“SEND THEM TO SCHOOL” – TREASURY'S NEW PROGRAM FOR THE MORBIDLY DEBT LADEN AMERICANS

In his remarks today at the CFED Asset Learning Conference, Assistant Secretary for Financial Institutions Michael Barr announced the Treasury Department’s newest attempt at rectifying the past mistakes of the financial consumer. In conjunction with the Financial Literacy and Education Commission, the Treasury has drafted a concept of core financial competencies for individuals. This ‘baseline’ of knowledge appears to be a way that the Treasury believes will bring financial consumers to a better understanding of what they are getting into.

While knowledge and education are a lofty goal, there has to be some understanding of the ability (or inability) of the financial consumer to be receptive to the program. The mistake of the past was that while a consumer was able to qualify for a loosely underwritten mortgage loan did not mean that such consumer should have been a homeowner. Pressure from the then current administration on down to the consumer’s desire to own a home, together with all the intermediaries (mortgage broker, appraiser, home builder, realtor, Wall Street banker/lawyer, etc.) drove the market into the wall with one huge “SPLAT.” Now, the Treasury believes that showing the consumer what he needs to know will somehow avoid this problem in the future.

One flaw with this concept is the fact that Wall Street, specifically the sub-prime mortgage market for which we have to thank as a significant contributor to the current financial hole we are in, will never want an educated consumer. It is the theory of “Caveat Emptor” or "Let the buyer beware" that fueled the current crisis and allowed those in the game to make vast amounts of money. Feeding these consumers easy credit allowed all involved to run this vast financial machine. Educating the consumer will not bring profits. To show the consumer what was being done would be like showing a person what it actually takes to turn a cow into a hamburger. And how many people really want to know what was in their McLoan or how it was made. Most of these lower income financial consumers (the sub-prime borrower) want something that is easy to swallow, tastes good and is cheap. Unfortunately, they are now experiencing the indigestion that comes from consuming so much “Fast Finance.”

Yet, Mr. Barr believes that Treasury, with the establishment of the Consumer Financial Protection Bureau, can become the home economics trainer of the debt overweight consumer. By putting the unbanked and underbanked consumer (again, the sub-prime borrower) on a “dollar watchers diet” and educating them on how to fiscally shape-up, Mr. Barr stated that this will empower American families and create a level playing field for all providers of consumer financial products and services. “We need to empower consumers to make good choices for themselves and their families. We need to recognize that inertia is a powerful part of human decision. Anything that we can do to create an automated aspect to savings decisions has a lasting impact. How choices are framed and ordered can also have big impacts, which requires us to be intentional about the architecture of choice; defaults are ubiquitous and powerful, so choose the default wisely, and people view gain and loss differently, so an assurance of safety can be an attractive draw to save. These are just a few of the lessons that behavioral economics has taught us about human behavior. These and other lessons should be considered wisely to access and asset building efforts.”

But like a gym membership, it only has an effect on those people that commit to the program for a consistent period of time. However, the financial consumers discussed by Mr. Barr were not the type to educate themselves before entering into significant financial arrangements. They just wanted their McLoan - supersized. Now, they are looking for the magic pill (HAMP) to get them “debt thin” again. But like the promises of so many of those diet pills, loan modifications or debt settlements appear to only work for a limited few. So, while this new education program may work to help a few of the morbidly financial obese that commit to the program, it probably will be like the treadmill in the corner of the basement and will not get most of these borrowers off the couch and stop them from eating “credit Cheetos”, once the shelves are restocked.

THE PLAY ON ALT-A SECURITIZATIONS – LET THE GAMES BEGIN (AGAIN)

In an article today in the Wall Street Journal by Prabha Natarajan, it looks like there is a renewed interest and demand for previously issued Alt-A securitization paper. While unclear, it appears these non-agency bonds include the sub-prime variety (there is some distinction between Alt-A and true sub-prime, which appears to have been lost in the recent financial hurricane).

As reported, in was stated by Jesse Litbvak, head of non-agency trading and Jefferies & Co in Stanford, CT (an MBS trading powerhouse?) that these trades are occurring because investors believe that the credit risk of continuing defaults are already priced into the bonds. That, together with the prospect of early redemption, as noted in the article by Matt Toms, head of U.S. public fixed income investment at ING Investment Management, means that the bonds have up-side potential.

Well, as we have seen from our recent past, that is anything but a sure thing. Of significance to this analysis of the value of the bonds is the redemption of the bonds before their maturity date. Currently, due to the refinance boom (or really, bubble), the bonds can be redeemed at their face value due to the early payment of the underlying mortgages. Where in the past, early redemption was something to be avoided (when the investor was paying 105 for the bond), now at the discount of 60-80, a redemption at face would be a good thing. And since in most securitizations, early payments are covered in the cash flow waterfall as a payment to the most senior bonds first, the AAA stand in line to get theirs before the rest.

Right now, with interest rates at historic lows, there has been an increasing portfolio of mortgages being paid off in the refinance market. However, this is still just a limited and decreasing pool of applicants. Beyond the fact that there are only a decreasing percentage of homeowners that will qualify for a refinancing over time, there is also the issue of whether the underlying mortgages are still tied to those ugly prepayment penalties that were the rage in the latter part of the Alt-A and sub-prime boom. And the only way to know that fact is to have loan level detail of the pool. So, while redemptions may be occurring today, do not expect this trend to continue strongly into the future.

The article discusses the fact that the play now is on the AAA bonds off the securitizations – yes those same AAA bonds that now everyone is questioning how the rating agencies reached that rating. More problematic will be the coming tsunami of realized losses on the securitization pools due to short sales and foreclosures that are then liquidated. With the failure of HAMP, HAFA, HALA and all the other programs to stem the tide, foreclosure still seems to be the outcome for a significant number of borrowers. Even Fannie is starting to put pressure on servicers to quicken the pace of foreclosures, as discussed in an article today entitled “Excessively Delaying Fannie Mae Foreclosures Will Now Cost Servicers” by Jacob Gaffney in HousingWire. And once the property is thereafter sold (at a loss to the unpaid principal balance of the loan plus costs and reimbursed advances), these “Realized Losses”, as defined in the securitization trust agreements, could press the losses beyond the mezzanine tranches and into the AAA bonds.

So, while the yields on these bonds may be double that of corporate paper and triple that of Treasurys, it looks like Wall Street is selling investors on stepping up to the tables and laying down money to roll the dice again. Let’s hope we don’t crap out (again).