Monday, April 23, 2007

Savings & Loan Crisis I

New Century's financing was provided by its warehouse lenders: big investment banks. They pulled the plug once the subprime problem became obvious.

In contrast, the banks and S&L's mortgage portfolios are financed by depositors - owners of savings accounts or CDs. And these depositors needn't worry about what management is doing with their money, since the federal government guarantees that they will be made whole.

"The major indirect cost of deposit insurance comes from its potential to subsidize inefficient types of bank risk-taking. Deposit insurance undermines the incentives of depositors to monitor and police bank risk-taking. This is the problem of moral hazard..." (Kane 2002[pdf])

This problem of moral hazard has occured before:

"Back in the early 1980s when Ronald Reagan deregulated the savings and loan industry, Texas became the nation's biggest cesspool of S&L crookery. At the core of their thieving strategy was a little trick they described thusly: 'A rolling loan gathers no loss.'

"These wily Texas coyotes had figured out a win/win situation. S&L operators could help their buddies "borrow" money from their S&Ls, not pay it back, and still allow the S&L to book loan fees and other profits, upon which the S&L executives based their salaries and bonuses.

"Ah, you say, but wouldn't bank regulators notice that the loans were in default? No. Because each time a loan came due the S&L would "roll it over" -- renew it -- adding all interest due into the new loan and booking it as income. The loans got bigger and bigger, and never got paid off. The bankers got rich, the borrowers got rich, American taxpayers got the bill. A classic Texas "win/win" business deal."

This is from Stephen Pizzo's blog. He is the author of Inside Job: The Looting of America's Savings and Loans. There are a couple of choice pieces from the book:

"Of the 56 banks that failed in the U.S. between 1959 and 1971, 34 had passed their most recent examination in a 'no-problem' category, and 17 of the 34 had been given an 'excellent' rating." (Rep. St Germain, qtd in Pizzo p. 475)

"Buttoned-down appraisers, plugging along in boring jobs... learned that by simply raising their opinion of a property's value to match a borrower's needs or desires, they could raise their own standard of living as well - and the higher the opinion, the bigger the paycheck."

The parallels here are too numerous to count. Decades from now, it will be difficult to remember the difference between S&L Crises I and II.

Meanwhile, while I was on a long road trip and hence not posting, Cramer was pounding the table about these garbage stocks. Anyone who doesn't already know about his track record can look at this previous post.

I didn't make any trades as a result of the rally in these Alt-A stocks. You can look at the data coming in at the Crucial Credit/Housing Sites and see what is really going on.


Anonymous said...

a lot of these loans went into asset backed securities which are usually structured so that the AAA tranche only gets hit if nearly all (90%+)the loans default (and so on for AA, A, BBB, BB rated tranches). No one is claiming that defaults will reach that high, so actual risk is going to depend on how much credit risk they kept - whether they own the AAA tranches or B rated tranches) and how much they sold to hedge funds. Plus, you need to know how much they sold with and without recourse. Banks do not typically break out portfolios by recent credit rating in the 10-K, so there is no way to intelligently gauge their true exposure.
the lack of evididence of non-exposure is not evidence of exposure.

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