American Securitization Forum

[If registering for ASF 2010, you may want to avoid using a credit card.  A registration clerk, employed by American Securitization, quoted me a total fee of $35, which I agreed to.  Two and a half months after the conference, the company added an additional unauthorized $2495 charge to the same credit card.]

Every year the folks who made our modern world of finance gather in Las Vegas for the American Securitization Forum.  Banks that made loans in the good old days held onto the loans.  An officer of the bank would look a neighbor in the eye across a table and ask “Bill, how are you going to repay this [house, car, business] loan?”  If they guessed wrong about their neighbors, the bank would go bust.  There was a lot of friction in applying capital from distant locations.  The bank would have to prove its soundness to a wealthy company or individual in another city and borrow some money, which it could then lend out to local customers.

Starting about 25 years ago, banks began to package up and sell their mortgages, car loans, credit card loans as securities, which could be bought and sold in global markets like other stocks and bonds.  The investors in these securities relied on rating agencies, such as Moody’s and Standard and Poor’s, and the integrity of the originating banks, to judge the credit risk.  Once this system was in place almost anyone could issue a loan.  Two guys with no capital could start selling mortgages.  A car dealer could issue car loans.  A startup company could issue credit cards.  Investors from Saudi Arabia and China could be financing houses in the U.S. just weeks after the loans had been made.

The system broke down starting in 2007.  The rating agencies had been paid by the issuers and assigned ridiculously optimistic ratings to crummy loans.  Guys in Germany ended up owning home loans in Cleveland where the new homeowners had never had a job, never made a single mortgage payment, wouldn’t answer the phone, wouldn’t reply to mail, and wouldn’t answer the door.

The American Securitization Forum is where the investment banks, rating agencies, bond salespeople, risk analysts, lawyers, and, most importantly, investors, meet.

A friend who attended the conference a year ago said “Last year these guys were predicting Armageddon.  I guess they were right, so we should probably listen to what they have to say this year.”

Here’s a sampling of what I heard…

Sandra Thompson, a top official at the Federal Deposit Insurance Corporation, talked about her goal of preventing foreclosures by rewriting home mortgages.  Payments could be cut by 20 percent and a lot of people would be able to stay in their homes.  She expected a 40 percent re-default rate.  An audience member greeted her plan with derision.  “Have you driven around neighborhoods right here in Las Vegas?  Half of the houses are empty.  The ones that are occupied have six cars parked out front and you can smell the meth cooking.  Do you think that the meth guys are going to answer the phone and start making payments if you cut their mortgage by 20 percent?”

Scott Polakoff, from the Office of Thrift Supervision, said “what we need to do is reduce unemployment and raise housing prices.”

James Lockhart, the regulator of federally issued mortgages and Fannie/Ginnie/Freddie, noted that 35 percent of the mortgage market is now FHA/VA, i.e., money that is lent out directly by and owed back to the federal government.  This is up from a historical level closer to 10 percent.  He related his involvement in an attempt by the Bush Administration several years ago to prevent Fannie and Freddie from exploiting their lower cost of borrowing to take on a lot more risk and rack up enormous paper profits (and therefore executive bonuses).  Lobbying by Fannie and Freddie in Congress prevented the government-sponsored entities from becoming subject to additional regulation and they blew up in the fall of 2008.  Lockhart waxed enthusiastic about private money coming back into the mortgage market.  A audience member noted that the government asked private money to invest in Fannie Mae in September 2008.  Tens of millions was duly invested in preferred stock.  The agency was nationalized a few weeks later and the new investment was wiped out.  “What guarantees do we have that future private investors won’t be treated so shabbily by the government?”  Lockhart mumbled that a lot had happened since September 2008, including the failure of Lehman.

Mary Kane, an executive of Citigroup, made the most confidence-inspiring comments. She noted that consumer spending was 2/3rds of the economy. The consumer savings rate was near zero percent of income. Now it is trending up towards 7 percent of income.  That alone would be enough to shrink the economy.  She noted that consumers had lost $7 trillion in paper value on their houses and stock investments.  That’s equal to an entire year of national income.

Ralph Daloisio cast scorn on the government’s new TALF program.  The $200 billion being lent isn’t enough to move the $11 trillion asset-backed securities market.  The program applies only to new loans and securities.  “Why would people buy this new stuff anyway when they can get a 20 percent return on existing mortgage-backed bonds, even in the worst-case scenario?”  [A money manager sitting next to me noted that the worst-case scenario is that houses go to zero.]

Attendees were surveyed as to the date when the market would “return to normal”.  “Never” was a reasonably popular answer, but 2011 was the most common.  People expected the U.S. economy to continue to decline through 2009 and start to pick up in 2010.

Nobody proposed changing the way that bonds are rated.  Moody’s and Standard and Poor’s get paid by bond issuers to assign risk ratings (see this video for an explanation).   Nobody suggested ending this conflict of interest.

For most of the government officials and many of the market participants, the goal seemed to be to turn back the clock by 5 years.  Everyone was happy then and making good money.  Most Americans had jobs and house prices kept going up.

Las Vegas town report:  The city is littered with partially finished real estate development.  A 4000-room hotel/casino on the strip has 90 percent of its windows in place, a steel skeleton poking above, and very little apparent construction activity.  A new shopping mall near Summerlin is a steel shell with nobody working.  Tract housing has come to a halt.  Hotels and restaurants are about 70 percent of the usual volume and taxi drivers report that business is slow.  Valley of Fire State Park is a beautiful place to drive around and take some short walks with a camera.  I learned that a great way to get rid of an unwanted spouse is to pick up Hiking Las Vegas: 60 Hikes Within 60 Minutes of the Strip and try out the “Turtlehead Jr.” hike/scramble in Red Rock Canyon.  If your companion does not slip and fall 100′, a slight push should suffice.

2 Comments

  1. Elmore Philadelphia

    February 14, 2009 @ 2:09 am

    1

    Here’s a better video (explaining the subprime crises and repackaging of mortgages)

  2. Mike Pettit

    February 19, 2009 @ 9:14 am

    2

    Hey,

    Pick up Janet Tavakoli’s new general(ish) reader book “Dear Mr. Buffet: What an Investor Learns 1,269 Miles from Wall Street.” She is a very good structured finance consultant, and she has been pretty constant in the past six years or more about the fiction of the credit ratings agencies. More important to the current debacle, she (and others) have taken apart the unadvertised non-comparability of ratings for traditional corporate debt and exotic structures. The default rates on securitizations and the instances of fraud using “investment-grade” securitizations has wildly outstripped regular vanilla debt. Many pension funds and municipal investment programs have gotten screwed by buying AAA rated tranches of funky sythetic securitizations because they believed the AAA rating absolved them of doing their own due diligence.

    Over the years I’ve been reading Janet’s practitioner focused books. Originally they were focused on how structured credit products can be used to do good things with risk carving. In the past few years, as she’s seen the greed, trickery, and mass-delusion begotten by poorly conceived structural controls in the market, she has been more and more outspoken about the dangers.

    Check out http://www.tavakolistructuredfinance.com for her press articles. It is interesting to watch them progress over the years from a defense of structured credit products to a harsh calling-out of the worst of the lot.

    There are others who saw this coming, and most of them are mentioned in her recent book.

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