Loan mods a failure and turning owners into renters

People will not learn the proper lesson from all this without facing the consequences of their actions. Perhaps more important, others will conclude that there is no consequence because the government will always bail them out.

"They did a lot of harm, because prices were driven up, so people, especially families with young children ... would have to take on unreasonable debt because of bad decisions that other people made."

Why would they HAVE to take on unreasonable debt? That would just be another bad decision.

Let me see... you can't afford to buy, so they let you break your promise to pay, and you pay rent instead.

Then you complain that you aren't building equity?

yes, its so sad that america can't build equity... so lets just start giving it away.

I like the idea of having homeowner payments be limited to 31% of their monthly income for 2-3 years in the case of homeowners who lost their jobs. These homeowners may be fundamentally responsible people who have the misfortune of working in an industry with severe cutbacks such as the newspaper industry. How sad for people who worked for many years for a home to lose everything so quickly.

lobster, 31% of 0 = 0.

Lobster, This makes a great deal of sense, but I can already here the counter-argument that this will limit home ownership and they will argue for "risk based pricing" the code word for writing any loan the market will bear. We need a "know your customer" rule where the borrower should state clearly his risk profile and if the mortgage writes a loan that a "reasonable person" would say goes against that standard the broker loses his license and can get sued. It works on the securities industry. This is no different. Gretchen Morgansen in the Times did a great piece on this about a year or so ago.

The more banks are told they have to cut breaks for this guy and that guy, the more they are going to have to charge the next guy....

"lobster, 31% of 0 = 0."

So there you go.

Until the homeowner finds re-employment.

> would say goes against that standard the broker loses his license and can get sued.

The brokerage industry lobbied hard, and they own congress... which is why brokers do NOT have fiduciary duty. It just has to be "suitable" as in you don't sell the old lady a junk bond.

But they are 100% ok with the broker selling the one with the 5% commission that he keeps.

If thats the standard, we're still screwed.

It might work in the case of a two income family where only one person lost their job. I'm certainly no financial wizard, but I can't imagine that all borrowers should be treated the same. At least let the homeowner get a reprieve for a year or so and hopefully, they can either find other job or sell their home. I'm sure to more sophisticated financial minds than my own will contend that this argument has many flaws, but again giving responsible people a little breathing room shouldn't be so difficult.

I don't see why this idea couldn't work.

Let's say you've lost your job, and your mortgage is $2000/month ... which, while you were working, was only 20% of your gross monthly income.

Now you lose your job and you're forced to live on the $405 per week the New York State Dept. of Labor has generously offered you. Of course, on this income, it's impossible to even pay one month's mortgage, let alone monthly maintenance and ... oh yeah ... FOOD and UTILITIES.

So the bank (after seeing proof of unemployment) provides a forbearance by lowering the monthly payment to 31% of the new income ($502.20), and tacks the remaining monthly balance of $1497.80 onto the back end of the mortgage. A horrible long-term strategy for the mortgage holder, to be sure -- you're now adding interest onto the principal -- but certainly a perfect short-term solution to avoiding foreclosure during unemployment.

In this scenario, everyone wins: the homeowner keeps his home, and the bank not only avoids the inevitable loss of a foreclosure or forced short-sale, but keeps the loan and makes a few bucks off of it by adding interest onto principal for the long term.

I agree that banks should try to work with the borrower as much as they can. I would guess for the most part the banks are already doing that, though I'm sure you'll find examples where they are not. However, I would stop at "forcing" banks to do that or for the government to subsidize such modifications.

"I would guess for the most part the banks are already doing that, though I'm sure you'll find examples where they are not. However, I would stop at "forcing" banks to do that or for the government to subsidize such modifications."

Actually, "for the most part" banks are NOT already doing this. They are holding a whole new set of people facing foreclosure -- the unemployed -- to a restructuring model that works only for the "old" set of people facing foreclosure -- employed people who got in over their heads, but have a steady income to easily service a loan modification.

And there would be no "government subsidizing" whatsoever for what I proposed above.

What I don't understand is why isn't the papers doing stories of the 85% of the population that bought within their means and actually paid of the mortgage? My ain't did it in college parkway md. She didn't heloc to send son to med school. Howz about we show them how 'real' ppl buy 'homes' and pay. By definition anyone losing a home in this economy we pretty fully stretched.

Off and aunt. Damn you Steve jobs

"What I don't understand is why isn't the papers doing stories of the 85% of the population that bought within their means and actually paid of the mortgage? My ain't did it in college parkway md."

How did she pay her mortgage while she was unemployed?

If a borrower still has equity, there's not much incentive for the bank to modify the loan.

If the borrower has no equity left, then the bank will have to make a decision based on a couple of factors.

If the loan will be guaranteed by the government, then it makes sense for them to modify the loan. No one will guarantee a loan unless the risk is of an acceptable level.

If the loan will not be guaranteed by the government, then they have to consider how much they can get back if they foreclose on them NOW vs. having to foreclose on them LATER. In case of the loan being 'deep' underwater, the borrower could walk away. Getting back 70% now is better than getting back 50% later...

It's easier to be charitable to a few, but quite a different story when the number is massive and charity can put your company out of business.

Lmao. Single mother same home 30 yrs, never looked at home as an ATM, shopped at Macy and never owned a pair of prada shoes. Next.

"It's easier to be charitable to a few, but quite a different story when the number is massive and charity can put your company out of business."

Actually, what nearly put most of Wall Street "out of business" last fall wasn't charity but GREED.

The same (unemployed) taxpayers they're trying to kick out of their homes saved their asses.

You're welcome.

wrong as usual. the chinese saved all of us. at least for now.

"Lmao. Single mother same home 30 yrs, never looked at home as an ATM, shopped at Macy and never owned a pair of prada shoes. Next."

You didn't answer the question.

While she was unemployed for an entire year, how did she manage to pay the mortgage on the home she responsibly bought "within her means"?

"giving responsible people a little breathing room shouldn't be so difficult"

Responsible people give themselves breathing room. For example, if there an overpriced item whose resale value is dubious at best, you do not purchase it with a big loan that you can only pay if all goes perfect in your life.

BTW, this money you speak of that you want to loan out for 30 years to a delinquent borrower on an already-underwater asset in hopes that all will be alright doesn't come out of thin air. It is not the bank's money that is lent out, it is the depositors' money (i.e., yours and mine sitting in our checking / savings / money market accounts). The reasonable thing for the deeply-underwater homeowner to do is to walk away, especially if they haven't been paying and their credit score is already in the toilet. If you modify the mortgage, the most reasonable thing for the delinquent homeowner might be to milk that for a while and then simply default at a later time.

I don't know about you, but I do not want my bank deposits put at risk like that. If the people need help with housing, I am happy to help them through tax contributions into government programs and charitable contributions that assist the poor and disfranchised. However, I don't want my bank deposits to be given to the newly-poor to continue living their formerly-rich lifestyles in the hopes that they may some day be able to pay it back. If I want that money at risk, I put it somewhere else.

If you feel differently, then you should take all your savings and put it in an investment vehicle that buys delinquent mortgages and modifies them. You may or may not be rewarded. There are no magic elves at banks with magic money to lend out: it is your money.

"Actually, what nearly put most of Wall Street "out of business" last fall wasn't charity but GREED."

People who live in glass houses should not throw stones, NYCMatt. No question Wall Street greed was a problem, but let's not forget the greed of the bubblicious homebuyers.

"you do not purchase it with a big loan that you can only pay if all goes perfect in your life."

Um, this is how 95% of all Americans have been buying homes since mortgages became widely available in 1934. The only way they could meet their mortgage payments is if they were employed full time. With the exception of people who are financially independent, this is -- and has been -- virtually EVERYBODY.

"The reasonable thing for the deeply-underwater homeowner to do is to walk away, especially if they haven't been paying and their credit score is already in the toilet. "

For the unemployed "underwater" homeowner who can't buy another home (and who can't even get a lease on a rental with no JOB), where are they supposed to "walk away" to? The homeless shelter?

matt---that is complete bullshit. up until recently, people thought long and hard before buying anything and going deeply into debt. still don't understand who you think is going to finance all of the unemployed people who's homes are underwater. back to the chinese?

"Um, this is how 95% of all Americans have been buying homes since mortgages became widely available in 1934."

Not really. First, the idea of a 20%-down loan does not date back to 1934, and the idea of putting less than 20% down is just from the last decade. That 20% buys you a lot of room. Second, it was only in the last decade that the montly-nut-after-tax comparison of buy vs. rent was 2x. I challenge you to find a period of time since 1934 other than the past 10 years where the buy vs. rent discrepancy was that high.

" People who live in glass houses should not throw stones, NYCMatt. No question Wall Street greed was a problem, but let's not forget the greed of the bubblicious homebuyers."

You're right.

Wall Street greed should be punished with a stern tongue-lashing and an infusion of federal funds to ensure the bank not only remains in operation, but continues to pay bonuses to the same irresponsible people who got us into this mess in the first place.

"Bubblicious homebuyer" greed should be punished with foreclosure and homelessness.

it's only fair and just.

You seem to assume that this homeowner can't right their course- can't ever find another job again. So you lose your job and then you lose your house right away. Not everyone makes so much money that they have hundreds of thousands of dollars in savings for a rainy day. Not everyone will eventually default on their mortgage. Yes, if you get seriously ill and blow through your savings, you'll likely default.

"still don't understand who you think is going to finance all of the unemployed people who's homes are underwater."

The homeowners themselves, through a forbearance vis-a-vis interest tacked onto the back of their principal.

but...when they finally walk away, who will pick up the tab for the extra principal and interest that you have tacked on to the original loan?

"Second, it was only in the last decade that the montly-nut-after-tax comparison of buy vs. rent was 2x."

We are not talking about buying versus renting. We are talking about people who bought homes they could afford while they were working.

Please keep your eye on the ball.

"The homeless shelter?"

A) get a friend or relative to co-sign a lease
B) move in with a friend or relative
C) move into a room of a strangers' house as many are having trouble paying the mortgage and could us a boarder
C) get a low-paying job and move into a low-rent place; see other thread about such a place where you were so spiteful towards the people
E) yes, a homeless shelter

What makes the bankrupt homeowner so special?

"A) get a friend or relative to co-sign a lease
B) move in with a friend or relative
C) move into a room of a strangers' house as many are having trouble paying the mortgage and could us a boarder
C) get a low-paying job and move into a low-rent place; see other thread about such a place where you were so spiteful towards the people
E) yes, a homeless shelter"

A) Good luck with that.
B) Good luck with that, especially if you're a single parent. Provided, of course, your relatives live in the same city.
C) Um ... yeah.
D) In case you haven't noticed, we're in a depression. Even "low-paying" jobs are few and far between, and unless that "low-paying job" is full time and pays at least $17/hour, you can't even afford to rent an $850 studio in the Bronx.
E) I'm sorry, but now you're just being a cunt.

"The homeowners themselves, through a forbearance vis-a-vis interest tacked onto the back of their principal."

And where does that money come from? Are you willing to lend that money? It doesn't come out of thin air.

"We are not talking about buying versus renting. We are talking about people who bought homes they could afford while they were working."

Just because you can pay the monthlies on a Ferrari doesn't mean you can afford one. The whole point is really buy vs. rent: if the fundamentals are strong, your risk of being hit with a drop in price (and hence an ability to refinance, take out equity while you're having trouble with payments, sell, etc.) are very low. If the fundamentals are weak, you are screwed.

"Please keep your eye on the ball."

Please take your head out of the sand with respect to buy vs. rent and its relationship to affordability and the ability to bear unforseen hardship.

"And where does that money come from? Are you willing to lend that money? It doesn't come out of thin air."

The same place where the banks are getting their bonus money.

*****

"Just because you can pay the monthlies on a Ferrari doesn't mean you can afford one."

Apples and oranges. Absurd.

"The same place where the banks are getting their bonus money."

For the most part, banks holding the turd are not the ones with the big bonus money to pay out. If you're holding the turd, you're not making money, you're not paying out big bonuses.

How much do you think Citi is paying in bonus to each of 276,000 employees? How many delinquent mortgages do you think they hold? Furthermore, much of the bonuses are in stock, but morgages need cash. Putting aside the issue of your magic elves converting stock grants at GS into cash for Citi, let's talk numbers. Across all the banks, maybe something like $50B will get paid in bonuses. In the last quarter alone, about 5 million mortgages were delinquent. Let's see, that makes for $10K per mortgage. I.e., that money doesn't go very far.

Citibank quite honestly terrifies me. The best thing they can do is stay partners with the govt for as long as possible.

Disclosure; Bought Citi stock at $1.10 and sold at $3. Still think it's worth $2 with the govt., .001 cents without. But that's just moi.

"E) I'm sorry, but now you're just being a cunt."

What do you think makes people go to shelters? What makes the former unemployed homeowner so much more special than "them"? Don't you think they had financial problems? Don't you think they exhausted their other possibilities, like friends and family?

Realize that these people do not have the luxury of a generous $2000/month in unemployment. For many of them, $2000/month was what they made when they were working because didn't have that fancy $17/hour low-income job you're talking about.

"Disclosure: ..."

LOL. I didn't have the guts to touch that turd at $1. Congrats on your bravery.

"For the most part, banks holding the turd are not the ones with the big bonus money to pay out. If you're holding the turd, you're not making money, you're not paying out big bonuses."

Citibank, Bank of America, and Wells Fargo are the largest mortgage lenders in the nation, and they're all reporting PROFITS for this year.

Could you please define "turd"?

"What do you think makes people go to shelters?"

What do you think makes homeless shelters a viable option for ANYONE?

Also, ever considered the fact that many of these people actually deserve the bonus? Why is it so hard for some to understand that the bonus is just part of their total negotiated compensation based on specific individual and firm wide performance criteria. Do people really believe that waiters should not get a tip because the chef screw up the order? Do people really say that waiters get a salary, therefore they should not get a tip (bonus?)?

"Also, ever considered the fact that many of these people actually deserve the bonus? Why is it so hard for some to understand that the bonus is just part of their total negotiated compensation based on specific individual and firm wide performance criteria. Do people really believe that waiters should not get a tip because the chef screw up the order? Do people really say that waiters get a salary, therefore they should not get a tip (bonus?)?"

Comparing a banker with a $1 million base salary to a waiter getting $2.75 per HOUR is absolutely insane.

"B) Good luck with that, especially if you're a single parent. Provided, of course, your relatives live in the same city.
C) move into a room of a strangers' house as many are having trouble paying the mortgage and could us a boarder"

"B) move in with a friend or relative
C) Um ... yeah."

For the record, I had a girlfriend way back when whose mom rented a couple of rooms for the two of them in someone else's house. Hadn't even thought about it as a "thing" until your abhorrence to living with someone else as a single parent came up. She wasn't unemployed, wasn't really poor either. That's just how they lived because that's what they could afford. That's life at $2000-3000/month. Not the end of the world.

Excuse me.

$4.65 per hour for wait staff and only HALF a million for bankers.

Wow, we've really bridged the gap now!

inonada

LOL. I won't lie, it wasn't easy!
I thought it was a lottery ticket. Either going to zero or something substancially up.
I am generally the kiss of death when it comes to stocks.

"For the record, I had a girlfriend way back when whose mom rented a couple of rooms for the two of them in someone else's house. Hadn't even thought about it as a "thing" until your abhorrence to living with someone else as a single parent came up. She wasn't unemployed, wasn't really poor either. That's just how they lived because that's what they could afford. That's life at $2000-3000/month."

Aw, that's sweet.

Now tell me how it works on $1620 per month today in New York City. How many landlords do you know would accept unemployment compensation as "income" for the purposes of being able to pay rent?

"Could you please define "turd"?"

A "turd" is any mortgage underwritten in the past several years. It is a "turd" because it is a highly-leveraged loan on an asset whose fundamental value is lower than the loan amount. The best possible outcome on the "turd" is that homeowners keep paying in the hopes that the underlying asset somehow defies the fundamental value.

"they're all reporting PROFITS for this year."

Why yes they are. Their book values are also above their market caps. If you actually believe those profits are meaningful of anything other than the government assisting the banks through aid and accounting changes so that they can "earn" their way out of this mess, then you should buy some Citi at $3. I believe truthskr10 will sell you some.

"The best possible outcome on the "turd" is that homeowners keep paying in the hopes that the underlying asset somehow defies the fundamental value."

Or that real estate prices turn around, like they always do.

"Now tell me how it works on $1620 per month today in New York City. How many landlords do you know would accept unemployment compensation as "income" for the purposes of being able to pay rent?"

Edna out in Medford for $309/month sounds nice:

http://newyork.craigslist.org/lgi/roo/1517817129.html

Also, I know the math can be tough, but there are 4.33 weeks in a month. That amounts to $1755 a month, not $1620. I know $135 may not sound like much to you, but when you're trying to make it on that amount, it makes a big difference.

BTW, have you ever lived on $1755/month?

"Or that real estate prices turn around, like they always do."

Yes, that's what I meant when I said "in the hopes that the underlying asset somehow defies the fundamental value". No question that every house ever sold will be of higher value some indefinite time in the future: such is the nature of fiat currency and engineered inflationary policy. It's also why you pay interest to borrow money.

Every person who works in a bank is not a banker and not every banker is responsible for the bad decision of other bankers, especially those from totally different business lines within a bank.

An employment contract should be valid regardless of whether the total compensation is $10K or $10 million.

For the record, I am not a banker.

If brain surgeons at a hospital get careless and cause the death of some patients, do you cut the total compensation of heart surgeons at the same hospital? Do you start saying all hospitals and all doctors, nurses are evil?

unfortunately, i don't think the answer to your question is that simple. depends a lot on the numbers involved....if a hospital gets a reputation based on a small fraction of its procedures going bad, it can present a significant problem.

My point is about how the heart surgeons should be treated when the brain surgeons caused the problem. Yes, the hospital could end up going bankrupt. They might close down the brain surgery practice and do cuts in services. They might have to lower the overall pay for everyone the following year, but you don't cut half (or more) of the heart surgeon's pay because the brain surgeons screwed up.

fair enough.

"Every person who works in a bank is not a banker and not every banker is responsible for the bad decision of other bankers, especially those from totally different business lines within a bank."

Sunday, your argument is missing a fundamental issue with banks.

First, the level of risk taken by the different business within a bank stem are commesurate with the aggregate capital and profitability of the bank. I.e., if those business lines were separate businesses with separate capital, then the risk taken by each business line would be significantly less, and the profits would be less in each business line. Hence, when one part of the bank blows up, the whole bank needs to suffer. The idea of "separate business lines" is false because each of those business lines is dependent on the capital and earnings of the other business lines to take the risks they take. As such, the pain from losses need to be shared. The attitude of "my corner of the bank made $X this year, so I'm entitled to 50% of that regardless of what's happening to the other corner of the bank or what happened to me last year when I lost a bizillion dollars" is the symptomatic of the sense of entitlement that some bankers have.

Second, banks have a special place in the economy and are offered certain protections by the taxpayer. The fundamental role of a bank is to borrow on margin (short-term money from depositors) and use that to buy out on long-term assets. However, when the long-term asset values fall and depositors issue a margin call on the bank by pulling their money, the bank does not go bankrupt: the government steps in and makes everyone whole in order to save the economy from a downward spiral. Because of this implicit protection, banks enjoy the ability to borrow money at lower rates and take higher risks for that borrowed money. Again, the attitude of "I am owed 50% of whatever I made" ignores the fact that the money made is based on risk whose negative outcomes are not felt by the one taking the risk, but rather by the taxpayer.

Bad example, the public sees some benefit from hostpitals and surgeons.

"My point is about how the heart surgeons should be treated when the brain surgeons caused the problem. Yes, the hospital could end up going bankrupt. They might close down the brain surgery practice and do cuts in services. They might have to lower the overall pay for everyone the following year, but you don't cut half (or more) of the heart surgeon's pay because the brain surgeons screwed up."

The analogy here would be that if you closed the brian surgery unit, then the heart surgeons could only do half as many heart surgeries. Clearly not the case with surgery, but it is the case with different business lines in banking.

ChasingWamus, If you truly believe banks do not provide a valuable service that benefits at least as many people as hospitals and surgeons, then we're too far apart to have a healthy discussion on this topic.

inonada, I do believe the performance of the overall firm effect everyone, note my earlier post where I noted '...part of their total negotiated compensation based on specific individual and firm wide performance criteria.'

Many banks are allowed to fail.

Sunday, fair enough. I'll leave it with a quote from Paul Volcker:

Mr. Volcker’s favorite financial innovation of the past 25 years? The ATM. “It really helps people, it’s useful.”

http://blogs.wsj.com/marketbeat/2009/12/08/volcker-praises-the-atm-blasts-finance-execs-experts/

Have to agree. The big money center banks over charge for basic services and provide uncompetitive rates of interest. They are the best advocate for disinter mediation out there.

"Many banks are allowed to fail."

You're kidding. Bear, Wamu, Wachovia, Merrill, Citi, BofA, AIG, Freddie, Fannie all had big gaping holes in their balance sheets that were plugged by the taxpayer. They all were effectively insolvent; with no private party willing to buy them because they owed more than they had. If they were allowed to fail, equity would have been wiped out, and creditors would have been paid only a fraction of what they were owed. An example of a creditor would be you, if you had a deposit at the bank.

"part of their total negotiated compensation based on specific individual and firm wide performance criteria."

The banks' mouths are writing checks their balance sheets can't cash. Suppose I'm a bank, and if I hire you, I have a 50% chance of making a bizillion dollars and a 50% chance of losing a bizillion dollars, and I need a bizillion dollars to make the bet. So I borrow some money from creditors (depositors and other sources) to make the bizillion dollar bet. The creditors are happy to lend me the bizillion dollars because they know if it gets lost, then Uncle Sam will step in to plug the balance sheet with a bizillion dollars of taxpayer money, and the creditors will remain whole. So as the bank, I have a free option to make a bizillion dollars with a 50% chance. The creditors are safe. So what do I do? I write you a contract that says I'll pay you some fraction of the bizillion dollars.

See the problem?

The thing I think you are missing with "I do believe the performance of the overall firm effect everyone" is that a single business line can lose more than the entire capital base of the bank. Suppose a bank has $10B of capital and 10 business lines. Each of the business lines will make a $20B bet using $1B of bank capital and $19B of depositor capital so that a total of $200B of bets are made. Say 5 of the business lines drop 40%, and 5 of them go up 20%. You got a $20B loss on your hands, $10B more than the capital you have, yet you got 5 that are up are saying "pay me"? Add to that the fact that the $10B hole is going to be plugged by John Q. Taxpayer, and then you gotta ask yourself what gives the bank the right to write such a contract?

Don't get me wrong here: I think much of the vitriol directed at banks and bonuses is misguided. In particular, I don't understand why so much hate is directed at GS since they were not making stupid bets (thought they were certainly intermediating them). In terms of people who gamed the system the worst in terms of using the implicit government guarantee for personal compensation, GS is probably last on my list.

However, we have a perverse system where the banker gets the upside and the taxpayer (and not the shareholder or creditor) gets the downside. That needs to be fixed. Suppose you worked at Citi in 2005, and you were smart/responsible/whatever, so you either said "let's stop making bets on housing going up" or even "let's bet against it". Do you think you ever got paid? Nope. As long as housing went up, you were wrong, and once housing went down, there was no money left. There was no incentive at an institutional level to manage risk properly.

inonada, over a hundred banks were allowed to fail this year. Depositors are protected by the FDIC insurance. The banks pays for the insurance. That insurance premium has probably gone up quite a bit.

The government did not "give" money away to every bank. They were "forced" to make 'invest' in some of these banks. They even made money on some of those investments. Other investors who invested in these banks before the melt down are the ones who lost tons of money. All bank employees holding stock and stock options also lost tons of money when the stock price tanked because of losses and dilution of the company stock. Also keep in mind that some banks were 'forced' to take those investments from the government whether they wanted it or not.

" I don't understand why so much hate is directed at GS since they were not making stupid bets (thought they were certainly intermediating them)."

GS ... with Hank Paulson at the helm ... is where the notion of securitizing mortgages was born.

From there, everything went downhill.

Inonada,
Goldman is being used as an example. It's not really about GOLDMAN.
That said, they were allowed to convert to a bank holding company and enjoy the same benefits as your neighborhood bank even though you can't buy a Goldman checking account or walk into a branch and buy a CD. If you look at their hedges(ABACUS CDO). They needed a housing collapse to benefit. I think the following is a bit over the top, but it's worth a look anyway.

http://dailybail.com/home/janet-tavakoli-wonders-did-friedman-paulson-geithner-conspir.html

NYCMATT.
I would have laughed my ass off and applauded Goldman's moves if they were a mere hedge fund. But as a deemed too important to fail major finanical firm, I feel otherwise.

"Also keep in mind that some banks were 'forced' to take those investments from the government whether they wanted it or not."

Sunday, no question about the TARP money that was shoved down the throats of the GSs and JPMs of the banks. They certainly got benefits from the bailout, and the taxpayer made money on those investments.

Two things, though. First, in aggregate, the taxpayer is going to lose money. The holes in AIG, Freddie, and Fannie are so deep that they make the few billion made on the "good" banks look like chump change. Second, you incorrectly equate "eventually making money" with not "giving away money". Suppose I got $1000 to my name, and I use this to margin and buy $1M of S&P 500. When S&P drops a bit, I'm out of margin. However, rather than going belly-up, I borrow money from Uncle Sam at 1%. I keep borrowing money until S&P comes back, which can take years or decades, and it eventually comes back. Heck, I even eventually make big money on my levered bet because S&P risk premium is higher than 1%. I pay Uncle Sam back the money owed plus a little kicker. We then declare Uncle Sam "made money".

The real question you should be asking is why Uncle Sam simply didn't take the money and put it in S&P. It was taking all the downside risk, but got limited benefits in its upside risk. Ask any banker worth their salt, and they will tell you that Uncle Sam got a "bad deal" in its "investments". There is a reason for this, and it's not because Uncle Sam is stupid.

The real story here is that in order to save the economy, Uncle Sam had to give money away to the banks. It stinks, but if you don't want the entire economy to crash, you have to hold your nose and do it. However, giving money away to the banks openly is fraught with political problems. Take the "fallout" you are seeing today and multiply by 100 if you want to get a sense of the outrage if the giveaway was done openly. So you have to wait until the stink becomes so apparent to everyone (e.g., let Lehman go belly-up) that the option of giving away money becomes politically viable (i.e., Ben and Hank give Congress the come-to-Jesus speech). Then, you're not stupid about it. You give away money through a bizillion hidden routes. That way, arguments of "giving away money to save the evil bankers" can be tempered by statements like "they even made money on some of those investments".

This issue is classic Keynes, and this line of thinking is present very high up in the Obama administration. They are also keenly aware of the perverse incentive structure it creates, hence the desire to push through regulations to deal with the systemic risk.

"GS ... with Hank Paulson at the helm ... is where the notion of securitizing mortgages was born."

No need to use expletives every time NYCMatt makes a wrong statement, CC. Were everyone to do that, we'd see 18 expletives after every other NYCMatt post.

NYCMatt, this is wrong on pretty much all levels. Why don't you take a moment to search the web on the history of mortgage securitization and tell us when and who invented mortgage securitization?

The real story here is that in order to save the economy, Uncle Sam had to give money away to the banks. It stinks, but if you don't want the entire economy to crash, you have to hold your nose and do it.

That's what Larry Summers & Tim Geither believe. The better answer would have been not to bail out the bond holders of the banks. Nothing the government did encouraged lending, and savers got hurt through lower interest on their money. The plan was to create more big banks and not solve the too big to fail dilemna.

Paul Volcker is right, but nobody wants to listen to him.

"That's what Larry Summers & Tim Geither believe."

No argument there; that's why we saw the actions we saw. That's their school of thought, and it's not obviously wrong.

"Paul Volcker is right, but nobody wants to listen to him."

That's because Volcker is bad-azz. This is the guy who crushed the U.S. economy to stamp out inflation because he believes that hard medicine for curing the long-term is the way to go irrespective of the short-term consequences. Maybe he's right: he did set the stage for 25 years of tempered inflation expectations and the economic growth that ensued. However, it could be argued that this tempered inflation environment with its low interest rates fueled the bubbles.

So Volcker is looking at the long-term, but in the words of Yoda: "hard to see the future is - cloudy is the dark side".

Inonada, Agree much I do.

good luck to you.

merry kawaanza, happy shalom allz.

Sunday, (why not monday... damn... run on brain). I'm shooting from hip, but read in a financial rag many years ago that financial intermediation was 2-3% of the economy, with this bubble it is like 10-12%. So it begs the question did our "real" economy all of a sudden need 4x financial intermediation? Or was the 4x just a reflection of housing bubble and ppl willingness/ability to heloc themselves to ever higher levels of consumption based on bubble assets?

Having said that... the 2 greatest drivers of bank Income over the last 10 yrs was the derivatives mkt and mortgage papering (I believe it was greater than 50% at some shops). So here is the deal, derivatives mkt was supposed to DECREASE risk, mortgage securitization was supposed to make an illiquid asset a liquid one, except when it isn't. One other point, as so eloquently pointed out by ikowsomething.... the WHOLE point of a banker is to borrow short and lend long (intermediation) and run CREDIT (i.e. get capital back plus interest).. if you can alleviate the need to reserve capital by buying a derivative, why pay a salary?

Derivative market did not decrease risk it hid the risk. Before swaps you saw the risk you knew where it was. After you weren't so sure.

I don't know why I ended up being the defender the banking industry when I only intended to defend the rights of the employees. In any case, whether you agree or disagree with the idea that some banks are too big to fail, going through the reasoning shows the important role the retail/commercial/investment banks play in our daily lives and that of the companies we work for. Yes, some changes are necessary to make them better. The banking system does more good than harm and the people who work for them are not evil and deserve to be treated fairly and legally. The banks and their employees are not any more greedy than any other average business and their employees.

is it the gun or the person that uses it? derivatives in thier many different forms have valuable uses.

Interesting, 91 comments, not a single one from me, and look at columbiacounty and alamefart going at it.

We've had this discussion before.
A bank enters into a $500,000,000 default swap with a firm holding $50,000,000 in capital and then gets a regulator to reduce risk capital by 80%. Another firm can't sell enough subprime mortgages backed CDO's to satisfy demand so they write a default swap hedge make housing bet and treat their clients as counter-parties. The banks create a monopoly in selling of CDS and make huge profits because they have inside information on positions.
I haven't heard of many "good" uses.

Not a single comment, but ten.

Eleven.

alanhart
3 minutes ago
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Not a single comment, but ten.

Am I also ph41? nopigorshrimp? Newman?

Sunday... I agree, it's not the person I am against. Look i have re broker friends over for my kids bday, and I go to my son's friend bday parties whose parents are Re brokers... it's not personal... 4x in 10 yrs... as surely as there was a bubble in RE, there was one in banking and so too in media and construction..... we all fed off the bubble... WE CAN't GET TO NORMAL.. .w/o some culling.. .the faster the better IMHO.

hi hfscomm1

Im too tired to pull apart the gibberish you just spewed. Ill revist you tomorrow. but just a quick point to the upside..what about the many institutions who bought cds and protected thier clients from corp. defaults? without cds they would have been left with a bag of hammers

Why not just sell the bad position?

Why not just sell the bad position?

its called jump risk my friend

w67, I guess you're more agreeable on "hump" days...

"I don't know why I ended up being the defender the banking industry when I only intended to defend the rights of the employees. In any case, whether you agree or disagree with the idea that some banks are too big to fail, going through the reasoning shows the important role the retail/commercial/investment banks play in our daily lives and that of the companies we work for. Yes, some changes are necessary to make them better. The banking system does more good than harm and the people who work for them are not evil and deserve to be treated fairly and legally. The banks and their employees are not any more greedy than any other average business and their employees."

There is a system to be gamed, and clearly many bankers (i.e., the employees) have been gaming the system. For the most part, they don't even know they're involved in gaming the system. They just say "well, my corner of the bank made money, I didn't blow up the bank, pay me". That is part of the gaming of the system. The management is complicit in gaming the system because they know how it is, or because they are too stupid to realize the risks they are taking because they're too busy playing bridge and smoking weed. Or else, they're to arrogant to cash in their chips when they are down. The fact that the bankers do not understand the relationship between the attitude of "my corner made money" and issues that economic mess that we went through is what the sense of entitlement is about.

I'm certainly not saying that people shouldn't be dealt with fairly and legally, but it is the fairness of the existing system that I question. And who is standing in the way of the changes necessary to make the system better? The bankers, of course. And who are these bankers? They are the stinkin' employees of the bank. I don't see how you separate some guy making a million dollars a year from the institution he works for. It's not like we're talking about the janitors.

And for the record, I do hold an appreciable amount of bank shares, and I'm all for profitable banks, the value they bring to an economy, and fair (and high) compensation. What I'm not for is a system that compensates stupid risk-taking at the expense of everyone else. Unfortunately, that's the system we got at the moment, and that's what needs to be fixed.

Well, it's only call 'stupid risk-taking' in the years that the company lose money... I think it was more due to a miscalculation of the level of risk involved. A huge mistake, yes. I am somewhat familiar with how people in risk management roles can be pressured to twist the formulas to make things seem much less risky than it really is. The number of employees in a bank responsible for such decisions are not that many. Yes, there should be better checks and balances, but it's a bit extreme to classify all banks as having a pattern of 'stupid risk-taking.' Yes, they take risk, because they are expected to. I remember some banks were given a hard time about not taking enough risk not too long ago.

Why not just sell the bad position?

its called jump risk my friend

I hear you, but I don't believe this is what's really going on. Entering into a CDS "hedge?" creates an interesting asymmetric profile. You cap your downside, give up some upside while retaining most of it and engage in risk based capital arbitrage.

....Companies that have the CDS hedge on no longer are interested in a work-out with the company. And many firms by a swap as a way of speculating on the failure of a company instead of shorting the stock because it's more of a shadow market(hedge funds love that!)

"Well, it's only call 'stupid risk-taking' in the years that the company lose money"

Not really. It's that kind of attitude that is problematic. Suppose I'm selling $1 lottery tickets that have a 1-in-a-billion chance to pay out $2 billion. I sell 100 million tickets a year, and most years I book a $100M profit, until of course the year it blows up and I owe $2 billion. Was the risk-taking stupid just in the year it blew up? No, it was stupid every single year. If you think that example is not realistic, then you don't understand the nature of these markets.

"I am somewhat familiar with how people in risk management roles can be pressured to twist the formulas to make things seem much less risky than it really is."

The idea that risk management is a separate role in a company, people who approve risk-taking, is fundamentally flawed. The most important job of a financial firm's top management is risk management, so if a firm is doing what it's supposed to be doing, you cannot twist the arm of risk management. I'm sorry, but having some risk group approve the trades of some traders is not risk management. Risk management needs to be integrated from the traders themselves all the way up. The past 2 years are littered with institutions that do not understand this (e.g., AIG) vs. companies that do (e.g., GS). When all is great, you don't can't tell the difference. When the crap hits the proverbial fan, the former get wiped out while the latter flourish.

I agree ionada, but I would not focus on AIG & GS as the examples
AIG may have intentionally entered into bad trades.
G.S. used its customers as a risk management tool. This takes it too far.