I posted back in July to the effect that
money is IMPORTANT and should not be played
with. I said then that we need experts, or
maybe we need non-experts, to tell us what
financial practices serve a useful social
purpose. I can think of a few — insurance
of tangible goods, mortgage loans, other
kinds of loans for business startups or
for business development — but my list
doesn’t reach as far as securitizations
in the Blackian sense(Bill Black called this
process fraud pure and simple, right?),
credit default swaps, and derivatives.
(What is “notional value”, anyway?)

Again: money is important, and games, defined
as financial actions with no social value,
should not be played with it. And so I
ask the knowledgeable on this E-list: what
financial activities are of social value.
(I don’t include financing golf clubs and
yacht basins in Greenwich CT as having
social value!)

Best wishes,

Alan McConnell in Silver Spring

http://blogsandwikis.bentley.edu/themoneyillusion/?p=2499#comment-8307

http://www.federalreserve.gov/boarddocs/snloansurvey/

and notably the January report

http://www.federalreserve.gov/boarddocs/snloansurvey/200902/fullreport.pdf

This contains results from senior loan officers at major FDIC insured banks. He notes that when asked why they were not making loans, they got the following responses:

A. “Possible reasons for tightening credit”
a. current or expected capital position (Not Important 73.5%)
b. less favorable economic conditions (Very Important 71.4%)
h. current or expected liquidity position (Not Important 87.8%)

Note the LAST – nearly 90% said their current or expected liquidity position was not important. Nearly 75% said capital position not important.

In other words, the entire “banks need better balance sheets to make loans” explanation of the crisis (which was the justification for the TARP infusions) is limited – certainly it explained some of the crisis. But by January, most banks had plenty of their OWN money to lend, yet didn’t want to lend it to the same class of borrowers whom they previously supported…

The so-called “breakdown” of the credit securitization markets reflects a return to reality…

In a sense, credit securities buyers are asking the obvious question: If banks (who have private information) are so eager to sell it, then why should I be so eager to buy it? In the presence of that level of information asymmetry, no market can function.

And that is why banks existed in the first place!

In terms of real lending constraints by banks, consider these points:

1) If banks really needed the capital to make loans, why are they so eager to pay back TARP?

2) Why are banks currently sitting on the mother of all mountains of reserves?

Proverbs 11:15 He who is surety for a stranger will suffer, But one who hates being surety is secure.

I see the same response in the financial community. Like the addicts we should put them in rehab, that is, take away all support, FED and otherwise, and let them try to find a new way or die trying. TARP was just a way to postpone the DT’s, and the FED will stop soon, because they can’t go on being the securities purchaser of last resort. Not only is it unhealthy, but it could be fatal, not only for the lenders, but for the global economy.

Really?

What we have is banks, who know there are no credit-worthy borrowers, unable to sell securities to investors who have just found out that, over the last twenty years, banks have shopped out all the credit-worthy borrowers and have been passing loans off to people with no hope of paying them back. The investors, quite correctly, don’t feel like playing this game anymore.

If the banks want to hedge their loans, let them buy insurance from someone who can audit their books and, apparently, better asses the risks of loans than they can.

I can see securitization starting back up once the fraud convictions start rolling in on the rating agencies and investment banks who slopped out sh*t as triplety-A plus rated paper. Till then, well:

http://2.bp.blogspot.com/_pMscxxELHEg/SqArWZUi5eI/AAAAAAAAGSA/BbnOub6fGXg/s1600-h/FedAssetsSept09.jpg

Trust is a hell of a thing to get back, once it’s lost.

Cheers,
Carson

I wonder if it also corresponds to the conversion of the investment banks to publicly held companies? (I don’t really know…)

- Banks don’t want to lend to real people – originate it and sell it is much easier and much much more profitable.
- Banks don’t know how to lend: The people who used to do this – 10 or 15 years ago – have gone away. The staff is new. See above.

You will, however, need a better book-keeping framework to track the value invested and the rights assigned.

First of all, for much of the outstanding non-prime loans, much of the credit information needed to value the loans is not available to investors, and there are many privacy issues since what you really need is information related to other debt held by the same borrower (e.g. credit cards, auto loans, etc.)

Also, the underwriting standards are all over the place depending on what vintage you look at. It’s pretty naive to assume that being able to track something via an ID is sufficient for doing anything useful except accounting and some really basic credit metrics.

The structure of the securities is an issue to some extent, but again, if you can’t reasonable approximate future loan cashflows you are screwed.

Then the banks changed the game. As underwriting dropped off the table, and residential real estate losses mounted, volume in the secondary market for securitized loans plummeted. This environment offered an interesting trade. By selling a tiny sliver of a specific security (say a senior loan secured by hard assets worth around 70% of the outstanding debt) at a severely depressed price (say 15 cents on the dollar) a bank could force margin calls on investors who had borrowed money to buy the loan. Some investors in specific issues would find themselves unable to meet the calls, and they would hand their portfolios over to the banks. 100% loss. Of course, the investors’ models had not accounted for performing loans trading significantly below their recovery value, and, in fact, no real holders of the assets were willing to sell them at those prices. But the banks were– in very small amounts. And they expected the majority of those loans to return to par. Oh well. Mark to market. Those are the breaks. This is Capitalist America, friend, not Communist China.

Any sentient investor would attach a higher discount factor to future securitized loan purchases after this experience– more because many are disinclined to lean heavily on unreliable, private portfolio leverage… Trust was important to this marketplace, and it should be gone (of course, many things that should be true are not…).