The Road to Housing Recovery 101: $8,000 for downpayment or closing costs
Homebuyers once again can avail of a new incentive. The $8,000 Federal Tax Credit, for those who purchase a primary residence before December 1, 2009, can now be used towards closing costs, buying down their interest rate or increase the minimum 3.5% downpayment for FHA loans. The up to $8,000 credit, which has no repayment clause, is also available to those who haven owned a home in the last 3 years.
You can find more from the Housing and Urban Development, by clicking on this link… http://www.hud.gov/news/release.cfm?content=pr09-072.cfm
This is definitely good news for both buyers and sellers. We expect to see positive results soon. Please email me at info@chicagoprimeproperties.com if you would like to receive additional information on how you can benefit.
Banks Under Fire-Part 2
The loose underwriting standards in home mortgages coupled with the shifting of risk perpetuated a venue for incubating moral hazard. The consequences were destructive to on and off balance sheet of banks.
As a Qualitative Asset Transformer (QAT), banks are rewarded for mismatching the two sides of the balance sheet- assets and liabilities or loans and deposits, and these create risks. As typically, the bank’s assets has greater credit risks than its liabilities. However, in recent years it has reached an unprecedented level, an example of which is when Moody’s Investors Service announced that it’s raising its loss expectations for US subprime residential mortgage-backed securities issued between 2005 and 2007, as it believes, without intervention, nearly all already-delinquent loans will eventually default.
Also, bank’s assets have usually longer maturities than liabilities, creating interest rate risk. These risks were inherent during the period of 2002-2004 when the federal funds target rate was in the average of 1.25% and loans that are adjustable rate mortgages (ARMs) were prone to prepayment.
Lastly, a bank’s liabilities are more liquid than its assets. When a depositor demands his money without notice, while the bank’s assets, such as loans cannot be traded in an active market, there is a liquidity risk. As what recently happened with the largest bank failure of Indy Mac Bank in summer of 2008, due to their enormous exposure in exotic/option loans, depositors doubted the bank’s viability, thus they withdrew their money. Similarly, the seizure and sale of Washington Mutual to Chase and Wachovia to Wells Fargo are examples of liquidity risk. These banks were required to mark-to-market or estimate the fair value of their assets, particularly the mortgage backed securities, at a time where the market for these assets were not active.
Over recent years, the rapid growth of banks’ off balance sheet exposure can be attributed to deregulation, technological and financial innovation. This has provided enormous opportunities, nevertheless it created a competitive environment. Most profits from conventional on balance sheet activities have been diminishing, thus banks have approached it aggressively in an effort to keep relationships with current clients intact and to increase fee income from other sources.
The most controversial of the bank’s contingent claims are the credit default swaps. The CDS market exploded over the past decade to more than $45 trillion in mid-2007, according to the International Swaps and Derivatives Association. This is roughly twice the size of the U.S. stock market (which is valued at about $22 trillion and falling) and far exceeds the $7.1 trillion mortgage market and $4.4 trillion U.S. treasuries market, notes Harvey Miller, senior partner at Weil, Gotshal & Manges.
These insurance-like contracts that promise to cover losses on certain securities in the event of a default have been difficult to value lately. What makes it more challenging is that at this time, most banks wrote down their mortgage related securities.
Considering that the banking industry is in turmoil, public regulatory agencies, including Federal Reserve, Office of the Comptroller and Currency, Federal Deposit Insurance, needed to step up. It has been criticized that during good times, when profits were flowing, rewards have been privatized, but now that inefficiencies in the financial markets exist, risks have been nationalized. Most of the risks inherent in the lending industry are now being absorbed by the government. This scenario creates moral hazard, as it signals that a party shielded from risk may behave differently from the way it would behave if it were fully exposed to the risk. The idea that financial institutions did not bear the full consequences of their actions, as they acted less carefully than they otherwise would, leaving the government to bear the responsibility for the consequences of their actions.
Endnotes:
-Basel Committee: The management of banks’ off-balance-sheet exposures: a supervisory perspective. Bank for International Settlements. Bis.org. March 1986
-Morrissey, Janet. Credit Default Swaps: The Next Crisis? Time.com. March 17, 2008
-Curran, Kelly. Subprime-Mortgage Defaults to Surge: Report. Housingwire.com. Feb 26, 2009
-FDIC Announces Plan to Free Up Bank Liquidity. Creates New Program to Guarantee Bank Debt and Fully Insure Non-Interest Bearing Deposit Transaction Accounts. October 14, 2008
-Zacks Investment Research. The Moral Hazard Of Bailouts. Dailymarkets.com. February 19, 2009
-FDIC Announces Plan to Free Up Bank Liquidity. Creates New Program to Guarantee Bank Debt and Fully Insure Non-Interest Bearing Deposit Transaction Accounts. October 14, 2008
*If you would like a full copy of the study, please email me at info@chicagoprimeproperties.com*
Banks Under Fire- Part 1
“The FDIC is taking this unprecedented action because we have faith in our economy, our country, and our banking system,” said FDIC Chairman Sheila C. Bair. “The overwhelming majority of banks are strong, safe, and sound. A lack of confidence is driving the current turmoil, and it is this lack of confidence that these guarantees are designed to address.”
What brought us here? In light of the current financial situation, moral hazard and asymmetric information as inherent factors of the banking model, have been key issues in the debate over how the government should respond to financial distress. It is certainly an interesting time to analyze the government initiatives, argue their viability, analyze the root causes of past inefficiencies, and investigate relevant solutions.
As financial markets have been functioning erratically lately, it is necessary to examine what brought about government intervention. Why would a perfectly functioning depository institution in 2007and prior years will be compelled to receive bailout funds this year and last’s? To understand this, we must first discuss what prompts individuals to act and choose a certain outcome over another. In addition, we can infer that there are two types of individuals- risk averse and risk preferring. The risk averse one desires to diversify. As such, man over the years has found ways to process risk, absorb it, and shift it. Likewise, we will attempt to discuss the natural emergence of banks as an essential component of a society. The banking model is a result of a collective aspiration to efficiently utilize scarce resources. Man needs a venue to park his money in a secure location and banks found ways to profit from it through lending. In order for markets to function efficiently, financial intermediaries must exist and based on empirical evidence, these banks’ existence present a positive signal, as they supply a special service that no other entity can adequately provide.
The intrinsic special nature of banks is prone to excessive abuse as managers enjoy a concentration of economic power. To remedy this, there needs to be a stabilizing influence, thus the creation of the central bank as the lender of last resort. The introduction of the Federal Reserve System, as the US’ central bank, established a type of moral hazard as member banks felt they have a safety net. To counter this, reserve requirements are imposed to limit the amount of money loaned compared to its cash assets. As fractional reserve banking is intrinsically susceptible to failure, over the years certain regulations have been introduced including the creation of the Federal Deposit Insurance Corporation (FDIC) in 1933 to restore public confidence in the nation’s banking system. According to the FDIC official website, this government entity “insures deposits at the nation’s 8,451 banks and savings associations and it promotes the safety and soundness of these institutions by identifying, monitoring and addressing risks to which they are exposed. The FDIC receives no federal tax dollars – insured financial institutions fund its operations”. Now, if this is so, why is the banking system in worse shape since the Great Depression?
As we have seen with the housing bubble of 2007, the subprime mortgage crisis exposed the realities inherent in the banking structure. It created a destructive impact to the financial system and the economy in general. The types of residential mortgage contracts originated in the last decade, where programs involving personal statement of assets and income without verification were in abundance and unregulated, uncovered the concept of asymmetric information. In this scenario, the borrower knew the truth, in consequence has better information over the loan officer. As such, is aware of his or her true capacity to repay the loan. However, this doesn’t seem to bother the system, as banks and brokers continued to originate loans, considering that they are not lending their own money. They shifted risk to lenders or other banks, who sold mortgages soon after underwriting them. These mortgages were then sold to investment banks, who then packaged them into mortgage backed securities or MBS. The MBS were bought by investors in the capital markets, who then hedged against the risk of default and prepayment. Thus, continuation of risk transfer created a type of moral hazard. In this scenario, the banks and other non depository institutions do not bear the full consequences of their actions. They acted less carefully, leaving the lender of last resort with the responsibility for potential losses. As such, it is now the Federal Reserve, in the form of tax payer funds, who assumed the ultimate risk.
*If you would like a copy of the full study (11 pages), please email me at info@chicagoprimeproperties.com*
6 Significant Steps to Housing Recovery
With the sharp decline in home prices and the rising mortgage delinquencies and foreclosures, the federal government through key branches and agencies, such as but not limited to the Department of Treasury, Federal Reserve, Congress and Federal Deposit Insurance Corporation have taken significant steps to address these problems. The end of the housing boom in summer of 2007, caused a severe strain to financial institutions and consequently to the entire United States economy.
Unless we get housing back on track, we won’t see financial stability and a sustainable economic recovery. These steps were instituted to support the housing market.
First, the Treasury Department placed under conservatorship the two mortgage giants, Fannie Mae and Freddie Mac, to be overseen by the Federal Housing Agency until they are on stronger footing.
Secondly, the Federal Reserve under the Federal Open Market Committee (FOMC) altered the federal funds target rate to range between 0.00% and 0.25%.
Third, through the Capital Purchase Program and Capital Assistance Program under the Emergency Economic Stabilization Act, financial institutions have readily available capital to continue private lending.
Fourth, to encourage additional sources of mortgage finance and strengthen financial institutions, the Department of Treasury introduced the development of covered bonds in the US market.
Fifth, through the American Recovery & Reinvestment Act, first time homebuyers will receive a $8,000 grant in the form of a tax credit.
Lastly, the Homeowner Affordability and Stability Plan intended to make loan modification within reach and refinance affordable to almost 9 million homeowners.
As we are currently experiencing, any further declines in home prices will lead to collateral damage to the economy, as consumer spending will be reduced and further broad credit tightening will continue. In addition, recently modified distressed mortgages will re-default at significantly high rate if prices continue to fall. Thus, it is crucial to gain buyers’ confidence back in the market, reduce the inventory and stabilize home prices. Until this happens we will not see a sustainable economic recovery.
*If you would like a full copy of this study (16 pages), please email me at info@chicagoprimeproperties.com*
