John At The Center

1:15pm The Future of the Housing Finance System

Nancy Wallace, UC Berkeley, Moderator

Panelists:

Brad Blackwell, Wells Fargo Bank

Talking about the importance of home ownership.

Wells stayed conservative as the real estate bubble expanded.  They certainly lost market share, but now, they are the only AAA rated bank.

We need better regulation.  Right now it’s a patchwork and we need a single regualtory body.

We need to reward quality and not quantity.

Also need to educate borrowers (in schools).

John Krainer, Federal Reserve Bank of San Francisco

Showing a lot of data in powerpoint.  Comparing across different vintage years of these mortgages.  New loans:

(source McDash Analytics)

Different delinquency rates:

Even in 2007, when we were already worried about this problem, delinquency rates are much worse than the earlier vintage years.

We are definitely seeing tighter lending.  Fico score average is much higher in 2008 than it was in 2006.  Option Arm is completely dead.

So the story here is that the majority of this is localized in the mortgages that ended up in private securitizations.

Paul Leonard, Center for Responsible Lending

Predicted large percentage of foreclosures but it was seriously underestimated.  Will get worse before it gets better.  What he believes is that we really need a broad loan modification program.

Presenting a lot of data on California defaults and foreclosures.  Foreclosures are rising.  Defaults are trending down but that’s only due to laws that simply delay the beginning of the default process.  Half of the sales in California are foreclosure sales

Alt-a wave is building next.  The majority of resets will be between May 2010 and Jan 2012.  Data is showing that a lot of defaults are happening even before loans are resetting.  That’s why he’s so confident that we will see foreclosure challenges well into the future.  Loss projections are 50-55% of outstanding option arm pool.  We need a more systemic way than what Yellen talked about to deal with this issue.

There are lots of structural barriers.  We already talked about issue with buying loans from securitization trusts.  Also, loan servicing shops are not equipped to deal with what’s happening.  We need technology to address.  In the last ten years, we’ve had huge innovations in underwriting but no innovation in loss mitigation.

Paul Jablansky, 400 Capital Management LLC

Loans that are housed in securitization trusts are very difficult to unwind.  There is an idea that loans can be bought from these trusts but you can only purchase delinquent loans at high prices from these trusts.

Missed the opening remarks.

Missed Janet Yellen’s Perspective but she’s doing Q&A now.

She’s talking about how house prices need to adjust down so we don’t recreate a bubble condition.  Feels that with the tightness in the credit markets and deterioration in the macroeconomy, we might be in danger of overcorrecting, which would take a greater toll on economy.

Someone asked about a lower Fed Funds rate and if that would help.  Yellen feels we could go lower.  Doesn’t know what the effective number corresponding to zero would be.  With rates going to zero, there are broad implications on money markets and such that would constrain the lower boundary on how low the Fed can take this rate. Talking about Japan.  Japan should’ve cut rates lower faster than they did to curb inflation.

Taking a couple questions about the Treasury capital injections and she’s emphasizing that these are Treasury programs, not Fed programs.

Talking about “quantitative easing”, (aka balance sheet expansion) in Japan, which corresponded with no economic impact.

Fed size of balance sheet has increased significantly. $800 billion before last year. That number doubled over the last year. At the end of this year, it could be at $3 trillion. This is a kind of “quantitative easing”.

Talking about how Fed can pay interest rates on reserves. Paying 35 basis point under fed funds rate. Enables Fed to come pretty close to floor on federal funds rate, which might be higher than zero but extend greater liquidity and extend size of balance sheet.

So fed funds doesn’t have to go to zero because they have other ways of extending liquidity and extend size of balance sheet.

Next question on what we can do about small businesses.  She agrees that there is a credit crunch but says it’s not true that small business loans are not being made.

FDIC took over IndyMAC, made a commitment to restructure mortgages and keep people in homes. We’ve come to a view where to do that, we make the payment more affordable.  Even for houses that are under water, they will be inclined to stay.

Effectively change it to interest only payments, that don’t write down the principal.  This is easier/not as complicated as when you’re writing down principal.  Could result in a streamlined process.

http://www.econbrowser.com/archives/2008/10/deflation_risk.html

I’ll attempt to live blog this event (pdf). Here’s the agenda for tomorrow:

AGENDA

THURSDAY, OCTOBER 30TH

11:00am Registration Opens

11:30am Lunch

12:00pm Welcome and Opening Remarks

Stuart Gabriel, UCLA

John Quigley, UC Berkeley

12:15pm The Policy Maker’s Perspective on the

Financial Meltdown and the Economy

Janet Yellen, Federal Reserve Bank of San Francisco

Stuart Gabriel, UCLA, Moderator

1:15pm The Future of the Housing Finance System

Nancy Wallace, UC Berkeley, Moderator

Panelists:

Brad Blackwell, Wells Fargo Bank

John Krainer, Federal Reserve Bank of San Francisco

Paul Leonard, Center for Responsible Lending

Paul Jablansky, 400 Capital Management LLC

2:30pm Break

3:00pm Are Government Agencies Up To The Task?

Anthony Downs, Brookings Institution, Moderator

Panelists:

Robert Van Order, University of Michigan

Susan Wachter, University of Pennsylvania

John Weicher, Hudson Institute

Susan Woodward, Sand Hill Econometrics

4:30pm Closing Remarks; Adjourn

“When investors don’t have full and honest information, they tend to sell everything, both the good and bad assets,” said Janet Tavakoli, president of Tavakoli Structured Finance, a consulting firm in Chicago. “It’s really bad for the markets. Things don’t heal until you take care of that.”

http://www.nytimes.com/2008/10/30/business/30aig.html

http://arxiv.org/abs/0810.4844

Mark to market was removed from the spotlight for 1-2 weeks while the rating agencies, banker compensation, etc. were the topics du jour.

Well, mark to market is back–

Obviously, these are triggered by events:

The SEC hosts its first roundtable on Mark-to-Market financial accounting today. You can take a peek at the exciting agenda here.

http://ftalphaville.ft.com/blog/2008/10/29/17592/asymmetrical-accounting/

The key issues you need to know here are:

Mark to market is built on top of efficient market hypothesis.

There are assets out there that are not efficiently priced, including CDOs.  I hate to break it to you but not all CDOs deserve to be priced at where they are right now.

Not fatal, says FT

Painful for those funds caught in the mire, yes – but far from fatal for the global hedge industry.

http://ftalphaville.ft.com/blog/2008/10/29/17585/so-how-many-hedgies-did-porsche-really-kill/

For the past five years or so, the dollar has been the single largest funding currency in a global carry trade worth untold trillions of dollars. People borrowed and sold dollars, buying all manner of other currencies, from the British pound to the Brazilian real. Now that carry trade is being brutally unwound, and the world’s currencies are snapping back to a much more natural level.

The go-to guy in the blogosphere when it comes to international capital flows is, always, Brad Setser:

This is much more of an unwinding of carry trades than a flight to quality

http://www.portfolio.com/views/blogs/market-movers/2008/10/29/the-dollars-not-that-strong

http://www.nakedcapitalism.com/2008/10/how-credit-default-swap-settlements-are.html

No, as with the repatriation of the Structured Investment Vehicles onto the balance sheets of C and other money center banks, the true significance of CDS comes when the markets function smoothly, as after a default event like Lehman. The trigger event putting a single name CDS contract in the money results in a liquidity-raising event for the seller of protection, who must fund the purchase of the debt at par less recovery value – whether or not the other party actually owns the debt!

This process of funding the CDS is reportedly a factor behind the high rates of dollar LIBOR in London and illustrates how cash settlement derivatives actually multiply risk without limit. Through the wonders of cash settlement, the derivative-happy squirrels at the Fed, BIS and ISDA created a liquidity-sucking monster in OTC derivatives that multiplies risk many times, for example, above the amount of underlying debt of Lehman Brothers. But remember two things: a) In some single-name CDS contracts, the buyer of protection must deliver to get paid; and b) in those contracts, where the buyer fails to deliver, the provider of protection can walk away.