Citigroup Says Put-Back Risk Declined

Citigroup set aside a $322 million reserve for mortgage repurchases, the bank said in its quarterly earnings.

Last week, investors sold off bank stocks after chatter began to spread about repurchase risk being much higher than expected.

The idea is that banks may have to repurchase mortgage loans sold to investors as securities, perhaps because mortgage pools didn't live up to the representations and warranties made in the sales materials.

Although this risk has been known for years, recently investors started to worry that the foreclosure moratoriums are evidence of faults in the mortgage and securitization processes.

Some analysts have estimated that some of the largest banks could face "put back exposure" amounting to tens of billions of dollars. Others regard that number as far too extreme. "Put back exposure" is the currently fashionable term for "repurchase risk."

Citi (NYSE: c) doesn't sound too worried about this. In fact, they say their reserves for put-backs declined.

"Revenues also reflected an addition of $322 million of mortgage repurchase reserves related to North America residential real estate, compared to $347 million in the prior quarter," the quarterly statement reports.

A credit card that lets you know when you are over your self-assigned limit?

August 16th, 2010 12:40 pm ET

MasterCard and Citigroup create a card that warns when you are over budget

Photo: Image: www.energolukss.lv

Have you ever wished your credit card would remind you when you were approaching your budget limit? Mastercard and Citigroup have gotten together to create a special service for their card-holders.

Bank Time is telling us, MasterCard is anticipated to be soon announcing a card in conjunction with Citigroup that will feature a never-before-experienced spate of features designed to protect consumers from their own irresponsible spending. 

MasterCard is anticipated to be soon announcing a card in conjunction with Citigroup that will feature a never-before-experienced spate of features designed to protect consumers from their own irresponsible spending. Most credit cards nowadays boast an extensive list of safeguards meant to shield consumers from identity theft and other fraud. MasterCard will take that a step further by shielding cardholders from their own stupid financial decisions. The dedicated MasterCard products will come packaged with a service called inControl that is described as a “financial chastity belt” similar to that already offered to a select class of Barclaycard credit holders in England. The inControl service puts cardholders in the driver’s seat, allowing them to choose from an extensive menu of options to curtail spending based on their own known weaknesses. The product would work in conjunction with credit or debit cards.

An Associated Press report gave these examples. A family that is trying to cut back on their expensive habit of dining out can request that their bank decline any attempted restaurant purchases after a fixed monthly spending limit has been achieved. Are you hellbent on keeping your total monthly spending within a certain limit? You can ask that your card be automatically declined every time you attempt to use it after hitting a certain monthly limit. You can even increase the fraud protections on your card by blocking all incoming charges from nations prone to pirating and scams, like Nigeria or Pakistan. Of course, you can make exceptions to these “rules” or amend them at any time with a quick phone call. It’s a very mild set of restrictions for those who need a little more than self-control to rein in their bad monetary habits. The old method of budgeting – using a spreadsheet and faithfully logging purchases to see where your problem areas are, then utilizing rigorous self-control to stick to the plan. Of course, anyone who’s tried this knows that it’s much easier said than done to commit to a life of financial solvency without help. How amazing is it that a major credit card company like MasterCard is going to enable credit cardholders to use their plastic as a tool for budgeting rather than a one-way pass to being broke?

Visa, MasterCard’s biggest competition, does not currently offer anything as tailored as inControl, although they do allow cardholders to request that their card be “shut off” beyond a fixed monthly spending allowance. That’s at least better than Discover and American Express, which feature nada in the ways of helping consumers make better financial choices. Citi customers won’t all be allowed access to inControl at once; it’s expected that the bank will roll the service out gradually and in phases to have the utmost control and monitoring over it successes and areas for improvement. Credit cards only will be included in the pilot phase of the rollout. MasterCard has announced that other issuing banks have received permission to offer inControl, although they declined to name which banks those were.

The AP report stated that inControl’s core purpose is twofold: warning customers about certain kinds of charges made to their accounts, and prohibiting transaction types classified as “wrong.” The system will send you an alert via text message any time that your card is used for a transaction of more than a certain dollar amount or in certain areas of the country or world. A customer who makes no internet transactions or recurring payments, for instance, might create a tailored alert that pings them any time the card is used other than in-person at a merchant, functioning as an almost real-time fraud alert service. You could then contact your card issuer tout de suite to get the charge reversed and the account flagged for fraud. You can discontinue the alerts at any time by getting in touch with your bank by phone or logging into your bank’s customer service site on the World Wide Web.

It’s expected that inControl will ultimately offer customers the ability to place spending limits on certain companies, although it does not at present. Does your college student blow too much money on Apple’s iTunes site enhancing their mp3 library? Does your wife have a weakness for sales at Ann Taylor? Or do you simply find yourself way too prone to grabbing lunch with coworkers at the local diner versus packing a brown paper bag like a good spendthrift? If there’s enough demand, says MasterCard, the ability to impose monthly spending limits on one or more of these merchants could become a reality. Right now, the best customers can do is block certain merchant groups. You can set a monthly dining cap, for instance, but you can’t specifically block Applebee’s, in other words.

I mentioned college students, and it’s believed that one of inControl’s greatest assets will be helping parents grant children the flexibility of a credit card with the benefits of both a monthly allowance and the responsibilities of sticking to that budget. Nervous empty-nesters sending Junior and Sally away to college can have a card linked to the parents’ account with, say, a monthly budget of three hundred dollars. Purchases at bars, liquor stores, or any other types of problem areas would be prohibited and declined. The parents get the benefit of monitoring spending from afar (and getting credit card rewards points, if applicable!), and the kids have the security and flexibility of plastic, plus a life lesson in the responsible use of grown-up spending tools. It’s a win-win situation. And that’s just one of the possible ways in which inControl can be used by one person to control another person’s spending – or even the spending of many people! Let’s say that you have a nanny who gets a card linked to the parents of her charges’ bank account for gas, emergency diaper or milk pickups, and favorite places to take the kids for entertainment and play dates. The inControl service would let Mom and Dad block out-of-state or Internet charges, as well as anything else that might be tempting to the babysitter. A small business owner could place restrictions on company credit cards so that employees can only use them during weekday hours and at certain categories of merchants – say, only hardware supply stores for the employees of a building contractor.

There’s no doubt that certain services already exist to do what inControl does, however the are not in conjunction with an actual credit card company. Mint.com offers a spate of customization options for alerts connected to your credit card spending, including the ability to narrow purchases by categories like grocery shopping and dining. Here’s the downside, however – Mint.com only syncs with yor bank account and updates your charges once every twenty-four hours, unless the user logs in during the course of the day. That’s far from the real-time protections offered by inControl. Additionally, using Mint.com (or any third-party banking site) requires parting with your bank account log-in info over the Web, which tends to –rightfully!- freak people out.

It’s true that empowering consumers to cap their spending could potentially stab banks in the gut through the consequence of less interest being accumulated as consumers get smarter about spending. But really, credit card companies win out as well by offerings services like inControl to their customers. First of all, they get the good word-of-mouth press that comes with offering a “superior” product to their customer base, as MasterCard’s CEO pointed out recently. Given the terrible reputations that America’s credit card companies have suffered in the wake of the financial crisis, the impression that they are heloing customers control their spending can only constitute a much-needed image boost. Banks might benefit if consumers start using credit cards more frequently to get a better picture of their monthly spending, turning other forms of budgeting over to plastic so they can put more controls on their purchases. Consumers might, for instance, start using their plastic to pay for groceries and gas since they know they can use inControl to limit how much they spend in these areas, then paying their balance off in case at the end of the month. Banks make more money in merchant fees from this increased transaction volume. Plus, customers with more responsible habits are more likely to pay their debts. Freewheeling spending doesn’t benefit card companies if the end result is a pile of defaults. There is definitely something to be said for upping the number of people who will be able to pay back their debt in full!

Of course, inControl is far from foolproof in its current incarnation. It’s a little too easy for customers to turn their spending controls off by either phone, internet, or an anticipated mobile app for Web-enabled cellular phones and devices. Plus, customers will need to exercise prudence with their banks accounts – good spending on your credit card means nothing if all the money to pay your monthly balance goes out the door on crap because you hit up the ATM too often. One might say that having your credit card company send you a nastygram for spending too much on dining options would put a damper on your enthusiasm for blowing illicit cash on lunch at McDonald’s, however.

There are also risks for any bank that would be implementing these controls on a wide basis. It’s a difficult thing to set up a bank’s website to allow customers to personalize their own spending limits and restrictions on merchant types. If any stage of the process were to go wrong, customers would take to the 1-800 phone customer service lines en masse, the staffing for which costs companies lots of dough. Plus, the issue of merchant coding – the lynchpin on which the whole premise of customizing purchases by category depends – is trick at best. The systems by which these codes are determined is recognizably flawed, and popular mass merchandisers like Target and Wal-Mart tend to defy proper categorization, leaving this area of implementation open to trouble.

As a result, it’s believed by some industry experts that Citi and MasterCard could take as long as two years to iron out all the kinks in inControl. The wait is likely to be worth while, they promise. Having these features on a credit card is a premise inherently better than using only cash, because of the inherent ability to track purchases. The real-time protections simply cannot be beat, and you would forfeit the cash back rebates and/or rewards points that you tend to earn as a faithful credit card customer. For all these reasons, it’s optimistically believed that suites of controls like inControl will eventually become the industry standard, as opposed to a cool exception. The long-term availability of these services will also be something of a test of banks’ sincerity in making good with customers after a long and painful recession. Are they willing to put their money where their mouths are when they talk about wanting to help customers make more prudent monetary decisions? Only time will tell.

I for one absolutely love the promise of inControl and the services that would be offered when it is rolled out on a wider basis. I’m pretty good with my budget, but I’d love the extra protection of being able to place an ironclad limit on, say, the impulse purchases I can make on cute children’s clothes at Old Navy or The Children’s Place. The ability to control my family’s dining out budget would also be a powerful and useful tool in my money belt! A lot of people I know would benefit greatly from this service, and I’m willing to bet that scores of families and individuals across the United States feel the same way. Let the customers make good decisions for themselves! It would be so lovely to think that the big credit card companies are actually doing something for us for once. When I read about this promising new service, it was definitely the first sign of anything remotely approaching good customer service and consumer relations that I’ve seen from banks in a while, during these days of account closings, spending limit hacks, and interest rate hikes. It’s time for the banks to give us a show of good faith. I’d be willing to take this one, if it works out.

Bucks reports, MasterCard is now offering a set of tools that can allow you to pick a category of stores or spending, set a monthly limit for yourself and then have your credit or debit card stop working altogether at those merchants once you have hit your limit.

Using Cards to Cut Off Your Spending

In this weekend’s Your Money column, I introduce an idea so simple and yet so potentially far reaching that you have to wonder why it didn’t occur to someone sooner.

MasterCard is now offering a set of tools that can allow you to pick a category of stores or spending, set a monthly limit for yourself and then have your credit or debit card stop working altogether at those merchants once you have hit your limit. So if you want to keep your dining out bills below $300 a month, you wouldn’t be able to swipe your card once you passed that amount.

There are a number of technical things that could get in the way of MasterCard’s inControl initiative becoming widespread, but they are relatively easy to solve. So it is probably only human behavior that could mess this up. Namely:

1) Will some banks refuse to offer MasterCard’s tools since they could cut down on overdrafts, bounced check fees or interest that credit card customers will pay? Or might they try to charge an annual fee to consumers for the use of inControl functionality?

2) Will customers lack the discipline to finally solve their budget problems by putting hard spending caps in place? (Or will they raid the A.T.M. anyway even if their card stops working at certain merchants at the end of the month?)

What do you think?

Five Cent Nickel says, Last night while going through the mail, I happened upon our Chase Freedom Visa statement. Don't ask why we're still getting a paper statement from them, as I'm honestly not sure - guess I need to change that. 

The High Cost of Credit Card Debt

Last night while going through the mail, I happened upon our Chase Freedom Visa statement. Don’t ask why we’re still getting a paper statement from them, as I’m honestly not sure – guess I need to change that.

Anyway, I don’t usually look at our credit card statements too closely, as we pay our credit card bills in full every month. I usually just skim over the transactions to make sure everything looks right, and that’s about it.

This time around, however, my eye was drawn to the “Minimum Payment Warning” box, pictured below. I’ve talked in the past about recent credit card statement changes, and this is one of the new additions.

For context, our closing balance was $2720.12, the APR is 15.24%, and the minimum required payment is $54. As you can see from the image above, if we made that minimum payment each month and never made another charge, it would take us 21 years to pay it off. 21 years!

Not only would we be paying for our July 2010 purchases through the year 2031, but it would come at a total cost of $5,936. That’s 118% extra. 118%! If that’s not motivation to get out of debt, I don’t know what is.

The whole point of this table is to make it clear to people just how much money they’re wasting by carrying a balance. They do their best to obfuscate things in the next line, however, where they present an alternate payment scenario.

Guess what? If you pay $95/month, you can pay it off your balance in three years while “saving” $2,525. That’s all well and good until you remember that this “savings” actually represents nearly $700 in extra interest payments vs. paying it all off up front.

Hmmm. No thanks. I think I’ll keep paying my bill in full. What about you?

After you've set your budgetary limit, you get notified real time if you attempt to spend over that limit. Yes, you can call and get "approval" to overspend, but we wonder if this might help people keep their spending more in line.

Man pleads guilty of campaign finance fraud for self enrichment

The U.S. Department of Justice has announced that Paul Magliocchetti, the founder and president of PMA Group Inc., a lobbying firm, pleaded guilty today in federal court in Arlington, Va.  Magliocchetti was charged with making hundreds of thousands of dollars in illegal campaign contributions and making false statements to a federal agency.  This, according to Assistant Attorney General Lanny A. Breuer of the Criminal Division and U.S. Attorney Neil H. MacBride of the Eastern District of Virginia.

In a statement from the DOJ they said; "For years, Mr. Magliocchetti, by using conduit contributors, hid the fact that he and his company were donating significant funds to campaigns in violation of the federal election laws.  Mr. Magliocchetti, in an effort to cover his tracks, used family, friends and business associates to secretly funnel hundreds of thousands of dollars to political campaigns, all in an effort to enrich himself and increase his power and prestige," said Assistant Attorney General Lanny A. Breuer.  "This case is an important reminder to all who seek to evade the federal campaign finance laws that they will be prosecuted to the full extent of the law."

The DOJ said that Magliocchetti was charged in an indictment that was unsealed on Aug. 5, 2010. According to the indictment, Magliocchetti orchestrated a scheme to make illegal conduit and corporate federal campaign contributions in an effort to enrich himself and PMA by increasing the firm’s influence, power and prestige.

The DOJ had special warning in their press release for those who would have any plans on cheating in this manner.

End of the American middle class

Various reports and publications have appeared recently showing the dire state of the American 'middle class,' which is normally defined as the middle 25% to 66% of households in the US. The economic well-being of this group has been diminishing steadily. The downward spiral began when President Reagan came to office and has continued unabated ever since.

During the Reagan presidency, the top marginal taxes were reduced from 70% to 28%. This pattern continued under President Clinton (with one exception), and both President Bush the father and the son. It is not clear what will happen with President Obama. Also, NAFTA exported numerous jobs to Mexico, the manufacturing base went to China and other countries in the far east, while many information technology jobs were exported to India, eastern Europe and Ireland, among other places.

Another contributing factor to the misery of the middle class has been the enormous expenditures on the US military adventurism around the world with astronomical costs the magnitudes of which are almost totally unknown. The military expenditures have contributed to the enormous deficits, with added expenses for the interests on the national debt. The burden of this debt will be simply transferred to future generations. While infrastructure spending has declined, schools are in a dire shape and teachers are being laid off, Congress continues to spend hundreds of billions of dollars on the Iraq and Afghanistan wars or on new weapons development.

According to a report by Professor Elizabeth Warren of Harvard University, in the general population of the US:

o  1 in 5 are unemployed (the official figure of about 10% is really misleading)

o  1 in 9 cannot pay their credit cards

o  1 in 8 are on food stamps

o  1 in 8 are in mortgage default or going through foreclosure proceedings

New York Post had a recent article, entitled "So long, middle class," where the following statistics were presented:

o  According to a 2009 poll, 61% of Americans 'always or usually' live paycheck to paycheck, which was up from 49% in 2008 and 43% in 2007.

o  36% of Americans say that they don’t contribute anything to retirement savings.

o  A staggering 43% of Americans have less than $10,000 saved up for retirement.

o  According to Harvard Magazine, 66% of the income growth between 2001 and 2007 went to the top 1% of all Americans.

o  In New York, the top fifth of earners collect more than 53% of the income; the bottom fifth takes home less than 3%.

o  In 1950, the ratio of the average executive’s paycheck to the average worker’s paycheck was about 30 to 1. Since the year 2000, that ratio has exploded to between 300 to 500 to one.

o  As of 2007, the bottom 80% of American households held about 7% of the liquid financial assets; the bottom 40% of income earners now collectively own less than 1% of the nation’s wealth.

o  The top 10% percent of Americans now take in approximately 50% of the income.

Also, among the 11 million workers whose 401(k) plans are run by Fidelity, 11% took out a loan from their plan during the 12 months ending in June 30, the company said recently, up from 9% at the same point a year earlier.

The Bush tax cuts are scheduled to expire at the end of 2010. While President Obama promised during the 2008 campaign that taxes for those earning less than $250K would not be increased, Republicans and many conservative Democrats are now advocating that all Bush the tax cuts be made permanent. By various estimates, if the taxes cuts for the upper income tax payers are made permanent, the deficit will grow by about $700B over 10 years, almost comparable to the entire cost of the health care budget that was hotly debated earlier this year.

One argument that Republicans use to justify lower taxes for the rich is that this group often runs small businesses and the extra money would be used for further expansion of their businesses. However, this argument is simply fallacious, since most business expenses are already tax deductible. Thus, any extra income from reduced taxes would essentially be used for personal expenditures. But, it is well-known that, while low-income and moderate-income families tend to use most of their tax cuts almost immediately, thereby contributing to the economy, the rich are more likely to just save the money. These savings do not contribute significantly to the growth of the economy. The banks may have more funds, but they are not lending anyway and nobody is buying houses.

The state of the middle class, tax policy and economic planning are complex issues that cannot be addressed adequately in one article. The following video discusses the 'death of the middle class.

'President Obama is a Muslim' and other beliefs

A recent survey showed that about 20% of Americans believe that President Obama is a Muslim. Also, the number of people who say that he is a Christian has dropped to 34%. The media seem to be the main source of these beliefs. According to a Washington Post article, 'Among those who say Obama is a Muslim, 60 percent say they learned about his religion from the media.' Apparently, this issue is of paramount importance to Americans. The article in question had over 3246 comments on 164 pages by readers at the latest count, probably more comments than any recent article in the publication.

Since the media seem to be the source of the 'belief' that President Obama is a Muslim, it stands to reason that the media are the source of many other misconceptions. Of course, one might say that the president is indeed a Muslim. But, the fact that there is no concrete evidence for such as an assertion does not seem to be different from the lack of a factual basis for many other beliefs by Americans and people in other countries. Here are some examples:

o   In a 2007 poll, 22% of Americans said they believed that President Bush knew about 9/11 attacks in advance.

o   In another 2007 Newsweek poll, 41% of Americans answered 'Yes' to the question, 'Do you think Saddam Hussein’s regime in Iraq was directly involved in planning, financing, or carrying out the terrorist attacks of September 11th, 2001?'

o   The same Newsweek story reported that 45% of Germans thought in 2007 that the United States was more dangerous than Iran.

o   In a 2006 poll, 64% of Indians believed that Iran is developing nuclear weapons even though India was the first country to test nuclear weapons after the establishment of the Nuclear Non-Proliferation Treaty (NPT), the goal of which was to stop the development of nuclear weapons by new countries.

o   According to a CNN poll, 71% of Americans believe that Iran currently has nuclear weapons.

o   Fox News reported in 2004 that 92% of Americans say they believe in God, 85% believe in heaven and 82% believe in miracles.

o   Reuters reported in 2007 that 72% of Americans believed that Jesus is God or the Son of God. Belief in hell and the devil was expressed by 62% of Americans.

o   According to the same Reuters report, only 42% of those surveyed said they believed in the theory of evolution as espoused by Darwin. Also, 35% of the respondents believed in UFOs and 31% in witches.

In review, it seems that there is little correlation between facts and beliefs. The following video is a humorous look at what people on the street seem to know or not know about the world.

Housing Stops

Yesterday morning, the National Association of Realtors reported a 27% drop in existing home sales for July (as compared to June), the largest month-over-month drop in 15 years. At sales that pace, given the number of houses on the market, existing home inventory jumped up to 3.98 million existing homes for sale, a 12.5 month supply of housing (i.e. if all houses currently on the market were purchased at the rate that houses traded hands last month, it would take just over a year to sell them all), the highest inventory by this form of measure in more than a decade. According to NAR, "Raw unsold inventory is still 12.9 percent below the record of 4.58 million in July 2008."

The report was much worse than economists predicted, with Bloomberg's median estimate (among the 74 economists asked for a prediction) being an annualized selling rate of 4.65 million homes versus an actual report of 3.83 million (again, an annualized number).

Prices were down 0.2% from the prior month but up 0.7% from a year earlier, showing perhaps that housing prices must fall further in order to get buyers interested.

It's not all about price, however, when it comes to housing. Two perhaps larger factors are employment and availability of mortgages, both of which are disastrously weak for what should be a point of recovery in a typical economic cycle.

Much demand for existing houses comes from people moving to a new location to go to a new job. With unemployment stuck near 10% and underemployment (including unemployment) near 17%, with entrepreneurs, particularly those who would normally consider starting up a small business, pinned to the sidelines by uncertainty about what Obama and Pelosi's next business-crushing shoe to drop will be (taxes? cap-and-trade? protectionist legislation?), the chances of job creation improvement in any single digit number of months is bleak. As the L.A. Times notes:

…the nation's tiniest companies had fewer new hires last month than any time since October. The data are further evidence of a trend that has had many economists worried for months and intensifies concerns that smaller firms may not be robust enough to help lead the country out of its financial slump. The slowdown in hiring is particularly troublesome, experts say, because small businesses typically hire first during a recovery. A reluctance by little companies to add positions could mean that the big firms, which typically lag behind, will add jobs even more gradually.

(For more on this topic, I recommend this fascinating study by the Kauffman Foundation: "The Importance of Startups in Job Creation and Job Destruction" which notes that "startups aren't everything when it comes to job growth. They're the only thing.")

With no new jobs, people are staying put. Unless you're simply outgrowing your current home by having kids (or having your mother-in-law move in), a house would have to get a lot cheaper to get you to move if you don't actually have any need to.

Then, even if you did want to move, you'd have to be able to get a mortgage. While mortgage rates have reached record lows in recent days, it's harder than ever to get a mortgage. Several years ago, a ham sandwich could get a 100% loan-to-value mortgage by just claiming a decent income in mayonnaise. Heck, it could even have been an illegal alien ham sandwich as long as he could show the right bar code for a jar of Hellmann's. Now, you have to have near-perfect credit, a high income, and the ability to put down a substantial down payment to be able to get even a conventional government-guaranteed mortgage, much less a "jumbo" mortgage needed for most loans over $417,000 in most parts of the country (the conventional limits are higher in certain high-cost areas.)

In a typical example of government shutting the barn door after the horse has left -- actually a few years after it's left in this case -- even the FHA is raising its lending standards, although calling requiring a 3.5% down payment a "standard" would be laugh-out-loud funny if those sorts of Barney Frank- and Chris Dodd- mandated levels hadn't cost the rest of us our jobs, our home values, and our retirement savings.

Between a lack of new jobs, a lack of available credit, and the tremendous uncertainty regarding how the newly established Consumer Financial Protection Bureau will punish lenders not only for mortgage failures which they contributed to, but also for failures entirely of the borrowers, it's hard to see how the housing market improves anytime soon.

As with the failed "cash for clunkers," the Obama Administration's actions have served only to shift demand between time periods, with their recently expired homebuyer tax credit briefly lifting sales only to give us this record plunge when the credit expired.

A rising housing market was critical fuel for the economic boom of the last decade, not least due to irresponsible homeowners using their homes like piggy banks, borrowing against their equity (which they no longer have) and spending the money on cars, trips, and perhaps most dangerously, on real estate speculation. That speculation caused rising prices which created a self-reinforcing game of real estate musical chairs that people with no experience, no investing talent, and no goal other than not to miss the money train all wanted to play. As is typical of bubbles, it turned out there was a lot more than one chair missing when the music stopped.

But even without such recklessness, and even treating the "wealth effect" as of minimal importance, a second dip in housing could point to problems not just for the broad economy but also for local budgets -- not least school districts -- whose finances are heavily dependent on property taxes. A 2009 paper on "House Prices and Economic Growth" by Norman Miller of the University of Cincinnati and Liang Peng of the University of Colorado concludes that "house price changes have significant effects on Gross Metropolitan Product growth…[and that] the effects last for eight quarters."

Furthermore, as the Federal Reserve Bank of San Francisco notes, much spending in recent years, and not just in America, was done with borrowed money that now must be repaid rather than spent or saved in an economically constructive way. Therefore,

Going forward, the efforts of households in many countries to reduce their elevated debt loads via increased saving could result in sluggish recoveries of consumer spending. Higher saving rates and correspondingly lower rates of domestic consumption growth would mean that a larger share of GDP growth would need to come from business investment, net exports, or government spending. Debt reduction might also be accomplished via various forms of default, such as real estate short sales, foreclosures, and bankruptcies. But such deleveraging involves significant costs for consumers, including tax liabilities on forgiven debt, legal fees, and lower credit scores.

It's not a pretty picture and it explains a lot about why 10-year Treasury Note yields this week hit an all time low of 2.5%, predicting an extended period of economic malaise. Like Jimmy Carter, our current president is presiding over a crisis of confidence, and as during the Carter presidency much of that crisis is due to a steadily declining confidence in the president himself.

The bursting of an asset bubble, especially one that so many people are involved with not just economically but also emotionally, is a painful but necessary experience. It's worse than the hangover after a party because if you find a cure for a hangover, the cure probably doesn't have too many bad side effects. Unfortunately, the government's efforts to minimize the pain of the bubble bursting -- because it fears the political fallout -- are, and only can be, the economic equivalent of the hair of the dog, namely trying to throw some duct tape on the bubble and pumping it back up again, if not to its full countrywide (and Countrywide) scale then at least to something that causes housing prices to stay steady when they would, in an unmanipulated and un-bailed-out market, be falling.

As little fun as it is, there should be a hushed but real enthusiasm for ending of decades of government pushing home ownership as a way to endear voters to the political party that best sells itself as the one making sure you own something you can't really afford. It's no more rational to say that everyone should own a home than that everyone should own a yacht or a Tibetan Mastiff (one of which sold last year for much more than the price of the average home in America). Remember, when a politician wants you to own a house, he does so because he thinks it's good for him.

In the long run, the only way for housing, like any other market, to return to health, is for the bubble to be allowed to collapse, to allow market forces to do what they do whether it feels good or not on a given day. Housing, like the rest of the economy, faces an additional unnecessary headwind in our current Administration whose disdain for and lack of understanding of the economic freedom -- including freedom to fail -- necessary for economic growth and prosperity simply add to potential homebuyers' hesitancy and confusion

Parting Shot

I'm at the BAI Retail Delivery conference this week, so blogging for this week will be severely curtailed. However, I wanted to make sure you didn't miss the in-depth post by Kevin Sullivan at Anti-Money Laundering Training Academy blog for his hard-hitting exposé of the latest Vatican bank money laundering scandal entitiled "...And Then He Created the Moon and the SARS." As only an ex-cop (Kevin's the New York State Police official who first pursued the SAR that brought down Eliot Spitzer) and fellow Irish Catholic boy can, he puts that kerfuffle in proper perspective.

This has all the makings of a Dan Brown novel. Angels and Dollars? The Da Vinci Load? The Cash Symbol? Somebody stop me…!

You gotta love his picture, too:

Small Biz Lending Law A Bust?

According to a recent American Banker article (paid subscription required), it looks like the $30 billion small business lending law enacted by Congress may be cocered with the same patina that slimed TARP.

So far, the response among bankers has been lackluster at best. Some said they can't get past the bitter memory of the Troubled Asset Relief Program, and have no interest in doing business with the government again — especially so soon after the Tarp experience.

"It's like all their programs," said Thomas O'Brien, the president and chief executive of State Bank of Long Island in Jericho, N.Y. "They're just subject to change and revision, and someday they'll turn around and attack or revile their participants, and I don't think any of us want to go through that anymore."

Mike Menzies, president of the $161.5 million-asset Easton Bank and Trust in Maryland and a past chairman of the Independent Community Bankers of America, said his bank is considering applying for the funds. He said the program could be a valuable tool to help the smallest banks preserve capital so they're prepared to lend once loan demand returns.

But he acknowledged that many bankers worry about how they might be viewed if they accept the capital.

"I think that there is an inherent dislike of the notion that the media could paint the small-business loan fund as a form of a bailout," he said.

Michael Clarke, CEO of the $789.2 million-asset Access National Bank in Reston, Va., said he has no doubt that the program will increase the volume of small-business lending. But he is not sure his bank should be involved.

"We're still evaluating it," Clarke said, "because if you are unable to reach the thresholds of volume, then this capital will prove to be costly. We don't want to find ourselves in a trap where we almost feel obligated or forced to make loans that we otherwise wouldn't, just to meet the objectives of the program."

The $2.8 billion-asset Bank of the Ozarks in Little Rock received $75 million in Tarp funds in December 2008, and repaid the investment in November 2009. George Gleason, the CEO, said the company has zero interest in more capital from the Treasury Department.

"I don't even know if we're eligible for it," Gleason said. "We haven't looked at it, and the reason is very simple: We're going to make every good loan that we can make, with or without the fund. So we're not going to mess with a government program."

It's good to know that many community bankers (a) learned the lessons of the recent past so readily and (b) aren't masochists. However, one group of bankers is likely to be much more receptive: those already dangling on TARP's hook.

That's because the law allows some banks that received funds through Tarp's Capital Purchase Program to refinance into the Small Business Lending Fund, where they have the chance to pay much lower dividends on the capital, said Joseph Longino, a principal in the investment strategy group at Sandler O'Neill & Partners LP.

Under Tarp, banks pay the Treasury Department a 5% dividend, and that will rise to 9% in 2013.

Through the new fund, banks with less than $10 billion of assets can apply for capital with an initial dividend payment of 5%, which could drop to as low as 1% for a few years as banks boost their lending.

"I think smaller banks that are laboring under Tarp and that believe … that there are small-business lending opportunities out there that they could tap — and therefore get the lower rate — are going to be the most interested in this program," Longino said.

There are no warrants this time around, either, so it's got that going for it.

Nevertheless, this doesn't seem to be something that is going to make the "splash" that TARP made. For that, thank (1) Members of Congress for changing the rules after the program was enacted and pontificating about how "bailed out" banks weren't lending; (2) articles in the main stream press that painted all banks that particpated in the "big bank" and "small bank" versions of TARP with the same broad brush; and (3) banks that didn't take TARP using that fact as a marketing ploy against those that did.

To me, the fact that the final bill didn't contain commercial real estate loss amortization provisions that were inserted in the initial House-passed version made it an exercise in futility for most community banks. As I noted previously, most of them who need the additional capital won't likely qualify for it. At this point, it appears that even those banks that would qualify for it aren't particularly interested in getting it. One more election year exercise in futility.

Bank Fees: Not As Bad As You Might Think

You wouldn't known it by reading the main stream media, which feasts on sad tales of consumers being gouged by evil banks at every turn (some of which are, indeed, sad tales), but as Fierce Spirits points out, a recent ABA survey found that 53% of customers pay no fees on their bank accounts, while another 14% pay $3 or less a month in fees. It's inconvenient when the facts get in the way of rip-roaring prejudices, but there you have it.

It doesn't lessen the irritation at the overdraft fee kerfluffle, but its always useful to put things in perspective. Big banks may be hosing (or "justifiably charging," depending upon your viewpoint) a minority of customers with beaucoup fees, but most customers seem to be managing their accounts without paying much (if anything).

The blog's author lists the follow "common sense" methods suggested by the ABA for keeping your fees low:

Free Checking and Savings Accounts – Most banks offer them.

ATM Machines – Avoid fees by using your own bank’s ATM.

Direct Deposit – Many checking accounts are free when your paycheck is automatically deposited each month.

Minimum Balance – Keep at least the minimum balance in your account.

Don’t Overdraw – Keep track of transactions and account balances to avoid bounced check fees.

Email or Text Alerts – Ask for an automatic alert when your balance falls below a certain level.

Don't Cry For Me OCC

Tell me you're surprised by this (paid subscription required)and I'll call you a fibber.

The merger of the Office of the Comptroller of the Currency and Office of Thrift Supervision is shaping up to be the match made in regulatory hell.

Three months after the regulatory reform bill ordered the OTS' elimination over the next year, efforts to bring the agency into the OCC fold have been plagued with bitterness, communication problems, unease on job placement and rampant conflicts. The latter range from the important to inane, covering everything from job titles to claims of unreturned phone calls to bickering over the placement of booths at an upcoming industry conference.

The fights go all the way to the top, with several sources suggesting acting OTS Director John Bowman is openly hostile to the merger and accusing him of being uncooperative.

"It's a little like the Middle East — the feud goes back so far it's hard to determine who threw the first stone." said Kip Weissman, a partner at Luse Gorman. "Both sides need to grow up a little bit and stop the personal attacks — there are plenty of difficult technical issues which need to be resolved."

If you think that's bad, just imagine what it would have been like if the FDIC and not the OCC had been the agency into which the OTS was being merged. After the enactment of FIRREA, which made the FDIC the successor to the dissolved Federal Savings and Loan Insurance Corporation (run by the Federal Home Loan Bank Board) and the FDIC-staffed RTC the successor to the assets of the insolvent thrifts that were disposed of post-FIRREA, the FDIC folks came in like Hawkeye and Trapper John burst into that hospital in Japan in M*A*S*H screaming they were the pros from Dover (*see below). The FSLIC Titanic was a ship of fools, and now that it had sunk, the FDIC was going to "crack this kid's chest and get out to the golf course before it gets dark." Arrogance doesn't even begin to describe the attitude, and hard feelings were the result.

Still...

While ABA COO Diane Casey-Landry does a politically correct job of soft-pedaling the dust-up by calling it the result of the "natural tension that comes with mergers," there's a whiff of thumb-sucking and tantrum-throwing in the air. You'd think that an agency that was declared a useless tool on national television by the likes of Chuck Schumer over twenty years ago, and the abolition of which opponents have been calling since it was created in 1989 would be expecting its luck to run out some day. Those of us in the world of private enterprise who've worked for business entities that have been merged out of existence are expected to suck it up and transfer to Plan B in our career track. It's called taking it like an adult and moving on.

Guess these folks are getting a taste of what the employees at Charter Bank, BankUnited, IndyMac, Wamu, and so many other savings institutions that have been consigned to thrift hell by the OTS have had to eat. Bitter, isn't it?

Hey, OCC: How do you want your steak cooked?

*

Will The Bite Be As Bad As the Bark?

With all the furor lately over bullies who drive sensitive adolescents to end their lives by harrassing them mercilessly, you have to wonder why no one takes the time to call out the FDIC for all of its public blustering about how hard its going to smack down all of those officers and directors of failed banks with liability suits that will hurt like hell. They've been talking about it for the last couple of years, but to date, only one lawsuit has been filed. Yet, just last Friday, Bloomberg "broke" another story about the coming tsunami of D&O liability litigation, with over $1 billion (to be) served.

The lawsuits were authorized during closed sessions of the FDIC board and haven’t been made public. The agency, which has shuttered 294 lenders since the start of 2008, has held off court action while conducting settlement talks with executives whose actions may have led to bank collapses, Richard Osterman, the FDIC’s acting general counsel, said in an interview.

“We’re ready to go,” Osterman said. “We could walk into court tomorrow and file the lawsuits.”

Well, if you're "ready to go," don't talk about it to the main stream press, make like Nike and JUST DO IT!

What's the purpose of all this public posturing in a "Jesus is Coming and He's Pissed" mode? Does the FDIC think it's scaring potential defendants into rolling over and playing dead? Is it actually squeezing substantial settlements out of officers and directors (or, more precisely, their insurance carriers) prior to filing suit?

The last fist fight I had in my life was as a 20 year-old, when I was jumped by two thugs outside a bar, who tried to take my money by threatenting me with all the bad hurt they were going to put on me unless I coughed up my wallet. I responded "If you were tough enough to take it from me, Alice, you would have done it by now instead of talking about it."

Of course, that prodded them to beat me senseless, although my brother "The Boxer" arrived in time to knock one of them unconscious and a crowd held the other until the police came roaring up to haul them away. So while a rational man might say that by talking tough, the punks would have led him to hand over the wallet and avoid the beating, to those of us of Irish ancestry with hard heads, a lack of a strong sense of self-preservation, and a prefernce for mixing it up, all the threats do is make us dig in our heels and call punks "punks." "Show them the money" is not what runs through our minds.

If officers and directors aren't settling prior to filing of lawsuits, perhaps all of this is merely priming the pump that the FDIC assumes will turn on the recovery spigots once the lawsuits are actually filed because directors and officers of the targeted banks will be "softened up", so terrified by anticipation of being pummeled that once the complaint is served, they'll "give it up" gladly just to avoid the anticipated pain. Or perhaps, there's something else at work, something suggested by the article's author, Phil Mattingly, and Mr. Osterman.

The FDIC "brings suits only where they are believed to be sound on the merits and likely to be cost-effective," according to an agency policy statement that dates from the savings-and- loan crisis of the 1980s. That requires considerations of whether an individual, if sued, has the means to pay or an insurance policy to cover all or part of the claim.

"It doesn’t make sense to file a lawsuit if at the end of the day you have a low chance of recovery," Osterman said.

Even if the FDIC thinks that the defendants have cash or a viable insurance policy, maybe the FDIC thinks that, ultimately, on many of these cases, it may have trouble winning on the merits if the defendants go all "jihad-like" and fight to the death. Certainly, an attorney for some of the defendants in the IndyMac case thinks the FDIC is going to have some difficulties.

Lawrence Kaplan, an attorney whose firm is representing two of the IndyMac defendants, said the paucity of cases filed to date shows the difficulty of assigning blame for a crisis that took down so many financial companies.

“The current crisis was caused by economic conditions that few, if any experts, including leading federal officials, saw coming,” said Kaplan, a lawyer at Paul Hastings Janofsky & Walker LLP in Washington.

“As a result, claims that directors and officers of many failed banks engaged in negligence lack credibility as such claims attempt to hold those directors and officers to an impossible standard of care,” Kaplan said.

Mr. Kaplan's spinning this in favor of his clients, naturally. That's why he gets paid the big bucks. Still, you have to wonder whether the FDIC's blowing smoke in many of these cases because it hopes it can run a bluff on enough directors and officers to force a settlement pre-filing or shortly after surviving a motion to dismiss and Rule 11 sanctions.

Personally, I think Mr. Kaplan may be onto something. Sheila Bair publicly opined that no one saw anything this bad coming down the pike. I've heard rumors that there exist certain former agency personnel who tried to raise the alarm about the potential meltdown years before it arrived but were stomped on by superiors. If I were a defense counsel today, I would feel a lot better about my chances than I would have felt in the late 1980s and early 1990s when the last wave of FDIC and RTC litigation washed over former directors and officers of failed banks and thrifts.

Then again, when I say "a lot better" I don't mean "good." I mean "not as helpless."

Misdirection

While the Department of Justice announced today that it will investigate the foreclosure practices of some of the big residential mortgage loan servicers arising from their alleged "robo-signing" of documents that were not actually reviewed by the person signatory, Housing Wire publisher Paul Jackson asks a critical question: So what?

But in the end, am I the only one asking: who really cares? Does any of this make it more likely that a borrower will suddenly be able to afford their mortgage? Isn't that what really matters?

What really should matter is this: as a nation, we have lost at least $2 trillion in wealth thanks to the economic downturn, led by an absolute collapse of our housing and mortgage markets. It’s a collapse we have all yet to recover from, as a host of well-intentioned but ill-fated policies have done nothing except prolong pain — not only for banks, who are still playing hide-and-seek with bad assets on their balance sheets, but also for borrowers, who are being lied to by our government and by the very consumer advocates who claim to wish to help them.

Read the whole rant. You'll be glad you did (assuming you're a banker and not a bank-hater).

Of course, our fearless leaders in Congress understand that at a juncture where many community banks are under the gun from so many directions, the economy is wallowing in the doldrums, and joblessness continues to impede a recovery, what one of this country's top priorities has got to be is the expansion of the Community Reinvestment Act and the toughening of its standards (paid subscription required).

House Financial Services Committee Democratic leaders introduced a bill [September 29, 2020] to expand the Community Reinvestment Act and impose stricter standards on banks.

The bill from Rep. Luis Gutierrez would make it tougher for banks to receive an "outstanding" rating on their CRA exams, add a new "sufficient" rating and require bank affiliates and subsidiaries to be included in evaluations.

"This is an important first step on the road to reforming and modernizing the CRA to better meets the needs of our communities and address the new financial marketplace," said the Illinois Democrat in a press release. "We are laying the groundwork for next year, identifying priorities, and evaluating what we have been able to fix and what remains to be fixed in our financial markets."

Yep, no doubt about it: you've got your "priorities" straight, Luis.

The Smaller They Are, The Harder They Fall

“Community banks are the lifeblood of our nation’s financial system, supplying much-needed credit to countless individuals, small businesses, nonprofit organizations, and other entities in large and small towns around the country.”-- Sheila Bair, May 29, 2009

A thoughtful piece by Randall Smith and Robin Seidel in last week's The Wall Street Journal entitled "Banks Keep Failing, No End in Sight" finally made the front section of today's The Dallas Morning News retitled "Broke-bank Mountain." I guess that proves that either the story has legs or somebody needed an excuse to demonstrate his or her cleverness as a headline writer. My guess is that it's more the former than the latter.

The authors cite one bank analyst who estimates that the number of banks that will be left standing when the dust settles will be closer to 5,000 than the 6,000 we've been heard from other sources. However, it's the exact number that was estimated by the chairman of an old-line community bank in the mid-west in a recent e-mail to me. Whichever number turns out to be accurate, and lot more banks are going to fail or be merged out of existence in the coming years. That fact has troubling consequences for our economy, as Smith and Seidel articulate.

The largest number of bank failures in nearly 20 years has eliminated jobs, accelerated a drought in lending and left the industry's survivors with more power to squeeze customers. 

The upside of failures is that they can represent a healthy cleansing of a sector that grew too fast, with bank assets more than doubling to $13.8 trillion in the decade that ended in 2008. Many banks that failed were opportunistic latecomers. Of the failed banks since February 2007, 75 were formed after 1999, according to SNL Financial.

Still, economists say, the contraction represents an enduring threat to capital, lending and the economy.

"When we step back and look at this financial disaster 10 years from now, the destruction of capital in our economy as a result of what we've endured will be the single greatest lasting impact on recovery and how the economy performs in the future," says Howard Headlee, president of the Utah Bankers Association.

Since 2008, the industry's assets have shrunk by 4.5%. 

"If you reduce the amount of assets at a bank, it means they make fewer loans, and that has a negative impact on the economy," says Richard Bove, a bank analyst at Rochdale Securities in Lutz, Fla.

From small towns like Rockford, Ill., to Miami, the banks' disappearance means not only cutbacks in lending but fewer banking choices, lower interest rates on savings accounts, and lost jobs.

The recession and collapse of the housing bubble have cut bank-industry employment by 188,000 jobs, or 8.5%, since 2007, according to FDIC data. Failures alone have cost 11,210 jobs, or 32% of the employees at failed banks, according to FIG Partners, an Atlanta investment firm that specializes in the banking industry.

I made the point in connection with the 2009 failure of Charter Bank in New Mexico that what often gets lost in this quest to ensure the "survival of the fittest" (or "biggest," or "most politically well-connected," or [insert irritating exception category here]) is the fact that mowing down thousands of small banks eliminates thousands of jobs those banks provide. It's nice that some reputable journalists have taken notice, although that won't matter a fig to people whose primary motivator in life is retiring with a vested government pension. Still, a lot of the laid off bank workers may not only swell the rolls of those needing unemployment benefits and other forms of public assistance, they might also end up as bitter voters at the next election who understand the difference between small and large banks and how the federal government and the political class treats the two banking segments. That's just a guess, but based upon anecdotal evidence, it may be a correct one.

Smith and Seidel give space to the views of contrarians. Among the points they raise are:

The overall economic impact of bank failures has been "muted" because, thus far, there have been enough buyers.

The number and rate of failures have, thus far, not been sufficient to have a large "macro-economic effect."

Banks that fail are almost always constrained from lending, while the acquirers are better capitalized and able to lend.

However, the authors close with the observation that the end result of this consolidation appears to be that the big will get bigger.

Bank of America, J.P. Morgan Chase & Co. and Wells Fargo hold 33% of all U.S. deposits, up from 21% in 2006, according to SNL Financial. That gives them more market power to squeeze out smaller competitors.

I've also seen statistics (not cited by the authors) that the four largest banks completely dominate the residential loan origination business in this country. Little guys are finding little elbow room at that table.

Earlier this year, I heard James Lockhart, former head of the FHFA (and now a member of Wilbur Ross' team) interviewed on one of the cable business news channels, and he stated that this country didn't need 8,000 "little" banks, it needed 50 large regional banks. So, heck, why stop at 5,000 when 50 appears to be the optimal number for some eggheads?

If you think that result would be bad for the economy and for consumers, you'd better get off your duff and do something about it, because the train has left station and it's rolling down the tracks, gathering speed by the day.

Public's TARP Tantrum Survives TARP's Death

Although the TARP program officially ends today, the Wall Street Journal's Deborah Solomon and Neftali Bendavid contend that Joe Sixpack and Mama Grizzly remain madder than wet hens over the program.

Lawmakers who voted for TARP are fighting for their political lives. Bailout anger has all but ruled out the chance of federal intervention in the foreseeable future. The Federal Reserve has seen its independence threatened. And the Obama administration's ability to respond to the economic crisis has been constrained.

"This whole event can have political implications for 30 years," says Kenneth Rogoff, a Harvard University economist and expert on financial crises.

Although TARP was designed to prevent a collapse of the country's (and, perhaps, the world's) banking system, to most folks it "has come to symbolize what some voters say they loathe about the wider bailout and, to a large extent, Washington: expansive government power, money spent to help Wall Street, and an unwillingness by policy makers to let people pay for their own mistakes." A lot of people want others to "pay for their own mistakes" unless that payment causes them, personally, to miss a daily does of a Quarter Pounder (with cheese), a large order of fries, and a liter of Cherry Coke. Then, by god, you can not only bail "the others" out, but make sure you give me a boatload of cash, as well. Not all, but some of the anger against TARP seems to flow from the fact that it bailed out "fat cats" and not "me." Again, in this country that was (as Nancy Pelosi contends) "founded on diversity" (although you'd look long and hard to parse the "diversity" among The Founding Brothers), painting people's motivations with a broad brush is a mistake. Nevertheless, enthusiasm for the desire to "let free markets take their course" seems to wax and wane depending on whose ox is being gored and/or whose pockets are being lined.

As I said around the time TARP was adopted, it was intended as a temporary, extraordinary measure to stave off a complete meltdown of the economy. As the Wall Street Journal article's authors (and others) point out, it did just that and is likely to cost the taxpayers relatively little in light of what it achieved.

The anger against it, paradoxically, takes no heed of the fact that TARP, along with the broader government rescue efforts, has been arguably a success. It will ultimately cost far less than the initial $700 billion price tag that stunned a nation. Major banks are profitable and can raise capital. Credit spreads—a key measurement of risk—are down to pre-crisis levels.

The White House now projects TARP will lose at most $50 billion, down from $105 billion projected earlier this year. Privately, Treasury Department officials say the U.S. may not lose a dime, and could ultimately make money depending on how some investments fare, in particular American International Group Inc. and General Motors Corp. In a $14 trillion economy, $50 billion is less than 1% of economic output.

"The incredible irony here is that TARP probably succeeded wildly beyond anybody's imagination," said Alan Blinder, a Princeton University economist who co-authored a paper crediting the administration's economic policies with preventing a second Great Depression. "Suppose the original TARP bill had been to spend $50 billion to avert a catastrophe. Would anyone have blinked?"

While irony may work for David Letterman and John Stewart viewers, it rarely plays well in the political arena. People are upset about the abysmal economy and astronomical federal debt and they're looking for scapegoats. As Bob Bennett and Mike Castle found out, angry people tend to make their voting decisions using their endocrine systems, not their cerebrums. Facts simply don't matter. Expect this rage-against-the-(TARP)-machine theme to play out for some time to come. November looks like a time when a whole lot of shakin' is going to be going on in D.C. and in state governments across America. Apparently, some of it will be motivated by anger over a bailout that actually worked.

Here's more irony, for the few that love it: TARP would have been even more successful if it hadn't been bastardized after enactment by two White House administrations, Congress, and federal banking regulators, who decided to extend it to businesses for which it was not intended (AIG and GM, to name two), change the rules of the game after-the-fact (executive compensation restrictions), and deny participation to many community banks who actually could have used the capital to survive (which would have thwarted a hidden agenda to reduce the number of commercial banks by a quarter to a third).

Smoke and Mirrors

I'm not the only blogger bleating about loan repurchase risks.

Francine McKenna has been pounding the large audit firms for several years about their failure to catch the repurchase risk inherent in the business operations of large mortgage bankers like the defunct New Century and the merged-out-of-existence Countrywide Financial. She recently discussed the fact that although KPMG has settled litigation over the failures of New Century and Countrywide, it still faces litigation over Citigroup and Wells Fargo/Wachovia.She also mentions that Price Waterhouse Coopers faces similar risk with respect to its audits of Bank of America and JPMorgan Chase, both under heavy buyback pressure from Fannie and Freddie.

Francine's gone back and parsed previous public reports that estimate the potential buyback risk to banks like JPMorgan Chase and the quarterly reports that contain reserves for such losses, and thinks she smells the stench of a gross mismatch.

I went back and looked at the JPM Chase and Bank of America (BAC) 2009 Annual Reports for more clues.

From JPMorgan Chase:

Page 241: At December 31, 2009 and 2008, the Firm had recorded repurchase liabilities of $1.7 billion and $1.1 billion, respectively. The repurchase liabilities are intended to reflect the likelihood that JPMorgan Chase will have to perform under these representations and warranties and is based on information available at the reporting date. The estimate incorporates both presented demands and probable future demands and is the product of an estimated cure rate, an estimated loss severity and an estimated recovery rate from third parties, where applicable. The liabilities have been reported net of probable recoveries from third-parties and predominately as a reduction of mortgage fees and related income.

2009 compared to 2008, page 66: Noninterest revenue was $12.2 billion, up by $2.8 billion, or 30%, driven by the impact of the Washington Mutual transaction, wider margins on mortgage originations and higher net mortgage servicing revenue, partially offset by $1.6 billion in estimated losses related to the repurchase of previously sold loans.

A reserve of $1.7 billion is much less than the $23.9 billion Compass Point Research and Trading estimated form the Wall Street Journal as JPM”s potential liability to the Federal Home Loan Banks alone, not including claims by Fannie Mae and Freddie Mac.

From Bank of America:

The Corporation records its liability for representations and warranties, and corporate guarantees in accrued expenses and other liabilities and records the related expense in mortgage banking income. During 2009 and 2008, the Corporation recorded representations and warranties expense of $1.9 billion and $246 million. During 2009 and 2008, the Corporation repurchased $1.5 billion and $448 million of loans from first lien securitization trusts under the Corporation’s representations and warranties and corporate guarantees and paid $730 million and $77 million to indemnify the investors or insurers. In addition, during 2009, the Corporation repurchased $13.1 billion of loans from first lien securitization trusts as a result of modifications, loan delinquencies or optional clean-up calls.

Bank of American admits “representations and warranties expense” as well as losses of $1.5 billion for repurchases of loans from first lien securitization trusts under their representations and warranties and corporate guarantees.  In addition, they’d already repurchased an additional $13.1 billion based on mods, delinquencies and other “clean-up”.

However, I can’t easily see anywhere in either bank what the actual reserves are for estimated future liabilities and how they come up with a number given the total loans sold by type and the current claims by various parties. I think it’s time for someone, perhaps the SEC, to demand more detailed disclosure about reserves for repurchase risk.

She also wonders how Deloitte can sign off on entities who are involved in both sides of the buy-back controversies.

Can PwC, in good faith, honestly sign off on financial statements on both sides of the disputes between the FHLBs and Freddie Mac and several PwC bank clients where completely different estimates of these liabilities are submitted?

I can understand judgment and leave some room for disagreement in a legal dispute as opposed to the valuation of an individual security. But, in the end, the quality of the documentation, the quality of the underwriting, the level of potential fraudulent documentation and the collectibility of the loan based on accuracy of the borrower ratings assigned at origination must all be relatively easy to ascertain on a comparable basis. These factors ultimately drive the value of the asset.

A loan doc is what it is. If it exists, that is.

The auditors have been helping the banks pull rabbits out of their hats for some time now.  But isn’t it about time we jump on the issue of audit firms behaving like Switzerland to protect their own self-interests? There are hundreds of millions of reasons in New York alone for PwC to stay neutral and to allow balance sheet “window dressing” via manipulation of reserves. But what does that say about the integrity of the financial information published by these banks?

Shareholders and other stakeholders will suffer greatly when the the banks eventually “surprise” us with the huge losses.

Strong stuff. Good stuff. Definitely worth a read.

Where a the federal banking regulators on these issues? Oh, that's right, we're talking about too-big-to-fail banks and audit firms. Similar facts involving a community bank and regional or local audit form would have had serious adverse supervisory consequences for them both long before this point.

Unlike Love, Banks Aren't Lovelier The Second Time Around

The Denver Business Journal's Renee McGaw discusses a quirky result of the recent meltdown in the community banking sector: a number of the banks that have hit the skids and are under regulatory enforcement agreements or orders were started and run by bankers who made a bundle with their first bank and we're trying to replicate their previous success.

An impressive number of the regulatory orders signed so far this year involve second-time-around banks whose founders fared very well with previous banks, in some cases selling them for tens of millions of dollars in the early 2000s. But regulators have signaled concern about their second incarnations.

According to professional recruiter Tim Pendergast, there's a certain irony in all this.

“What’s ironic is that not only did these investors try to duplicate the same business model a decade later, but many hired back the same people and used the same or very similar bank names in round two.”

I don't see it as much ironic as unfortunate. As Ms. McGaw points out, most community banks have traditionally made much of their money in an area where they seem to be able to compete with their bigger brethren: commercial real estate. As some bank consultants have opined with perfect 20/20 hindsight, that made them vulnerable when the subprime mortgage bubble popped and the resulting domino effect cratered all real estate prices, including commercial real estate. If only these bankers had possessed the foresight that so many armchair quarterbacks seem to possess in 2010! If only they had foreseen the inevitability of the worse economic recession since the 1930s, they wouldn't have concentrated so heavily in commercial real estate, but would have diversified into C&I (whoops, also taking a beating) or "safe" investments like FNMA preferred stock (whoops, also the cause of many banks taking it the shorts) or AAA mortgage-backed securities ('nuff said)!

There's no question that a number of banks failed to diversify their asset base suffciiently. It's also true that no one expected the debacle we're now wallowing in, other than a few contrarians who went short and got rich and (according to at least one of my correspondents) regulatory Chicken Little's whose warnings were ignored and/or actively suppressed. The rest of us idiots who were actually in the arena slugging it out might have been uneasy, but never saw the train that hit us.

I'm sure a number of these "replayers" wish they had a chance to "rewind," but that's not how life operates, is it? On the other hand, as Ms. McGaw points out, merely because a bank operates under an enforcement order doesn't mean it's not going to make it out of the swamp and onto dry land eventually. What it does mean is that it won't be repeating its past mistakes. How any of these banks are going to make money in an economy like this one is going to be a challenge, regardless of asset concentration or diversification. "Don't make commercial real estate loans" is the easy part. "What's the alternative in this economy?" is the tough nut to crack, whether or not this is your second time around.