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April 24, 2007
Guest Blog: Banks Thrive While Borrowers Dive
Here's a guest blog from Mara Der Hovanesian, BW's banking and finance editor, who has written frequently about the housing mess. She wrote last year's cover story, "How Toxic Is Your Mortgage?"
I’ve been thinking about the diverging fortunes of big banks in the business of mortgage lending and lowly American homeowners. At a stylish midtown Manhattan hotel I recently sat down to breakfast with a CEO of one of the top 10 largest banks. “So what is going on with all these mortgages and the housing market?” I pressed. “How is this all going to shake out?” This particular bank has, like others, been expecting losses post-housing boom and has stepped up reserves to make up for the problem loans. “Oh, I’ve seen this all before,” said the career banker. “We always have some losses, but it’s contained. The banks are going to be just fine. In fact, I see business picking up by summer.”
I rephrased the question: “I’m not talking about the banking industry,” I clarified. “I’m talking about the people. What’s going to happen to all the borrowers?”
“The borrowers?” replied this button-downed banker. “Oh, they’re screwed.”
Second-quarter earnings reports are streaming in from Wall Street firms and big banks, and they’re for the most part reporting that the mortgage mess is contained. Take Merrill Lynch, which reported growth in revenues from almost all its divisions—-except mortgages. Merrill’s CFO Jeffrey N. Edwards says if you added up all of Merrill’s originations, securitization, warehouse lending, trading and servicing revenues, both directly in the bank’s subprime business as well as its derivative business involving subprime loans, including all the retained interests, then revenues from subprime mortgage-related activities comprise less than 1% of the firm’s net revenues for the past five quarters.
That's a drop in the bucket for Merrill. And it apparently is a drop in the bucket for Goldman Sachs and Bear Stearns and Chase and Citigroup as well, according to their earnings conferences. But what may be a rounding error to these enormous institutions amounts to real numbers for millions of people who are on the precipice of losing their homes. So while many lenders report that they’ve sidestepped the mortgage mess after making a mint during the boom, let’s not forget that they have the luxury of diversified sources of income and capital cushions and loan-loss reserves. They have the money to take calculated risks on a sector like housing when it’s white hot. And many funded loans to satisfy the demand of their investors for mortgage securities that would pay a handsome yield.
In the meantime, while each individual bank may have played only a partial role in the excesses that are resulting in so many foreclosures, the drops in the bucket are adding up to a very large pool of homeowners who are now very much underwater.
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...Which is why I have a lot of my investment portfolio in big banks (who were smart enough not to throw money at sketchy subprime loans).
Posted by: Brandon w at April 24, 2007 10:00 AM
Correct me if I'm wrong, but I think the large banks didn't fool around with the exotic/toxic mortgages. In fact my traditional mortgage is with one of the largest banks and they sold it off years ago.
Posted by: bubble watcher at April 25, 2007 12:35 PM
Most of the bigger banks either sold the "exotics" off after originating or didn't get involved in the first place. I tend to avoid the ones that got in and then sold them off, because it may yet come back to bite them; though that's a low probability. A lot of these loans were packaged up and sold as investments to investors, many of them foreign. "Capitalism" is beneficial primarily to those that own the capital -globalized capitalism is all the better; and no one has more capital than the banks. That's why I have a significant portion of my investments in banks. They will always come out on top in this system... "The one with the gold is king."
Posted by: Brandon W at April 25, 2007 01:24 PM
That power breakfast sound-byte is way to close to "Let them eat cake." I sense a Louis XVI super-sized helping of political risk coming up.
Posted by: John M at April 26, 2007 11:27 AM
Last time I checked, Washington Mutual was a big bank, and they're in it up to their eyeballs.
Wells, Citi, HSBC. Check out www.ml-implode.com, if you haven't already.
Many of those sub-prime divisions are separated from the giant bank parent, but one wonders by how much.
Posted by: Jim Driscoll at April 27, 2007 12:53 PM
As a real estate broker with over 20 years of experience, I wanted to weigh in on the current sub-prime debacle.
In this last housing boom, lenders created loan products to meet consumer's hearty desires, they created a huge amount of equity but missed a vital point; they allowed consumers to buy a payment, not a house. Items like "Stated Income" and "Hybrid ARMs" made an egregious amount of money for banks and brokers but put people in places they should never have been allowed to go. The sad part is that the public will end up paying for the lender’s mistakes.
One of the biggest problems is how the market defines "sub-prime", they label it as 640 FICO or less. One 30 day late can unjustly bring you to that level, to use that against borrowers is criminal. Banks have been manipulating borrowers with excellent credit so that they can put them into lousy loans that make the bank a ton of money but place the borrower into a larger payment that is built to fail sooner or later. If the credit scoring mechanisms (FICO) were realistic and banks rated a borrower's credit correctly, allowing for mistakes and some unavoidable items, it would result in borrowers being put into the proper loans. Banks would have made a bit less money but not bankrupted their customers eventually. It is a system in which the borrower has very little leverage; you play on the bank's field or you go home……..if you have one.
Of vital need for change is the way loan brokers are compensated. The YSP or "Yield Spread Premium" is nothing more than the Bank's kickback to the broker for doing the loan. The worse the loan, in terms of interest rate, that the broker gets the borrower to agree to, the higher the YSP dollars go to the broker. What exactly, other than honesty, is the broker's motivation for helping a borrower get the best available deal? Combine greed, low barrier to entry and minimal mandated disclosures and you have a recipe for a lending disaster at the borrower level. Until there are mandated disclosures that spell out, in 14-point type and plain language, what exactly a borrower is encumbering themselves to in total and how the broker or bank is compensated this system will continue to fail the public.
I have personally seen lenders and brokers lie to consumers about their credit-worthiness and play bait-and-switch games to get them into appalling loans. The residential industry is rife with such tactics and their bill is coming due for it. They killed their own Golden Goose; we're going to get stuck with the feathers.
Huntington Beach, Ca
Posted by: Michael Hoskinson at May 10, 2007 10:59 AM