They could see the meltdown coming. (LA Times)
Freelance financial watchdogs who examined the paperwork on sub-prime home loans being sold to Wall Street had an inside view of the boom in easy-money lending this decade. The reviewers say they raised plenty of red flags about flaws so serious that mortgages should have been rejected outright — such as borrowers’ incomes that seemed inflated or documents that looked fake — but the problems were glossed over, ignored or stricken from reports.
As time passed, Clayton and Bohan executives said, Wall Street firms and their investor customers accepted increasing levels of default and fraud in sub-prime loans as they grew to trust software designed to offset those risks by charging higher interest rates, extra fees and penalties for paying off mortgages early.
As Wall Street grew more comfortable, it demanded less of the review process. Early in the decade, a securities firm might have asked Clayton to review 25% to 40% of the sub-prime loans in a pool, compared with typically 10% in 2006, although the requirements varied, Filipps said.
By contrast, loan buyers who kept the mortgages as an investment instead of packaging them into securities would have 50% to 100% of the loans examined, Bohan President Mark Hughes said.
The loan reviewers’ role was just one of several safeguards — including home appraisals, lending standards and ratings on mortgage-backed bonds — that were built into the country’s complex mortgage-financing system. But in the chain of brokers, lenders and investment banks that transformed mortgages into securities sold worldwide, no one seemed to care about loans that looked bad from the start. Yet profit abounded — until defaults spawned hundreds of billions of dollars in losses on mortgage-backed securities.
“The investors were paying us big money to filter this business,” said Cesar P. Valenz, one of the loan checkers. “It’s like with water. If you don’t filter it, it’s dangerous. And it didn’t get filtered.”
As foreclosures mount and home prices skid, the loan review function, known as due diligence, is gaining attention. The FBI is conducting more than a dozen probes into whether companies along the financing chain concealed problems with mortgages. And a presidential working group has blamed the sub-prime debacle in part on a lack of diligence by investment banks, rating firms and mortgage-bond buyers.
“Although market participants had economic incentives to conduct due diligence,” the group said in a policy statement, “the steps they took were insufficient.” To prevent mortgage crises, the group recommended increased disclosure of “the level and scope of due diligence performed” on home loans underlying the securities.
CNN money points to pushback from non-US banks simply refusing to have a BS counterparty. Seems they were simply refusing to stay at the party.
It’s unclear what exactly started Bear Stearns’ nightmare this week. Veteran repurchase agreement traders told Fortune.com that a major European bank last week refused to accept Bear Stearns as a counterparty to a large swap trade. By late Monday and early Tuesday, traders at hedge funds told Fortune that they were being charged a premium by the swaps desks at Deutsche Bank (DB), UBS (UBS) and Citigroup (C, Fortune 500) to execute trades with Bear Stearns as the counterparty or which involved its credit.
The bottom fell out on Thursday, Bear Stearns CFO Molinaro told investors. The demands for cash came from counterparties as well as hedge fund clients who wanted to close out their prime brokerage accounts. The market voted with its feet and wallets.
NYT sells bailout story with no alternatives:
“You get to where people can’t trade with each other,” said James L. Melcher, president of Balestra Capital, a hedge fund based in New York. “If the Fed hadn’t acted this morning and Bear did default on its obligations, then that could have triggered a very widespread panic and potentially a collapse of the financial system.”
Already, investors are considering whether another firm might face financial problems. The price for insuring Lehman Brothers’ debt jumped to $478 per $10,000 in bonds on Friday afternoon, from $385 in the morning, according to Thomson Financial. The cost for Bear debt was up to $830, from $530.
According to the current plans being crafted in Washington, you will. Bear Stearns, one of the longstanding giants of Wall Street investment banking, is now on life support, the victim of its own excessive greed and bad judgment. Apparently, the wizards who run the show at Bear Stearns (I will resist the temptation to us initials) somehow couldn’t see an $8 trillion housing bubble in the US economy. They made highly leveraged bets on assets backed by mortgages.
If they can’t get away with the “no bailout” nonsense, the Wall Street welfare boys will then try the route of claiming we have to bail them out in order to prevent the whole financial system from collapsing. Such a collapse could turn the recession into a depression leaving millions unemployed for years.
This is also nonsense. We know how to keep banks operating even as they go into bankruptcy. England just did this with Northern Rock, a major bank that managed to get itself into huge trouble because of its holding of bad mortgage debt. After it was clear the bank was insolvent, the Bank of England stepped in and essentially took over the bank. It replaced the incompetent managers who had ruined the bank and brought in a new team to straighten out the books. The plan is to resell the bank to the private sector once the books are in order.
In the meantime, the bank keeps operating. The depositors can continue to make deposits and withdrawals just as before. This prevents any chain reaction from bringing down the financial system.
The difference between the Northern Rock route and what happened with Bear Stearns last week is that in the Northern Rock, the highly paid managers that ruined the bank are sent packing. Similarly, the shareholders will get little or nothing. They own a bankrupt company; why should the government give them money?
As the financial crisis deepens, it is important the public realize the distinction between what the Bank of England did with Northern Rock and the handout from the Fed to Bear Stearns. There are other banks in serious trouble that are also looking to the Fed for help.
The best thing the Fed can do is to go the Northern Rock route. Instead of giving more money to troubled banks, it should give less. It should end the Term Auction Facility and other special mechanisms for injecting money into banks. The economy will recover quickest if we let the banks and the bankers get the full benefit of their own bad judgment. When they have written down their bad debts and are taken over by new management, the banks will again be able to play a productive role in financing growth.
The NYT reports on the Fed, Bears Stearns valuation, and interventions.
The Fed, working closely with bank regulators and the Treasury Department, raced to complete the deal Sunday night in order to prevent investors from panicking on Monday about the ability of Bear Stearns to make good on billions of dollars in trading commitments.
In a potentially even bigger move, the Federal Reserve also announced its biggest commitment yet to lend money to struggling investment banks. The central bank said its new lending program would make money available to the 20 large investment banks that serve as “primary dealers” and trade Treasury securities directly with the Fed.
Much like a $200 billion loan program the Fed announced last Tuesday, this program will essentially allow the government to hold as collateral a wide variety of investments that include hard-to-sell securities backed by mortgages. But Fed officials told reporters on Sunday night that the new program would have no limit on the amount of money that can be borrowed.
Hedge Fund implode-meter for broker dealers insolvency issues (much less liquidity).
World Exchanges(MG link)
CNN money (MG link)
There certainly is a lot happening. Bear Stearns sold at $2/share. Another quarter point dropped on the interstate bankrate. Unlimited borrowing being authorized to ‘market participants’ and ‘primary dealers’ from the Fed.
How are reasonable arguments even in the running? I sure hope it works. The whiplash in other areas is sure to be wicked.
John McCain’s site John McCain ran into a lot of trouble with Republicans the last time he proposed a bill on climate change, getting only 38 votes in the senate. I could not find an energy policy different than the current President’s. If you have access to one, let me know and I will link.
Here is a list of some of the possibilities floating around the media and blogs concerning what is relevant to the Spitzer case:
1. Use of campaign funds to finance the activity.
2. Violation of the Mann Act.
3. Suspicion of making bank transfers to avoid the $10,000 alert threshold.
4. A public official contributing to a criminal organization.
6. Specific leaks of named suspect.
How could these not be possibilities for the DC Madame case if one looked half-heartedly?
1. Any SARS not acted upon? Even legitimately. Should we recheck them?
2. Does going from Virginia to DC and back constitute interstate traffic? Or another state close by?
4. Easily established…paying is assumed.
5. To what intensity does it count?
6. No leaks…why not? Must have been a lot of work to keep this from leaking.
What is up with the so-called DC Madam – aka Deborah Jeane Palfrey – case? Is the stunning contrast between the lid being kept on the names of male clients in this matter and the interest of the media compared to the speed with which Eliot Spitzer name became notorious in a similar DC case significant? One guess as to why the DC Madam client list is being handled so gingerly: the appearance on it of too many good news sources not to mention the possibility of a few well-known, media types as well.
What are some predicted consequences if Bear Stearns failed? They do not have depositors like a bank. They invested for people, but for whom? Why would the credit market take the hit so severly if J P Morgan can get it for a penny on the dollar? Surely there are some good assets.
Reuters reported this from CNBC.
NEW YORK (Reuters) – Bear Stearns Cos (BSC.N: Quote, Profile, Research) Chief Executive Alan Schwartz on Wednesday dismissed recurring speculation that the investment bank faces a cash crunch, saying it has hefty cash reserves that have remained little changed this year.
Schwartz, in a televised interview on CNBC, also said he is comfortable with the range of analysts’ earnings estimates for the fiscal first quarter ended Feb. 29. Results for the quarter are due next week.
“We don’t see any pressure on our liquidity, let alone a liquidity crisis,” he said.
Bear finished fiscal 2007 with $17 billion of cash sitting at the parent company level as a “liquidity cushion,” he said.
“That cushion has been virtually unchanged. We have $17 billion or so excess cash on the balance sheet,” he said.
Schwartz denied speculation that other brokers were turning down Bear’s credit on trades for fear of counter-party risk.
“There’s been a lot of volatility in the market, a lot of disruption. That’s causing some administrative pressure, getting trades settled. We’re in constant dialogue with all the major dealers, and I have not been made aware of anybody not taking our credit,” he said.
Now that the stock is below $35, will they claim simple Herstatt risk for the transaction?
This news might be significant or not, and the action is timed around an oil deal with China in the area, but provides a glimpse perhaps of how Sadr forces have used the time of reduced violence. The militias in Anbar have done the same.
Violence erupted once again in central and southern Iraq as heavily armed Shiite militia groups battle with police and army over control of residential quarters.
The most ferocious clashes are reported to be taking place in the Province of Wasit of which the city of Kut is the capital.
Police sources in Kut say the Mahdi Army, the military army of the Shiite cleric Moqtada al-Sadr, has driven police forces from city.
The clashes follow orders from Sadr to permit his militias to carry arms and defend themselves. This is the first breach of the six-month truce he and U.S. commanders had agreed upon.
So far the fighting has involved his militias and Iraqi forces. But the latest clashes in Kut prove that Iraqi troops are no match for Sadr’s heavily armed militia.
Police and security forces have fled the city and are reported to be regrouping for a counter attack.
Iraqi troops have asked for reinforcements but it is not clear whether U.S. occupation troops will interfere.
Update: Today’s news