CategoryFinance

Sub-prime fallout: shanty towns outside LA, and watch the red ink flow

This is amazing, shocking – I find it hard to believe that the voiceover is telling what’s really happening, but there it is: a sort of shanty town outside Los Angeles composed of people whose sub-prime mortgages went bang.

And now there’s the pair of illustrations that I came across showing how American banks’ mortgages went bang. (These look terrible in Firefox and Camino on the Mac; fine in Safari. No idea how they are on Windows – anyone care to tell me? OK, fixed.)

The source is And Still I Persist which has used its own technology, called Boomerang, to disentangle this colossally complex topic. The first graph shows (by bank) the value of mortgages, by bank, where there were payments outstanding by 90 days or more. The number of “late” loans is vertical; the asset size of the bank horizontal; its total loan portfolio is the area of the circle at any point. (It’s bad to be vertical, small and near the x-origin.)

And secondly, total charged-off loans – that is, number of loans that have been written off as “non-performing” (vertical axis), total assets (shouldn’t that be claimed assets?) of the bank on the horizontal, and the area of the circles showing the bank’s total loan portfolio. (Being vertical and not far along the axis and having a small circle is bad.)

So – the question we now have is, why did it all go pear-shaped in 2007? What in particular happened?

More BSE in the banking system: claiming income that wasn’t

BusinessWeek continues to be must-read stuff at the moment (even if its latest paper issue has been overtaken by events, such as Bear Sterns getting bought for less than its building is worth, while the paper version makes encouraging noises about how it could come back..).

The latest example of the Banking BSE is the way that some of the organisations that loaned money for Adjustable Rate Mortgages (ARMs) booked income – even after you’ve dealt with the way that they handed out money to people who didn’t have what you’d loosely call “enough income”.

BW has the dope:

During the housing heyday, banks aggressively sold risky adjustable-rate mortgages known as option ARMs. Under the terms of those loans, borrowers pay less than the total interest owed each month. Yet lenders report the full amount of interest as income by adding the shortfall to the borrower’s outstanding balance. In essence, banks are counting their chickens before they hatch.

Let’s just try that again. I lend you, say, £100,000 (which I’ve borrowed anyway from Some Big Financial Institution). It’s a 25-year loan whose rate will vary from, say, 3% to 8%. That’s going to bring in £5,000 over those 25 years – so, £125,000 over its life.

You book this as income. Great! You’ve made a profit of £25,000 and it’s only 11am! Lattes all round!

A month later, a payment comes due. You don’t pay. I add this to your capital owed. This actually could be counted as even more profit since this extra capital is all yours to keep; you’ve got an agreed payment schedule with the BigFinInst, and the extra money this person owes is good news – it’ll be extra for you to keep.

Another month goes by, and another and the person still doesn’t pay. Fantastic news! Your profits are going up all the time! Pity about the cash flow, but there’s always someone willing to lend you some more money – especially when you indicate to them that you’ve got a really profitable loan which is due to make more money than the normal loan from a BigFinInst. Hey, why not sell them a slice of the loan?

Got the idea? Back to BW:

Companies don’t disclose the full details on such loans. Countrywide Financial (CFC) earned at least $561.7 million on option ARMs in 2007. It was one of the few bright spots for the lender last year, which reported an overall loss of $704 million. WaMu recorded $1.42 billion from such loans during that period.

But those gains at Countrywide and WaMu may soon be wiped out by writedowns. Other types of subprime mortgages already have reset en masse to higher rates, triggering defaults and wreaking havoc on banks’ earnings. At Countrywide and WaMu, option ARMs are only now starting to reset.

Oh-oh.

The resulting situation could be ugly for them judging from the fate of early entrants into the option ARM game, including Downey Financial (DSL) , IndyMac (IMB) , and FirstFed Financial (FED). Frederick Cannon, a bank analyst with Keefe, Bruyette & Woods (KBW) estimates that a third of FirstFed’s Option ARMs now resetting will default this year while similar loans at IndyMac are going bad at a faster rate than other mortgages. Downey began to ease the terms for borrowers in option ARMs last summer. But the troubled debt at the lender jumped nonetheless from 1.53% of assets in June to 4.79% by yearend. IndyMac declined to comment. FirstFed and Downey did not return calls for comment.

If WaMu and Countrywide experience the same sort of problems, they will face significant writedowns and reverse years of gains. “The benefit of hindsight shows that income was clearly overstated,” says KBW’s Cannon. Says a WaMu spokesman: “It’s difficult to project delinquencies, but the credit profile of these loans would not have historically been defined as high-risk.” Countrywide said its financials conform to accounting standards.

Oh, sure, they conform – you’re allowed to book that “income” as money, even though none of it has come through the door yet.

The thing that is different about this finance problem from the shares bust of 2000-2001 is that that one was only that – shares. It was a stock bubble, purely. In this one, houses and finance are intertwined, and that’s far more toxic, because where in previous recessions you might be able to shelter in one or the other (except, of course, the Lawson-created housing bust of 1987/8/9 – which I took part in, dammit – followed by the global recession of 1990/1), this time it’s taking in both. And that’s really hard to work your way out of.

What’s also interesting is that the Americans’ strict religion about money is preventing them from acting in the most effective way – the one the Swedes took. (Yes, BusinessWeek again.)

When the bust hit, it hit hard. Gross domestic product fell 6% between 1990 and 1993, prompting a tide of bankruptcies that threatened to swamp the financial system. The central bank governor, Bengt Dennis, was dubbed “Dennis the Menace” after he briefly jacked up interest rates on loans to banks to 500% in an effort to halt speculation against the currency in 1992. “Everything was so black you almost didn’t dare open the paper,” recalls Lars H. Thunell, at the time the deputy chief of Nordbanken, Sweden’s No. 2 bank, and now CEO of the World Bank’s International Finance Corp. in Washington.

The government’s response: A $14billion restructuring fund and a takeover of Nordbanken, the hardest-hit player. The bank’s bad loans were sold off at a steep discount to a new government-backed company called Securum, which was headed by Thunell. At one point the operation owned 2,000 buildings, controlled industrial companies such as chemical giant Nobel Industries, and employed 30,000 people. “The Swedes were smart, they moved quickly, and they knew how to organize the rescue,” says John R. Macey, deputy dean of Yale Law School, who has written about the Swedish approach.

BSE in the banking system: Bear Sterns is stuffed. Who’s next?

A while back I blogged on how BusinessWeek had done a fantastic job getting inside how Bear Sterns had, if we’re being generous, been overconfident about the reselling of sub-prime mortgages and similar stuff.

Let’s remind ourselves how it worked: they had things called names like “Bear Stearns High-Grade Structured Credit Strategies fund” and “High-Grade Structured Credit Strategies Enhanced Leverage fund”. Sounds copper-bottomed, right? In fact, these were funds which borrowed against any assets they had on the most astronomic scale:

[Ralph] Cioffi [who set up and ran the funds] also used a type of short-term debt to borrow billions more; in some cases he managed to buy $60 worth of securities for every $1 of investors’ money. But he made a critical trade-off: For lower interest rates, he gave lenders the right to demand immediate repayment.

Now, Bear Sterns – after weeks of rumour – has had to get emergency funding after saying that its financial position had “deteriorated sharply” in the past 24 hours. Only the past 24?

But here’s the thing: all the reselling and leveraging of debt, in some cases producing up to $60 of “debt” from $1 of assets (and those assets not always too certain – how much is a house worth? Only what you can get someone to pay for it), was a way of feeding back into the system things that were already contaminated.

Which reminds me of the story that I covered in great detail in the late 1990s and early 2000s: BSE. Cows, fed ground-up cows. Any trace of disease (especially a brain-rotting one, which may have been endemic) gets transmitted throughout the (thundering) herd.

BSE turned out to be very, very hard indeed to eradicate – I’m not sure it’s gone away even now. (I’ll check the stats in a bit.) I think that the financial BSE in the system now is going to prove just as hard to get rid of; only when you flush all the crap that the banks have been feeding each other out of the system can you be sure it’s OK. And how long exactly will that take?

Yeah, sure, just send the phone anywhere. Who cares where they say they live?

A letter arrived at our house the other day. “Who’s this name?” we asked each other. It was from Orange, the mobile phone company. Being suspicious types, we opened it – and found a letter from Orange pleading with this person, who had never lived here, not to give up their Orange subscription, and think of all the good that could come from staying with the company.

Only two scenarios lead to letters like this: Orange having screwed up its subscriber database, or someone fraudulently using our address to get a phone and abscond with it, leaving Orange to send annoyed letters and perhaps, eventually, bailiffs to try to find their missing phone (and person).

It turned out, as you’d expect, to be the second one: fraud. They took out the contract on January 3rd (the second working day of the year – even crooks take time off, I guess) and cancelled it at the end of February. But of course they still have the phone.

The perplexing thing though is: what details did this person give? Credit card details? Did they match the address? I guess they got it delivered to their “work” address, though that will no doubt turn out to be a block of flats where they can get in the front door and then pretend to be “at home” when the postie arrives.

Questions: does this affect our credit record? If someone goes on the lam allegedly on your address, does Orange put a black mark against the address? If it knows it’s fraud, should it have the responsibility of making sure that our credit record isn’t affected?

And how are its systems so weak that someone presumably – because there’s been no suspicious activity against our credit cards – using faked details, such as a credit card address that doesn’t match the “accommodation” address and a delivery address that’s also different can get past Orange’s fraud systems? I wonder if they said they’re a student, and ours is their home, but they’re working (or at uni) in some other city, so their credit card stuff goes to the other address. Quite a tough one for the anti-fraud systems to check against.

Obviously, though, we have hired the boys – with Tony Sirico on the right – to go and tell this person how much we, uh, don’t like this. He did real jail time in Sing Sing, ya know.

BT “charges” for cheques – the next “penalty charge” retreat?

So another comment pings in on the “credit card companies can’t charge for penalty fees”. (And what’s happened to the OFT’s case against the banks? Haven’t heard about that for a bit. Or at all.)

And now, the BT “you haven’t paid by direct debit for we’re charging you £4.50” fee. The Telegraph is the first with the story, and Radio 4’s PM followed up (except that – I suspect – so many people wanted to comment on it that the blog exploded).

From the Telegraph:

Mrs Fernihough, like 5.5 million fellow BT customers, chooses not to pay by direct debit. As a result her monthly line rental costs £13.25 a month, compared to £11.75 a month.

She said: “On a £10 note, it says quite clearly ‘I promise to pay the bearer on demand the sum of 10 pounds’, not ’10 pounds, plus a £1.50 handling fee’. This is not a spurious claim. BT’s position won’t wash.”

The grandmother of seven said she has paid her telephone bill in cash ever since she became a BT customer in 1964. She goes to the local branch of her bank in Sutton Coldfield and either pays in notes and coins or by transferring cash electronically to BT’s account.

Since May last year, BT has levied a £1.50 handling charge on cash or cheques; the company insists, however, that direct debit customers have always enjoyed a discount on their line rental, but it is not made clear on their bills.

As Eddie Mair got from her, her case rests on our familiar friend – the Unfair Terms and Contracts act (or whatever it’s called). BT can’t impose these charges if you don’t agree to them. It shouldn’t really be allowed to impose them by inertia either, I don’t think.

And here’s the question: I pay my bill by electronic transfer, not cheque. How is that any different from direct debit? Oh, yes, BT doesn’t get to take an unlimited amount from my account. Tell me why that’s a bad thing, where customers keep control of their own bank accounts and don’t open themselves up to identity theft through any insecurity in BT’s systems?

I think BT may be on weak ground here and that it’s going to have to make a big payback. The case comes up next month at at Walsall County Court in front of District Judge Hearne. Google Alert for “Fernihough”…

(Afterthought: why does it matter in the least that this woman is a grandmother? Is her ability to reproduce and produce fertile children somehow important? Should it raise, or lower her in our esteem? It’s a classic example of irrelevant facts – like the worst of American newspaper reporting.)

(Double afterthought: surprised that none of the other nationals seems to have picked up on this. It’s a really good human interest/money story which affects virtually every reader, and she can’t be hard to find in the.. er.. phone book.)