Bernanke Urges Banks to Forgive Portion of Mortgage Debt
Bernanke Urges Banks to Forgive Portion of Mortgage DebtAssessment: The Fed's remarks predicts further distress in residential real estate and mortgage markets. The Fed's recommendations will negatively impact mortgage backed securities and derivatives markets. Expect credit markets to be tighten and become increasingly illiquid. Long term interest rates will have higher risk premiums. Long term borrowing costs will increase even as the Fed reduces the Fed Funds and/or Discount Rate.[
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Federal Reserve Chairman Ben S. Bernanke, battling the worst housing recession in a quarter century, urged lenders to forgive portions of mortgages held by homeowners at risk of defaulting.
``Efforts by both government and private-sector entities to reduce unnecessary foreclosures are helping, but more can, and should, be done,'' Bernanke said in a speech in Orlando, Florida today. ``Principal reductions that restore some equity for the homeowner may be a relatively more effective means of avoiding delinquency and foreclosure.''
Bernanke's call goes beyond the stance of the Bush administration and previous Fed comments. By comparison, the central bank's Feb. 27 report to Congress called for lenders to ``pursue prudent loan workouts'' through means such as modifying mortgage terms and deferring payments.
The Fed chief highlighted the threat posed by home values falling below mortgage balances, something Treasury Secretary Henry Paulson played down yesterday. Bernanke said the ``recent surge'' in delinquencies has been ``closely linked'' to the slide of home equity.
Paulson said in an interview with Bloomberg Television yesterday that ``almost too much'' has been made out of concerns about homeowners whose house prices have dropped below their mortgages. He also said the administration's strategy of encouraging lenders to modify loans is ``the right approach and we are making substantial progress.''
Democrats' Push Democrats in Congress, by contrast, have said relying on lenders to alter loan terms hasn't yielded enough progress and are pushing for a stronger government response. Bernanke warned today that the housing crisis may deepen.
``Delinquencies and foreclosures likely will continue to rise for a while longer,'' Bernanke said in the comments to the Independent Community Bankers of America. A surfeit of homes for sale indicates ``further declines in house prices are likely,'' he said.
Subprime borrowers are about to see their mortgage rates increase more than 1 percentage point, he said. ``Declines in short-term interest rates and initiatives involving rate freezes will reduce the impact somewhat, but interest-rate resets will nevertheless impose stress on many households.''
In the past, homeowners could refinance, though that option is now ``largely'' gone because sales of bonds backed by subprime mortgages ``have virtually halted,'' Bernanke said. ``This situation calls for a vigorous response.''
Interest Rates Bernanke didn't comment in his speech text on the outlook for the economy or interest rates. Traders expect the Federal Open Market Committee to lower the benchmark rate by 0.75 percentage point by or at the panel's next meeting on March 18, based on futures prices.
``Lenders tell us that they are reluctant to write down principal,'' Bernanke said. ``They say that if they were to write down the principal and house prices were to fall further, they could feel pressured to write down principal again.''
The Fed chairman countered that by reducing the amount of the loan, this ``may increase the expected payoff by reducing the risk of default and foreclosure.''
Bernanke also urged investors in mortgage bonds to accept ``short payoffs'' of loans by allowing borrowers to refinance at a lower principal.
OTS PlanFor investors, a reduction in principal that's ``sufficient to make borrowers eligible for a new loan would remove the downside risk'' of further writedowns or defaults, Bernanke said. Investors may be able to share in future gains in home prices under some plans, he said, citing a proposal by the Office of Thrift Supervision.
Paulson, by contrast, has declined to endorse the OTS plan. John Reich, director of the OTS, last month proposed a program where borrowers would refinance mortgages at current home values. The lender would receive a ``negative equity'' certificate that could be redeemed if the house is sold.
The number of U.S. homeowners entering foreclosure rose 75 percent in 2007, with more than 1 percent in some stage of foreclosure during the year, according to RealtyTrac Inc. of Irvine, California. For the year, more than 2.2 million default notices, auction notices and bank repossessions were reported on about 1.3 million properties.
Yesterday, the Fed and other regulators sent letters to institutions they supervise, encouraging the banks to report on their efforts to modify mortgages at risk of default.
``This will make it easier for regulators, the mortgage industry, lawmakers and homeowners to assess the effectiveness of these efforts,'' Fed Governor Randall Kroszner said in a statement yesterday.
Bernanke spoke in a state that's among the worst affected by the housing collapse. Miami home prices have dropped 17.5 percent in the past year, the most of 20 large U.S. cities, according to the S&P/Case-Shiller index. Foreclosures in Florida jumped at more than double the nationwide pace, rising 158 percent in the past year, according to RealtyTrac.
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Labels: credit derivatives, FED, federal reserve, mortgage backed securities, mortgage derivatives, real estate
Subprime fallout has Wall Street scrambling
Subprime fallout has Wall Street scramblingWall Street firms are trying to contain the subprime-mortgage fallout and reassure investors. Observers now expect a resolution to resemble a quick, brutal crash of the subprime market, a slow meltdown or a short-term blip.
Mutually Assured MayhemWall Street is on edge, scrambling to buck up Bear Stearns and avert a domino-effect debacle
On June 26 managers of Credit Suisse's (CS ) alternative investment group sent an e-mail to investors reassuring them that its portfolios "have minimal direct exposure" to subprime mortgages and "do not have any direct exposure" to the two Bear Stearns & Co. (BSC ) hedge funds that had nearly collapsed the week before. As that note was wending its way through the ether, other investors were quietly trying to sell their stakes in hedge funds full of subprime securities. Some were noting that Toronto bank CIBC holds many subprime bonds. Paris bank BNP Paribas (BNPQY ) was fending off questions about its investment in the Bear fund with heaviest losses.
It's white-knuckle time on Wall Street as firms try to prevent the subprime mess from spreading. The hedge fund blowup has suddenly thrown the world's biggest financial institutions into a game of brinkmanship that will end in one of three ways: a quick, brutal crash of the subprime mortgage market and possibly the broader corporate bond market; a slow, painful meltdown of one or both lasting many months; or a short-term blip that, over time, will be forgotten as conditions return to normal.
Disaster has been averted so far. But pressure continues to come from all sides. The decisions made by Wall Street's bankers, hedge fund managers, and bond raters over the next several weeks will determine which way the game plays out. One twitchy move by any of them could lead to mutually assured destruction.
ELBOW DEEPAt first the subprime mess looked more or less like a Bear Stearns problem. When its funds stumbled, it was Bear that put up a staggering $1.6 billion in loans to stanch the bleeding. It was Bear's stock that took the biggest hit of any brokerage house, falling some 3.2% in a day. And it was Bear that, as reported by BusinessWeek.com on June 25, drew the scrutiny of the Securities & Exchange Commission, which has opened up a preliminary investigation into what went wrong inside the 84-year-old firm led by CEO James E. Cayne.
Ordinarily, rivals wouldn't shed tears if Bear Stearns were suffering—they'd pounce on the weakness. But much of Wall Street is elbow-deep in the same troubled securities, all created during the height of the mortgage boom, that are now coming back to bite Bear. Last year, Wall Street churned out some $550 billion in so-called collateralized debt obligations (CDOs): complex bonds often backed by subprime loans that pay high yields in good times but are dangerous when the market gets rocky, as it is now. "This is not [only] a Bear Stearns problem," says Joseph R. Mason, associate professor of finance at Drexel University's LeBow College of Business.
A DOZEN PROBESCDOs are especially troublesome in a choppy market because they're illiquid— difficult not only to sell but even to value. Until now, accounting rules have let firms peg their CDOs at roughly the price they paid for them. But if the market sets new prices, then others must use those prices to value their holdings. What gives Wall Street nightmares is the possibility that Bear Stearns' struggling hedge funds, which once controlled $16 billion in assets, will be liquidated by their creditors. A shotgun sale of poorly performing securities would provide Wall Street with a true price for valuing the slumping assets. "Nobody wants to officially acknowledge the worthless nature of these products," says Peter Schiff, president of Euro Pacific Capital, a Darien (Conn.) money management firm. Indeed, SEC Chairman Christopher Cox, during a hearing on Capital Hill on June 26, disclosed that regulators have opened a dozen separate probes on the subprime market and the issue of CDO pricing, in addition to the Bear inquiry.
If Bear's holdings were auctioned off at, say, 60 cents on the dollar and other firms marked down their CDOs accordingly, losses would spread. Firms would start dumping their CDOs to get what they could for them. Thus would begin a quick, brutal crash.
That's one reason Wall Street firms such as Merrill Lynch (MER ), JPMorgan Chase (JPM ), Goldman Sach (GS )s, and Deutsche Bank (DB ), all of which had financed the funds in the first place, have been in no rush to liquidate them. A liquidation would have hurt everyone.
There's another force bearing down on CDO holders: credit rating agencies such as Moody's Investors Service (MCO ) and Standard & Poor's, which like BusinessWeek is a unit of The McGraw-Hill Companies (MHP ). If the ratings agencies were to downgrade the CDOs, it would force holders to mark down their values accordingly, potentially igniting the same sort of disaster scenario. That hasn't happened yet. "Our surveillance involves significant testing and analysis, and our long-term record is excellent," says an S&P spokesman. Noel Kirnon, head of global CDO ratings at Moody's, says the firm has a rigorous process for monitoring CDOs, and adds that deterioration in the underlying assets "has not exceeded expectations."
The wild card is institutional investors such as pension funds, university endowments, and foreign governments. If they get more nervous about the hedge funds they're invested in, they could start looking to cash out—as some have done already. If they rush for the exits, hedge funds will feel pressure to get out of CDOs, perhaps prompting a downward spiral.
The broader housing market also presents a potential threat. In Maricopa County, Ariz., which includes Phoenix, houses are entering foreclosure at a rate of more than 50 a day, according to Foreclosure.com, up 60% from last year, as recent buyers are hit by high payments and falling equity. The faster foreclosures rise, the more it may become apparent that the loans held by the CDOs are in trouble and the greater the risk of CDO downgrades.
In this high-stakes game, the risks to other lines of business are major. Already, concerns are growing that the Bear situation may be spilling over to junk bonds and leveraged loans—two red-hot markets that have kept leveraged buyouts booming and generated big profits for big banks. An index of leveraged loans has fallen 2% the past two weeks. Junk bonds are down as well. Steven C. Miller, managing director of Standard & Poor's LCD, a loan market research service, says that for the first time in two years, investment bankers have had to issue "bridge" or back-up financing for an LBO after running into difficulty selling junk bonds to fund the deal.
LBO firms are going back and offering investors higher yields and better protections to raise money for pending buyouts such as the one for retailer ServiceMaster Co. (SVM ), owner of Terminix and Merry Maids. "There's a much more sober view in the leveraged finance market right now," says Miller.
For all the pressure on CDOs, though, a crisis hasn't yet been touched off. Some observers are downplaying the significance of the hedge fund blowup to Bear Stearns' bottom line. Roger Freeman, an analyst at Lehman Brothers Inc. (LEH ), says in a June 26 research note that the matter will not have "a meaningful impact on Bear's earnings." Likewise, Miller of S&P LCD predicts that, for all the consternation over Bear, the LBO pace will only slow, not stop. CIBC, meanwhile, rejects suggestions that it could be the next firm to tumble. The assumptions about its subprime exposure "are simply not true," says bank spokesman Stephen Forbes. Paribas declined to comment.
Wall Street's strategy from here will be to try to maintain the status quo, putting out new fires quickly. "They are hoping to buy themselves as much time as possible," says James Melcher, founder of Balestra Capital, a hedge fund. "The game could work out if the top dozen firms get together to hold the market and gradually deflate it over time."
But the prospect of a meltdown is on everyone's mind. On June 26, UBS (UBS ) analysts held a conference call with money managers to review the Bear situation. "There's a search for contagion going on," says Douglas J. Lucas, a UBS analyst on the call. "I've talked to people from as far away as Australia." Everyone is watching to see who might blink.
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subprime, CDO, mortgage derivatives, CDS, ABXLabels: ABX, CDO, CDS, mortgage derivatives, subprime
Hedge fund future bleak with Merrill sell-off
Hedge fund future bleak with Merrill sell-offMerrill Lynch's planned auction of about $800 million of bonds held by a money-losing Bear Stearns hedge fund could signal the end of a Bear Stearns effort to save the fund. The 10-month-old fun run by Bear Stearns senior managing director Ralph Cioffi has lost 20% this year and is under increasing pressure from creditors, including Merrill. Bear Stearns has attributed the falloff of the fund and a sister fund to the slump in the U.S. housing market.
Some Lenders Dislike Plan to Save Bear Stearns FundBy JULIE CRESWELL and VIKAS BAJAJ
An effort to save a troubled hedge fund at Bear Stearns hit a major hurdle yesterday when Merrill Lynch signaled that it would move forward with plans to auction $850 million in subprime securities that had been held as collateral.
While negotiations are continuing and the auction could be averted, the move signaled that some lenders in the High Grade Structured Credit Strategies Enhanced Leverage fund are not happy with some terms of the Bear Stearns bailout plan.
Executives at the bank have been scrambling to shore up the fund since three lenders — Merrill, Citigroup and JPMorgan Chase — asked the bank to put up more capital. The executives had offered to inject $1.5 billion in new loans into the fund, and a consortium of other banks, including Citigroup and Barclays, would infuse $500 million in new capital.
In return, the Wall Street banks and brokerage firms that had provided nearly $6 billion to the hedge fund would have had their own exposure reduced but would have had to agree not to demand more cash or collateral from the fund for a year, according to people briefed on the plan who were not authorized to speak for attribution.
If Merrill moves forward with an auction, it could make it much more difficult for Bear Stearns and the longtime portfolio manager of the fund, Ralph Cioffi, who has spent the last few days scrambling to try to bring in new money, to save the 10-month-old fund. If other lenders decide to follow Merrill’s lead and seize and sell assets, it could lead to the dissolution of the hedge fund.
Late yesterday, some people briefed on the plan said that one option might be for Bear Stearns to buy out Merrill’s stake. Representatives at Bear Stearns and Merrill declined to comment.
But if the assets — securities and bonds backed by subprime mortgages that can be difficult to value — are sold at prices well below where they are currently valued, the reverberations across Wall Street would be strong. Not only would Merrill be forced to post losses on its holdings, but other banks, hedge funds and investors owning similar securities would have to mark down the value of those holdings to new, lower prices.
“If we end up seeing these assets sold at significantly distressed prices, it will likely cause other funds to have to re-evaluate how effective and fair the values that they have been carrying these securities have been.” said Josh Rosner, a managing director at Graham Fisher, an investment research firm in New York.
The potential for a large ripple effect across the financial markets has been one reason many of the other lenders, even those unhappy with the terms of the bailout plan, stayed at the negotiating table with Bear Stearns, according to people briefed on the talks.
Started just last year, the Bear Stearns hedge fund was hit by a combination of bad bets on bonds backed by subprime mortgages as well as high levels of leverage. Investors originally put $600 million into the fund and another $6 billion was borrowed from the Wall Street banks.
Through the end of April, the fund had lost about 23 percent, prompting investors to try to redeem their investments. In May, the fund froze redemptions and soon faced margin calls from its banks.
While Bear Stearns has little exposure to the fate of the fund — the company and individual executives invested just $40 million in it — its stock nonetheless declined 2.2 percent, to $146.79. in the last two days.
Investors are probably concerned about how the outcome could affect the larger Bear Stearns business of underwriting and trading bonds backed by mortgages.
Full articleVideohedge funds, mortgage backed securities, CDO, CDS, credit derivatives, mortgage derivativesLabels: CDO, CDS, credit derivatives, hedge funds, mortgage backed securities, mortgage derivatives
