Legacy Loan Program Called Off

New York Times:

The Federal Deposit Insurance Corporation indefinitely postponed a central element of the Obama administration’s bank rescue plan on Wednesday, acknowledging that it could not persuade enough banks to sell off their bad assets. . . .

Many banks have refused to sell their loans, in part because doing so would force them to mark down the value of those loans and book big losses. Even though the government was prepared to prop up prices by offering cheap financing to investors, the prices that banks were demanding have remained far higher than the prices that investors were willing to pay.

I don’t think I’ve ever done this before, but . . . Simon and I, March 24:

The problem in the market today is that the prices demanded by the banks are much higher than the prices that private buyers (hedge funds, private equity firms, sovereign wealth funds) are willing to pay. The government has no way to bring down the banks’ minimum sale prices . . .

The subsidy may not be sweet enough to close the deal. According to one analysis, a specific mortgage-backed security was held on a bank’s books at 97 cents, while its market price was about 38 cents. Even if you limit the buyer’s potential loss to the capital he put in, it’s unlikely he will raise his bid from 38 cents to anything near 97 cents. . . .

Just last week at least some banks wanted to participate in the program – to buy assets from themselves. Once Sheila Bair rejected that idea, I guess they lost interest. Essentially the stress tests placed a big government stamp of approval on their balance sheets, so their current strategy is to wait out the recession and hope the prices of their legacy loans recover. There’s no downside risk, because if the economy gets worse and they ever need to unload those loans, they can count on the plan being resurrected.

I guess we were, however, wrong to worry about inter-bank collusion in the legacy loans program.

(Note that this does not apply to the legacy securities program, which may still be going ahead.)

By James Kwak

29 responses to “Legacy Loan Program Called Off

  1. So instead of continuing with this particular version of rip off the taxpayers now, we wait until all this toxicity explodes again, and rip off the taxpayers later. In the meantime, we’ll play the rigged market and rip people off that way. The house always wins…

  2. I think that if you and many others weren’t worrying about collusion, we probably would have gotten it.

  3. Does this mean PPIP is dead?

    Frankly, if banks were seeing a good deal in snapping up more toxic assets, I think that they’re perhaps not quite as toxic as we were led to believe last fall.

    But then again, these are the banks that loaded up in toxic assets to begin with. So their judgment is askew, at least when it comes to assets such as this.

    Perhaps they are drawn to toxicity like moths to the flame….

  4. James Kwak

    Technically I think it’s on hold, at least the legacy loan program. This news doesn’t affect the legacy security program.

  5. I had a lot of similar thoughts. Feels a lot like Super Siv v5.0 or so. Amazing what a trillion dollars in stimulus, liability guarantees, a super steep yield curve, zero cost funding, etc., etc. can do for a bank. My thoughts here:

    http://investmentlinebacker.blogspot.com/2009/06/ppip-put-on-hold.html

  6. “I don’t think I’ve ever done this before, but…”

    Hee, or perhaps croak. Have you been inducted into The Order of the Shrill yet?

  7. winstongator

    Nearly all the legacy loans that are causing problems will never recover their value. An overwhelming percentage of the properties the loans are against, either homes or commercial, will be foreclosed and the recovery rate will be in the 33% – 50% range.

    They may think that prices may recover somewhat. Consider a $1M loan. Annual interest in the neighborhood of $70k. Mortgage holder not paying. Identical home next door just sold for $500k. Do you go through the fastest FC possible, or do you wait it out? If you think the price would go up to $600k in a year, then you might wait. The lost interest is a real loss that has to be showing up somewhere. It’s a big loss today vs. a smaller loss continuously until the bigger loss comes.

    It will be at least 10 years before that home might sell for $1M again, and many of the homes in FL, it might take longer than that. By that time, the lost interest will more than outweigh any price increase they might get.

  8. Howard Hunt's corpse

    Of course the government has a way to bring down banks’ minimum sale prices. Let them go bust. But then Obama is begging for another bloodless coup like 2000 or 1974, or another not-so-bloodless coup like 1963. The president should go for it. The Secret Service is more competent now, and the kleptocrats are off balance.

  9. winstongator

    Foreclosure is a form of the LLP. Chase owns a $1M mortgage, home gets FC’d. Either at auction or later through REO sale, someone buys for $500k, putting 20% down, Wells funds the new mortgage…a Fannie Mae backed mortgage. Loan is ‘transferred’ from Chase to Wells, with Fannie backing. The process is slower, but price discovery is not by the banks, but by the homebuyers.

    With jumbo rates 1% higher than conforming, I wonder how much of a step-function pricing is happening around the conforming limit.

  10. I don’t have any reasonable expectation the government will investigate all of the double dealing involved in AIG enough to suit me with a rational conclusion to financial industry wide insolvency fed by pulled forward profit taking ‘with the stench of fraud on the streets’.

    Still the complacency of banks to hold on to over priced assets just to ‘stick it to the man’ is the worst kind of big business. The banks should be bankrupt and liquidated, the assets should be moving, and I would imagine all this panic would by causation lead to a bit more than busywork.

    Bad investments will only affect assets classes of valuation less than what $70,000 in the future? Not that everyone is a winner, just that denial is apparently far better ‘at least for the banks’.

  11. Apparently doctors have a bigger problem with getting sued for malpractice than banks.

  12. or ruined or whatever

  13. we_are_toast

    Absolutely correct!

    There were so many obvious ways to game this scheme that many saw collusion as a real possibility.

    Please continue to publicly worry about many of the finance supported schemes being tossed around, and why more reasonable plans to protect the taxpayers are not being considered.

  14. Pingback: Wonk Room » FDIC Confirms Banks Have No Interest In Toxic Asset Plan

  15. I think the central issue to all of these toxic assets plans (reverse auction, public-private) is how to value them when a market for them no longer exists and the market that did exist was too opaque for accurate/efficient pricing.

    As we have seen, any policies that do not lavish gains/advantages to the banks for these assets are non-starters. After all that has transpired, this cannot be surprising. This is the way oligarchs operate.

    The comment that the banks will “wait it out” may be correct but ask yourself “when do greedy people/banks practice patience?”

    I, instead, await some other rent-seeking legislation to further subsidize the banks and accommodate this socialized funding of the wealthy.

    Which leads to another question – Who can blame the poor and middle class for wanting socialism when they see it making the bankers quite wealthy?

    BTW, I am a capitalist!

  16. I’m becoming less optimistic with each passing day that the oligarchy will be broken peacefully.

  17. “Essentially the stress tests placed a big government stamp of approval on their balance sheets, so their current strategy is to wait out the recession and hope the prices of their legacy loans recover. There’s no downside risk, because if the economy gets worse and they ever need to unload those loans, they can count on the plan being resurrected.”

    You are correct. However, the problem is also on the buy end. After all, if the sellers could get their asking price, then they’d sell. Without a Subsidy to buy these assets, balancing the implicit subsidy of government guarantees, no reasonable person would buy these assets. It’s also very true that one can imagine a tax introduced later to get the subsidy back, which is the buyer’s big vocal complaint.

    The big problem is that, now, these assets aren’t distressed enough, compared to other investments. In other words, the buyers can afford to be patient as well. We’re back to where we were before.

  18. James says: “Many banks have refused to sell their loans, in part because doing so would force them to mark down the value of those loans and book big losses.”

    Not an economist, so I’m forced to ask these questions –

    Isn’t the reason Paulson came to Congress in the first place because the value of these loans had dropped dramatically, thus freezing up the financial system from making loans to each other because they had lost so much money from these bad loans?

    What do these toxic loans look like on the books of these banks today? Different than last fall? More than they’re really worth?

    I realize that issues surrounding the pricing of these loans was a reason Paulson backed off his “troubled asset relief” idea and instead handed the bankers tax-funded capital to play with and pay those billions in contractually obligated bonuses – but aren’t the toxic assets being shown at a diminished value on the books today? Is the loss only shown when they sell it?

    (As a consumer, if my house diminishes in value, my net-worth likewise plummets – even if I hang on to the home for dear life. Are the bankers planning to hang on to all this toxicity until the inflated housing prices return? Aren’t people predicting those days of over-inflated housing values are gone for good?)

    Not clear on how this accounting stuff works for the “too big to fail” folks….

  19. winstongator

    The banks cannot wait forever. The troubled loans are nonperforming and the loss of interest payments is a loss today. There is a balance of that loss today with a potential gain, but the lost interest is a real loss.

  20. Pingback: U.S. Program to Help Banks Sell Bad Assets Is Halted « Gary Secondino’s Blog

  21. strike three

    Well I’m glad the FASB (Financial Accounting Standards Board) requires mark-to-market financial statement reporting, and the “Final Four” national accounting firms enforce these rules before they will certify a corporations financial statements after their annual audit, and the S.E.C. brings legal action against the cheaters.

    Just think of what a terrible place the NYSE would be if we didn’t have all these safeguards in place. Why, it would be hard to analyse financial statements and make reliable investment decisions without this.

    Or, what the heck, …. just shuck all that hard work, turm on CNBC in the evenings and watch Jim Cramer on Mad Money. The NASDAQ has made a double bottom, it broke through it’s 200 day moving agerage. Techincians agree. There is a bull rally ahead guaranteed 250 points to the upside. Only a fool would miss this. Buy, buy, buy…. Boo_yah!

    In Cramer We Trust.

  22. Pingback: Top Posts « WordPress.com

  23. This scenario reminds me of that Twilight Zone episode I saw where the girl went through the back of her closet into another dimension…and she found herself in something that looked like a big bubble. She kept calling for help, hoping someone would hear her. The guy who finally heard her was able to determine that she was somewhere “in” the closet, but he couldn’t figure out how to get her back…

  24. Hooray, the PPIP is a dead issue, and so are the banks, who continue to game us on the toxic assets. Sorry, boys, but Congress is not going to bail you out when the bad assets you wouldn’t put on the market for something approaching their real value continue to decline to near zero and cause much greater credit and banking disruption. The next time around, the tax payers will demand that you be broken up, so that there won’t be a repeat performance beyond this fall when you wave the flag of surrender. No doubt about it, the toxicity continues to grow, even as you rely on the results of the bogus half-assed stress tests for consumer confidence and a continuation of business as usual. GM and Chryslers bankruptcies are now verging on a much larger drop in employment and economic slowdown, and you go on fiddling as Rome begins to burn. That’s what good little oligarchs do. The PPIP was a bogus idea to begin with, fraught with great peril and little chance of success. Now there is absolutely no solution available, and that will enable the appropriate outcome to occur. If you hear a loud “PFFFFFFT”, it’s the air going out of the oligarchies balloon.

  25. Pingback: Business Items :: Humid, All Too Humid

  26. The banks are trying to earn their way out. Indeed, the spread has moved even more in their favor recently as interest rates on 10 years rise.

    Remember, that as interest rates rise, the net-present-value of their current loan assets (which are fixed income streams) drops. However this doesn’t matter if you have access to cheap govt. credit (the spread remains the same, and although the net present value of future earnings decreases the nominal value remains positive unless banks are forced to pay more money for deposits). Moreover, if banks can stabilize asset values then they can reduce nominal losses from mortgage defaults while continuing to clean up on loan spreads.

    The REAL subsidies to banks are being generated through the provision of super-cheap credit to banks during a time of scarce credit (thus giving banks market power in raising their lending rates), and the markets now believe that will manifest as an inflation tax. (Who knows whether that will happen or not, but if the markets think it will happen we could see a run on the dollar; the dollar has already lost value against the Euro recently. And certainly, with the number of dollars abroad and the number of people who want to get out of dollars, that run could move quickly if it happens. Or, a lot of people could bet against the dollar and get burned.)

    The refusal of banks to dispose of bad-assets-on-books also returns us to the fear of zombie banks, which suck money out of the economy to fill holes created by non-performing assets. But I don’t think that’s really the risk because there are enough banks willing to lend; I think the risk has now shifted to deep structural problems with the US economy that spent 20 years overinvesting in financial services and other non-productive sectors, combined with fears of inflation, and future costs of entitlement programs that are still not being reformed.

    But right now the markets are focused on inflation. If you listen to Bernanke’s recent speech, and consider the market’s response (a further spike in 10 year rates), you can explain recent activity.

    The danger now is high expectations of inflation (manifested in rising rates) without the actual inflation. The Fed is having trouble threading the needle, partly due to inability to control velocity, and partly due to lack of control over international capital flows.

    The govt. would be better off if they just made a big structural adjustment to banking practices, debt and the money supply (fast). “Once and Done”. The Ortho way. The anticipation is worse than the event itself. But politically, this is very hard.

  27. Also, I would add, after making a big structural adjustment the govt. would need some mechanism to commit itself to not making anymore big adjustments for a very long time.

  28. StatsGuy: “Also, I would add, after making a big structural adjustment the govt. would need some mechanism to commit itself to not making anymore big adjustments for a very long time.”

    The Taiwan gov’t did something like that in the 70s. Faced with high inflation that was uncontrollable by ordinary means, they instituted price controls, upping the price of everything by 75%, and holding the line there. :)

  29. Pingback: Wonk Room » TARP Oversight Panel Member Endorses ‘Semi-Regular’ Stress Tests