPI in 2012, again in a “stressed” scenario. This implies that the Fed’s “normal” estimate for HPI is positive for 2011-2012? Hello?
Meanwhile, during our several trips to Washington last week, we learned a great deal more about how and why the private mortgage insurance (MI) providers have been spreading more than a little money around town to protect their evil role in the US housing sector. The first goal of the MIs seems to be creating a safe harbor whereby MIs can play a role in the prime mortgage market once the Fed defines a Qualified Residential Mortgage as required by Dodd-Frank. Once that is achieved, the next goal is said to be creating a safe harbor for MIs in the Qualified Mortgage definition to be set by the Consumer Financial Protection Bureau.
Securing a role for MI to “enhance” QRMs above 80% LTV ratios would essentially allow the top four banks and MIs to restart the subprime mortgage game — and this using the very structure created under Dodd-Frank to protect consumers. Pretty cool trick, eh? Now you know why the large zombie banks, who are in league with the MIs and GSEs, want to kill any chance for Elizabeth Warren to lead the CFPB.
We noted in a recent comment (“Toryism, Socialism and Housing Reform: Real and Imagined,” March 7, 2011) that the MIs are not a form of insurance at all. Rather, the MIs are an “out”, an escape clause that allows banks and the GSEs to avoid statutory collateral and credit underwriting requirements. We wrote:
“The difference between an FHA guarantee and [private mortgage insurance] (MI), of course, is that the FHA pays out on valid insurance claims, wherease MI does not. Repeat after us: MI is not insurance! The major MI underwriters have no capital reserves. They do not buy reinsurance to cover tail event loss. Most MI underwriters are insolvent, so they spend their staff time exercising “right of rescission.” Claims are litigated. The remaining bit of the private mortgage market which does attempt to operate in a prudential fashion lies in tatters. The world of MI, which itself is a by-product of the government manipulation of the housing sector, provides no true indication of the free market pricing of default risk for a prime mortgage.”
To us, any loans that fit the QRM designation should have 20% down payments, not second liens, MI or other structural “enhancements” that ultimately undermine credit quality. MI created huge losses to the taxpayer and to the entire banking industry, which ultimately stands behind the FDIC’s deposit insurance fund. Even letting MIs into the QRM discussion is really just another attempt to hide the fact that the private mortgage guarantee industry is a complete fraud. When the FDIC board meets to consider the issue of QRM, we hope that Sheila Bair and the other directors vote for a minimum 20% down for a QRM.
The reason we return to the issue of MI comes in part from the fact that a number of colleagues in the Washington policy community have been fed a bill of goods to the effect that MI is a viable substitute for a federal government guarantee on residential mortgages. Yet MI is widely seen in the industry as window dressing for the GSEs. In effect, MI is a tax. “All regulators are in on the scam,” a former MI official told The IRA. “The SEC, state insurance regulators and rating agencies, all of them. It is very crooked and very puzzling that no one calls the MIs out. Seriously, this is Twilight Zone material. It looks like a true conspiracy.”
An informative white paper published by American Enterprise Institute, which sites data on MI defaults from Freddie Mac, states in part:
“Loans with private mortgage insurance have experienced a default rate of about five in one hundred loans. Loans with FHA insurance have experienced a default rate in excess of ten in one hundred loans.”
Now reading this sentence, you might be tempted to think that mortgages with private MI have a lower default rate and thus lower insurance payouts on defaulted mortgages than loans guaranteed by one of the GSEs. And looking at the rescission vs. payout data from the MIs in their SEC disclosure, you might reach that same conclusion. But this is not the case.
Many of the mortgages that the MI’s pretend to insure are actually ‘rejected” upon default. The act of “rejection” is not the same as rescission and, in effect, amounts to the MI pretending that the loan was never insured in the first place. Litigation typically ensues. A good example of the litigation strategy involves Genworth Financial (“GNW”), which began a litigation with Countrywide to reject insurance coverage of securitizations by this large thrift. There are dozens of other lawsuits and arbitrations ongoing by GNW and its peers in the MI sector involving private label mortgage securitizations.
The same litigate rather than pay approach is used by JPMorgan Chase (“JPM”/Q4 2010 Bank Stress Rating: “C”) on reps & warranties claims by investors with respect to the private label securitizations of Bear, Stearns & Co. Ditto with respect to Bank of America (“BAC”/Q4 2010 Bank Stress Rating: “C”) and the legacy securitizations of Countrywide. “Foxtrot Yankee, sue me,” is the standard reply from the MIs and large bank CEOs when it comes to private label exposures. But the biggest exposure to the MIs lies with loans sold to the GSEs.
While the large servicers seem to be able to negotiate great deals with the Federal Housing Finance Administration, and this with the apparent approval of Treasury Secretary Tim Geithner, the MIs have not yet gotten a similar deal. The “world class regulator” of Fannie and Freddie seems most adept at awarding subsidies to the zombie banks, in the case of BAC to the tune of $20 billion plus in reps & warranties payments forgiven by Tim Geithner.
Now you understand why we recently raised the issue of potential restatements by the zombie banks in The IRA Advisory Service. But in the case of the MIs, the question of mere restatements is entirely inadequate to describe the public disclosure shortfall. Few claims made against MIs are paid because they have no capital, especially compared with their total exposure. Instead of raising real capital or trying to shed risk exposures, senior officials from the MIs instead spend money on litigation and lobbyists. The MIs talk to regulators and rating agencies to “explain new ways of looking at their unique capital position,” in the words of one official of a leading private mortgage insurer. The MIs also pay big money to the major rating agencies, who like the GSEs have a vested interest in the continuation of the fraud called private mortgage insurance.
The big question that needs to be asked is WHY DON’T THE RESPECTIVE STATE INSURANCE REGULATORS CLOSE THE MIs DOWN? In the case of a California MI incorporated in Arizona, they have been able to create a shell company and have it rated. While the shell company has little capital, it is still allowed to write GSE business by the Arizona state insurance regulator. Why? MIs have much less “capital” than insured losses. Premiums paid over the past two years were used to pay past claims, NOT rebuildi reseves. If the smiling image of Charles Ponzi comes to mind, then you’ve got the idea.
But it gets better. Most MI contracts are written against GSE guaranteed loans and pay only after all losses are known. Until a year ago, when the FASB changed the rules on accounting for securitizations, the GSEs would leave defaulted loans in pools and pay investors principal and interest as though the loan was still money good. The FAS 166/167 rule change forced the GSEs to buy bad loans back from investors for cash, but the same rule change allowed the GSEs to value delinquent loans at a higher value than the expected loss estimates would suggest.
In the last year, problem loans started popping up on the balance sheets of the GSEs, but Fannie and Freddie have so far refused to press the MIs for payment. Remember that MI pays only at the end of the default process, when the total loss is realized. And the GSE only just completed the review of losses for the 2004-2008 period. As the GSE warehouse of delinquent and defaulted loans grows by billions of dollars each month, there is still no demand for payment from the MIs by the FHFA. As we noted in an earlier comment, we figure that there is as much as $200 billion in defaulted loans sitting on the books of Fannie and Freddie at cost — that is, close to par value. Neither GSE details the total amount of defaulted loans on its books.
Q: Is the Obama Administration deliberately hiding the losses of the GSEs from Congress? Or maybe Secretary Geithner wants to window dress the accumulating losses at GSEs until after he leaves office for that big corner office at Goldman Sachs (“GS”/Q4 2010 Bank Stress Rating: “A+”)?
Both investors and Congress need a lot more details about the purchases of defaulted loans by Fannie and Freddie. We need to know exactly how many dud loans have migrated back to the GSEs, what their loan loss reserve is, how much of that loan loss reserve is “covered” by the MIs and how much “capital” the MIs have against these exposures. The GSE are letting dead loans sit on their books in part to avoid recognizing the losses, an event that would drive many of the MIs into bankruptcy. If you look at how slow the process of final loss recognition by Fannie and Freddie is proceeding, then you’ll understand why the publicly disclosed loss rates reported by Fannie and Freddie have been falling.
Instead of demanding insurance payments, the GSEs are doing everything in their power to keep the MIs looking like going concerns so that they can count the MI “receivable” as a good asset. This is why the GSEs direct LTV based LLPAs to the MIs, to keep some cash flowing their way, and to prevent the performing homeowner who may be paying monthly MI premiums, from refinancing into a lower rate mortgage. The same corrupt interests who want you to believe that the MIs are solvent are preventing millions of Americans from exercising their legal right to refinance their mortgages to lower fixed rate loans. As interest rates rise, the true cost of this pretense will be visible in rising loan defaults and bank credit expenses in 2011 and 2012. So much for the CCAR stress tests.
If there was a proper mark-to-market on the MIs (like all proper insurance/reinsurance businesses do), then the MIs would be massively insolvent. The GSEs would have to take another huge amount of capital from Treasury. Geithner and the GSEs are trying to avoid it, and to date are getting away with it. Sad to say, nobody at the FHFA seems to have a clue about this issue. But we understand that a certain independent minded committee chairman on Capitol Hill is preparing for hearings on this monumental act of fraud against the taxpayer, not to mention the holders of GSE debt.
Final note. Remember, all of the MIs have the same management that they had when the subprime debt market blew up. And these exectutives are mostly sales guys, people who don’t understand what they are doing when it comes to risk and insurance. The MI executives don’t care about reality, they just want to finish building their big houses in Marin County, CA. The other reason that the MI will try to go back to their old ways is simple politics. Many regulators and elected officials believe that the way to end the current crisis is to get mortgage lending volumes back up. The easiest way to do that is by providing credit to deadbeats again. Some people in Washington believe that resurrecting the private MI’s are the key to make this happen.