Homeowners who treated their houses like cash machines, tapping the equity as home values rose, are among the most likely to end in foreclosure, even more than those who bought at housing’s peak, a new study finds.
Labels: Financial Meltdown
Labels: Financial Meltdown
I have been called the devil by strangers and “the Facilitator” by friends. It’s not uncommon for people, when I tell them what I used to do, to ask if I feel guilty. I do, somewhat, and it nags at me. When I put it out of mind, it inevitably resurfaces, like a shipwreck at low tide. It’s been eight years since I compiled a program, but the last one lived on, becoming the industry standard that seeded itself into every investment bank in the world.
I wrote the software that turned mortgages into bonds....
Labels: Financial Meltdown
Labels: Financial Meltdown
Consider the bill sponsored by Representative Ed Perlmutter of Colorado - the "Federal Accounting Oversight Board Act of 2009." It fairly bristles with the kind of rewards the banking industry would love: better than bonuses, it could give them the kind of regulation they want. The bill would transfer the SEC's oversight of the FASB to the new "Federal Accounting Oversight Board." Look at its mission - it's a banker's dream come true:
(1) APPROVAL OF ACCOUNTING POLICY- The FAOB shall approve and oversee accounting principles and standards… the FAOB shall consider--
(A) the extent to which accounting principles and standards create systemic risk exposure for--
(i) the United States public;
(ii) the United States financial markets; and
(iii) global financial markets;
[…]
(C) whether certain accounting principles and standards should apply to distressed markets differently than well-functioning markets;
(D) the balance between investors' need to know a value of a company or financial institution's balance sheet at any given time versus financial regulators' responsibility to examine a company or financial institution's capital and value on both a liquidation and going concern basis;
[…]
(G) the need for accounting principles and standards to take into account the need for financial institutions to maintain adequate reserves to cover expected losses from assets held by such institution
[…]
It's downright Orwellian: to protect the public, this "oversight body" would blind them from the mistakes made by financial institutions by making accounting less transparent. The body has right to determine "the balance between investors' need to know a value of a company's balance sheet ... versus regulators responsibility to examine capital?" Doesn't that mean that the actual owners of an institution take a back seat to the regulators' decision to keep them in the dark about its true condition?
Truly incredible stuff. This bill wouldn't just turn the asylum over to the inmates; it would arm them with pistols and napalm, too.
On Tuesday the FASB released two exposure drafts that tinker with the edges of fair value reporting.
[…]
First up: FSP FAS 157-e, "Determining Whether a Market Is Not Active and a Transaction Is Not Distressed," which is intended to help preparers and auditors determine when a financial asset's trading price is affected by illiquid markets or a distressed transaction. It provides a list of indicators of illiquid markets; upon reviewing, if the preparer judges the securities in question to be trading in an illiquid market, it must take a second step.
That second step is a presumption that the price is associated with a distressed transaction; it's a presumption that can only be overcome by evidence that sufficient, usual and normal marketing activities occurred for the asset before measurement date, and that multiple bidders existed for the asset. If those conditions aren't met, then the asset must be valued using a valuation technique other than one that uses the quoted price without significant adjustment.
Bottom line, this will grease the skids for the expansion of "Level 3" valuations.
Next: FSP FAS 115-a, FAS 124-a, and EITF 99-20-b, "Recognition and Presentation of Other-Than-Temporary Impairments." This tweak will create a broad class of new long-term corporate investors in both debt and equity securities. Why? Because a firm will not recognize an other-than-temporary [OTT] impairment charge through earnings if it does not intend to sell an impaired security, and it is more likely than not that the firm will not have to sell it before the recovery of its cost basis. Therefore, we will likely witness an outbreak of "patient capital."
[…]
Net result: if OTT impairments ever do occur, the hit to earnings will be less than they are now, all else equal. Accumulated other comprehensive income will take a blow for the non-credit loss charges - but financial institutions won't mind because it won't affect regulatory capital. Charges through the income statement definitely affect regulatory capital, and they'll decrease. And earnings will be so smooth, they'll make a baby's bottom look like 20 grit sandpaper.
This week, the Financial Accounting Standards Board unveiled what may be the dumbest, most bankrupt proposal in its 36-year history….
Here’s what the board is floating. Starting this quarter, U.S. companies would be allowed to report net-income figures that ignore severe, long-term price declines in securities they own. Not just debt securities, mind you, but even common stocks and other equities, too.
All a company would need to do is say it doesn’t intend to sell them and that it probably won’t have to. In most cases, it wouldn’t matter how much the value was down, or for how long. In effect, a company would have to admit being on its deathbed before the rules would force it to take hits to earnings.
[…]
A FASB spokeswoman, Chandy Smith, confirmed my understanding of how the rule change would work.
[…]
Under the current rules, securities get differing accounting treatments depending on how they are classified on the balance sheet. When labeled as trading securities, they must be assigned marked-to-market values each quarter, with all changes flowing through to net income. Otherwise, changes in value don’t hit the income statement, unless the securities have suffered what the accountants call an “other-than-temporary impairment.”
While the term may be cumbersome, the idea is that companies need to show losses in net income once they no longer can pretend that an asset’s plunge in value is only fleeting…..
The board’s proposal tosses the old principle aside. Even if a loss is deemed not temporary, companies still would be allowed to keep it out of net income. There’s one exception: If a company holding debt securities concludes some of the decline is due to credit losses, that portion would need to be included on the income statement. Otherwise, the losses stay off.
You just know how this will turn out: Debt holders will say their losses almost always are due to something other than credit losses, such as liquidity risk, because it’s impossible to prove their judgments wrong. So the dents to net income will be minimal. That’s exactly what the FASB is trying to accomplish.
Labels: Financial Meltdown
Reinhart and Rogoff (2008a) included all the major postwar banking crises in the developed world (a total of 18) and put particular emphasis on the ones dubbed “the big five” (Spain 1977, Norway 1987, Finland, 1991, Sweden, 1991, and Japan, 1992). It is now beyond contention that the present U.S. financial crisis is severe by any metric. As a result, we now focus only on systemic financial crises, including the “big five” developed economy crises plus a number of famous emerging market episodes: the 1997–1998 Asian crisis (Hong Kong, Indonesia, Malaysia, the Philippines, and Thailand); Colombia, 1998; and Argentina 2001. These are cases where we have all or most of the relevant data that allows for thorough comparisons. Central to the analysis is historical housing price data, which can be difficult to obtain and are critical for assessing the present episode. We also include two earlier historical cases for which we have housing prices, Norway in 1899 and the United States in 1929.
Reinhart and Rogoff (2008b), taking advantage of newly unearthed historical data on domestic debt, show that this same buildup in government debt has been a defining characteristic of the aftermath of banking crises for over a century…. As Reinhart and Rogoff (2008b) note, the characteristic huge buildups in government debt are driven mainly by sharp falloffs in tax revenue and, in many cases, big surges in government spending to fight the recession. The much ballyhooed bank bailout costs are, in several cases, only a relatively minor contributor to post–financial crisis debt burdens.
By contrast, the consensus of forecasters surveyed by Blue Chip Economic Indicators in February predicted that the GDP will fall by a larger 1.9 percent this year and then increase at weaker rates of 2.1 percent in 2010, 2.9 percent in 2011 and 2012 and 2.8 percent in 2013.
[…]
For 2010, when the administration is forecasting the deficit will decline to $1.17 trillion, the administration is forecasting that the rebounding economy will boost revenues by 8.9 percent. Based on the stronger growth, the administration is forecasting steadily declining deficits in coming years with the deficit dropping to $912 billion in 2011, $581 billion in 2012 and $533 billion in 2013.
Labels: Financial Meltdown
The federal agency that insures bank deposits, which is asking for emergency powers to borrow up to $500 billion to take over failed banks, is facing a potential major shortfall in part because it collected no insurance premiums from most banks from 1996 to 2006.
The Federal Deposit Insurance Corporation, which insures deposits up to $250,000, tried for years to get congressional authority to collect the premiums in case of a looming crisis. But Congress believed that the fund was so well-capitalized - and that bank failures were so infrequent - that there was no need to collect the premiums for a decade, according to banking officials and analysts.
[…]
But if the FDIC suddenly had to take over a giant bank such as Citigroup or Bank of America, the fund would be drained "in a flash," said Cornelius Hurley, director of the Boston University law school's Morin Center for Banking and Financial Law.
[…]
Bair said yesterday that the agency's failure to collect premiums from most banks "was surprising to me and of concern." As a Treasury Department official in 2001, she said, she testified on Capitol Hill about the need to impose the fees, but nothing happened. Congress did not grant the authority for the fees until 2006, just weeks before Bair took over the FDIC. She then used that authority to impose the fees over the objections of some within the banking industry.
"That is five years of very healthy good times in banking that could have been used to build up the reserve," Bair, a former professor at the University of Massachusetts at Amherst, said in an interview. "That is how we find ourselves where we are today. An important lesson going forward is we need to be building up these funds in good times so you can draw down upon them in bad times."
[…]
Then, a booming economy left banks flush with cash, and by 1996 the insurance fund was considered so large that it could grow through interest payments and fees charged only to banks with high credit risk. Congress agreed that premiums didn't need to be collected if the fund was sustained at a level that was considered safe. Thus, about 95 percent of banks paid no premiums from 1996 to 2006, including some new ones that did not have to pay a premium, the FDIC said.
Congress mandates that the insurance fund must stay between 1.15 percent and 1.5 percent of all insured deposits. The reserve ratio on Dec. 31 was 0.40 percent, down from 1.22 percent at the end of 2007.
Labels: Financial Meltdown
Of the $8.46 trillion in assets held by the 12 largest banks in the KBW Bank Index, only 29 percent is marked to market prices, according to my analysis of company data. General Electric Co., meanwhile, said last week that just 2 percent of assets were marked to market at its General Electric Capital Corp. subsidiary, which is similar in size to the sixth-biggest U.S. bank.
What are all those other assets that aren’t marked to market prices? Mostly loans -- to homeowners, businesses and consumers.
Loans are held at their original cost, minus a reserve that banks create for potential future losses. Their value doesn’t fall in lockstep with drops in market prices.
Yet these loans still produce losses, thanks to the housing meltdown and recession. In fact, bank losses on unmarked loans are typically bigger than mark-to-market losses on securities like bonds backed by mortgages.
These investors already believe banks are underestimating just how bad losses will be on their unmarked loans. GE investors, for example, fled the stock due to concerns over its corporate loans and lending to Eastern Europe.
If investors could get a better sense of the losses actually facing GE, they might have more confidence in its financial strength. In other words, we need more mark-to-market accounting, not less.
This makes banks very different than, say, a homeowner who borrows a lot of money. In most cases, the homeowner has locked in funding. So long as the homeowner makes payments and doesn’t need to refinance, market prices aren’t that important.
Banks must tap debt markets for new money all the time. Investors buying that debt want to know how much the bank’s assets are worth. That tells them how much of an equity cushion the bank has to absorb losses.
For those investors, the current value of an asset, not what management thinks it will be worth, is vital. After all, their biggest concern is getting paid back in the event of default.
If they can’t gauge that likelihood, they stop lending. Banks then can’t finance themselves.
So why is mark-to-market such an issue? It is being used as a scapegoat by banks and others to dodge two big issues -- their reckless use of borrowed money to boost returns and their inability to make sound loans and investments.
Labels: Financial Meltdown
In fact, if one browses through the academic macroeconomics and finance literature, “systemic crisis” appears like an otherworldly event that is absent from economic models. Most models, by design, offer no immediate handle on how to think about or deal with this recurring phenomenon. In our hour of greatest need, societies around the world are left to grope in the dark without a theory. That, to us, is a systemic failure of the economics profession.
[…]
Much of the motivation for economics as an academic discipline stems from the desire to explain phenomena like unemployment, boom and bust cycles, and financial crises, but the dominant theoretical model excludes many of the aspects of the economy that will likely lead to a crisis. Confining theoretical models to ‘normal’ times without consideration of such defects might seem contradictory to the focus that the average taxpayer would expect of the scientists on his payroll.
Many of the financial economists who developed the theoretical models upon which the modern financial structure is built were well aware of the strong and highly unrealistic restrictions imposed on their models to assure stability. Yet, financial economists gave little warning to the public about the fragility of their models; even as they saw individuals and businesses build a financial system based on their work. There are a number of possible explanations for this failure to warn the public. One is a “lack of understanding” explanation--the researchers did not know the models were fragile. We find this explanation highly unlikely; financial engineers are extremely bright, and it is almost inconceivable that such bright individuals did not understand the limitations of the models. A second, more likely explanation, is that they did not consider it their job to warn the public. If that is the cause of their failure, we believe that it involves a misunderstanding of the role of the economist, and involves an ethical breakdown. In our view, economists, as with all scientists, have an ethical responsibility to communicate the limitations of their models and the potential misuses of their research. Currently, there is no ethical code for professional economic scientists. There should be one.
For structured products for credit risk, the basic paradigm of derivative pricing – perfect replication – is not applicable so that one has to rely on a kind of rough-and-ready evaluation of these contracts on the base of historical data. Unfortunately, historical data were hardly available in most cases which meant that one had to rely on simulations with relatively arbitrary assumptions on correlations between risks and default probabilities. This makes the theoretical foundations of all these products highly questionable – the equivalent to building a building of cement of which you weren’t sure of the components. The dramatic recent rise of the markets for structured products (most prominently collateralized debt obligations and credit default swaps - CDOs and CDSs) was made possible by development of such simulation-based pricing tools and the adoption of an industry-standard for these under the lead of rating agencies. Barry Eichengreen (2008) rightly points out that the “development of mathematical methods designed to quantify and hedge risk encouraged commercial banks, investment banks and hedge funds to use more leverage” as if the very use of the mathematical methods diminished the underlying risk. He also notes that the models were estimated on data from periods of low volatility and thus could not deal with the arrival of major changes. Worse, it is our contention that such major changes are endemic to the economy and cannot be simply ignored.
There are some additional aspects as well: asset-pricing and risk management tools are developed from an individualistic perspective, taking as given (ceteris paribus) the behavior of all other market participants. However, popular models might be used by a large number or even the majority of market participants. Similarly, a market participant (e.g., the notorious Long-Term Capital Management) might become so dominant in certain markets that the ceteris paribus assumption becomes unrealistic. The simultaneous pursuit of identical micro strategies leads to synchronous behavior and mechanic contagion. This simultaneous application might generate an unexpected macro outcome that actually jeopardizes the success of the underlying micro strategies. A perfect illustration is the U.S. stock market crash of October 1987. Triggered by a small decrease of prices, automated hedging strategies produced an avalanche of sell orders that out of the blue led to a fall in U.S. stock indices of about 20 percent within one day. With the massive sales to rebalance their portfolios (along the lines of Black and Scholes), the relevant actors could not realize their attempted incremental adjustments, but rather suffered major losses from the ensuing large macro effect.
A somewhat different aspect is the danger of a control illusion: The mathematical rigor and numerical precision of risk management and asset pricing tools has a tendency to conceal the weaknesses of models and assumptions to those who have not developed them and do not know the potential weakness of the assumptions and it is indeed this that Eichengreen emphasizes. Naturally, models are only approximations to the real world dynamics and partially built upon quite heroic assumptions (most notoriously: Normality of asset price changes which can be rejected at a confidence level of 99. 9999…. Anyone who has attended a course in first-year statistics can do this within minutes). Of course, considerable progress has been made by moving to more refined models with, e.g., ‘fat-tailed’ Levy processes as their driving factors. However, while such models better capture the intrinsic volatility of markets, their improved performance, taken at face value, might again contribute to enhancing the control illusion of the naïve user.
Many economic models are built upon the twin assumptions of ‘rational expectations’ and a representative agent. ‘Rational expectations’ forces individuals’ expectations into harmony with the structure of the economist’s own model. This concept can be thought of as merely a way to close a model. A behavioral interpretation of rational expectations would imply that individuals and the economist have a complete understanding of the economic mechanisms governing the world…. Leaving no place for imperfect knowledge and adaptive adjustments, rational expectations models are typically found to have dynamics that are not smooth enough to fit economic data well.
Technically, rational expectations models are often framed as dynamic programming problems in macroeconomics. But, dynamic programming models have serious limitations. Specifically, to make them analytically tractable, researchers assume representative agents and rational expectations, which assume away any heterogeneity among economic actors. Such models presume that there is a single model of the economy, which is odd given that even economists are divided in their views about the correct model of the economy….
The major problem is that despite its many refinements, this is not at all an approach based on, and confirmed by, empirical research.5 In fact, it stands in stark contrast to a broad set of regularities in human behavior discovered both in psychology and what is called behavioral and experimental economics. The corner stones of many models in finance and macroeconomics are rather maintained despite all the contradictory evidence discovered in empirical research. Much of this literature shows that human subjects act in a way that bears no resemblance to the rational expectations paradigm and also have problems discovering ‘rational expectations equilibria’ in repeated experimental settings. Rather, agents display various forms of ‘bounded rationality’ using heuristic decision rules and displaying inertia in their reaction to new information. They have also been shown in financial markets to be strongly influenced by emotional and hormonal reactions (see Lo et al., 2005, and Coates and Herbert, 2008) Economic modeling has to take such findings seriously.
Labels: Financial Meltdown, General Economics
Bloomberg reporter David Evans' piece ("FDIC May Need $150 Billion Bailout as Local Bank Failures Mount," Sept. 25) does a serious disservice to your organization and your readers by painting a skewed picture of the FDIC insurance fund. Let me be clear: The insurance fund is in a strong financial position to weather a significant upsurge in bank failures. The FDIC has all the tools and resources necessary to meet our commitment to insured depositors, which we view as sacred. I do not foresee – as Mr. Evans suggests – that taxpayers may have to foot the bill for a "bailout."
The Independent Community Bankers of America put out a statement Friday saying that its members are disappointed with the decision, and arguing that community banks and regional banks didn’t participate in the high-risk practices of Wall Street, yet they and their customers are being asked to “pay for the sins of Wall Street,” said Camden Fine, president and chief executive officer of the Independent Community Bankers of America, in a prepared statement.
“How ironic that on the same day that Citi is getting its third bailout from the government in six months, community banks are being kicked in the teeth by sharply higher FDIC assessments. The largest financial institutions are the ones that destabilized our economy,” Fine said.
Senate Banking Committee Chairman Christopher Dodd is moving to allow the Federal Deposit Insurance Corp. to temporarily borrow as much as $500 billion from the Treasury Department.
The Connecticut Democrat's effort -- which comes in response to urging from FDIC Chairman Sheila Bair, Federal Reserve Chairman Ben Bernanke and Treasury Secretary Timothy Geithner -- would give the FDIC access to more money to rebuild its fund that insures consumers' deposits, which have been hard hit by a string of bank failures.
Last week, the FDIC proposed raising fees on banks in order to build up its deposit insurance fund, which had just $19 billion at the end of 2008. That idea provoked protests from banks, which said such a burden would worsen their already shaken condition. The Dodd bill, if it becomes law, would represent an alternative source of funding.
Mr. Dodd's bill could also give the FDIC more firepower to help address "systemic risks" in the economy, potentially creating another source of bailout funds in addition to the $700 billion already appropriated by Congress.
[…]
In an interview, she stressed that all insured deposits were already backed by the "full faith and credit of the United States government."
Labels: Financial Meltdown
Labels: Financial Meltdown
Labels: Financial Meltdown
Labels: Financial Meltdown, General Economics
Labels: Financial Meltdown
Labels: Financial Meltdown
