Geithner Outlines Accomplishments, Future of Financial Reform

Treasury Secretary Timothy Geithner told
the Financial Stability Oversight Council that the financial system is getting
stronger and safer and that much of the excess risk-taking and careless
financial practices that caused so much damage has been forced out.  However, he said, “These gains will erode
over time if we are not able to put our full reforms into place.”

He outlined the basic framework has been
laid, with new global agreements to limit leverage, rules for managing the
failure of a large firm and the new Consumer Financial Protection Bureau (CFPB)
up and running, and the majority of the new safeguards for derivatives markets proposed.  Geithner ticked off the major accomplishments
of reform.

First, banks now face much
tougher limits on risk which are critical to reducing the risk of large
financial failures and limiting the damage such failures can cause.  The focus in 2012 will be “on defining the
new liquidity standards and on making sure that capital risk-weights are
applied consistently.”

 The new rules are tougher on
the largest banks that pose the greatest risk and are being complemented by
other limits on risk-taking such as the Volcker Rules and limits on the size of
firms and concentration of the financial systems.  These will not apply only to banks but to
other large financial institutions that could pose a threat to financial system
stability and this year the Risk Council will make the first of these
designations.

Second, the derivatives market will,
for the first time, be required to meet a comprehensive set of transparency
requirements, margin rules and other safeguards.  These reforms are designed to move
standardized contracts to clearing houses and trading platforms and will be
complemented with more conservative safeguards for the more complex and
specialized products less amenable to central clearing and electronic
trading.  These reforms, the balance of
which will be outlined this year, will lower costs for those who use the
products, allow parties to hedge against risk, but limit the potential for
abuse, the Secretary said. 

Third, is a carefully designed set
of safeguards against risk outside the banking system and enhanced protections
for the basic infrastructure of the financial markets: 

  • Money market funds will have new
    requirements designed to limit “runs.”
  • Important funding markets like the
    tri-party repo market are now more conservatively structured.
  • International trade repositories are
    being developed for derivatives, including credit default swaps.
  • Designated financial market utilities
    will have oversight and requirements for stronger financial reserves;

Fourth; there will be a stronger set
of protections in place against “too big to fail” institutions.  The key elements are:

  • Capital and liquidity rules with
    tough limits on leverage to both reduce the probability of failure and prevent
    a domino effect;
  • New protections for derivatives,
    funding markets, and for the market infrastructure to limit contagion across
    the financial system;
  • Tougher limits on institutional size;
  • A bankruptcy-type framework to
    manage the failure of large financial firms.
    This “resolution authority” will prohibit bailouts for private
    investors, protect taxpayers, and force the financial system to bear the costs
    of future crisis.

Fifth, significantly stronger
protections for investors and consumers are being put in place including the
CFPB which is working to improve disclosures for mortgages and credit cards and
developing new standards for qualified mortgages.  New authorities are being used to strengthen protections
for investors and to give shareholders greater voice on issues like executive
compensation.

Geithner pointed to the failure of
account segregation rules to protect customers in the MF Global disaster as proof
of the need for more protections and said that the Council will work with the
SEC and the Commodity Futures Trading Council on this problem.   

Moving forward, reforms must be
structured to endure as the market evolves and to work not just in isolation
but to interact appropriately with each other and the broader economy.  “We
want to be careful to get the balance right-building a more stable financial
system, with better protections for consumers and investors, that allows for
financial innovation in support of economic growth.” 

First, he said, we have to make sure
we have a level playing field at home; that financial firms engaged in similar
activity and financial instruments that have similar characteristics are
treated roughly the same because small differences can have powerful effects in
shifting risk to where the rules are softer. 
A level field globally is also important, particularly with reforms that
toughen rules on capital, margin, liquidity, and leverage, as well as in the
global derivatives markets.  “In these areas we are working to discourage
other nations from applying softer rules to their institutions and to try to
attract financial activity away from the U.S. market and U.S. institutions.” 

It is necessary to align the
developing derivatives regimes around the world; preventing attempts to soften
application of capital rules, limiting the discretion available to supervisors
in enforcing rules on risk-weights for capital and designing rules for
resolution of large global institutions.  Also, because some U.S. reforms are different
or tougher from rules in other markets, there needs to be a sensible way to
apply those rules to the foreign operations of U.S. firms and the U.S.
operation of foreign firms.

 The U.S. also needs to move
forward with reforms to the mortgage market including a path to winding down
the government sponsored enterprises (GSEs.) 
The Administration has already outlined a broad strategy, Geithner said,
and expects to lay out more detail in the spring.  The immediate concern is to repair the damage
to homeowners, the housing market, and neighborhoods.  The President spoke this week about the range
of tools he plans to use.  Our ultimate goals
are to wind down the GSEs, bring private capital back into the market, reduce
the government’s direct role, and better target support toward first-time
homebuyers and low- and moderate-income Americans.

Geithner said the new system must
foster affordable rentals options, have stronger, clearer consumer protections,
and create a level playing field for all institutions participating in the
system.  For this to happen without
hurting the broader economy and adding further damage to those areas that have
been hardest hit, banks and private investors must come back into the market on
a larger scale and they want more clarity on the rules that will apply. 

Credit availability is still a problem
and there is a broad array of programs in place to improve access to credit and
capital for small businesses.  As
conditions improve, it is important that we remain focused on making sure that
small businesses, a crucial engine of job growth, have continued access to
equity capital and credit.

Many Americans trying to buy a home
or refinance their mortgage are also finding it hard to access credit, even for
FHA- or GSE-backed mortgages.  The Administration has been working closely
with the FHA and FHFA to encourage them to take additional measures to remove
unnecessary barriers and they are making progress.  They will probably outline additional reforms
in the coming weeks.

Bank supervisors, in the normal
conduct of bank exams and supervision, as well as in the design of new rules to
limit risk taking and abuse, must be careful not to overdo it with actions that
cause undue damage to the availability of credit or liquidity to markets.

Geithner said the U.S. financial
system is getting stronger
, and is now significantly stronger than it was
before the crisis.  Among the achievements:

  • Banks have increased common equity
    by more than $350 billion since 2009.
  • Banks and other financial
    institutions with more than $5 trillion in assets at the end of 2007 have been
    shut down, acquired, or restructured.
  • The asset-backed commercial paper
    market has shrunk by 70 percent since its peak in 2007, and the tri-party repo
    market and prime money market funds have shrunk by 40 percent and 33 percent
    respectively since their 2008 peaks.
  • The financial assistance we provided
    to banks through TARP, for example, will result in taxpayer gains of
    approximately $20 billion.

The Secretary said the strength of
the banks is helping to support broader economic growth, including the more
than 3 million private sector jobs created over 22 straight months, and the 30
percent increase in private investment in equipment and software.  
Broadly, the cost of credit has fallen significantly since late 2008 and early
2009.  Banks are lending more, with commercial and industrial loans to
businesses up by an annual rate of more than 10 percent over the past six
months.  

He concluded by saying that no
financial system is invulnerable to crisis, and there is a lot of unfinished
business on the path of reform.  The reforms are tough where they need to
be tough.  “But they will leave our financial system safer, better able to
help businesses raise capital, and better able to help families finance safely
the purchase of a house or a car, to borrow to invest in a college education,
or to save for retirement.  And they will protect the taxpayer from having
to pay the price of future crisis.”

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DeMarco: Principal Write-Downs Expensive, Benefits Uncertain

Getty Images
Edward DeMarco, acting director of the Federal Housing Finance Agency

How far should the federal government go to stabilize the housing market?

Many Democrats say more should be done. That’s why there have been a series of calls of late from Democratic lawmakers on Capitol Hill and Federal Reserve officials to have government-controlled mortgage finance companies Fannie Mae and Freddie Mac reduce the value of borrowers’ mortgages for homeowners who are “underwater,” meaning that they owe more on their properties than their homes are worth.

Fannie and Freddie and their regulator, however, have resisted doing so, despite pressure from the highest levels of government.

Last week, the acting director of the Federal Housing Finance Agency, which regulates Fannie and Freddie, sent lawmakers a detailed analysis of why cutting loan balances doesn’t make sense from a financial standpoint, given the regulator’s mandate to “preserve and conserve” Fannie and Freddie’s assets.

The letter was requested by Rep. Elijah Cummings, the top Democrat on the House Oversight Committee.

Edward DeMarco, acting director of the FHFA, argued that doing so would cause taxpayers to spend more money on the mortgage giants’ rescue than other foreclosure-prevention strategies. Fannie and Freddie have been propped up by taxpayer support for more than three years, a rescue that’s cost taxpayers about $151 billion

“Any money spent on this endeavor would ultimately come from taxpayers and given that our analysis does not indicate a preservation of assets for Fannie Mae and Freddie Mac substantial enough to offset costs, an expenditure of this nature at this time would, in my judgment, require congressional action,” DeMarco wrote in the letter.

About 3 million borrowers with loans backed by Fannie and Freddie owed more on their homes than their properties were worth as of last summer. That’s about 10% of the loans they own or guarantee. A write-down of all 3 million of those mortgages would cost taxpayers $100 billion, Mr. DeMarco estimated.

Fannie and Freddie do offer forbearance plans, in which lenders don’t require any payments on a portion of the loan for up to 12 months. What they don’t offer is forgiveness, where that portion of the loan is wiped out.

Mr. Demarco, in his letter to lawmakers, said FHFA’s analysis concluded that “forbearance achieves marginally lower losses for the taxpayer than forgiveness, although both forgiveness and forbearance reduce the borrower’s payment to the same affordable level.”

In addition, Mr. DeMarco noted that Fannie and Freddie would face significant up-front technology and training costs to launch a principal write-down program.

“Unless there is an expectation that principal forgiveness will reduce losses, we cannot justify the expense of investing in major systems upgrades,” he wrote.

This position has put Mr. DeMarco at odds with many Democrats and some Federal Reserve officials. In a paper earlier this month, the Fed noted that, “Some actions that cause greater losses to be sustained by the [companies] in the near term might be in the interest of taxpayers to pursue if those actions result in a quicker and more vigorous economic recovery.”

However, Mr. DeMarco’s letter noted that “our determination has been based on projected economic costs to taxpayers, not short-term accounting considerations.”

Fannie and Freddie would also risk giving up money if they reduced loan balances because they could no longer recover money from mortgage insurers, which cover some losses for borrowers who have a down payment of less than 20%.

First Horizon’s Buybacks; Buyback Legal Chatter; Basel III and Construction Loans; Congress Snubs Small Business?

I have been subtly warning groups during speeches, and writing in this commentary, about the implications of Basel III. Most of the focus is on servicing & the value of it. But did you know that under the new Basel III rules, construction lending would likely go into the “high risk commercial real estate” category and require a 150% risk weighting? “Lenders would seek deals where a developer would contribute a substantial amount of cash equity; while banks would be less likely to let developers rely just on the equity from appraisals” per American Banker. And the government and the Fed are asking why banks aren’t lending? This is just another reason.

Last month we sold the house where my kids grew up, and I had a handyman remove the doorframe where we marked heights on birthdays. I am not mentioning this to turn the daily into a Hallmark card, but because it reminded me of one thing that the press seems to forget: a house is a home and not a share of stock. And when it comes to that, the popular press seems to forget that people need a place to live, that people want a good school district for their kids, a place to get to know the neighbors, a place to create an emotional attachment. I could go on and on, but there are very concrete reasons why people who are underwater on a house still make the payments, why many who supposedly saw the real estate decline didn’t sell their home, and why so many people don’t care about minute fluctuations in the price of housing based on the latest metric.

I’ll get off my soapbox, and get on with business: I think that the last time the S&P/Case-Shiller Home Price Index went up was during the Eisenhower Administration – until now. Seriously, for the first time in eight months the S&P/Case-Shiller Home Price Indices rose over levels of the previous month.  Data through April 2012 showed that on average home prices increased 1.3% during the month for both the 10- and 20-City Composites. Prices are still down 2.2% for the 10-City and 1.9% for the 20-City over figures for one year earlier but this is an improvement over the year-over-year losses of 2.9% 2.6% recorded in March. This report followed Monday’s news that New Home Sales jumped 7.6% in May to 369k and was up 19.8% from a year ago, and last week’s Existing Home Sales, Housing Starts and NAHB HMI which all contained some positive signs.

How’s this to grab one’s attention: “Congressional Subcommittee REFUSES Small Business Brokers and Appraisers a Seat at the Table.” The notice from the NAIHP goes on, “For the second time in a week, the Subcommittee on Insurance, Housing and Community Opportunity, Chaired by Rep. Judy Biggert (R-Illinois), refused small business housing professionals the right to be represented during Congressional testimony.” Here you go: http://www.naihp.org/.

Yes, there are plenty of rumors that the agencies are hotly pursuing buybacks to recoup taxpayer losses, and that the agencies are losing personnel except for QA & auditing. But that reasoning doesn’t help companies like First Horizon National Corp. It “cited new information it recently received from Fannie Mae as the basis for incurring the $272 million charge this second quarter. About $250 million will go to repurchase loans made with “inadequate or incorrect” documentation, and $22 million is being charged to address pending litigation.” I don’t make this stuff up.

Last week I received a legal question about buybacks. “I was asked by a former customer of a major investor’s correspondent lending group about how others are handling repurchase/make-whole requests on older vintage loans.  His experience has been that the investor will ask to be reimbursed for losses associated with loans that have been foreclosed and disposed of without being given an opportunity to refute the alleged rep and warrant deficiency.  He has had to hire a law firm to argue each of these requests and the major investor has backed off each time. Normally, when a correspondent is still active, there is obviously leverage against the correspondent under an implied or actual threat of being terminated as a customer if a make-whole is not made, and when an investor is no longer in the correspondent business, I’ve heard rumors of it being more inclined to back down but sometimes taking a former customer to court or ‘saber rattling’. Needless to say, it is expensive to have a lawyer prepare a rebuttal to a make-whole request, just to have the investor ultimately back-off – what to do?”

I turned this over to attorney Brian Levy, who wrote, “Your question about investor willingness to sue originators over repurchase claims is difficult to answer with specificity.  My clients have been able to settle and/or avoid litigation in every engagement that I have undertaken in this area. That does not mean, however, that the threat of investor repurchase litigation over individual loans is not real or that litigation is not occurring, but it has been my experience that these disputes can be resolved (or dismissed) through extensive and detailed settlement negotiations and information exchange.  Litigation over individual repurchase claims may be fairly unusual now, but so were repurchase claims entirely prior to 2007-2008. Due to the unique nature of each originator’s position and the facts around applicable repurchase claim(s), however, it would be reckless to assume one will not be sued on specific claims based on what is generally occurring in the industry or based on what may have been past investor appetite for litigation (although these are important elements to consider in one’s strategy).”

Brian goes on. “For example, much depends on the facts and circumstances of the loan(s) in question, whether there are any other relationships between the parties that can be leveraged (loans in the pipeline, warehouse lines etc.) the overall quality, stability and reputation of the originator and, significantly, the parties’ tolerance for risk, availability or need for reserves and the desire for finality.  Moreover, investor and originator appetite for lawsuits may change over time as strategies can change in organizations and as the few cases that have been filed begin to yield decisions that are more or less favorable to one side or another. Even the tenor of discussions or lack of attention to the matter can impact a party’s willingness to file a lawsuit. All of these issues should be explored with legal counsel as part of an originator’s comprehensive repurchase management strategy.” (If you’d like to reach Brian Levy with Katten & Temple, LLP, write to him at blevy@kattentemple.com.)

Here are some somewhat recent conference & investor updates, providing a flavor for the environment. They just don’t stop. As always, it is best to read the actual bulletin.

Down in California, it is time again for the CMBA’s Western Secondary conference. (I’ve been wandering around that San Francisco conference since 1986 – if those halls could talk…) The CMBA has presentations on “QM, QRM, the CFPB, Agency Direct Delivery – Reviving the Lost Art of Servicing Retained Execution, Compliance issues Facing State Licensed Mortgage Banks Today and How Regulatory Change will Impact Your Business and the Secondary Market, Manufacturing Quality – Steps to Produce a Quality Loan (Operation Focus),” and several other topics. Check it out.

In light of the increasing number of non-conforming transactions where the departure residence is retained by the borrower and is in a negative equity position, Wells Fargo issued a reminder that underwriters must weigh any and all risk factors evident in the loan file.  Each case should be weighed individually, as there are only so many situations underwriting guidelines can predict.  The Wells Seller Guide now states that, in a case where the departure residence won’t be sold at the time of closing and is in a negative equity position, paying down the lien or using additional reserves to cover the negative equity may be required to reduce overall risk.

Wells has issued another reminder that a signed Borrower Appraisal Acknowledgement is required for all loans.  The Acknowledgment, whether it’s the Wells-issued form or a custom document, must include the property address, complete lender name, borrower name, borrower signature, and borrower signature date.  If the form has checkboxes where the borrower can make a choice, these boxes must be ticked.

Due to changes to FHA Single Family Annual Mortgage Insurance and Up-Front Mortgage Insurance Premiums announced by HUD back in March, one of which requires lenders to determine the endorsement/insured date of the FHA loan as part of a Streamline Refinance transaction, Refinance Authorization results will need to be submitted to Wells with the closed loan package.  These results are necessary to ensure that the accurate MIP was applied.  This applies to all FHA Streamline Refinances with case numbers assigned on or after June 11, 2012, while loans purchased through Pass-Thru Express are excepted.

Wells’ government pricing adjusters are set to change on July 2nd.  For VA loans with scores between 620 and 639, the adjuster will go from -0.750 to -1.500.  The adjuster for loans with scores between 640 and 679, currently at -0.250, will change to -0.500.  This affects Best Effort registrations, Best Effort locks, Mandatory Commitments, Assignments of Trade, and Loan Specified Bulk Commitments.

How sensitive are our markets to European news? Sure, instead of buying our 10-yr yielding 1.65% you could buy a Spanish 10-yr yielding 6.74%. But there is instability, evidenced by this note from an MBS trader yesterday: “News of Merkel stating Europe would not have shared liability for debt ‘as long as she lives’ caused Treasuries to immediately surge higher, only to be met by better real money selling of 7s.  While the selling did help to stall the rally, the true relief didn’t come until Reuters posted a correction to its initial release, re-quoting Merkel as having said Europe would not have ‘total shared’ liability for debt as long as she lives.  The amendment took Treasuries off the highs ahead of the 2yr auction…”

Say all you want about the market, bond prices and yields are not doing a whole heckuva lot. Tuesday the 10-yr closed at 1.63%, very close to where it’s been all week, although there was some intra-day volatility blamed on Europe. (European problems will be with us for years, and paying attention to intra-day swings can become wearisome after years…) For agency mortgage-backed securities, volume has been around “average” all week, with the usual buyers (the Fed, hedge funds, money managers, overseas parties) absorbing it. Up one day, down another – yesterday was down/worse by about .250, which was about the same as the 10-yr T-note. We could have been helped by the Conference Board’s Consumer Confidence index which dropped for a fourth straight month, to 62 from a revised 64.4 in the prior month, but nope.

No one is getting any younger… (Part 1 of 2)
I very quietly confided to my best friend that I was having an affair. She turned to me and asked, “Are you having it catered?” And that, my friend, is the definition of ‘OLD’!

Just before the funeral services, the undertaker came up to the very elderly widow and asked, “How old was your husband?”
“98,” she replied. “Two years older than me.”
“So you’re 96,” the undertaker commented.
She responded, “Hardly worth going home, is it?”

Reporters interviewing a 104-year-old woman:
“And what do you think is the best thing about being 104?” the reporter asked.
She simply replied, “No peer pressure.”

I feel like my body has gotten totally out of shape, so I got my doctor’s permission to join a fitness club and start exercising.  I decided to take an aerobics class for seniors. I bent, twisted, gyrated, jumped up and down, and perspired for an hour. But, by the time I got my leotards on, the class was over.

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