Nightmare on Wall Street II

Nightmare on Wall Street II

There is nothing that gives more assurance than a mask.

~Colette

Subprime Crisis Part IIAt the risk of using hyperbolic Halloween metaphors too early in October, I’d like to point out an issue that has, until very recently, received very little attention in the mainstream media. It’s the resurgence of trouble in the banking sector due to toxic mortgages that caused the Nightmare on Wall Street in 2008. You wouldn’t know it from the best September stock market performance since 1939, but the mortgage monster that terrorized global financial markets may be ready to trounce Manhattan once more.

Many have been warning that central bank and government interventions could divert attention from the toxic assets on bank balance sheets for awhile, but that they wouldn’t get rid of them once and for all. Like the millions of barrels of oil in the Gulf of Mexico, trillions of dollars in faulty mortgages are still floating around out there. Capping the well doesn’t mean the problem is solved, but in today’s attention deficit society, out sight is out of mind. 

3 Horror Shows to Watch

There are a few people who have been warning about the resurgence of trouble in the housing market. Chris Whalen, Co-Founder and Managing Director of Institutional Risk Analytics, has led the charge. He recently did an interview, along with Jim Rickards, Senior Managing Director of Market Intelligence, in which they issued a Tsunami Warning for Banks. According to Rickards, there are 3 components to this perfect storm:

1. Strategic Foreclosures

Many people owe more on their mortgage principal than they can ever hope to recoup. Rather than continuing to make the payments on a losing investment, they purposely default, leaving the bank to clean up the mess. Chris Whalen recently cited a study that estimates that 1 in 5 U.S. residential properties could eventually go into foreclosure. This would represent a huge hit to the capital of several large U.S. banks.

2. Put-Backs

You will recall that a lot of the trouble that banks had during the 2008 subprime crisis stemmed from the securitization of residential mortgages. Financial institutions packaged mortgage loans into RMBS (Residential Mortgage-Backed Securities) and sold them to investors around the world. Many of those investors are now looking at what’s in those loan portfolios to find defects that will allow them to force the financial institutions to buy back these loans. Obviously, the prospect of taking these balance sheet-eating loans back is not appealing to the banks, and they have their hands full trying to repel them.

This is a trillion dollar game of hot potato that will not end well for the financial institutions that underwrote these toxic products. Of course, many of those entities have either disappeared or been absorbed into larger institutions. Bank of America is the name that I’ve heard mentioned most often in this regard. Remember that they bought both Countrywide and Merrill Lynch, two of the most prolific purveyors of poisonous potatoes out there.

3. Faulty Foreclosure Process

You can imagine how hard it might become to foreclose on a property when it’s not clear who owns the loan. Indeed a tangled cluster of problems are just now seeing the light of public scrutiny. Foreclosures are being halted in some states and by some financial companies because of accusations of fraud at multiple levels. Now on some level, this may be a positive in that foreclosure stats will likely slow. Be aware, however, that the problems are still there. The New York Times reported on flawed bank paperwork on Monday, reflecting the complexities of the situation as a result of the sheer volume of underwater homeowners out there.

Accusations range from document fabrication to the use of robo-signers, who sign off on foreclosure documents even though they have little or no knowledge of the loans in question. According to Bloomberg, bond-insurer Ambac is suing Bank of America “over $16.7 billion of mortgage-backed securities, saying the bank’s Countrywide Financial Corp. unit fraudulently induced Ambac to insure bonds backed by improperly made loans.” Stories like these are beginning to scurry across cyberspace like cockroaches right now, and I suspect the old roach aphorism (there’s never just one) will prove true once more.

How Will This Movie End?

Bank of America, Wells Fargo, JP Morgan, Citigroup, and GMAC (now Ally) are some of the institutions mentioned by Whalen and Rickards as having higher exposure to these toxic assets. They speculate that some of these banks, and perhaps many more, will be forced to seek help once again from the government. This time, we will need to do the restructuring we should have done during Nightmare on Wall Street I. The bad loans will have to be separated from viable assets, and bond holders will need to take significant haircuts.

At some point, the mask will come off and the ugly reality of these asset-backed securities will be revealed. Whalen and Rickards expect financials to feel the impact of these balance sheet blows by late in the first quarter of 2011. They state that we are currently in a Depression that may last until 2012 or 2013 – longer if we throw in some policy miscues. In this environment, Whalen recommends that “investors should be looking at liquid, government-covered vehicles to preserve principal through deflation, then stocks when the inflation updraft begins.”

Rickards assesses the situation this way: “Best case is Japan of the 90’s. Ten years of no growth. Worse case is we let the forces play out and we find a bottom. Good news with that is then you can start to grow. But the bottom will be ugly.”

So the financial problems emanating from the U.S. housing market continue like a horror film villain that just won’t die. The bad news is that this is no movie. It’s all-too real. The good news is that it will end at some point, and we can hopefully transition out of the horror genre for a while.

What do you think of Rickards and Whalen’s take on the renewed housing worries?


Written by Kim Petch

8 Responses to Nightmare on Wall Street II

  1. Rickards assesses the situation this way: “Best case is Japan of the 90?s. Ten years of no growth. Worse case is we let the forces play out and we find a bottom. Good news with that is then you can start to grow. But the bottom will be ugly.”

    I agree with this take.

    It’s like a bad marriage. Say that there has been cheating in a marriage and loss of trust and all sorts of bad stuff. Both parties avoid talking about it because it is so painful.

    One day the pain gets so great that one of them blurts out the truth: “This is not a real marriage anymore.” It hurts. There are lots of tears.

    But then they get to work rebuilding things. Finally, there is some hope for the future.

    The worst of all worlds is to know that things will be getting a lot worse before they get better. The only way we change that is to get the worst behind us. The only way we do that is by coming clean about how we all participated in causing all this. It won’t be the end of the world, and, once we see that, we will all start feeling better.

    We’re so busy whitewashing with our words that our imaginations are painting the picture worse than it really is. We need to at least start being honest with ourselves.

    Rob

    • I like the bad marriage analogy. Unfortunately, with traders giddy about the probability of QE2, we are in a bizarre stage where bad economic news causes stocks to rise. Apparently, we still aren’t ready to talk about reality.

      I think you’re onto something with the idea that if we just address this thing directly, we might realize that it’s not so bad and that we are capable of coming up with viable long term solutions, even if they mean a little short term pain.

  2. IMPORTANT FACTS ABOUT FORECLOSURE AND MORTGAGE FRAUD

    Foreclosures via DECEPTIVE and FRAUDULENT PROCEEDINGS enables repetitive, and illegal property flipping; it enables lenders to falsify IRS form 1099-A’’s; it enables unscrupulous foreclosure mill lawyers (especially because of judges who purposefully abet deceit) to deceptively hold auctions and make insider bids to acquire those properties; and blighted neighborhoods. Fraudulent foreclosures ensure the success of FABRICATED BANKRUPTCY COURT ‘Lift Stay motions’ and false ‘Proof of Claims’.

    Two particular companies that benefit from fraudulent foreclosures are Wells Fargo and Freddie Mac. Representations about Freddie Mac’s billion dollar losses should be weighed against the needless money Freddie Mac –as well as other lenders– PAY to foreclosure mills and debt collectors who utilize court systems to outmaneuver and persecute property owners who oppose unlawful foreclosures and repossessions.

    Foreclosure fraud causes illegitimate homelessness and underhanded evictions, unjustified IRS tax bills due to false 1099-A’s, and unfair “Deficiency Judgments.” Ironically, some people who express their anger at “deadbeats” appear to be more acceptable about the manifest fraud and criminal activity being carried out by people with credentials to practice law. Equally ironic is the reality that some people pretending to be annoyed about “deadbeats”are the actual people who are participating in real estate racketeering -fully sanctioned by the majority of courts, especially Bankruptcy Courts! *more @
    http://www.lawgrace.org/2010/09/30/important-facts-about-foreclosure-and-mortgage-fraud/

  3. I read something interesting on another blog that in the good times, banks were perfectly happy to foreclose on people over small debts and take their entire homes away from them. Is it really fair for them to complain now, given that these are the terms of the loans that were made?

    Then there’s the faulty foreclosure process that you mentioned… gotta think about the people currently going through legal trouble due to false foreclosure documents.

    What a mess!

    • It really is a mess. There are problems in the title insurance industry as well, as nobody seems to know who actually owns the title to many of these homes.

      Thanks for your comment Kevin.

  4. Heh, I thought by the title that this was going to be a review of Wall Street 2 (“Never Sleeps”), the movie.

    Anyway, here’s my take.

    “…by late in the first quarter of 2011. They state that we are currently in a Depression that may last until 2012 or 2013 – longer if we throw in some policy miscues. In this environment, Whalen recommends that ‘investors should be looking at liquid, government-covered vehicles to preserve principal through deflation, then stocks when the inflation updraft begins.'”

    There’s way too much market timing in there for my taste, and government-covered vehicles are providing paltry returns right now. I’d prefer, instead, to buy shares of high-quality companies at reasonable prices, based on fundamental analysis, and hold onto them for the long-term. And, I’m focusing on companies that have a lot of international exposure and/or are in sectors that I’m bullish on for the next decade, like healthcare, technology, and energy. I’ve also been loading up on low-valuation, dividend-paying insurance companies that can provide great shareholder returns without growing profits at all, like Chubb.

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