American Banker  |  Tuesday, August 11, 2009

By Aleksandrs Rozens

Henry Kaufman_Kaufman has never been a fan of floating-rate financing, and to illustrate why, he related an anecdote about Alan Greenspan.

The former Federal Reserve chairman famously suggested in 2004 that some families might save money by opting for adjustable-rate mortgages. In an interview at his Midtown Manhattan office last week, Kaufman, the renowned economist and a longtime critic of the Fed and its response to the credit crisis, recalled asking Greenspan about his tacit advocacy of floating-rate financing.

“He blurted out, ‘Well, I guess I said that, but in my own housing finance I have always used the fixed rate,’ ” Kaufman said.

As everyone in the industry now knows, in the current maelstrom many homeowners have been trapped in mortgages with higher rates because they wrongly expected to be able to readily refinance out of one ARM into another.

But Kaufman, 81, has been wary of floating-rate loans since the 1980s.

“My first concern then was that floating financing rates would take commercial banks out of the credit-restraint process,” he said. “When it comes to floating-rate financing, the only sector that can really pay the floating rate is the federal government because it can always raise taxes.”

Kaufman is a former economist with the Fed and the former vice chairman and head of research at Salomon Brothers. He has been referred to as Dr. Doom long before Nouriel Roubini earned the sobriquet.

One of his criticisms of the Fed is that like other regulators, it has been too chummy with financial services firms.

“The supervisor and the regulator cannot be a folk hero. He can’t be a friend of financial institutions and markets,” Kaufman said. “Good supervisors and regulators are like parents to a child. They are not friends. They are guardians who expect the child to adhere to certain standards of behavior.”

Greenspan, Kaufman said, “was not a good parent.”

Kaufman’s belief that the Fed may have to offer some tough love and behave more like a parent crops up in his latest book, “The Road to Financial Reformation: Warnings, Consequences, Reforms.” In it he republishes a series of essays warning about the dangers of debt for corporations and consumers that were first delivered in the mid-1980s.

As part of his tough-love approach, Kaufman is no fan of the Fed’s gradualism — the practice of not aggressively raising rates by increments of 100 basis points and resorting to quarter-point or half-point rate increases when putting the brakes on the economy.

That approach, he said, “doesn’t restrain anyone in the financial system. The financial system arbitrages that.”

When it comes to the current head of the Fed, Ben Bernanke, Kaufman was more charitable: “He is somebody who studied the Great Depression at great length, but it took him quite a while before he recognized the extraordinary problem in the financial markets. He did not come and meet this problem head-on. He met it belatedly.”

Kaufman said he believes securitization is here to stay but that it will be more closely regulated when it returns. Leveraged buyouts “will not come back quickly to the level we attained three or four or five years ago,” he said.

LBOs have been an important tool for financiers since the 1980s, but Kaufman has never been a proponent. “The most important aspect of many LBOs were financial considerations,” he said, adding that his skepticism about them was rooted in “the very simple reason it operated on the assumption that the entity that was going to be acquired was going to have a thin sliver of equity and huge amount of debt.”

Kaufman said the U.S. economy remains fragile in spite of some positive signs because bank lending is still limited. With the recent gains in U.S. stock prices as well as improved credit market conditions, he also worries that lawmakers and regulators may not have the stomach to go through with reforms in banking and financial markets.

“I am a little fearful that if equity markets continue to rally … the fervor to restructure the financial system will diminish,” Kaufman said.

Aleksandrs Rozens is the managing editor of Investment Dealers’ Digest.

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By Heather Landy
The Financial Accounting Standards Board took plenty of heat in April for loosening mark-to-market guidelines, a move that critics assailed as a gift to the financial industry and a nod to political pressures.

The FASB’s latest idea, however, if seen to completion, would go a long way toward silencing accusations that the rulemakers have gone soft on banks.

Under consideration: an unprecedented proposal to vastly widen the use of mark-to-market accounting, so that it becomes the default method for valuing financial instruments, including loans that banks plan to hold to maturity. If adopted, the rule could set off a new wave of writedowns at a time when investor confidence in banks is fragile at best.

Proponents say that stricter use of mark-to-market would simplify accounting rules and give investors a clearer picture of companies’ financial health. The opposition, led by the bank lobby, says it is unfair to make companies absorb the blow of falling market values for loans they have no intention of selling. And they say that new questions would be raised as to how to value specialty loans and other assets for which there are no ready markets.

Debate on the issue has been relatively muted because the FASB has not yet initiated its formal process for considering new rules. But a July board meeting gave observers the most detailed look yet at the ideas being floated, and the topic is on the agenda again for a FASB meeting scheduled for Thursday, when a formal proposal may get hammered out.

“What they’re discussing now would be the biggest accounting change we’ve ever seen,” said Donna Fisher, theABA’s senior vice president of tax, accounting and financial management. “If you wait too long, then everybody is wed to their positions, so we really need to start early.”

The desire to redraw the rules on valuations predates the financial crisis, with the FASB and its counterparts at the International Accounting Standards Board discussing the topic at two joint meetings in 2005. But the crisis heaped new attention on the issue, with the mark-to-market methodology currently in use alternatively criticized as a dangerous catalyst for the financial system’s disarray or a convenient scapegoat for it.

In April, the FASB issued new guidance on determining whether a market is active, and increased the flexibility companies have for valuing illiquid assets. At the same time, the board allowed banks to separate credit writedowns from market writedowns when accounting for other-than-temporary impairments to assets, requiring that only the credit portion of the loss be subtracted from earnings.

That action, which critics of the FASB took as a sign that the board had caved in to pressure from financial industry lobbyists and their allies in Congress, sought to answer some of the questions about when and how mark-to-market valuations ought to be applied. The latest proposal would seek to clear up the “when” question, with companies potentially instructed to use mark-to-market for nearly every financial asset on the books. But questions about how to apply valuations remain.

“If the FASB is going to move to requiring that every instrument be marked at market value, it’s going to require a lot more specific guidance for companies and auditors as to what to use for the market value in different situations,” said Brian Bushee, an accounting professor at the University of Pennsylvania’s Wharton School. “Most companies might not be opposed to [using] market value if they had confidence that a true market value was showing up on the balance sheet.”

The FASB, which referred questions about the thinking behind its latest proposal to a fact sheet posted on its Web site, appears to be taking a harder line than international accounting standard-setters, who issued a different set of proposals after deliberating separately on the topic. The IASB, which is trying to develop global standards that may eventually converge with U.S. standards, would let companies eschew mark-to-market for basic loans that would be held to maturity.

Marking loans to market under the blanket rule being considered by the FASB would be especially tough for banks that traffic in agricultural loans and other niche products for which no organized market exists, said Ann Grochala, vice president of lending and accounting policy at the Independent Community Bankers of America.

“FASB appears to think they’ve moved forward enough with valuation methodology that it shouldn’t be a problem anymore. We’d beg to differ,” she said.

Most community banks do not use mark-to-market when given the option, but they must apply it to their investment portfolios. The new FASB proposal certainly would simplify the preparer’s approach, allowing for a single methodology for all kinds of assets, but Grochala questioned whether that would produce a clearer snapshot of a company’s health.

“Continuing to use an accounting basis that’s more difficult is better than switching to something that’s going to give a significantly less accurate picture and add much more volatility to your valuations for organizations that are not buying and selling their balance sheet items on a daily basis,” she said.

Bushee, the accounting professor, suggested two potential compromises that might make the proposal more palatable for the industry. First, have downward marks kick in only after prices have been depressed for a set amount of time, say six or 12 months. Second, have regulators base bank capital requirements on numbers that are less subject to the vagaries of the market.

“There are multiple constituencies here, where investors and regulators may want different types of information, and we may want different rules to facilitate that,” he said.

American Banker  |  Tuesday, August 11, 2009

American Banker  |  Tuesday, August 11, 2009
By Steven Sloan

 
 Loans with fees that exceed $583 will have to include additional disclosures under the Home Ownership and Equity Protection Act starting Jan. 1, 2010, the Federal Reserve Board said Monday.

The target was originally set at $400 but the Fed is required to adjust it annually in line with changes to the consumer price index.

Under HOEPA, lenders will now be required to make disclosures available to borrowers if they pay fees in excess of $583 or 8% of the loan, whichever is greater. This rule is separate from a standard the Fed adopted last year that required disclosures for high-cost loans.

Since Monday’s change is required by statute, the Fed said public comment is unnecessary.

Ginnie Mae and FHA are becoming $1 trillion subprime guarantors.

Much to their dismay, Americans learned last year that they “owned” Fannie Mae and Freddie Mac. Well, meet their cousin, Ginnie Mae or the Government National Mortgage Association, which will soon join them as a trillion-dollar packager of subprime mortgages. Taxpayers own Ginnie too.

Only last week, Ginnie announced that it issued a monthly record of $43 billion in mortgage-backed securities in June. Ginnie Mae President Joseph Murin sounded almost giddy as he cheered this “phenomenal growth.” Ginnie Mae’s mortgage exposure is expected to top $1 trillion by the end of next year—or far more than double the dollar amount of 2007. (See the nearby table.) Earlier this summer, Reuters quoted Anthony Medici of the Housing Department’s Inspector General’s office as saying, “Who would have predicted that Ginnie Mae and Fannie Mae would have swapped positions” in loan volume?

Ginnie’s mission is to bundle, guarantee and then sell mortgages insured by the Federal Housing Administration, which is Uncle Sam’s home mortgage shop. Ginnie’s growth is a by-product of the FHA’s spectacular growth. The FHA now insures $560 billion of mortgages—quadruple the amount in 2006. Among the FHA, Ginnie, Fannie and Freddie, nearly nine of every 10 new mortgages in America now carry a federal taxpayer guarantee.

Herein lies the problem. The FHA’s standard insurance program today is notoriously lax. It backs low downpayment loans, to buyers who often have below-average to poor credit ratings, and with almost no oversight to protect against fraud. Sound familiar? This is called subprime lending—the same financial roulette that busted Fannie, Freddie and large mortgage houses like Countrywide Financial.

On June 18, HUD’s Inspector General issued a scathing report on the FHA’s lax insurance practices. It found that the FHA’s default rate has grown to 7%, which is about double the level considered safe and sound for lenders, and that 13% of these loans are delinquent by more than 30 days. The FHA’s reserve fund was found to have fallen in half, to 3% from 6.4% in 2007—meaning it now has a 33 to 1 leverage ratio, which is into Bear Stearns territory. The IG says the FHA may need a “Congressional appropriation intervention to make up the shortfall.”

The IG also fears that the recent “surge in FHA loans is likely to overtax the oversight resources of the FHA, making careful and comprehensive lender monitoring difficult.” And it warned that the growth in FHA mortgage volume could make the program “vulnerable to exploitation by fraud schemes . . . that undercut the integrity of the program.” The 19-page IG report includes a horror show of recent fraud cases. 

If housing values continue to slide and 10% of FHA loans end up in default, taxpayers will be on the hook for another $50 to $60 billion of mortgage losses. Only last week, Taylor Bean, the FHA’s third largest mortgage originator in June with $17 billion in loans this year, announced it is terminating operations after the FHA barred the mortgage lender from participating in its insurance program. The feds alleged that Taylor Bean had “misrepresented” its relationship with an auditor and had “irregular transactions that raised concerns of fraud.”

Is anyone on Capitol Hill or the White House paying attention? Evidently not, because on both sides of Pennsylvania Avenue policy makers are busy giving the FHA even more business while easing its already loosy-goosy underwriting standards. A few weeks ago a House committee approved legislation to keep the FHA’s loan limit in high-income states like California at $729,750. We wonder how many first-time home buyers purchase a $725,000 home. The Members must have missed the IG’s warning that higher loan limits may mean “much greater losses by FHA” and will make fraudsters “much more attracted to the product.”

In the wake of the mortgage meltdown, most private lenders have reverted to the traditional down payment rule of 10% or 20%. Housing experts agree that a high down payment is the best protection against default and foreclosure because it means the owner has something to lose by walking away. Meanwhile, at the FHA, the down payment requirement remains a mere 3.5%. Other policies—such as allowing the buyer to finance closing costs and use the homebuyer tax credit to cover costs—can drive the down payment to below 2%.

Then there is the booming refinancing program that Congress has approved to move into the FHA hundreds of thousands of borrowers who can’t pay their mortgage, including many with subprime and other exotic loans. HUD just announced that starting this week the FHA will refinance troubled mortgages by reducing up to 30% of the principal under the Home Affordable Modification Program. This program is intended to reduce foreclosures, but someone has to pick up the multibillion-dollar cost of the 30% loan forgiveness. That will be taxpayers.

In some cases, these owners are so overdue in their payments, and housing prices have fallen so dramatically, that the borrowers have a negative 25% equity in the home and they are still eligible for an FHA refi. We also know from other government and private loan modification