Author: Daniel Indiviglio

A few days ago, I wrote about my worry that it’s too easy to foreclose, because banks got too comfortable with the culture of little or no down payment. Adam Ozimek at Modeled Behavior disputes my worry that there isn’t a high enough economic cost to foreclosure. He believes other significant costs exist to deter people from walking away. Let’s look at his arguments.

First he says:

1. Interest < Rent: If interest payments are less than rent, then it costs you money to move out and start renting.

But is interest less than rent? Most of these underwater homeowners we’re talking about are generally pretty early on in their mortgages. So most of their payments consist of interest. And many of those interest rates are also pretty high. In one model I just ran, by the end of your second year paying a $150,000 mortgage at 6% (which is relatively low), you’re still paying over 80% interest. This also doesn’t take maintenance costs into account or homeowners insurance, which can often be higher than renters insurance. Finally, since rents tend to decline as home prices decline, those rents should be falling at a similar rate to home price, making renting a much better deal than paying even only the interest on an underwater mortgage. In some markets you could have a $3,000 mortgage payment (originated during the boom), but can now rent a comparable home for just $1,800. For these reasons, I’m generally unconvinced that rent will be greater than interest for most underwater homeowners.

Next, he says:

2. Moving = $ . . .

Sure. But does it cost more than whatever money you’ll save by not having to pay the underwater balance on your mortgage? Probably not.

And then:

3. Recourse: If the mortgage is a recourse loan, the borrower faces the possibility of losing other assets if the bank comes after him.

Right, this is the best criticism, when applicable. In some cases, the bank may go after your other assets. Of course, this only matters if you’ve got more assets than the money you’d save by walking away. In a country that doesn’t do much saving, that’s probably not the norm for deeply underwater homeowners.

Moreover, in the states with the biggest foreclosure problems, I understand that banks are often treating the difference between the principal balance and market price kind of like a credit card settlement. I’m hearing stories about banks encouraging short sales, then forgiving most of what the original borrower still owes. For example, someone with a principal balance of $400,000 is preparing a short sale of the property for $240,000. The lawyer he’s working with believes they can settle the $160,000 difference for $10,000 to $15,000. There are so many pending foreclosures right now that banks just don’t have the time or resources to take all of these people to court. So if even if the mortgage is a recourse loan, the banks often aren’t going after the borrowers with much vigor.

As for the additional argument that there’s a psychological barrier to foreclosing, I’m sure that’s true. I think few people relish in the idea of foreclosing (though I could tell you some awful stories about people bragging). But I also question the theoretical poll that Ozimek mentions where he says that:

Even when the home is 50% underwater, only 17% said they would default if they could still afford the mortgage.

Frankly 17% is still too high. But I don’t really believe the statistic. A few days ago, I mentioned actual servicer experience shows that when underwater homeowners undergo a “strategic reevaluation” of whether they should continue to pay their mortgages there’s a 75-80% likelihood of default. I’d trust actual experience over a poll.

So I concede (and didn’t really mean to assert) that it isn’t truly economically *costless* for a borrower to suffer foreclosure. But I do mean to assert that the cost is quite low. And when faced with the alternative of foreclosing on a deeply underwater home, that cost is comparably negligible under these market conditions. That’s why I still believe that higher down payments would rightly add to that economic cost, which is why I argue in their favor.

The national unemployment rate declined in January to the seasonally adjusted rate of 9.7% from 10.0% in December, according to the Bureau of Labor Statistics. The rate beat consensus expectations of remaining unchanged at 10.0%. But even though the national rate declined, 20,000 more jobs were lost. That was worse than consensus expectations, where economist expected a gain of 15,000 jobs. This is one of those months where the decline in rate should warrant little more than cautious optimism. In reality, the economy still lost jobs and the employment situation is quite ugly. Today’s report definitely requires some analysis to understand what’s really going on.

First, here’s how BLS shows the unemployment rate’s progression over the past few years:

And here’s its chart of actual job losses:

I’ll get to the weirdness of the rate declining significantly while more jobs were still lost in a second, but this graph tells a fairly unambiguous story: the trend is still in a good direction. Even though the economy is a net job loser, we’re definitely flirting with real job growth. That should begin over the next few months.

First, let’s tackle the question of what this seemingly conflicting data means. This positive news could have a lot to do with seasonality. Remember, the reported number is seasonally adjusted. It says that in January, we had 14.8 million unemployed Americans, which is about a half million fewer than the 15.3 million unemployed in December. Sounds great, right?

Maybe, maybe not. If you don’t adjust for seasonality that changes. A lot. Then, January had 16.1 million unemployed, while December had 14.7 million — an increase of 1.4 million jobless Americans.

There’s a similar story with rates. Seasonally adjusted, the national rate dropped to 9.7% from 10.0%. If you don’t adjust for seasonality, then the unemployment rate rose from 9.7% in December to 10.6% in January. Here’s the graph I often show that details the historical variance over the past few years:

This wide variance isn’t surprising — just look at January 2009. We saw the same sort of thing there. In that case, however, the seasonally adjusted data rose to meet the unadjusted rate in April. Let’s hope we don’t see the same sort of thing this year. Otherwise we’ll be nearing 11% come spring.

The trend of additional discouraged workers also doesn’t paint a very positive picture. They leaped to over 1 million:

This isn’t what you’d like to see. It’s the largest month-over-month increase in discouraged workers since the start of the recession. If you thought a new year might encourage more unemployed Americans to decide to try to find a job, you’d have been wrong. And don’t forget: those 1 million Americans will need to enter the work force eventually, which will cause the rate to rise.

The non-seasonally adjusted rate that takes into account discouraged workers rose a full percentage point from 10.2% in December to 11.2% in January. If you want to take seasonality into account, the news is better, but even there the rate only came down from 10.5% to 10.3% from December to January.

The broader marginally attached unemployment rate continues to be very ugly. The number of jobless there are essentially unchanged, but that rate is 11.2% seasonally adjusted and 12.0% unadjusted. Adding in those forced to work part time brings those rates up to 16.5% and 18%, seasonally adjusted and unadjusted.

For a little industry-level detail, construction is still losing jobs, with the sector shedding 75,000. Manufacturing also continues to lose jobs, but the numbers aren’t looking as bad, with only 11,000 lost in January.

Temp and retail added jobs: 52,000 and 42,000, respectively. I noted the increase in temp jobs last month. This trend is an indicator that employers will probably begin hiring more permanent workers before too long. The most resilient sectors, health care and the federal government continued to add jobs. They grew by 15,000 and 33,000 jobs, respectively.

I should also note that December’s job losses were revised from 85,000 to 150,000. That’s almost double. Let’s hope we don’t see a similar revision for January.

The duration of those unemployed also continues to be troubling. Those unemployed for more than 27 weeks increased again. 6.3 million Americans have been unemployed for more than 27 weeks:

I think you should look at this confusing report today in two ways. Seasonality is useful for recognizing trends. As a result, the trend is clearly positive. But unadjusted unemployment shows total worker suffering. And that’s quite awful, as the broader rate including marginally attached unemployed who can’t find full time work is up to a whopping 18% — the highest we’ve seen since the beginning of the recession. So while the economy is beginning to make a turn, things are still very, very bad on the actual employment front.

Lastly, readers who took yesterday’s unemployment poll didn’t fare too well. Only 2% accurately predicted 9.7%. It seems Atlantic readers are a pessimistic bunch — a full 79% thought the unemployment rate would rise. Here are those results:

Today, there was a rather brilliant hearing conducted by the Senate Banking Committee about the Volcker rule. Unfortunately, I missed the beginning. But what I did manage to catch was wonderfully amusing. The Senators questioned a panel including representatives from banking behemoths Goldman Sachs, Citigroup and JP Morgan, as well as finance professors from MIT and Harvard. The discussion got quite heated several times. My favorite part was Goldman’s representative denying that it ever needed, or even really got, a bailout.

That representative was managing director Gerald Corrigan. If he was really the best representative that Goldman could send to represent the bank from both political and philosophical standpoints, then that’s pretty scary. Corrigan was the exact caricature of a Goldman banker that the general public envisions. He was arrogant, presumptuous and skirted responsibility at every opportunity.

At one point, there was a contentious exchange between Corrigan and fellow panelist, economist Simon Johnson regarding whether banks’ exposures to certain kinds of derivatives should be limited. It went something like this:

Corrigan explained that some big banks, like Goldman, regularly ran stress tests to ensure their derivatives exposure were well hedged and capital levels were adequate to cushion the blow of even several of their major counterparties going bust. Another panelist said that it might be a good idea for regulators to require banks to perform such internal stress tests.

Johnson balked. He questioned whether it was wise to put much value in such tests conducted by the banks. After all, he mentioned, if Goldman Sachs is the gold standard of stress testing, why did it fail to do so properly before the crisis and have to run to the Fed for a bailout?

Well, that was an easy one for Corrigan to answer: they never needed a bailout.

Huh? Johnson rebutted, asking why it was converted to a bank holding company practically overnight so that it could receive emergency assistance from the Federal Reserve if it didn’t need a bailout. And what, wondered Johnson, would have happened if it didn’t get that assistance? Wouldn’t Goldman have failed? He pointed to Former Treasury Secretary and once Goldman CEO Hank Paulson’s new book as providing proof of the deep trouble Goldman was in at the time.

But Corrigan wouldn’t budge. Instead, he said:

There is no question whatsoever that when you look at totality of the steps that were taken by central banks and government, particularly in 2008, that Goldman Sachs was a beneficiary of this. There’s no doubt whatsoever about that — as was everybody else. I mean, that’s what those extraordinary measures were all about. But again, I’m not suggesting for one minute that Goldman Sachs was not a beneficiary of these initiatives. It was clearly.

And yet, it would have been fine without those measures? So why, then, did it request emergency funding from the Fed? Did it just want to borrow money on the cheap (without really needing it for any kind of emergency) so it could reap more profit? While extraordinarily doubtful, isn’t that, in a sense, even worse? The prevailing logic to why banks like Goldman got emergency Fed assistance is because without that help they would have failed. If that logic is wrong, then the bailouts disturb me even more.

The Washington Post reports that Google and the National Security Agency are working together to fight cyberattacks. In December, Google detected a security breach that originated in China. The attack led to Google threatening to abandon the Chinese market. This new partnership shows that Google wants to fight back. I think this is great news.

According to the Post:

Under an agreement that is still being finalized, the National Security Agency would help Google analyze a major corporate espionage attack that the firm said originated in China and targeted its computer networks, according to cybersecurity experts familiar with the matter. The objective is to better defend Google — and its users — from future attack.

I was critical of Google’s threat to leave China as a result of the attacks. I thought Google would show more boldness by keeping its presence in the Asian superpower, beefing up its fight against Chinese hackers and continuing to promote freedom. Whether it ultimately ends up staying in China or not, this move shows that Google isn’t content just labeling such hacker attacks as unavoidable: it seeks to ramp up its security.

That’s good for Google, because its enhanced security will make its customers feel safer. But it’s also good for the entire tech industry. Security is a major concern among businesses and individuals in today’s highly Internet-reliant culture. Any progress the NSA and Google make in preventing such attacks in the future will benefit everyone.

Should privacy advocates worry? Not according to the Post. It says that Google won’t allow the NSA to view users’ searches or e-mail accounts. Presumably that’s unless you happen to be a hacker? I would assume and hope that Google will hand over whatever data the NSA requests regarding anyone the company identifies as a malicious hacker.

There’s a fine line between cyberattacks and cyberterrorism. It’s nice to see the NSA willing to work with a company of Google’s caliber to prevent security breaches and bring these hackers to justice.

Troubled U.S.-owned lender GMAC continues to shrink its investment holdings, preparing to sell another $6.5 billion in mortgage assets. Anytime I read news about GMAC, I have to rub my eyes to make sure they aren’t playing tricks on me. A Dow Jones article on this topic today is no exception. Let’s examine GMAC’s incredible shrinking portfolio and balance sheet.

I already mentioned the $6.5 billion transfer of assets from its investments portfolio to its “for sale” inventory. But that doesn’t even properly describe how much its assets held for investment have shrunk. The firm also wrote off 60% — 60 cents on a dollar: that’s not a typo — of those assets’ value before transfer. That brought its held-for-investment portfolio from $25 billion to $12 billion in the 4th quarter.

And that’s not even the most shocking statistic in the article:

During the past year, GMAC has made a concerted effort to trim its mortgage lending arm, Residential Capital LLC’s holdings. ResCap’s balance sheet stands at $19 billion at the end of 2009, compared with $140 billion in 2006.

For those who like percentages, that means that ResCap’s balance sheet has shrunk by more than 86% since 2006. While that was due in large part to big losses, it has also sold off some assets. Although ResCap is only a part of GMAC’s overall mortgage operation, this still shows that GMAC’s mortgage assets are a fraction of what they once were.

You might take this to mean that GMAC is winding down. I wish that were true. But the article also says:

In the fourth quarter, origination of new mortgage loans jumped to $18.1 billion. Hull said a third of the business was through purchases, while the rest consisted of refinanced mortgages.

The lender wouldn’t be originating new mortgages if it was really finished doing business. Even though most were refinancing, the approximately $6 billion of new purchases shows that the company hasn’t given up just yet.

I’m not sure if this is good or bad news for taxpayers. If its efforts lead to paying back its bailout, then I guess that’s good. But I can’t help but think taxpayers would have been much better off if GMAC was liquidated early on, rather having been awarded multiple bailouts.

Earlier this month, I wrote about the lender’s bailout total thus far. That’s up to around $17.3 billion. While no where near the size of say, AIG or Fannie Mae, that’s still a pretty big number if it turns out to be a taxpayer loss. And as long as GMAC continues to need even more cash to cover losses, it’s hard to see when the company might manage to pay back any of that.

Some would argue that some bailout banks may not have made deep enough mistakes to deserve to fail, despite coming very close. I don’t see how it’s possible to make that argument for GMAC. Any firm still needing billions to cover new losses now that the broader financial industry has recovered never should have been saved in the first place.

Can you believe it’s already time for our first monthly unemployment reading of 2010? Tomorrow, the Bureau of Labor Statistics will reveal the unemployment rate for January. Now that the holidays are over, we can resume analyzing these numbers as more indicative of whether businesses have really begun hiring or continue laying people off. And as usual, we want to give Atlantic readers an opportunity to predict how the labor market’s important measure has changed. Vote after the jump!

First, a tiny bit of analysis. Yesterday, we learned that ADP estimated 22,000 job cuts in January. While not exactly positive, that’s certainly an improvement compared to what the economy experienced throughout most of 2009. It was the smallest cut in two years, according to ADP.

And yet, we found out this morning that first-time weekly jobless claims unexpectedly rose by 8,000 to 480,000 last week — the highest level seen since mid-December. There have also been reports that some big companies intend to continue laying off workers throughout 2010. One would imagine that some seasonal holiday-driven jobs were also shed in January.

This all seems to indicate that predicting January unemployment won’t be easy, but give it a shot anyway below. Last month, respondents did fairly well, with 26% accurately predicting that the unemployment rate would remain at 10%. Can we beat that for January?

iPhone users who love TV have reason to celebrate today: AT&T has announced that its 3G network will now support the SlingPlayer Mobile TV app. SlingPlayer is a service that allows users to watch live or digitally recorded television through the Internet. Up to now, that kind of live video streaming hasn’t been very functional through the AT&T’s 3G network. This development is significant for several reasons: it shows that AT&T is working to improve its network capabilities, it adds an additional dimension to the iPhone’s capabilities and it could make the iPad a little more attractive.

AT&T’s Getting It

First, it should be noted that this announcement comes from AT&T — not Apple. MarketWatch explains:

Sling Media, a wholly owned subsidiary of EchoStar, originally developed its wireless app to make efficient use of 3G network bandwidth – and to conserve the finite wireless spectrum available to the wireless industry. Since mid December 2009, AT&T has been testing the app and has recently notified Sling Media — as well as Apple – that the optimized app can run on its 3G network.

AT&T has drawn a great deal of criticism about its network. This news indicates that its improvements must be working, as it feels comfortable that its network can sustain the additional 3G traffic that streaming live television would bring.

This also indicates that AT&T must be serious about wanting to continue soaking up all iPhone business going forward, despite reports that Apple might want to expand its iPhone service coverage to other carriers. The more functional AT&T allows Apple’s mobile devices to be, the more likely Apple is to stick with AT&T. And, of course, iPhone users will be happier with AT&T as well.

The iPhone As A Mini-TV

This also marks an important step for the iPhone. It has always shown video, and even streamed video nicely if stored internally or through WiFi. But it didn’t work quite as well over the 3G network. What you got there was generally pretty low-quality, slow, and unreliable. If AT&T really has improved its network so that its traffic can handle live video, then iPhone users will begin relying on the device for the purpose of watching live TV too.

Of course, this is still only a first step. Not all iPhone users are also SlingPlayer customers. But the fact that this app could pass AT&T’s and Apple’s standards means more live video apps should follow. The biggest barrier was network capability.

The iPad As A Bigger Mini-TV?

Finally, assuming that the optimized video will also display well on the iPad’s larger screen, this is a very important development for Apple’s newest device. Remember, it runs on AT&T’s 3G network, so this news should apply to it as well. That means, suddenly, it becomes a TV anywhere you can get a 3G signal. And with its screen size significantly larger than that of the iPhone, iPad users can watch television comfortably. Although watching video is possible on the iPhone, it will actually be pleasant on the iPad. I’ve mentioned in the past that I think the iPad will have trouble differentiating itself as a necessary device to own, but now it can also appeal to those who want an extremely portable television on which they can watch live programming wherever they can get 3G.

A while back I got embroiled in a little blogger debate about whether a house should be considered an investment. I contended that it probably should be, though I have a pretty weak standard for how something could qualify as technically being called an investment. An article today in the New York Times led me realize an interesting difference between real estate and other investments: over the past decade, banks have made if very easy to walk away from your home.

The Times article I’m talking about explores the new and disturbing trend of homeowners who can continue to make mortgage payments on their underwater homes but simply choose not to. After all, it seems pretty awful to have to pay a $150,000 mortgage on a home only worth $100,000 in this brave new housing market. The article begins:

In 2006, Benjamin Koellmann bought a condominium in Miami Beach. By his calculation, it will be about the year 2025 before he can sell his modest home for what he paid. Or maybe 2040.

“People like me are beginning to feel like suckers,” Mr. Koellmann said. “Why not let it go in default and rent a better place for less?”

Indeed, it seems an easy way out. But that’s only because banks developed the bizarre notion that it’s okay if people contribute little or no money as a down payment on a home. Oddly, they generally wouldn’t be willing to sell investors a security or asset where they pay little or nothing down. They even have higher margin requirements for stocks than they did for houses. So you can’t generally welsh on most other investments the way you can with your promise to pay for a home. Investors have money at stake; underwater homeowners don’t.

With a home, if you’ve got little (or no) principal to lose, then it’s pretty easy to walk away and not incur any monetary loss. That’s vastly different from most other investments. Think about a stock. Imagine if you bought a share of Toyota’s stock on January 19th for $92 (before the recall), then right now you’d have lost $18, since its price has dropped to around $74. You can sell the stock, but you’ll be $18 poorer.

An underwater borrower certainly wouldn’t want to sell the home. If sold at prevailing market prices, then the former homeowner would still owe the bank money but have nothing to show for it. By just walking away, however, the only thing underwater homeowners have to lose through foreclosure is their credit rating. While that’s not completely insignificant, if you’ve got a home, say, $50,000 underwater, at some point you have to ask yourself what a few hundred point hit to your credit score is really worth.

And therein lies the central problem: other than their credit rating, underwater homeowners have nothing to lose on their investment. That makes one of the biggest problems of the boom-time housing market pretty clear: the lack of substantial down payments. As I mentioned yesterday, that’s one of the reasons why the mortgage modification effort isn’t going so well. Who wants to keep a mortgage that costs them more than the home is now worth?

Going forward, I don’t think it would be too bad an idea to have a universal, regulated minimum down payment standard for a home. Something in the range of 10% to 20% seems reasonable. The housing market would be a lot better off. Only then can a bank responsibly write a mortgage, because whoever purchases the asset will then have something to lose.

In the ongoing AIG bonus saga, the troubled insurer will distribute around $100 million in bonuses today, that’s likely much to the dismay of taxpayers who now own the firm. Despite the fact that AIG is technically under compensation restrictions, many so-called “guaranteed bonuses” that were in place before AIG’s collapse still must be honored by law. This is a regrettable situation, and speaks loudly to the messy problem that bailouts pose.

This is not the first time I’ve written about these bonuses. Indeed, we’ve been anticipating them since last summer. Back then, the compensation czar was trying to figure out a solution to not having to pay these bonuses out. Clearly, he didn’t think of a very good one. Here’s what’s he came up with, according to the New York Times:

Fearing a firestorm like the one last spring, A.I.G. had been working with the Treasury’s special master for compensation, Kenneth R. Feinberg, on a compromise that would allow it to keep its promise in part, without offending taxpayers.

The agreement calls for employees who still work for the financial products unit to accept 10 percent cutbacks, while employees who have left the company must take 20 percent cuts. Those employees are still entitled to their bonuses under the contract, which adheres to the scheduled payments even if people have lost their jobs. The financial products unit has shed almost 200 people as it has wound down A.I.G.’s derivatives business.

A.I.G. has told all the affected people that if they do not accept the reduced amounts, they will get no bonus at all, according to a person with knowledge of the agreement.

Because I’m sure taxpayers won’t be at all offended to have to pay only 80-90% of the bonuses. And you read correctly: if someone promised a bonus doesn’t even work at AIG anymore, he still gets 80% of the guaranteed bonus. Must be nice. Clearly, the talent retention argument doesn’t go very far with those former employees.

Unfortunately, there’s little that the government can really do to prevent these bonuses from being paid. As long as AIG stays in business, it legally owes this money to the recipients. And since the government kept AIG afloat, it has to pay the bonuses. In fact, if any employees decide that 10% or 20% cut is worth taking the government to court about, they could very well win and get the full 100%. Luckily, this probably isn’t worth the hassle and bad publicity for most of them.

This episode, again, stresses the problem with bailouts. If the government decides to stand behind a company that should have failed, it must honor all of its awful contracts in the process — whether that means millions of dollars in bonuses to employees or billions of dollars to domestic and foreign banks. If AIG had been able to fail without bringing down the economy with it, then all of those compensation contracts would have been void, and reduced to a general unsecured claim in bankruptcy court. If the company reorganized, then those employees might choose stay, but only after the contracts would have been renegotiated.

Monday evening, economist Simon Johnson wrote a blog post indicating that the Obama administration is quietly soliciting suggestions for a replacement for Treasury Secretary Tim Geithner. Johnson has stepped up to the plate to offer a suggestion: Kansas City Federal Reserve President Tom Hoenig. From the little I know about Hoenig, I would second that nomination.

First, I should say that I’m not entirely convinced that the Obama administration would toss out Geithner. He hasn’t really done anything to be a clear candidate for firing. But then, I guess you could argue that’s because he hasn’t really done anything at all. The Treasury’s mortgage modification program hasn’t had particularly significant success, but it hasn’t made things worse either (as far as I can tell). Its public-private investment fund intending to buy up banks’ toxic assets also hasn’t really gotten off the ground. The stress tests actually did a pretty good job at stabilizing the market, but at the likely cost of giving the impression that the big banks would be backstopped by the government, if necessary. And Geithner pretty much just let the Paulson bailouts run their course.

So Geithner didn’t really screw anything up, but he also hasn’t impressed anyone I’ve talked to. And he definitely hasn’t taken a very hard line with Wall Street. After all, the President announced his toughest proposal thus far to reform Wall Street — the Volcker Plan — with the former the Federal Reserve Chairman at his side, not Geithner. But as I said before, I’d be pretty surprised to see Obama replace Geithner in the near term. But that doesn’t mean he couldn’t be a casualty if and when the Republicans massacre the Democrats in midterm elections this November. Geithner could be one of the fall men that Obama uses to indicate that his administration will seek a new direction going forward.

If Obama does choose to replace Geithner, who should he choose? He certainly can’t pick a former Wall Street banker. In fact, he probably wants to avoid anyone with any ties whatsoever to Wall Street. Even Geithner’s relationship posed problems, despite the fact that he never worked for a bank, but worked with the big ones regularly as New York Fed President. So his economic advisor Larry Summers is also probably out. Volcker might have been an interesting choice, but I can’t see him nominating an 83-year-old to that high-stress post after November. Then, there are more prominent economists like Paul Krugman. But with greater Republican control over the confirmation process after November, Obama would be wise to pick a lesser-known name that they would have a harder time finding ways to criticize.

That leaves someone like Hoenig. By no means am I an expert on Hoenig, but I have observed a thing or two about him. I actually first heard him speak last year when I attended a Joint Economic Committee hearing where he testified about the Too Big To Fail problem. He took a no nonsense, practical approach to the problem. He didn’t appear opposed to the idea of breaking up big banks. He seemed very committed to ensuring that failure was possible and the bailouts stop. He’s also no pawn of the big banks, but a champion of smaller, regional banks. After all, Kansas City is a long way from Wall Street.

Interestingly, Republicans might not have too much trouble confirming Hoenig. Johnson speculates that Hoenig is probably a Republican himself. He’s also an inflation hawk. I noted last week that he, bizarrely, was the lone dissenter on the Federal Reserve Board who thought it might be a good idea to raise interest rates. While Republicans might like that, it probably won’t come into play as Treasury Secretary, since he’d have no direct effect on interest rates in the post. Though, it might indicate that he’s more likely to also be a deficit hawk than other potential Obama nominees.

Indeed, it’s possible that Hoenig could pose a more difficult sell to Democrats than Republicans. Though, if they reject a Treasury Secretary chosen specifically because he’d be tough on Wall Street, then that probably won’t look good to their constituents. So you’d likely have enough Democrats to go along with it if Republicans are on board.

On Tuesday, Senate Banking Committee Chairman Christopher Dodd (D-CT) voiced concern over the so-called Volcker Plan during a committee hearing. The proposal, brainchild of former Federal Reserve Chairman Paul Volcker, has been championed by the Obama administration. It seeks to prevent banks from using customer deposits to trade for their own account (“prop trading”) and caps their exposure to various liabilities. While many regulation advocates love the idea, others believe that eliminating prop trading would have done little to avoid the kinds of risks that led to the financial crisis and that it’s hard to figure out how to limit banks’ exposures to different kinds of products. And although Dodd is no opponent to the regulation in theory, he worries that the President may be reaching too far in advocating this plan.

As I’ve noted before, the Senate is having a very difficult time putting together a financial regulation bill that can pass. Dodd is rightly concerned that the President’s ambitious proposal will make getting the legislation done even more difficult, if possible. Further, the Wall Street Journal reports:

Mr. Dodd also appeared slightly annoyed that President Barack Obama threatened during his State of the Union speech last week to veto the legislation if administration officials weren’t satisfied with it. Mr. Dodd called it “somewhat interesting” that the White House would threaten a veto when Mr. Dodd’s bill was the only major piece of legislation in the Senate that had a chance of attracting Republican support. White House officials didn’t respond to questions about Mr. Dodd’s comments on the veto threat.

Mr. Dodd also slammed the White House for not having answers to technical questions about the proposals, saying he was calling the administration and “not getting good answers.”

Dodd’s anger is understandable. The Obama administration is clearly stepping on his toes. He’s been working hard for the past two months to put something together that can actually get through the Senate, and the President’s insistence on having this highly controversial measure included in the bill as a pre-requisite for his signature makes Dodd’s job next to impossible.

I think, ultimately, Dodd will call Obama’s bluff on this one. It’s incomprehensible that the President will refuse to sign a broad financial regulation bill similar to the one the House passed in December if it comes across his desk — even if it doesn’t include the Volcker plan. I just can’t see Obama cutting off his nose to spite his face here.

But this stance by Dodd pretty much puts the last nail in the coffin containing the Volcker plan. I interpreted it as an obvious political play from the very beginning, with little chance of actually making its way through Congress. Without Dodd’s support, it doesn’t stand a chance.

As my time at the American Securitization Forum conference had nearly concluded on Tuesday, I attended a session specifically addressing the question of how the industry could better align incentives. In other words, how should things change so that issuers don’t make money by originating bad loans? Like so many sessions during the conference, this one boiled down mostly to discussing whether or not it’s a good idea for securitizers to keep some “skin in the game,” retaining some of the risk in the pools of loans they sell. While bankers and issuers are very wary of the idea, one panelist made it clear that some investors support it.

A quick refresher in case you haven’t read any of the other posts I’ve written about the “skin in the game” proposal. The idea is that, by holding back some of the risk for themselves, securitizers would naturally have more prudent underwriting standards than the originate-and-distribute model provides. The problem is that it’s a little bit unconvincing that it will help: most banks had plenty of mortgage- and asset-backed bonds in their portfolios when the mortgage market collapsed — they had lots of skin in the game. And yet, they still originated plenty of bad loans. Moreover, it would curb securitization volume significantly if banks had to retain a portion of the risk. It would also make securitization more expensive, undermining one of its best features: the low cost.

So instead, most banks and issuers prefer other alternatives. They include better disclosure, enhanced reporting, providing more information on the underlying loans to investors and better due diligence on data integrity. Yesterday, I noted an additional proposal by Comptroller of the Currency John Dugan. He suggests universal minimum underwriting requirements, to ensure that issuers aren’t just giving out loans to anyone with a pulse. The bankers and issuers also stress that any “skin in the game” proposal should be carefully crafted to have different risk retention requirements for different types of structures and loans, as not all asset-backed bonds are created equal.

Of the panelists in this session, however, one stood out: an investor. And this wasn’t just any investor. This was Kishore Yalamanchili, a managing director at the investing titan BlackRock. He supports the “skin in the game” proposal. He said:

If you look at the issue on a more dispassionate basis, which is hard for me, you look at what happened. The originators typically get all the cash flows from the transaction and they securitize them They were originating loans at 101 and selling loans at 103, and making good money, so they could care less what happens . . . Same thing with bankers: they’re getting their transaction fees. Same thing with rating agencies: they’re getting their rating fees . . . So who’s the guy left behind? The investor is the guy left behind holding the bag on the performance of the loans for the next 30 years or 40 years.

Although he prefaces this statement claiming to be looking at this issue from a dispassionate basis, I’m not convinced he really is. It sounds pretty obvious to me that he’s talking from the investor’s point-of-view. If he wasn’t, then he’d take a little responsibility and concede that some blame also should fall on the shoulders of investors, who voluntarily bought this stuff without understanding what they were getting. They were left “holding the bag” because they wanted it.

Indeed, there’s something rich about BlackRock, of all people, complaining they got taken advantage of by tricky bankers and issuers. BlackRock is arguably the most sophisticated investor out there. If anyone should have known better than to purchase bonds that they didn’t understand, it’s BlackRock. And if anyone had the infrastructure and expertise to actually do enough analysis to better evaluate the bonds, it’s BlackRock.

Again, no one crammed these securities down investors’ throats: they all purchased them willingly, even happily. While issuers certainly should have originated safer loans, investment banks could have pushed them to provide more information for disclosures and rating agencies could have used more accurate models and assumptions, none of that matters if investors refused to purchase what they didn’t fully understand. The reason that mortgage-backed securities flourished wasn’t because issuers wanted to write millions of bad loans, investment banks were willing to sell anything or rating agencies were too easy with their grades — it was because investors strongly demanded these bonds. If they hadn’t, there would have been no market for bad MBS.

And maybe that’s part of the answer to aligning incentives. Investors need to be more prudent going forward. If investors will only buy what they understand, then that’s the banks and issuers’ incentive: they’ll be forced to originate better loans if they want to securitize them. In fact, this is what we’re seeing now in the market, and why securitization has been essentially lifeless other than the Federal Reserve’s support for the past two years. Investors have realized their mistake. Let’s just hope they don’t forget the need for to understand what they’re buying now that the rest of Wall Street is feeling better.

Perhaps the biggest surprise of the ASF conference so far was during a session on Tuesday about the future of the government-sponsored entities like Fannie Mae and Freddie Mac. The panel, consisting mostly of mortgage bankers and investors, debated how the GSEs should be reformed. While I had expected the Wall Street crowd to champion the free market and declare that these troubled entities should be wound down, and that the private market should take care of housing market liquidity going forward, I heard a quite different answer. Most panelists wanted the government to remain involved in the liquidity business.

First, the panelists agreed that it was probably best to separate out the two major functions that the GSEs serve currently: providing market liquidity and helping to create more affordable housing in the U.S. I recently mentioned that House Financial Services Chairman Barney Frank (D-MA) made a similar statement. He wanted those priorities left to separate entities as well.

It’s pretty clear that government officials would be the ones who would want to create more affordable housing. But it’s less clear that Washington should be where the liquidity comes from. After all, that’s what a market is for. So later in the session, the moderator asked whether the government should get out of the liquidity business. I was shocked at the responses.

Most of the panel agreed that the government should continue to support some agency to provide liquidity to the mortgage market. Garry Cipponeri of JPMorgan didn’t believe that privatization would work, because there would be a lack of consistency if the government wasn’t in charge. But more importantly, he thought the price shock would not sit well with the market: investors would have to add a risk premium if Uncle Sam wasn’t standing behind half of the mortgage market.

Another panelist Wellington Denahan-Norris,CIO and COO of Annaly Capital Management, agreed. She was unconvinced that the market would able to live with the new risk pricing if mortgage liquidity providers were completely private. This would curtail lending and make it more expensive for consumers to get mortgages.

A third panelist, Armando Falcon, CEO of Falcon Capital advisors, also wanted government ownership of an entity in charge of liquidity. He even suggested that the Federal Reserve could serve this function if it made its mortgage security purchase program permanent.

Only one panelist disagreed: James Lockhart III, vice chairman of WL Ross & Co. and former director of the Federal Housing Finance Authority. He wasn’t prepared to reject the notion of privatization entirely. When Cipponeri asserted that the absence of a government liquidity provider would raise funding costs by as much as 150 basis points, Lockhart thought it might not be that much.

This is kind of amazing. What you have here is a group of investors and bankers who would prefer to keep the government propping up the market so that costs remain low. This idea spits in the face of free market economics. It would dictate that if the market demands a higher price for mortgage funding, then that’s what the price should be. Indeed, if recent history has taught us anything, then it’s precisely that: mortgage funding was entirely too cheap and easy. That’s what created the housing bubble. If costs were higher, then fewer mortgages would have been originated, and credit quality would have been better as well.

Also interesting is that all of these panelists essentially agreed that the two objectives of providing liquidity and making homes more affordable should be separate. But, in a sense, providing liquidity also makes homes more affordable. If something is more liquid, it has cheaper transaction costs. So if the government kept liquidity artificially high, then prices would be kept artificially low: it couldn’t escape the dual purpose of providing liquidity and also making home ownership more affordable, since banks’ funding costs would be lower as a result.

This is a great illustration of where businesses only support the free market until it costs them to do so. As soon as the realization that a privatized mortgage market liquidity provider might increase funding costs and decrease loan volume, all that great free market philosophy goes right out the window. After all, that could make Wall Street bonuses a little lower.

The truth is that there’s no reason the U.S. needs government-sponsored entities to provide mortgage market liquidity. Other countries leave that function in private hands, and their mortgage markets function perfectly well. Indeed, given the disaster seen in the U.S. mortgage market over the past few years, theirs may perform even better.

Another session I attended today at this week’s ASF conference focused on the mortgage modification effort, both by the U.S. Treasury’s HAMP program and banks privately. It’s not going so well. The panelists generally appeared to agree that borrowers who are underwater or have second liens are mostly doomed to foreclose. But some believe the key might be for principal reductions to become more prevalent.

The panel’s only government representative, Seth Wheeler, Senior Advisor in the Treasury leading the mortgage modification effort, believes the program is doing fairly well right now. Even though he says its success rate thus far hasn’t shown that very clearly, he sees a large number of modifications being made permanent in the months to come. According to Wheeler, about 75% of the over 900,000 borrowers who have received trial modifications are making their payments. So if they can get all their documents in, then that would amount to quite a lot of permanent modifications.

Of course, those who receive trial modifications, in theory, should be able to bring them permanent. There are underwriting standards that dictate who gets into the program in the first place, and many borrowers are turned away if it isn’t believed that they would even be able to make payments on a reasonably modified loan. So how many HAMP trials that are made permanent doesn’t exactly speak to the success of preventing foreclosures in a broader context.

For a more complete picture, we can turn to Doug Potolsky, another panelist who works with modifications at Chase Home Finance. He explained that HAMP is only one option for troubled homeowners. Chase offers other modification programs of its own. According to Potolsky, Chase’s pull-through rate for modifications is only around 20% — and that would include those loans that can apply for the HAMP program and the bank’s own programs.

Laurie Goodman, Senior Managing Director at Amherst Securities Group, noted one of the major problems: so many homeowners remain underwater. She revealed a number of startling statistics about how unlikely underwater homeowners are to bother trying to save their home from foreclosure once they’ve gone delinquent. Once underwater homeowners miss that first payment, they strategically reevaluate whether they should continue to pay. According to Goodman, at that time there’s a 75-80% likelihood of the mortgage’s default in the coming months. If the borrower has positive equity, however, the rate of default is much lower.

An additional problem was explained by Nancy Mueller Handal, Managing Director of Structured Finance at MetLife. She focused on the second lien problem. If borrowers are also trying to pay off a second lien, like a home equity loan, then the likelihood of a modification’s success also plummets. Unfortunately, she says that there’s no great solution to the second lien problem. This is just a situation where borrowers have more debt than they can handle. Goodman chimed in with a scary statistic: 51% of non-agency borrowers (those whose mortgages aren’t owned or guaranteed by the government agencies like Fannie Mae and Freddie Mac) have second liens.

What’s the solution? Goodman and Mueller Handal both agreed that principal forgiveness is the only way to prevent foreclosure for these borrowers. While this certainly isn’t a new suggestion, it’s a proposal that’s beginning to gain more support. We’re at the point where it’s become pretty obvious that nobody wants to pay a mortgage for more than their home is worth. The easy solution would just be to rewrite the mortgage for a value more in-line with the home’s current value.

There are a few problems with this. The most obvious is the moral hazard involved. If people made poor decisions to purchase a home they knew they couldn’t afford, principal reduction would sort of act as their reward. At least if they are forced to foreclose, there’s a consequence for their bad behavior of losing the house and their credit score taking a big hit. Yet, what about the borrowers who aren’t entirely to blame for their inability to pay, because they got sold a bad mortgage by a unscrupulous mortgage broker? Should they suffer the same consequences?

Of course, banks have yet to jump on the principal reduction band wagon. As I’ve noted in the past, this would cause banks to immediately take deep losses on that principal. By creating these modifications — many of which will end in re-default — at least they can take those losses over a longer period of time. So without the brute force of government coercion, I find it unlikely that the principal reduction possibility will be considered much by banks.

Speaking of that re-default potential, I had one other interesting observation from Seth Wheeler’s testimony. He indicated that unemployment benefits can count as income in the underwriting process for the HAMP program modifications. I wasn’t aware of that, and find it a bizarre feature of the program. These unemployment payments are temporary, and there’s no telling how long it can take for these borrowers to find new employment. And even when they do, it’s unclear whether their new job’s pay will fall short of their modified payment requirements. This doesn’t bode well for the permanent modifications through HAMP actually performing well for the life of the loan.

The American Securitization Forum’s annual conference began Tuesday with a speech by the Comproller of the Currency, John Dugan. He began talking around 8:30, not but not exactly to a packed house. I estimated only 200 or so out of the over 4,000 total conference participants were present. Either they weren’t much interested in hearing him speak, or the festivities last night carried on into the wee hours, and they couldn’t make it out of bed that early. That’s a shame, because it was a far more understanding and constructive speech than yesterday’s by Assistant Secretary for Financial Institutions of the U.S. Treasury, Michael Barr. Dugan suggested that the popular “skin in the game” risk-retention proposal is misguided and offered an alternative.

He began by reviewing just how severely the financial crisis struck the securitization market. He noted that in 2009 securitization volume was about $1 trillion lower than three years prior. He sees the value that securitization can provide to the credit markets and believes the sector needs to be reformed and healed going forward.

He went through several of the major proposals on the table, but then focused on one that he found problematic. Like music to the conference participant’s ears, he explained that he was uncomfortable with the “skin in the game” risk retention proposal. While he understands and agrees with the ultimate goal of the proposal, he has concerns. About the proposal he said:

But while lax underwriting is plainly a fundamental problem that needs to be addressed, mandatory risk retention for securitizers is an imprecise and indirect way to do that, and is by no means guaranteed to work. How much retained risk is enough? And what type of retained risk would work best – first loss, vertical slice, or some other kind of structure?

He said it’s also “perverse” to require additional risk retention if new regulation already requires that securitizations are kept on-balance-sheet. He believes it would “materially reduce the amount of credit available for housing or any other sectors” that securitization serves. Instead, he suggests a better alternative for improving the quality of loans originated. Why not just allow regulators to directly establish minimum underwriting standards?

He names four basic, core standards:
– Effective verification of income and financial information
– Meaningful down payments
– Reasonable debt-to-income ratios
– For monthly payments that increase over time, qualifying borrowers based on the higher, later rate, rather than the lower, initial rate

Although he doesn’t think this is the only reform necessary, he believes such minimum standards could be a better alternative to risk retention. He would also like to see better disclosures, credit rating reform and changes in compensation practices.

I’ll be interested to gauge the reactions of the bankers present to this proposal. On one hand, they hate the “skin in the game” idea. On the other hand, minimum underwriting standards tie their hands in some ways. They could particularly hurt smaller banks that cater to specific niches or underserved segments of the population. Even though subprime borrowers broke the market over the past few years, subprime borrowing can be done effectively under certain circumstances.

But policymakers might find this suggestion an attractive way to streamline regulation. It has the flavor of a consumer financial protection agency, as it should prevent banks from writing loans that would harm consumers who are unable to pay. After all, that’s not smart underwriting. But it would also accomplish the goal of banks adhering to sounder borrowing standards, without requiring them to retain some risk, which would necessarily curtail their loan volume and harm their capital position. I’m a little bit mixed on the proposal, for the reasons I explained, but it’s certainly an idea worth thinking about.

Towards the end of Monday at the American Securitization Forum conference, I attended a break out session on covered bonds. I thought this would be a particularly interesting topic, because right before I left banking in 2008, covered bonds were said to be the next big thing. Then that whole financial crisis thing happened and the market came to a grinding halt. So much for covered bonds. But now that finance has come back to life, the push for covered bonds is back too. They could help.

First, what is a covered bond? First, imagine a regular unsecured bond from a bank. An investor buys that bond and hopes that the bank is able to stay in business and pay him as promised. If it goes bankrupt, then the court will divide up all the bank’s assets and award him some portion of what he’s owed based on his debt’s seniority. Since there’s no specific asset that the bond the investor held was referenced to, the debt is considered unsecured.

Next, think about a mortgage-backed security. An investor buys the MBS and hopes that the mortgages in the pool that are referenced by his bond do well. The investor gets periodic payments of principal and interest, based on the bond’s structure and the mortgage pool’s performance. This is a secured bond, since the investor technically has a claim on some portion of the pool of mortgages.

A covered bond sort of blends these two ideas. Remember that bank bond? Imagine it was exactly the same, but now it’s also secured by a pool of mortgages. So the investor still gets his payments, just like with the bank bond before. Here’s the twist: if the bank goes bankrupt, then the investor has a claim to some portion of the pool of mortgages that back covered bond. But as long as the bank is able to pay its debt, the mortgages are just held like any other assets on its balance sheet.

Get it? A covered bond behaves a lot like an unsecured bond, except that if the bank goes under, then whoever holds the bond has a claim on the mortgages that back the bond. It’s essentially like the bank bond, but much safer, because it’s secured by the pool of mortgages. So for the investor to lose money, you’d need a sort of perfect storm, where not only does the bank go bankrupt, but all the mortgages also turn out bad.

In fact, with covered bonds, this possibility is even more remote, because the mortgage pools used tend to be pristine. Remember, these are mortgages that the bank keeps 100% on its balance sheet. So the bank has all of its skin in the game when it comes to that pool. Clearly, it isn’t going to want to knowingly hold bad assets. For this reason, covered bonds are generally considered to be among the safest of corporate bonds.

The problem is that we don’t really have much of a covered bond market in the U.S. As the session I went to yesterday explained, Bank of America attempted to lead the way in getting the covered bond market going in the summer of 2007. Unfortunately, it had pretty bad timing, as the mortgage market collapsed a few months later. The following year, the financial crisis hit and there was no market for anything — especially not anything having to do with mortgages.

In Europe, however, the covered bond market is far better developed. France, Germany and Spain have been issuing them for years. In fact, the covered bond’s origins can be traced back to the year 1770. Why haven’t they caught on in the U.S.? For a few reasons.

First, the U.S. has the government-sponsored entities like Fannie Mae and Freddie Mac. They either purchase or guarantee the most pristine mortgages, so banks don’t have any trouble securitizing them. But European nations don’t have GSEs, so covered bonds are a great way for their banks to lower their borrowing costs and enhance liquidity, while still keeping the mortgages on their balance sheets.

But there’s another problem: U.S. law. Currently, there are regulatory barriers that make covered bonds harder to create in the states. As a matter of law, it isn’t that easy for a bank to issue debt backed by a specific pools of assets it still owns. A large portion of yesterday’s session consisted of a progress report on the legislative effort in Congress to pass regulatory changes which would allow the covered bond market to flourish in the U.S. Luckily, those on the panel explained that the effort to reform the law to better accommodate covered bonds is doing well in Congress. There have been hearings in the House of Representatives, and the proposal appears to have bipartisan support.

Covered bonds could be a great way to solve several of the problems facing the financial industry and mortgage market today. First, any mortgages used would be prudently originated, which is something that many fear isn’t the case with securitizations where entire pools are sold as bonds. With covered bonds, the bank keeps all the mortgages on its balance sheet. Second, it’s a good longer-term funding strategy for banks. The mortgage pools are dynamic, and the bonds generally last anywhere from two to ten years. Third, they could help investors to get comfortable with mortgage securities again. When done right, covered bonds lack the complexity of many securitized bonds and are very, very safe — even safer than the most pristine of corporate bonds and just about as simple. Finally, they could help to lessen the market’s dependence on the GSEs. They would provide additional funding and liquidity to issuers, without the need for a government guarantee or purchases.

Right before lunch, I attended ASF’s keynote address: a speech by Assistant Secretary for Financial Institutions of the U.S. Treasury, Michael Barr. I’m not sure if it was a lack of interest in his speech, or its proximity to mealtime, but the room was only about half full for this one — probably the least number of people I’ve seen so far in a major session today. For those who were present, they witnessed the first speaker who didn’t hold back his criticism of the securitzation market.

Barr was the first Obama administration representative that I have heard speak at the conference, and his tone was definitely different from representatives from the IMF and Federal Reserve who were on other panels. While those other officials seemed understanding to the interests and problems in the securitzation market, Barr didn’t appear as sympathetic.

He did begin by saying securitization is essential. He then went through the administration’s regulatory proposals thus far, such as the consumer financial protection agency. He continued by reminding everyone all of the actions that the government took — both Treasury and Federal Reserve — during the financial crisis to stabilize the market.

But then, he didn’t hold back in criticizing the market’s actions during the housing boom. He directed some comments at the issuers who created badly constructed deals. He also accused rating agencies of falling prey to conflicts of interest.

These disparaging comments were not well received. I saw a few of the conference participants look at each other quizzically, as if to say, “Is this guy serious?” Although the securitization community knows that mistakes were made, few believe that the mistakes were intentional, or as malicious as many in Washington assert.

During the lunch that followed, I discussed the speech with a few securitization professionals. They all had the perception that I observed during the speech. Barr didn’t appear to get it. He read the administration’s talking points, instead of addressing the problems that the securitization market worries about and offering constructive advice on how to tackle the problems that lie ahead through regulation.

As I type this, I am sitting through another session at the Asset Securitization Forum. This one seeks to investigate the shape that policy reforms should take. The session is only an hour long, but given the broad financial regulation push in Washington, it could last for weeks. Luckily, there are several more targeted sessions over the next two days. This panel explained changes they think we will see, and what they hoped we would see, in broad strokes. One thing is clear: they want something a little different from what we’re seeing in Congress thus far.

The industry panelists all agree that some regulatory reform is justified and needed. But they aren’t all on board with all of the suggestions that policymakers have made concerning what those changes should be. The prevailing belief, found in both the House and Senate versions of financial reform, is that banks and issuers need to keep some “skin in the game.” These provisions seek to have those who create securitizations hold some of the risk. The idea is that banks would have to eat a little of what they cook, which policymakers believe will result in less poisonous securities offered to the public.

Panelists took a few issues with this position. One problem was the across-the-board nature of current proposals, where issuers would be required to hold onto something like 5% of the risk for any securitization deal they create. Hal Scott, a Harvard Business School Professor on the panel, thinks this regulatory proposal would function better if the retention requirements were tailored to each specific deal. Some deals are riskier than others, due to their underlying assets and/or structures.

Scott voiced another worry about this proposal. He pointed out that it conflicts with the other broad regulatory goal of making safer banks through higher capital requirements. Banks required to hold additional risk from the securitizations they create will be less safe, which is exactly what regulation seeks to avoid.

One investor on the panel, William Moliski of Redwood Trust, Inc., also wondered what the portion of a securitization held back is supposed to do. Is it to cover representations and warranties violations? He wonders who will have access to that piece of the deal if things go bad, and under what circumstances. If it is the first loss piece, then he worries about what this means for consumers. If banks have to take a first loss on all securitizations, then he fears that there will be some consumers that are permanently shut out from loans. One of the benefits of securitization is diversification of loan risk, which generally spreads losses over the entire pool, making them easier to stomach.

The official ASF position, however, is that the entire idea of risk retention is misguided. While the Forum “fervently” supports the idea of aligning the interests of investors and issuers, it fears that risk retention could interfere with securitization and reduce volumes. That could conflict with the very essence of securitization, which is the ability for issuers to obtain funding and to create more loans.

Instead, what ASF and the panelists are in clear favor of is greater transparency. They believe that could come through better disclosure and modified reps and warranties. Scott suggested that disclosure reform for publicly issued securities should be mandatory and not just a best practice suggestion. This could even extend to privately issued securities.

Moliski also addressed transparency. He is pleased additional information is being provided these days, but he wants even more. There is some data that is considered private or sensitive, but that information would be very helpful for investors to use in their analysis. He named the addresses of mortgage borrowers as an example. He said transparency only gets you so far without more detailed information.

(Written around 10:45am, posted later due to technical difficulties!)

For the next two days, I’ll be blogging from the Asset Securitization Forum (ASF). It’s the largest gathering of securitization market professionals in the U.S. each year. Though previously held in Las Vegas, this year the convention has chosen a more relevant locale: the Washington, DC area. As I write this, I’m listening to the first substantial talk of the day: the 2010 Securitization Market Outlook. Its message: things are improving; the market has a ways to go; nobody is sure what the future holds.

While broader banking has recovered, the securitization market is one that remains mostly asleep. As a result, the atmosphere at the conference is what you might expect: rather somber. It certainly isn’t as lively as what I witnessed when attending the event back in early 2008, prior to the financial crisis and the failure of Bear.

The main convention room appears smaller than it did back then, but it’s surprisingly packed — standing room only. Everyone was listening intently to the securitization market outlook. The panel consisted of representatives from a variety of different aspects of the industry. Their message was mostly the same: the market will come back, we just don’t know when.

Panelist Valerie Kay of Morgan Stanley predicted $20 billion of new issue commercial mortgage-backed securities in 2010. That would be quite a feat, because as panelist Jordan Schwartz of Cadwalader, Wickersham & Taft LLP reminded the audience: today marks the two year anniversary of the last successful new issue private label CMBS deal without Federal Reserve assistance.

Residential mortgage securitization is much worse off. In a poll of conference participants, only 35% thought that the RMBS market would come back to life this year. That could make for a difficult year for consumers to get mortgages, since the Federal Reserve is ending its program to purchase mortgage securities in March. 81% said they feared that day more than when the Fed removes its support of the other securitization markets through its Term Asset-Backed Securities Loan Facility.

The panelists were also asked about whether private investors will come back once the Fed removes its support. They thought so, but were less optimistic for residential mortgages. They worried that Fannie and Freddie would still crowd-out any private-label RMBS, since the government’s decision to provide seemingly unlimited insurance is sure to please investors more than MBS without a guarantee. They believe once the government mortgage agencies begin to curb their guarantee volume, the private label market would pick back up.

(Written around 9:45am, posted later due to technical difficulties!)

In its final installment of the Big Think’s “Went Went Wrong” Series on the financial crisis, they interviewed Financial Services Committee Chairman Barney Frank (D-MA). Much of the interview was predictable: Frank mostly explained what anyone closely following the financial regulation push in Congress already knew. But there was one fascinating gem in discussing where Fannie and Freddie went wrong. Frank views ushering the poor to own homes as a mistake and believes they should rent instead.

Frank was responding to the question about how Fannie and Freddie could be structured to avoid moral hazard and a too cozy relationship with the regulators. After stating that we should separate the liquidity creation function from the subsidy objective (which we already knew he supported), he said:

I think the answer is you separate out the function of providing the equity in general for the mortgage market and doing some subsidy and in my judgment, the subsidy again, as I said before, should be focused on affordable rental housing, not in pushing low income people into owning homes that they can’t afford.

Can I get an “Amen!”? If someone cannot afford a house, they should not be encouraged to purchase a house. The logic couldn’t be simpler. And yet, over the past decade it was utterly ignored. I’ve never understood why renting is viewed as so shameful or low class. I’ve rented my entire adult life. I once had a supervisor pushing 50-years-old with a wife and two kids that probably made over a million-dollars-per-year, and he still rented.

Not to say there’s anything wrong with owning a home either. There may be reasons why some individuals would prefer buying over renting, despite the fact that buying a home is often not a very good investment. But I think people need to get past the view that you can’t have a successful life without one day owning a home. It’s a bizarre psychological barrier that, frankly, helped lead us into the worst financial crisis in about 80 years.

For low income people, the argument for owning gets even thinner. By definition, they will have trouble purchasing a home, since in most markets it’s more expensive to buy the same property you could rent — especially when you have to worry about homeowner’s insurance, risk-based interest rates and maintenance. Sometimes, these individuals also have a more irregular income stream, which can lead to trouble paying on-time each month, leading to foreclosure and wrecking their credit. They would also be better off having better labor mobility, which is provided if you can more easily pick up and leave a rental.

So it’s perfectly acceptable if someone in a low income band wishes to try to buy a home. That’s certainly their right. But the government shouldn’t be subsidizing it. If it really wants to help Americans with relatively lower incomes, it would be better off focusing on affordable rental housing, as Frank suggests. From his lips to President Obama’s ears.