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WhaleMu – JP Morgan’s Next Surprise?
Cross-posted from nakedcapitalism.
In an admittedly strange twist of timing JP Morgan
, the same JP Morgan that just announced a surprise $2 billion loss caused by the “London Whale,” became the first and only of 26 banks disclosing subprime investor data to flip me the digital bird, refusing access to the public loan-level performance data for their Washington Mutual loans. WaMu, one of the most reckless subprime lenders, was swallowed whole by JPM and they’re having serious indigestion.
Nelson D. Schwartz and Jessica Silver-Greenberg of the New York Times verify that the purpose of the Chief Investment Office — the London Whale — is to offset risk caused by the Washington Mutual loans:
Under Mr. Dimon’s leadership, the chief investment office — which was responsible for the outsize credit bet — was retooled to make larger bets with the bank’s money, a former employee said. Bank executives said the chief investment office expanded after JPMorgan Chase’s 2008 acquisition of Washington Mutual, which added riskier securities to the company’s portfolio. The idea behind the strategy was to offset that risk.
It isn’t hard to figure out why JP Morgan doesn’t want anybody looking into and through their garbage. I have not been able to ascertain whether these reports are required under disclosure requirement Regulation AB (the law itself seems to say yes, but the experts I spoke to gave divergent readings). Whether they are or aren’t, JPM’s refusal — when everybody else cooperated speaks for itself.
As those loans sour, and they continue to rot like a dead skunk on a hot July day, the bets needed to offset the losses are increasing. It looks like the bank, peering into that portfolio they refuse to share, is becoming more than a little bit desperate. Like a compulsive gambler after a multi-day bender resulting in crippling losses they decided to double down rather than walk away, leading to their current whale of a surprise and likely a mirror-image follow-up for the WaMu losses this was supposed to offset.
For anybody who believes that JPM’s position is normal .. it isn’t. Twenty-six other banks quickly popped open the doors to their repositories, as they’re required to do. Perennial bad-boy Aurora Loan Services is the only other one that’s ignored my requests, though since it looks like they’ve sold their servicing operations the jury’s out whether their silence is purposeful or whether there’s nobody home on the other side of those requests.
Like I said, I’m not sure whether these disclosures are exempt. There are certainly many marked private, but they seem to be overwhelmingly CDOs and similar more exotic or clearly closely held instruments. I’ve never seen an entire series of MBS from an issuer that is exempt: even a few stray WaMu deals that ended up in other repositories are open to the public.
JP Morgan’s insistence that “[t]he site is maintained for JPMorgan Chase RMBS clients,” only, demanding that I include my JP Morgan Chase contact, may be legal but it is unprecedented. In context of their recent trading losses, the knowledge that those losses were to hedge against the WaMu losses, Dimon’s prior comments downplaying both losses, and strong analysis that the WaMu loans are some of the most impaired MBS it’s fair to conclude that JPM is hiding something in the basin of their loan outhouse.
I’ve spent the past couple months holed away downloading MBS data in bulk to enable investors, analysts, academics, government agencies, or whoever else wants to inspect performance information and project losses for every subprime loan trust. When finished, this week hopefully, I’ll have a veritable ABS MRI machine that can peer into the true health of the housing and housing finance market. It’s harder than it sounds: one of those projects where software engineers emerge from their digital caves after months, bleary eyed and long past due for a haircut but holding game-changing technology.
My database, which includes everything except WaMu loans thanks to Jamie, is finally almost finished. But even in preliminary form it is clear that the AAA-rated senior tranches — the ones that really were never supposed to take losses — are toast that’s burning worse by the day. Servicers, trustees, government officials have been doing anything to delay the inevitable losses but when people don’t pay their mortgages, and housing has declined by over 50% in many of their markets, there’s only so much accounting chicanery they can do: the money just isn’t there.
My suspicious are more grounded than tin-hat delusions we’ve been hearing from the housing is hot again crowd. R&R Consulting, a well-regarded structured valuation expert I work closely with conducted a portfolio-wide analysis of undisclosed (“limbo”) losses on RMBS. In a special in-depth report dated February 2012, long before JPM told me piss-off when asking for access to the more granular WaMu loan-level data, they reported that WAMU had the highest limbo loss level–about $810 million—in just one transaction. Repeat: experienced analysts dug this out even without loan level data. It sounds likely that it won’t be long until Dimon reports another ten-figure surprise that I’m sure he’ll apologetically pawn off on the US taxpayer.
For anybody asking “um — isn’t this over — didn’t all this fall apart back in 2008?” the answer is not really. That mega-meltdown was really a mini tremor caused by the lower and smaller tiers of these securities; last time junior visited to stir things up but this time papa’s walking down the street carrying a mean look and a big stick. That’s because the mezzanine level tranches of most bubble-era MBA are either gone or guaranteed to be gone — finally eaten up by current or pending losses — leaving the lower AAA tranches to take their place as the bearer of losses. This was never supposed to happen. Everybody knew that CDOs created from the lower tranches were risky, even if the ratings agencies said otherwise, but nobody thought the meltdown would last this long that the actual top tranches would be nicked. But the data couldn’t be clearer: those bottom level A-class tranches of yesterday are the new bottom level M-class tranches of yesterday.
All this is surprising because these same MBS tranches have been on fire lately. Hedge funds bought them for very little when nobody wanted them — setting their own price — and now they’re selling them back at steep gains because housing is peachy again, never mind the enormous amount of shadow inventory. Hopefully the buyers of these same securities aren’t being set up, again, because nobody would be stupid enough to fall for that same trick, again. Hopefully.
It is these lower tranches and other derivative products, which are by definition exponentially smaller than the more senior securities like the ones JPM is hiding (well, before the banks multiplied them several times over using credit default swaps) that blew up the world economy in 2008.
I’m guessing that it is the inevitable meltdown of what remains of the AAAs (the amount outstanding has been reduced considerably by refis) that has been at the impetus for the housing cheerleaders. By refusing to move their foreclosures forward, then refusing to take title, then refusing to REO those homes, the trusts don’t have to recognize the losses because, ya’ know, the abandoned and dilapidated properties will magically double in value as long as we hold our breath and wish.
My mountain of data that shows loss severity in excess of 100-percent is not uncommon. When we look at the loans, compare similar loans from those who report them more honestly, multiply the average severity by pending reported and, um, overlooked foreclosures, then it becomes clear that the lowest rated AAA’s are toast. This reaffirms the report by R&R Consulting report that $175 billion of loan level losses had not been allocated to the trusts. Whoops!
Jamie Dimon admitted his $2 billion loss “plays right into the hands of a bunch of pundits out there” on his conference call explaining his stinky. Dimon went on to call the losses “egregious” and “self-inflicted.” In light of the London Whale it is clear that when it comes to sky-high risk, like JPM’s WaMu exposure, the bank has adopted an advanced risk management strategy: telling researchers to piss off then hiding.
Fannie & Freddie Signal Congress By Spending $600K at the MBA Convention
Oops, they did it again.
Mortgage Daily News reports Fannie and Freddie spent $600K in Oct., 2011 at the MBA’s annual convention. In 2010 they spent $640K on the same conference and Congress went ballistic. Apparently Fannie, Freddie, and the FHFA thought the outrage of our elected officials warranted a change, so they responded by reducing spending by a whole 6.25%.
I shouldn’t be writing. I’m backed up with arguably the most complicated and important data aggregation project I’ve ever been involved in. When finished I’ll be pushing out chart’s that make CR’s chart fascination look benign.
But I can’t help but to take a few minutes and digitally ink a few words about this.
Fannie Mae and Freddie Mac just stuck up the middle-finger to you, Congress, and to the American’s that you’re supposed to represent. Will you finally do something meaningful about it?
Unlike many I don’t think that Ed DeMarco is evil incarnate. I think that he’s doing his best given the constraints of HERA but he’s dealing with two unruly, entitled, dishonest beasts who hold themselves above the law, who have shown that they can’t be regulated, and who need to be unwound.
Let’s finally change HERA, the law that funds these monsters. Let’s admit we can’t mend it, and finally end it.
It’s time for Congress members to stand, Reagan-style, in front of their headquarters and scream “Fellow members of Congress, tear down these organizations.”
This isn’t a Democrat nor Republican problem: Fannie and Freddie have become the vision of an equal-opportunity contemptuous monster. They’re like the child of parents who bitterly divorced and who later realizes he can play them off one another, listening to neither, while repeatedly spending wildly on their credit-cards then sneering when called out.
Speaking of children, my own son is in a public charter-school math and science program where three years of honors high-school math are required before starting high-school. His class is the first where Hon. Algebra II wasn’t offered in summer-school because of budget cuts, so they took the class online. Teachers confirm that the whole group has struggled substantially more in pre-calc and now calc classes than their predecessors who had a real teacher for what is, for eighth graders, a tough class.
Congress, why don’t we have enough money to fund honors math classes for our brightest kids — the one’s who have proven by working their asses off that they’re the future one-percent types that pay all those taxes — but we do have $180 billion to fund these reckless, worthless, market-destroying organizations.
Here’s a blueprint to burn down Fannie Mae and Freddie Mac:
1. Over 3-6 months auction the portfolio, the loans they own, at whatever the private market is willing to pay. Allow people to “buy” their houses out of the pool at auction value plus a small administrative fee, and the rest go to private investors. Leave the guarantees intact since they’re contractual obligations. If people scream this is “illegal,” that it’s some type of taking, then just stop funding them, call Fannie and Freddie’s own loans when they miss a payment, and allow a bankruptcy judge to do what the Constitution contemplates should be done to bankrupt organizations. Since Fannie and Freddie executives advocate for fast foreclosures I’m sure they’ll be enthusiastic at their own organizations quick liquidation; they can quickly pack and leave, with no severance.
2. Create a new organization to continue the guarantees, albeit on a ramp-down period of 5-8 years until the private market can find it’s footing. That is, for the first 48 months the guarantee program will continue as-is, though with first-loss provisions for originators, then over the next 36 months the maximum volume of guarantees would be reduced by 1/36th of the volume from the first 48 months. Then .. they’re gone; nothing but a bad memory of failed social experiment that caused immeasurable suffering.
That’s it. Loans will be held by private organizations who have shown they have a substantially lower 12-month re-default rate, who are willing to write down principal when they realize it is in their bests interests, and who — while they’re far from perfect — are a lot better than the GSE’s.
Don’t leave them around to “create standards” for new technical infrastructure, their latest gambit. That’s best left to a consortia of private businesses. Plenty of people, myself included, would love to compete for this work by creating private businesses that will do this more competently and even more transparently than the GSE’s, since we’re not exempt from disclosure laws and have to answer to market forces.
With this latest move the GSE’s have set the stage for their own well-deserved execution. Now the question is whether our legislators will have the backbone to do what’s needed. Any legislator, from either party, that won’t cooperate deserves to lose their jobs this fall.
Pro Publica’s Freddie Mac Story .. Remixed
I’ve been working with Alan Boyce and his staff to better understand the ProPublica/NPR Freddie Mac story I criticized along with many other bloggers, Freddie Mac Bets Against American Homeowners.
To reiterate, ProPublica wrote that Freddie Mac kept (or “purchased”, though they really did neither) the IO coupon of newly purchased securities, called inverse floaters. These securities carried relatively steep interest rates, so it appeared that Freddie was aiming to discourage refinancing and place borrowers in “financial jail,” as one borrower put it.
Many bloggers, including me, responded “nonsense” .. there’s nothing wrong or strange about keeping the interest-only portion of newly issued securities; we weren’t even sure if anybody else would be interested in purchasing them.
What really happened is, like most issues affecting housing, more complicated, more sinister, and still entirely (as noted by Pro Publica) entirely legal. It’s arguably the type of deal Freddie was required to enter into under the 2008 Housing and Economic Recovery Act (HERA 2008), which mandates that the GSE’s minimize taxpayer losses.
Background: the GSE’s, Fannie Mae & Freddie Mac
Before explaining let’s review some basics. There are two Government Supported Enterprises, or GSE’s, related to housing, Fannie Mae and Freddie Mac. People who work with them refer to them as Fannie and Freddie, or FMFM though I shy away from the latter. They compete to purchase loans from banks. They do not lend directly to borrowers.
Fannie and Freddie were “private” companies until 2008. Because they were created by the US Government they were able to borrow money at lower rates than other private companies. Their prospectuses explicitly clarified the money they were raising was in no way backed by the US Government, though when they failed this explicit disclaimer was replaced by an “implied guarantee.”
When Fannie and Freddie began to collapse they were seized and back-stopped by the US Government.
There’s an irony that many sub-prime mortgage brokers made a rather explicit guarantee that, say, people could refinance before the interest rate on their adjustable mortgages exploded which were entirely ignored. At the same time, the explicit non-guarantee affecting Fannie and Freddie investors was cast as exactly the opposite.
Fannie and Freddie purchase mortgages from banks, bundle them into “pools,” add a guarantee to loans with less than 80-percent equity, then resell the bundled mortgages to investors. Sometimes they’ll sell only the interest only part of the loan, called IO, sometimes the principal only, called PO, and sometimes both.
At the same time they run what’s essentially an enormous hedge fund, purchasing many of the securities they themselves have guaranteed. That is, one half of the organization bundles mortgages into pools, guarantees them, then sells them to investors which often includes people working in the other half of the organization.
Fannie and Freddie collapsed at the end of the housing bubble and the government swooped-in to rescue them, keeping them “private” but putting them under government “conservatorship” run by regulator Edward DeMarco. To date, they’ve received over $182 billion of corporate welfare and the money keeps flowing.
As mentioned above, DeMarco is bound by HERA 2008; his job is to minimize the losses of the GSE’s to the American taxpayer while still retaining the aim of making houses affordable.
Fannie and Freddie, and DeMarco too, tend to make people’s blood boil across the political spectrum. Some of that is justified; for example, approval of multi-million bonuses for the CEO’s of the GSE’s, refusing to answer Freedom Of Information Act Requests, and ignoring the loan-level reporting requirements in HERA 2008 are indefensible.
But in other ways the conflicting goals of minimizing taxpayer losses — i.e., by making money, or at least losing the minimum possible — and making housing affordable put DeMarco in an impossible situation. For a more detail on how the US ended up in this position Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon by Gretchen Morgenson and Joshua Rosner is the best primer.
The Freddie Inverse Floaters Explained
Inverse floater are mortgage instruments that do best if the borrower does not refinance. I examined the 29 deals Pro Publica used as the basis to their story. What was not clear is that these were not new mortgages; Freddie took mortgages they already owned — that were purchased by their hedge-fund — and rewrote them into new instruments, keeping the interest paying pieces.
Despite that the new securities were created in 2010-2011, they involved $1.23 billion of mortgages written in 2009, $3.68 billion of mortgages written in 2008, $6.61 billion written in 2007 .. even $105 million written in 1995.
That is, Freddie essentially purchased usually old mortgages from themselves and remixed them into new securities where they benefited if borrowers could not refinance to lower interest rates.
Here is a spreadsheet detailing the Freddie Inverse Floaters & Related Instruments.
Freddie started to write these deals on March 1, 2010, though the majority — three times the prior volume — were written between Dec. 1, 2010 and April 1, 2011. That’s important because Freddie increased its “Post Settlement Delivery Fee,” — a junk fee that makes refinancing to a new GSE loan less affordable — on Nov. 22, 2010.
Altogether Freddie wrote $17.19 billion in inverse floaters — instruments where Freddie loses if borrowers refinance — or instruments that function similarly to inverse floaters.
These loans were at relatively high interest rates, most likely from the lowest credit borrowers. For example, the 2006 era loans carry an average interest rate of 6.65%, the 2007 era loans 6.52%, and the 2008 era loans 6.29%.
Principal and interest payments on a $350,000 30-year loan at 6.29% is $2,164/month. At 3% interest the same loan costs $1,476/month, or $689 dollars per month less, so there is an an appreciable difference. Over the life of the loan the higher interest costs a borrower $247,863 extra, money Freddie stands to gain at the expense of their borrowers.
As Pro Publica pointed out, correctly, Freddie stands to lose if people who took out these higher interest payments refinance to lower interest payments. Where they blew it was not breaking down the new instruments, the inverse floaters, into the years that the underlying mortgages came from.
Thanks to DeMarco’s thankless and somewhat schizophrenic mandate, it is not clear whether Freddie and the FHFA did anything wrong or whether the mandate itself — if not the GSE’s — needs to be revisited with the purpose of finally dismantling the GSE’s. Freddie Mac and a host of banker have defended the deals, though I suspect most bankers did not realize Freddie was remixing old loans, not new one’s.
All the confusion, the conflicts of interest, and the grey areas of morality, point to the need to dismantle the GSE’s and push tirelessly to restart the private secondary market, which has essentially vaporized since the financial crisis.
As long as government continues to dominate the lending business, especially with such a conflicted and emotionally charged mandate, the private market — and the discipline putting one’s own money on the line inspires — will never return.
Shadow Houses: Inconsistent government data is baffling
Arguably, the most important factor for the US economy is the number of shadow inventory loans, loans that are now or are likely to wind up in foreclosure.
Economists might argue the US debt matters more, or unemployment, or our trade deficit, but the US economy is driven by the middle-class and, for the overwhelming majority of that same middle-class, their house is their largest asset.
If the value of our homes is being artificially inflated by poor data the psychological effect once the invisible hand steps in to correct those prices could be devastating.
CoreLogic suggests there’s just over a million homes headed for the auction block. If they’re right, which I’m reasonably sure they are not, then we’ll probably be fine: it’d be a great time to buy a house. Laurie Goodman, of Amherst Securities, argues that figure is closer to 11 million homes. If Goodman is correct that same house becomes a terrible investment.
An increase by a factor of ten is referred to as an order of magnitude, so Amherst’s 11 million figure is about an order of magnitude higher than CoreLogic’s 1.2 million estimate. I’ve estimated, in coordination with others (especially Abigail Field), that there are about 9.8 million shadow properties.
As the size of a sample grows the amount of guesswork should shrink, especially if the sample is easily measureable. Estimates about the number of shadow inventory loans, from leading experts, should come nowhere close to differing by an order of magnitude.
It should be easy to compute the total number of houses with mortgages; these are large loans tied to real property. We’re counting elephants, not ants.
My shadow inventory analysis is based upon census data, which uses substantially different base figures than those released by other government agencies and relied upon by analysts as a base. According to the 2010 census, a $13 billion study, there are 76.4 million owner-occupied homes, and 52.2 million which have at least one mortgage.
While that sounds straightforward enough the Office of the Comptroller of the Currency (OCC) reports that there are about the same number of mortgaged homes total for first-lien residential mortgages.
During the real-estate boom it was common for ordinary people to become back-yard real-estate moguls; they’d buy and rent a house or condo or two while the loans were easy and cheap. Predictably, the census reports there are 37.5 million rentals. Further, there are 17 million vacant properties. Since it appears irrational that a person would abandon a property they own outright it’s fair to say that some number of those rentals and a large number of those abandoned properties are mortgaged.
If the OCC has been reporting only owner-occupied houses with mortgages as the total pool of mortgages, and if government agencies and financial analysts have been relying upon this figure, we’re in serious trouble.
When a property hits the auction block it does not matter whether the former owner lived there, rented it out, or even if the property was vacant. At auction, it’s just one more house vying for a limited number of buyers and a limited pool of capital. Increased supply and flat demand mean lower prices.
Something is profoundly wrong when government, consumers, and even the banks are left guessing about the most basic metrics used to gauge economic health.
Data is akin to a map, and the US continues to sail through dangerous waters. We can have intelligent and vehement debates about how we ended up here, and how best to navigate to a more sustainable place. However, the placement of rocks and the depth of the ocean should not be open for debate.
We know that the market for multi-family rentals is booming; constructions starts are up as investors rush to build apartment complexes, despite the high number of vacant properties. This rush to expand rental housing — the willingness of investors and bankers to bet money on an ongoing lack of willingness to purchase homes — speaks louder than the rosier forecasts.
Over the long-run the market is always right: the invisible hand is an unbeatable, unstoppable force of nature that can’t be tricked indefinitely.
Something is amiss if economists, bankers, and consumers have been using a map altered either by incompetence or politics while working in good faith to steer an already injured US economy to safer harbors. Conversely, there’s a different but probably equally dire problem if we spent $13 billion on the census and cannot accurately count the number of houses in the country.
This is a case where, for the sake of the economy, I hope that my analysis is incorrect, though I suspect that I am right. But since releasing those sky-high figures nobody has proffered any explanation, rational or otherwise, refuting the significantly higher figures or explaining the discrepancy.
