U.S. To Face A Financing Crisis?

Merrill Lynch has warned that the United States could face a foreign “financing crisis” within months as the full consequences of the Fannie Mae and Freddie Mac mortgage debacle spread through the world.

The country depends on Asian, Russian and Middle Eastern investors to fund much of its $700bn (£350bn) current account deficit, leaving it far more vulnerable to a collapse of confidence than Japan in the early 1990s after the Nikkei bubble burst. Britain and other Anglo-Saxon deficit states could face a similar retreat by foreign investors.

“Japan was able to cut its interest rates to zero,” said Alex Patelis, Merrill’s head of international economics.

“It would be very difficult for the US to do this. Foreigners will not be willing to supply the capital. Nobody knows where the limit lies.”

Brian Bethune, chief financial economist at Global Insight, said the US Treasury had two or three days to put real money behind its rescue plan for Fannie and Freddie or face a dangerous crisis that could spiral out of control.

“This is not the time for policy-makers to underestimate, once again, the systemic risks to the financial system and the huge damage this would impose on the economy. Bold, aggressive action is needed, and needed now,” he said.

Mr Bethune said the Treasury would have to inject up $20bn in fresh capital. This in turn might draw in a further $20bn in private money. Funds on this scale would be enough to see the two agencies through any scenario short of a meltdown in the US prime property market…..

Yves here. The problem is that the Treasury lacks statutory authority to do so, and despite going to the trouble to announce a plan on a Sunday before markets opened in Asia, there is no sign that anything concrete has been done to advance the ball.

Roughly $1.5 trillion of Fannie and Freddie AAA-rated debt – as well as other US “government-sponsored enterprises” – is now in foreign hands. The great unknown is whether foreign patience will snap as losses mount and the dollar slides.

Hiroshi Watanabe, Japan’s chief regulator, rattled the markets yesterday when he urged Japanese banks and life insurance companies to treat US agency debt with caution. The two sets of institutions hold an estimated $56bn of these bonds….

But the lion’s share is held by the central banks of China, Russia and petro-powers. These countries could all too easily precipitate a run on the dollar in the current climate and bring the United States to its knees, should they decide that it is in their strategic interest to do so.

Mr Patelis said it was unlikely that any would want to trigger a fire-sale by dumping their holdings on the market. Instead, they will probably accumulate US and Anglo-Saxon debt at a slower rate. That alone will be enough to leave deficit countries struggling to plug the capital gap. “I don’t see how the current situation can continue beyond six months,” he said.

Merrill Lynch said foreign governments had added $241bn of US agency debt over the past year alone as their foreign reserves exploded, accounting for a third of total financing for the US current account deficit….

Global inflation is now intruding with a vengeance as well. Much of Asia is having to raise rates aggressively, drawing capital away from North America. This may push up yields on US Treasuries and bonds, tightening the credit screw at a time when the US is already mired in slump.

Russia’s deputy finance minister, Dmitry Pankin, said the collapse in the share prices of Fannie and Freddie over the past week was irrelevant because their debt has been effectively guaranteed by the US government under the rescue package.

“We don’t see a reason to change anything because the rating of the debt of those agencies hasn’t changed,” he said.

Foreign policy experts doubt that the picture is so simple. Russia is likely to use its $530bn reserves as an implicit bargaining chip in high-stakes diplomacy, perhaps to discourage the US from extending Nato membership to the Ukraine and Georgia.

Vladimir Putin, now Russia’s premier, has stated repeatedly that his country is engaged in a new Cold War with the United States. It is clear that Moscow would relish any chance to humiliate the United States, provided the costs of doing so were not too high for Russia itself.

China is regarded as a more reliable partner, with a greater desire for global stability….

Yves here. Partner maybe, only in the way Ambrose Bierce defined it in the Devil’s Dictionary:

When two thieves have their hands so deeply plunged into each other’s pocket that they cannot separately plunder a third party.

If we think China is a friend, we will be disappointed.

Brad Setser, from the US Council on Foreign Relations, said the Chinese have a stake in upholding Fannie and Freddie, not least to ensure that their loans are “honoured on time and in full”.

David Bloom, currency chief at HSBC, said fears that regional banks could start toppling after the Fed takeover of IndyMac last week were now the biggest threat to the dollar.

“We have a pure dollar sell-off,” he said. “It’s a hating competition: at the moment the markets hate the dollar more than they hate the euro, even though German’s ZEW confidence indicator was absolutely atrocious.”

FANNIE MAE AND FREDDIE MAC BEING SUPPORTED BY

(From Portfolio.com)

World markets are cheering the U.S. government’s support for the mortgage giants Fannie Mae and Freddie Mac.  This morning, the dollar is rising, European stock markets are higher, and futures of U.S. stock indexes and even the futures for Fannie and Freddie are pointing to an opening rally.

“The U.S. authorities are doing everything they can to prop up the financial system, ” Peter Dixon, an economist at Commerzbank in London, told Reuters. “It’s good news in an unremitting cycle of gloom.”

But stepping in to give support when in the past such backing had only been implied, Washington has crossed a Rubicon that puts the economic credibility of the United States to the test.

As Clive Crook puts it in the Financial Times: “U.S. taxpayers are about to find out what their long-standing and (strictly speaking) non-existent guarantee of Fannie Mae and Freddie Mac will cost them. One way to think of it is this: Take the US national debt of roughly $9 trillion and add $5 trillion. Not bad for an obligation still officially denied.”

Fannie and Freddie were created by Congress in the 1930’s, but are now owned by shareholders. Their special status as government-created corporations, however, has given them the implied backing of the federal government and their borrowing costs have been cheaper as a result. Combined, the two companies have some $5 trillion in mortgage-related debt.  The stocks of the two have been in a free fall and their solvency questioned.

On Sunday, Treasury Secretary Henry Paulson said he would seek Congressional approval to buy billions of dollars of stock of Fannie Mae and Freddie Mac if they need it, as long as the two firms have adequate capital to continue their mission of buying and selling mortgage loans. It also will seek approval to temporarily increase lines of credit for the two companies. And it will propose that the Federal Reserve take a greater role in the oversight of the mortgage giants.

The Fed, meanwhile, said it would allow Fannie and Freddie to borrow from it through the central bank’s New York facilities.

The immediate reaction to the moves has been generally positive.

Even a critic of the administration, Paul Krugman of the New York Times, was supportive, saying “And let’s be clear: Fannie and Freddie can’t be allowed to fail. With the collapse of subprime lending, they’re now more central than ever to the housing market, and the economy as a whole.”

Indeed, after the mortgage market imploded Fannie’s and Freddie’s share of the secondary market in mortgages has grown from 40 percent to two-thirds.

But others are skeptical of the Treasury effort:  Mike Shedlock says:

“In the course of a few days we have seen Paulson go from saying ‘financial institutions must be allowed to fail’ to requesting Congressional ‘authority to buy unlimited stakes in and lend to the companies.’

Paulson now seems to be acting on the principle that as long as one is telling lies there is no additional harm in doing it with gusto. Otherwise it is very hard to explain how an “unlimited lending line” can possibly have “terms and conditions necessary to protect the taxpayer”.

There is one other possibility. Perhaps as Paulson crossed the Rubicon he landed in the 5th dimension. In some alternate universe, his statements just might make sense.

Yves Smith on Naked Capitalism notes:

“Oh, minor detail, the plan still has to be approved by Congress, which will hopefully roll over. But what if it doesn’t? Anyone with an operating brain cell knows that these moves put the US on the path to having taxpayers assume Fannie and Freddie liabilities. That in the end is probably unavoidable.”

The weekend rescue by the government will come into focus tomorrow, when Ben Bernanke, the chairman of the Federal Reserve, appears before Congress.

Could U.S. Become Japan In The 90’s?

(From NakedCapitalism.com)

Posted: 11 Jul 2008 03:28 AM CDT

Blomberg columnist William Pesek plays out a line of thought that may have occurred to some readers: what if the resolution of the credit crisis and global imbalances isn’t a nasty recession or punishing inflation but Japan-like protracted low growth, with stagnant to deteriorating living standards?

This idea may not be as much of a stretch as it sounds. Policy makers, in trying to avoid the depression/entrenched inflation extremes, may steer themselves into the Japan solution.

In the US, despite the brave talk of free markets, we have been socializing losses right and left and trying to shore up plummeting asset values. Although inflation is running at high rates in many countries, it is the product mainly of commodities price increases due to developing economy demand. If the banking system in the US, UK and Europe are in as bad shape as I think they are, demand for imports will slacken further, which will reduce growth, and in some cases, reduce consumption. Reader DownSouth reminded us that from 1979 to 1983, oil consumption fell from 67 million barrels per day to 58 million bpd. And high fuel price act as a tariff, again hurting exporters. We have already discussed that factories near Hong Kong are being shuttered at a rapid pace, and this is before the expected post-Olympics slowdown.

Similarly, the strain on food prices is due to biofuels, increased consumption of meat in third world, and poor harvests in Australia, have put pressure on foodstuffs. Biofuels subsidies may get undone (one can only hope) and similarly, higher food costs will have us all, not just people in developing countries, being more sparing of our meat consumption. A near-global slowdown will intensify that trend.

And there is the bigger question of whether we really have reached a crisis of capitalism, whether a system whose raison d’etre is growth and increasing standards, can adapt to a world of resource constraints. The optimists at the Milken Institute Global Conference felt that technology would provide and answer. But new technologies take time to be developed and implemented, particularly on a broad scale, while the needs appear urgent.

From Bloomberg:

Count Hong Kong real-estate mogul Ronnie Chan firmly among those who think Japan’s 1990s experience is highly instructive. The reason: Lost decades may become the rule, not the exception.

“What if the lost decade in Japan becomes the global norm?” Chan, chairman of Hang Lung Properties Ltd., said at the Asia Innovation Initiative conference in Fukuoka, Japan, on July 8. “Can you imagine that? Perhaps we should. Perhaps people should get used to slower growth, or no growth.”

It’s not that Chan, who runs Hong Kong’s fourth-largest real-estate development company by market value, is a pessimist. Property developers don’t often relish 10 years of lost growth here and 10 years of declining asset values there. Chan sees a rare confluence of economic and demographic trends that bode poorly for a global rebound.

No one should be surprised by the rapid pace of economic expansion after World War II…. It began from a low base, following the devastation of economies in Europe and parts of Asia. Next came rapid population growth and a boom in innovation. Then there were new social and institutional paradigms as democracy spread and organizations such as the United Nations and the World Bank offered support.

Today, the picture looks vastly different. As everyone tries to stabilize growth, things are hardly at a low base. Population growth is fueling demand for commodities, driving up inflation and increasing poverty rates. Innovation may slow as investment dries up. And institutions such as the International Monetary Fund hardly seem up to today’s challenges.

Oddly, one of Asia’s potential failures is democracy, Chan says. It simply isn’t proving to be the panacea that leaders in the U.S. and Europe promised. Poverty rates remain stubbornly high in many Asian democracies, and so does corruption. The former is often a result of the latter.

It’s certainly not that democracy is bad. Yet there’s something to be said about what Chan calls “premature democratization” in Asia.

Elections matter only when nations build strong institutions such as independent courts, ministries, a free press, credible central banks and ample systems of checks and balances. Their absence means many governments don’t operate as transparently or successfully as expected.

Yves here. That is not a trivial point. My Communist college roommates would remind me that Russia and China were the only economies to industrialize in the 20th century (for the record, I was apolitical then and previously had a someone who appeared in the Ivy League Playboy issue and later a brilliant but highly wound poet as roommies).

Similarly, Japan with its one party system is not exactly a Western-style democracy. Singapore, an island with just about nothing going for it, and some serious disadvantages at the time of its independence, prospered under a far sighted nation-builder who bordered on being a benevolent dictator, Lee Kwan Yew. Yew in particular was concerned about corruption, and early on created tough watchdog agencies and implemented the policy that top bureaucrats would earn the same level of pay as top private sector professionals, both to make sure the government would attract good people and reduce the incentives to cheat.

Back to Pesek:

All this may be a problem for the region as it tries to avoid the worst of the credit-market crisis. Chan wonders if the type of prosperity during the decade before the 1997 Asian crisis will be more unusual in the future.

“Those 10 golden years of rapid growth and high returns may well have been an aberration,” Chan says.

The combination of surging energy and food prices will challenge economies with political rifts, such as Thailand and Malaysia. Nor does it bode well for high-poverty ones such as Indonesia and the Philippines, or those trying to compete amid China’s boom — South Korea, Singapore and Taiwan, for example.

Slower growth is absolutely necessary, of course. Economists, including Kenneth Rogoff of Harvard University, argue that accelerating inflation is a clear sign the global economy needs to cool to let commodity supplies and fuel alternatives catch up. Yet a sharp slowdown in Asia may be devastating.

Take China, which needs to expand about 10 percent annually to raise the living standards of 1.3 billion people. Slowing growth will place dangerous pressure on Asia’s second-biggest economy. For a nation at China’s level of development, 5 percent growth is essentially a recession…

Policy makers are merely putting off the inevitable and treating the symptoms of what ails the global economy. If they aren’t careful, Japan’s experience during the 1990s will become a familiar one.

“It’s not a scenario many expect for the West or for Asia,” Chan says. “But I’m not sure it can be ruled out.”

Fannie and Freddie: Insolvent?

Just a few weeks ago, experts were saying the credit crisis was on the mend and we could all get back in the pool. But as we discussed in an earlier post, worries about Fannie and Freddie are on the rise, and the increase in agency spreads back in January was probably the biggest trigger of the last acute phase of the credit crunch that peaked in March with the bailout of Bear Stearns.

Bloomberg reports that former Fed president Richard Poole said the GSEs are insolvent and that Congress needs to recognize this fact. This is, needless to say, a provocative statement, particularly from a former regulator. The officialdom generally accepts the premise that more than a little dissembling is OK if it keeps the great unwashed public from worrying about things that are deemed to be beyond them.

But Poole didn’t respect that convention even during his term. He has long been a critic of the half pregnant status of the GSEs. In 2003, he rattled markets by saying the government should strip them of their implied backing (some readers point out that Fannie and Freddie securities clearly say that they are not guaranteed by the government but their prices say the world at large thinks otherwise) and in 2006 and 2007 said their charters should be revoked.

From Bloomberg (hat tip Dwight):

Borrowing at Fannie Mae, the government-sponsored mortgage company, has never been so expensive and it may not get better any time soon.

Fannie Mae paid a record yield relative to Treasuries on the sale of $3 billion in two-year notes yesterday amid concern the biggest provider of financing for U.S. home loans won’t have enough capital to weather the worst housing slump since the Great Depression. The company’s credit-default swaps show traders are treating the AAA rated debt as if it were five steps lower. Fannie Mae shares tumbled 13 percent yesterday in New York to the lowest level in almost 14 years.

Chances are increasing that the U.S. may need to bail out Fannie Mae and the smaller Freddie Mac, former St. Louis Federal Reserve President William Poole said in an interview. Freddie Mac owed $5.2 billion more than its assets were worth in the first quarter, making it insolvent under fair value accounting rules, he said. The fair value of Fannie Mae’s assets fell 66 percent to $12.2 billion, data provided by the Washington-based company show, and may be negative next quarter, Poole said.

“Congress ought to recognize that these firms are insolvent, that it is allowing these firms to continue to exist as bastions of privilege, financed by the taxpayer,” Poole, 71, who left the Fed in March, said in an interview…

“At some point we’re going to reach that inflection, where the government is going to have to either guarantee explicitly or Fannie and Freddie are going to have be left to fend for themselves,” Peter Boockvar, an equity strategist at Miller Tabak & Co. in New York, said in an interview with Bloomberg Television. “We’re getting to that point where a decision has to be made by Washington.”…

The government is counting on Fannie Mae and Freddie Mac, which own or guarantee about half the $12 trillion in home loans outstanding, to help revive the housing market. Congress lifted growth restrictions on the companies, eased their capital requirements and allowed them to buy bigger “jumbo mortgages” to spur demand for home loans as competitors fled the market.

Paulson said on July 8 he was pleased with Fannie Mae and Freddie Mac’s efforts to raise capital. Bernanke said the same day the firms need to be “strong, well-regulated, well- capitalized” to provide credit “without posing undue risks to the financial system or taxpayer.”….

Congress created Freddie Mac and expanded Fannie Mae in 1970 to promote home buying in the U.S. The companies’ charters give the Treasury the authority to buy as much as $2.25 billion in each of their securities in the event of possible default.

The government will likely be forced to take over the companies because of the mortgage meltdown, Poole said.

“We know in a crisis the Federal Reserve tap would be open,” said Poole, now a senior fellow at the Cato Institute…

“I worry about those institutions,” retired Richmond Fed President Alfred Broaddus said. “They are huge. They dwarf the Bear Stearns issue. In the very worst case scenario, I don’t know how you do it other than extend money and the public takes the loss.”…

The companies have access to the Fed’s so-called Fedwire payments system allowing them to access funding if needed, said Vincent Reinhart, the Fed’s chief monetary-policy strategist from 2001 until September 2007.

They can withstand the slump in part because most of their investments are mortgages made before 2006 when lending standards were tighter, making them less likely to default, said Eileen Fahey, a Chicago-based analyst at Fitch Ratings.

“We do not believe they are technically insolvent,” Fahey said. “People seem to lose sight of the fact that a majority of the mortgages that they are holding and are guaranteeing were originated pre-2006.”

Mortgage and Housing Markets Fragile

The big federally backed mortgage firms are under the gun, as investors worry about the firms’ ability to finance the loans they hope will end the country’s housing crisis.

But Sacramento mortgage brokers said Tuesday they’re confident the region’s real estate market is withstanding the new turmoil – so far.

Fresh fears that the loan market may tighten more haven’t yet affected a region where home sales have climbed rapidly in recent weeks. That’s because home loan rules have already tightened so much during the past year.

“I’ve been doing this for 36 years. This is the most difficult time I’ve ever experienced with underwriting,” said Michael McGee, president of Winchester McGee Financial in Rancho Cordova. “I would venture to say in the next two or three years you will see the lowest foreclosure rate this country has ever seen because you just have to be solid gold to get a loan.”

Fears mounted this week on Wall Street that Freddie Mac and Fannie Mae, the government-backed firms that buy a majority of the nation’s mortgages, may lack the deep pockets to buy more. That could severely limit new loans at the very moment the real estate market needs them most for a recovery.

On Monday, both institutions saw huge drops in their stock values but rebounded Tuesday after assurances they are well-capitalized.

Pasadena-based IndyMac Bank also announced Monday it would suspend its mortgage lending due to defaults and losses on its existing loans.

The uncertainty involving market leaders created the latest set of jitters for real estate markets – including Sacramento’s – that can best be described as fragile. Though year-over-year sales have risen for the first time in 36 months in the area, still more restrictions and fewer loans have the potential to curb the supply of buyers and stall a recovery, brokers said.

McGee said his firm is already rejecting one in three loan applicants under the current lending rules.

Whether those restrictions get tighter is open to debate. Federal Reserve Chairman Ben Bernanke announced a crackdown Tuesday on the exotic loan products offered to risky borrowers that fueled the housing boom.

But Sacramento brokers and others said the market has already taken care of that: Most of the loans Bernanke has in his sights haven’t been available for a while.

“Gosh, it’s almost nine to 12 months ago that these loans stopped,” said Brent Wilson, mortgage strategist with Sacramento’s Comstock Mortgage.

“That, in some ways, is how government reacts. It’s kind of behind the curve,” said Dustin Hobbs, spokesman for the California Mortgage Bankers Association.

Mortgage consultant Beth Gewerth of Mason-McDuffie Mortgage Corp. in Sacramento said many who might have gotten the riskier loans in the past are now using government-backed Federal Home Administration loans. Those require 3 percent down payments.

Many are also using “gift” programs by Sacramento’s Nehemiah Corp. of America. In those transactions, Nehemiah covers the down payment and is reimbursed by the seller. The buyer essentially buys a house with little money down.

Brokers said the recent boost in home sales locally is largely due to borrowers with good credit and the ability to put money down. But they said they’re hearing that mortgage insurers may start requiring 10 percent down payments instead of 5 percent in so-called “declining markets” like Sacramento.

Still, Gewerth said the economic system will somehow keep the loans coming.

“As we all know, housing drives the economy,” she said. “They can’t get too exotic. But they have to keep things going so people can purchase homes and keep it going.”

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IndyMac: Capital Starvation And Deflating Assets

(From NakedCapital)

For anyone who’s remained in denial, this press release paints a clear picture of the severity of the credit crisis: Indymac can’t raise needed capital, and can only sell off assets at a loss. Part of this story is specific to Indymac, but the problem of capital starvation and deflating assets is a general condition. Evidently the regulators can’t find a buyer for Indymac, and are shrinking it as a prelude to nationalization.

What’s interesting is how they are shrinking it. The prohibition on opening or rolling brokered deposits is an obvious thing to do, but forcing Indymac out of the non-GSE mortgage business is not. The problem for FDIC is that non-GSE mortgages wind up getting pledged to FHLB, and as a secured creditor with an over-collateralized position, FHLB borrowings must be paid off by FDIC if the bank becomes insolvent. This is a large cash flow hit to the insurance fund (over $10B or 1/5 of the Fund in the case of Indymac), but the obligation of FDIC as Receiver to marshall the assets of the estate leaves no discretion for over-collateralized borrowings. The Board of the FDIC made some public comments about this problem a few months ago. FDIC has no access to the Fed to liquify and park a FHLB portfolio. In a bridge bank scenario, the FHLB borrowings remain in place, but FDIC is still obligated to provide a combination of capital and guarantees against loss sufficient to launch a new, well-capitalized institution (perhaps in partnership with private capital)–also a large figure, and the main driver behind Fed/FDIC’s push to modify the bank holding company regulations to allow in more unregulated capital.

My view is that the regulators have adopted a go-slow program in order to kick these problems over to the next administration. The obvious danger to this stratagem is a deposit run requiring intervention. The less obvious danger is that the over-hang of impaired but not written down assets may further depress prices.

When Northern Rock blew up, invidious comparisons were made in the British press between the US system of deposit insurance and the hodge-podge of miniscule deposit guarantees and vague regulatory responsibilities in the UK. We’ll see how the US system holds up in a systemic crisis that has reached large institutions that aren’t `too big to fail’, but have combined liabilities many times larger than the Insurance Fund. FDIC could fall back on Treasury for additional emergency funds, but that’s precisely what the current—and no doubt next—administrations want to avoid at all costs.

Bank Modeling and Financial Derivatives To Hedge Risk Caused Credit Meltdown

As Wolfgang Münchau says in today’s FT:

If this had been a mere financial crisis, it would be over by now. The fact that we are suffering its fourth wave tells us there might be something at work other than merely financial euphoria and bad regulation.

This is true, even if you don’t buy Münchau’s assertion that the real cause of the crisis was New Keynesianism and the dynamic stochastic general equilibrium model in particular. I would rather place the blame at the acceptance of models in general. Gillian Tett explains:

This decade, financiers have invented so many brilliantly clever mathematical tools to repackage risk that the industry has slipped, almost unthinkingly, into an assumption that “credit” is a collection of abstract equations, stripped from any human context.
Thus banks have become so dazzled with their powers that they have ignored how they interact with the rest of society – or how the tribal aspects of their own institutions can create dangerous traps.
Meanwhile, the cult of models has become so extreme that banks have believed them even when this collides with common sense. Yet, as any Latin scholar knows, the word “credit” hails from credere: “to trust”. It is, in other words, also a social construct.
And bankers forget this human dimension to their cost.

Sam Jones has one striking visual of that cost: a bar chart showing the current ratings of 469 CDO tranches which were rated AAA at issue. Fewer than a quarter of them retain that top rating; a lot of them are now CCC rated, and a fair few even have a D rating.

The reason that IndyMac was writing so many horribly bad mortgages was that there was no shortage of investors willing to trust models telling them that the bonds secured by those mortgages were incredibly safe. They didn’t need to look at the mortgages themselves, since they had bankers using models to do that for them.

In other words, IndyMac’s behavior was certainly irresponsible, probably illegal, and also entirely predictable. Could we have known that IndyMac specifically would extend a loan against a stated Social Security income of $3,825 a month, even when the maximum Social Security income at the time was barely half that? No. But inevitably someone would, just because of the ease with which lenders were able to sell all their downside at a substantial profit.

Hudson concludes his report by calling for “rigorous oversight” of lenders, and “rules that will prevent such disasters from happening again”. But that’s only half the solution. The real art is to try very hard to design a financial architecture where rules and incentives work with each other, rather than in opposition to each other. Because when there are billions of dollars to be made by breaking the rules, you can be sure that the rules will end up being broken.

New York Law Forces Lenders, Mortgage Brokers Into “Duty of Care” For Suitability of New Loan

(From New York Times)

NEW YORK’S borrowers could notice a different tone in their discussions with mortgage brokers in coming months, as brokers adjust to a new state law that seeks to stem foreclosures.

The legislation, which was passed by the New York Legislature in June and is expected to be signed by Gov. David A. Paterson, aims to curb the current surge in foreclosures, but it also includes provisions meant to prevent borrowers from taking out loans they cannot repay.

Among other things, it says that brokers have a “duty of care” to offer appropriate loans to subprime borrowers — those with poor credit.

Brokers are asking, however, what constitutes an appropriate loan, and what happens if a borrower disagrees with a broker’s recommendation.

“We have some serious issues with this law,” said Gene Tricozzi, the president of the New York Association of Mortgage Brokers. “There are some things here that’ll hang us out to dry.”

Specifically, Mr. Tricozzi said, the legislation requires brokers to weigh a borrower’s future earnings in selecting appropriate loans. For some borrowers, like pregnant women or workers nearing retirement, such prognostications might be unreliable. Yet refusal to offer loans to such borrowers could be construed as age or gender discrimination, he said.

The legislation comes as lawmakers and consumer advocacy groups have sharpened their scrutiny of mortgage brokers, because many seem to have offered loans to borrowers who had little chance of repaying them.

Often lost amid this scrutiny, brokers argue, is the fact that lenders themselves checked the borrower’s finances and willingly approved these loans.

Still, some advocates want to hold mortgage brokers to the same legal standard as stockbrokers and other financial advisers, who carry a fiduciary duty to act in their clients’ best interests and offer only “suitable” financial products. New York’s proposed law specifically stops short of the suitability standard, said Richard H. Neiman, New York’s banking superintendent.

But brokers may still face situations where they must argue against matching a borrower with a certain loan, even though the borrower could qualify for that mortgage and the loan would allow the borrower to afford — in the short term, at least — his or her dream home.

Not all borrowers suffer for taking on high risk, of course. During the recent real estate bubble, some borrowers who chose loans with skyrocketing interest rates emerged unscathed because they were able to refinance into less risky loans or quickly sold the homes for a premium.

When the real estate market rebounds and lenders make loans more liberally, brokers fear they may be held liable if a borrower overrides a recommendation and opts for a riskier loan and the loan fails. But if brokers deny loans, they fear they could lose business and possibly do a disservice to their customers.

Rholda Ricketts, the deputy superintendent of mortgage banking for the New York Banking Department, which had a role in drafting the bill, said a broker who disagreed with a borrower’s loan choice might be wise to have him or her sign a document that essentially releases the broker from legal responsibility.

Before such details can be worked out, though, borrowers with subprime credit could find fewer loan options, as brokers avoid potential liability.

“In some cases, I might say I don’t have a lender that supplies a certain subprime program,” said Mr. Tricozzi of the state mortgage brokers group, “even though, in reality, I do.”

REFINANCE REALITY: FULL DOC AND GREAT CREDIT

(From MiamiHerald.com)

BY TAMARA HOLMES

During the height of the real estate boom, it was not only possible to buy a home with little cash and less-than-ideal credit, but with soaring real estate prices, it was easy to refinance as well.As a result, many homeowners cashed in on lower interest rates and pulled equity out of their homes to pay off other debts. But that was then and this is now. As home prices fell and lenders started tightening their underwriting rules, the equity many thought they had vanished. While refinancing still provides the same advantages to homeowners, fewer consumers will be able to benefit from it.

”Refinancing is still being done,” says Jason Vasquez, a spokesman for the Mortgage Bankers Association. However, people will likely need good or great credit scores, income documentation and equity in their homes to qualify.

For homeowners who are thinking about refinancing, George Hanzimanolis, president of the National Association of Mortgage Brokers, says it’s a great idea for a number of reasons:

• Rates are low. Rates for 30-year mortgages are just above 6 percent. By refinancing to a lower interest rate, consumers can often save several hundred dollars a month. ”Start recognizing that $200 to $300 monthly savings now rather than wait several months to see if the interest rates are going to drop another quarter,” Hanzimanolis says.

• Homeowners can switch to a fixed rate. Homeowners who currently have an adjustable mortgage can refinance into a fixed-rate mortgage so they don’t have to worry about rising mortgage costs after a loan resets.

• Debt can be consolidated. Consumers with other debts may be able to refinance and use some of the equity in their homes to pay off those debts, improving cash flow.

Seeing the benefits of refinancing is easy, but for some, realizing those benefits is another story.

Those consumers who won’t be able to refinance typically fall into two camps.

• Low credit scores. ”There were people who had credit scores in the mid-500s who were able to get subprime loans,” says Hanzimanolis. ‘Their feeling was, `I’ll take this, keep it for a year or two, work on my credit and when my credit score gets better, I’ll be able to refinance.’ Well, if they’re still in that mid-500 range, they’re having a very difficult time refinancing.”

• Low equity. The second group is made up of those who have little or no equity in their homes. ”If they bought their home at the top of the market and now with the real estate correction, that 10 percent that they put down becomes 3 percent in equity or 5 percent in equity, those people may not be able to refinance today,” Hanzimanolis says. Worse yet, some may have put zero to 3 percent down and with the market correction are ”upside down” — owe more than their home is worth.

To protect their investments in a declining real estate market, some lenders have increased the amount of equity consumers must have in a home, so homebuyers will have to put down, say, 5 percent more, and homeowners who are refinancing will be able to borrow 5 percent less. In such cases, the less equity you have, the less likely it is that you’ll be able to refinance.

A HIGHER COST

Homeowners who have credit scores in the 600s and a modest amount of equity may be able to refinance, but at a higher cost.

For example, mortgage loan providers Fannie Mae and Freddie Mac recently announced that borrowers who have credit scores of 680 and below will have to pay a surcharge that could add thousands to the cost of the loan.

”In the past, lenders always considered anything above 620 good,” says Hanzimanolis. ”People come in today with a 675 and the rates that the banks have to offer are so much higher that it doesn’t make sense for many customers,” he adds.

There are also fewer options for people who have unconventional financial situations such as self-employed individuals. ”There are still programs out there, but they’re being offered by fewer lenders,” Hanzimanolis says. Such programs typically require higher credit scores and a larger down payment, meaning there is less money available to borrow if a homeowner is refinancing.

SECOND MORTGAGES

Finally, consumers who have second mortgages on their homes may run into a snag. In order for a consumer to refinance a first mortgage, the holder of the second mortgage must agree to ‘’subordinate” the second mortgage to the new first mortgage. That decision is entirely up to the second mortgage holder. If that lender refuses to subordinate the second mortgage, the only option the consumer has is to qualify for a new first mortgage that will pay off the second.

For people who have limited options, it might make more sense to use a mortgage broker rather than a bank, says Hanzimanolis, since brokers work with a variety of lenders and typically offer more loan products.

For those consumers with more than 20 percent equity in their homes and credit scores in the 700s or higher, the world of refinancing is their oyster.

”There are folks that have purchased their property 10 years ago and housing prices have escalated astronomically. Those people who brought those properties — even with property declines — still have that level of equity that if they choose to refinance, it’s still something they can probably do,” says Vasquez.

Consumers with equity and excellent credit will also get the lowest interest rates, whether they use a bank, credit union or a broker, so it typically does not matter as much where they apply for their loan.

A good place to start your refinancing journey is with your current lender. A mortgage company such as Fannie Mae that works with various lenders is another good place to start a search for a good refinancing deal, says Marilyn Kornfeld, a spokeswoman for Fannie Mae.

But no matter what type of lender you select, ‘’shop around and compare,” says Hanzimanolis. “Any good mortgage originator whether it be a bank, a credit union or a broker, should have no problem offering you a complete good faith estimate at your initial sit-down with them, whether you’ve officially applied or not.”

Arson Rages In Foreclosed Homes…Housing Bubble Breaks Records

July 3 (Bloomberg) — At 10:40 p.m. on April 27, a blaze at the beige Victorian house at 19 Nye St. lit up a neighborhood littered with boarded-up homes on the north side of New Bedford, Massachusetts. It left charred wood and melted vinyl siding on the three-story structure.

The house had been abandoned after the owner defaulted on a $240,000 home loan from GreenPoint Mortgage Funding, a Novato, California lender that shut down in August, 2007. The fire was one of four suspicious blazes in foreclosed properties that month in the southern Massachusetts city. All are under investigation.

The biggest surge of mortgage defaults in seven decades coincides with an increase in blazes in foreclosed properties led by states with the most repossessed homes, according to fire safety officials in Nevada, Massachusetts and Ohio.

“The more empty houses we have, the more fires we are going to see,” said James Wright, chief of the Nevada State Fire Marshal Division in Carson City, the state’s capital. “It’s particularly dangerous for firefighters, because they don’t know what condition these buildings are in or what they might find in them.”

National arson statistics for 2007, due in September or October, probably will show a significant increase as foreclosures climbed toward an all-time high in 2008’s first- quarter, said James Quiggle, a spokesman for the Coalition Against Insurance Fraud in Washington.

Arsons Follow Foreclosures

“Home arsons follow foreclosure trends, with a lag,” Quiggle said, pointing to an increase after the last housing slump when the number of blazes reached 116,600 in 1992 from 111,900 in 1990. “We’re facing a potential spike in arson like we’ve never seen before.”

The most recent national data is from 2006, when the median price of a U.S. home reached an all-time high of $221,900, as measured by the National Association of Realtors. There were 31,000 arsons that year, compared with 31,500 in 2005, according to the U.S. Fire Administration in Emmitsburg, Maryland.

Profit usually is not the motive when foreclosed properties burn, Quiggle said. Cases such as Sheryl Christman, 38, sentenced in February to five years probation for torching her Caledonia, Michigan, home four days before it was repossessed are the “exception not the rule,” Quiggle said.

Nevada Fires

Insurance pays the replacement cost, which rarely covers the mortgage of a property in foreclosure, he said. The value of the land is not covered.

“It takes a lot of chutzpah to set fire to a house when you’re the policy holder and would be first on any suspect list,” Quiggle said. “It doesn’t take much for a squatter to knock over a candle or for some kids to set a fire when a building is vacant.”

Last year, fires in vacant Nevada buildings increased 4 percent from a year earlier, said Wright, the fire marshal. That number may grow, he said. The state had the worst foreclosure rate in the U.S. during the first quarter, with one filing for every 54 households, according to data compiled by RealtyTrac Inc. The national rate was one filing per 194 households, analysts at the Irvine, California company said.

In Ohio, where one of every 161 households had a foreclosure filing during the first quarter, the number of blazes in vacant buildings rose 18 percent in 2006, according to the latest figures compiled by the state’s Division of State Fire Marshal in Reynoldsburg.

Empty Buildings

Damages climbed 52 percent to $22.7 million from a year earlier in the state where home sales began tumbling in 2004’s second half, a year before the national decline began.

The value of homes owned by U.S. banks more than doubled to $8.6 billion in the first quarter of 2008 from $3.59 billion a year earlier as lenders repossessed homes in default, data compiled by Federal Deposit Insurance Corp. in Washington show.

“Empty buildings have more fires and more serious fires than occupied buildings,” said Steven Westermann, president of the International Association of Fire Chiefs in Fairfax, Virginia. “There’s no one around to sound an alarm.”

Nationally, there were 396,000 home fires of all types reported in 2006, the highest in 10 years, according to the latest data available from the National Fire Protection Association in Quincy, Massachusetts. They caused a record $6.83 billion of damage.

Seeking Reward

Almost two-thirds of fires that occur in unsecured vacant buildings are intentionally set, said John Hall, head of research at the National Fire Protection Association. The rate drops to 32 percent in empty buildings protected with locks or boarded windows and 7 percent in occupied homes, he said.

In New Bedford, where the Nye Street home was boarded up, the city has posted signs on the charred building that read: “Reward of up to $5,000 if you know who did this.” So far, there are no leads.

The house has been empty since the subprime mortgage defaulted in August 2007, the same month the lender, GreenPoint Mortgage, went out of business after selling the loan to investors in a mortgage-backed security called BS ABS 2004-AC5 2300, according to documents at the Bristol County Registry of Deeds.

“For every foreclosure, you have more empty homes and more people who may become homeless,” said Hall, of the National Fire Protection Association. “These properties are on the fringe of society’s attention.”

`Exercise in Futility’

The growing number of vacant buildings, however, has not escaped the attention of firefighting officials. Flint, Michigan, put out a June 2007 study that called vacant-building fires “a dangerous exercise in futility.” Blazes in empty structures such as foreclosed homes account for 40 percent of the city’s fires and 62 percent of its firefighter injuries, Fire Captain Andy Graves said in the report.

Nationally, there are 3.7 firefighter injuries per 100 blazes in vacant buildings, compared with 1.9 injuries per 100 fires overall, Graves said in the report.

“We lose a lot of firefighters in vacant structures,” said Westermann of the International Association of Fire Chiefs.

Firefighter Mark Reed knows how dangerous a vacant, foreclosed property can be. He was critically injured battling a June 2007 fire in Buffalo, New York, set by arsonists in a foreclosed home on the city’s east side. Bricks from the chimney crushed Reed, who was then 36. His mangled right leg later was amputated.

Firefighters in Danger

“Every vacant home that’s allowed to deteriorate becomes a danger to firefighters because they can’t just sit back and say `Let it burn,”’ said Barbara Reed, Mark’s mother. Her only child lost his senses of smell and taste as a result of his brain injuries, and still goes to physical therapy twice a week, she said.

When the chimney fell on Reed, he was standing between the burning building and the home next to it, trying to protect lives and property, his mother said. The other members of Reed’s company, Engine 31, dug him out from under the bricks, she said.

“Even if the bank doesn’t care enough to maintain a home and keep it from being a hazard, firefighters still have to answer the call to go and put out any fires that might come from their negligence,” the retired fourth-grade teacher said.

Buffalo had 677 foreclosure filings in the first quarter, including notices of default and auctions, RealtyTrac reported. Since last year’s accident, firefighters have begun inspecting and marking the city’s 10,000 vacant houses with “their own form of graffiti,” said Reed. They use red spray paint on the doors or front walls of the buildings to cite potential dangers, she said.

“Structurally, we’re talking about a massive amount of heavy plaster, bricks, and glass in every one of these houses,” said Reed, 61. “Buffalo is not the only city where firefighters are putting their lives on the line to take care of these homes that no one wants.”

To contact the reporter on this story: Kathleen M. Howley in Boston at kmhowley@bloomberg.net.