BofA breaks logjam, signs up for piggyback loan modification program

Here's hoping that lenders are just as much as lemmings as other businesses and join Bank of America in signing up for modifying 'piggy-back' loans as part of President Obama's $75 billion foreclosure prevention program. This is a big step in preventing foreclosures, as these lenders have traditionally been stuck in second place behind first mortgages and didn't want to take huge losses on short sales. From BuilderOnline.com:

Mortgage companies are finally starting to sign up for a long-delayed piece of the Obama administration's $75 billion foreclosure-prevention program.

The administration had been offering lenders who made so-called "piggyback" mortgages - second loans that allowed consumers to make a little or no down payment - incentives to lower payments or eliminate the loans entirely.

But no one signed up until Tuesday when Bank of America became the first to do so.

During the housing boom, lenders readily gave such second loans. While home prices soared, such mortgages were even extended to borrowers with poor credit and people who didn't provide proof of their incomes or assets.

Those loans are now an obstacle to alleviating the housing crisis. That's because piggyback lenders - fearing they won't be repaid - can veto a borrower's efforts to modify their primary mortgage..

If more lenders follow Bank of America it could clear the way for more mortgage companies to cut borrowers' principal balances on their primary loans. But administration officials appear wary of subsidizing such reductions with taxpayer money.

That could spark a backlash from critics who claim it's unfair to people who are still paying their mortgages on time and a bailout for banks that made reckless loans.

With foreclosures still at record-high levels, The Obama administration's program to aid homeowners has been a disappointment. Only about 66,500 borrowers, or 7 percent of those who signed up, had completed the program as of December.

The Treasury Department plans later this week to announce a streamlined process designed to get more borrowers to complete the loan modification program. The program reduces mortgage rates to as low as 2 percent for five years.

But many experts say more dramatic changes are needed.

"Unless you modify principal, there is absolutely no hope of restructuring mortgages on a mass scale to keep people in their homes," Daniel Alpert, managing director of the New York investment bank Westwood Capital LLC said earlier this month. "Eventually their hand will be forced."

Economist Krugman seconds the call to nationalize banks

New York Times columnist and economist Paul Krugman seconds Nouriel Roubini's call to nationalize the nation's largest banks, laying out his case in plain English. From his column:

The case for nationalization rests on three observations.

First, some major banks are dangerously close to the edge — in fact, they would have failed already if investors didn’t expect the government to rescue them if necessary.

Second, banks must be rescued. The collapse of Lehman Brothers almost destroyed the world financial system, and we can’t risk letting much bigger institutions like Citigroup or Bank of America implode.

Third, while banks must be rescued, the U.S. government can’t afford, fiscally or politically, to bestow huge gifts on bank shareholders...

To end their zombiehood the banks need more capital. But they can’t raise more capital from private investors. So the government has to supply the necessary funds.

But here’s the thing: the funds needed to bring these banks fully back to life would greatly exceed what they’re currently worth. Citi and BofA have a combined market value of less than $30 billion, and even that value is mainly if not entirely based on the hope that stockholders will get a piece of a government handout. And if it’s basically putting up all the money, the government should get ownership in return...

The real question is why the Obama administration keeps coming up with proposals that sound like possible alternatives to nationalization, but turn out to involve huge handouts to bank stockholders...

How would nationalization take place? All the administration has to do is take its own planned “stress test” for major banks seriously, and not hide the results when a bank fails the test, making a takeover necessary. Yes, the whole thing would have a Claude Rains feel to it, as a government that has been propping up banks for months declares itself shocked, shocked at the miserable state of their balance sheets. But that’s O.K....

What we want is a system in which banks own the downs as well as the ups. And the road to that system runs through nationalization.

Why the banks are broke

Wondering why banks like Bank of America or Citigroup are technically broke after $165 billion in bail-out funds to the nation's eight largest of them and *may* need to be nationalized until they can be re-sold to investors? A story in Time magazine summarizes:

Since October, the government has deposited $165 billion into the accounts of the nation's eight largest banks. Yet those same financial firms are now worth $418 billion less than they were four months ago, and the Congressional Budget Office estimates that the government's preferred shares are worth at least $20 billion less. In Wall Street terms, that's throwing good money after bad. All told, the government's annualized rate of return on its investment in the nation's largest banks is -1,096%. That's well beyond Bernie Madoff territory; he topped out at a mere -100%. (See pictures of the demise of Bernie Madoff.)

So how could $438 billion — $418 billion of their money and $20 billion of ours — go poof, just like that? Here's the easiest explanation: our banking system has sprung a leak..

To understand why nationalization may be inevitable, you have to get a handle on the true source of the banks' problems. The banking business — at least the way George Bailey practiced it in It's a Wonderful Life — was all about deposits and loans. You take in deposits, on which you pay a relatively low interest rate, say 2%. Then you lend that money to other people at a higher interest rate, say 7%. Pocket the difference. Repeat.

But starting in the early 1970s, banks began funding less of their lending with old-fashioned deposits. Bank deposits backed 90% of all loans four decades ago; today they back 60%. Where does the rest of the loan money come from? From the bank's past earnings and the money given to it by its investors. Using the house's money has generated higher profits — with significantly higher risks...

Another way banks sought to boost their profits — at least those available to shareholders — was through stock buybacks. Investors cheer buybacks, because they shrink the number of outstanding shares, boosting a company's profits per share and usually its stock price. But corporate stock purchases also decrease banks' capital, because their earnings are used to purchase shares rather than being retained as cash.

Worse, sometimes banks borrow money in order to buy back shares, upping their leverage and lowering their capital at the same time. In the past four years alone, the nation's largest banks, as defined by Standard & Poor's, have spent $300 billion buying back stock...

TARP does nothing to patch the hole in the banking system. And it certainly doesn't do anything to encourage banks to make more loans. Yes, banks have gotten nearly $300 billion in money from the government, and that's a lot of dough. But it's not free dough. In return for federal cash, the government has taken preferred-stock shares as the firm's markers. Unlike common stock, which is the kind you or I would buy from a broker, preferreds have to eventually be paid back, so they are really loans, not additional capital. (See which country has the best bailout plans.)

Say a bank has $5 in capital and $100 in loans. Now the government gives the bank an additional $100 in preferred shares and says, "Go make more loans." Well, the bank might then have $200 in loans, but it still has only $5 in common shareholders' equity. The result: if just 2.5% of its loans go bad, the bank's shareholders are wiped out. Wisely, the largest banks in the nation lent less in the fourth quarter of 2008 than in the previous three months — a strategy that has drawn some complaints.

But that hasn't removed the pressure on their shares. That's because the banks have had to continue to take loan losses. And banks don't have the option to pass those losses off on the new money they got from the government. They have to write down their common stockholders' equity first. And as that capital falls, so go the bank's shares. Some are alarmingly close to zero...

Nouriel Roubini, the New York University economics professor who was famously early in predicting that the end of the housing boom would cause a financial crisis, estimates that continued loan losses will force U.S. banks to come up with an additional $1.4 trillion just to stave off bankruptcy. And since the banks aren't likely to earn much money or attract new investors anytime soon, much of the money will have to come from the government.

Regulators are split on what to do next. The Federal Deposit Insurance Corporation is backing a plan to create what it calls an aggregator bank, which would buy up the loans of BofA, Citigroup and the rest of our now troubled system, theoretically putting an end to the escalating losses eating away at the banks' capital. But if the government buys those assets at current market rates, banks would be forced to take immediate losses on the sales, doing more harm than if the government just left the troubled loans where they are. Sources say the Federal Reserve would prefer to let the banks keep the loans and troubled bonds for now and instead provide the banks with insurance policies guaranteeing that the government will swallow a good deal of future credit losses. But a similar deal that the Fed struck with Citi did little to boost that company's stock or stave off fears that it may soon go under.

That's why a small but growing number of people are starting to talk about nationalization. Speaker of the House Nancy Pelosi recently said nationalization, or something close to it, is a better solution than just buying bad assets, because if the government takeovers succeed, then taxpayers get to keep the profits when they eventually resell the banks. But if the government doesn't turn a nationalized bank around, it could be very costly to taxpayers...

Click here for full story.

Private builders increasingly under duress

Recently I've been hearing increasing reports of subs and suppliers not getting paid by homebuilders. In the case of Barratt, it's been due to cash flow problems resulting from its longtime lender, Bank of America, declining to provide new financing. From a BuilderOnline.com article:

This week, Barratt American expects to have short-term loans in place, secured through the sale of “unencumbered assets,” to shore up a cash-flow problem caused by a significant decline in its business. That decline recently led Barratt’s primary lender, Bank of America, to cut off the Carlsbad, Calif.-based builder after a 28-year relationship.

“I call it ‘constructive default,’ ” says Mick Pattinson, Barratt’s president and co-owner, who spoke with BUILDER on Friday. “We’re not in default, but the bank wouldn’t renew our two loans.” He explains that his company had a $125 million credit facility with Bank of America, of which $100 million were available when the bank informed Barratt seven months ago that it would not go forward with its lending. Barratt drew another $30 million of that facility, although at higher interest rates, until Pattinson balked at the expense and found himself without a line of credit to tap...

“We’ve been stymied without cash,” Pattinson tells BUILDER. His company’s inability to pay its bills has triggered more than 40 lawsuits filed mostly by subcontractors with liens against the company’s assets that guarantee payment for labor and materials.

Pattinson confirmed he has been in London seeking private equity money, where “we’ve been getting a good reception.” (Pattinson is British and Barratt was once based there.) He is confident that he’ll find new financing from overseas sources, and can settle disputes with vendors or contractors. “They understand how we got here, and we’ve had relationships with some of them for 10, 15 years.” The bigger problem for his company, and builders in general, is that domestic capital has dried up. “Right now, you couldn’t get cash from a bank to build a house if your life depended on it,” he laments.

What irks Pattinson is how Bank of America rewarded his company’s decades-long loyalty by throwing Barratt under a bus the minute business went soft. “When times were good, we had banks lining up in our lobby for our business, but we told them we were with Bank of America. Now, when times are bad, we get screwed. The banks are a disgrace.”