Bankruptcy Primer, FDIC’s Bank Takeover Strategy, Economic Stat Roundup

The other day we were playing Monopoly. Of course someone inevitably landed on Park Place, which happened to have three houses on it, and he promptly declared bankruptcy, but then wanted to keep playing. It reminded me that “declaring bankruptcy” doesn’t seem to have quite the finality that it once did. This year many well-known companies have done it, but still seem to be around. Individuals were sent (in the US until the 1830’s; England until 1869) to debtor’s prison, or at least threatened with being sent to a damp, dark, place with rats in it. In the United States, laws have always favored debtors versus creditors. But in 2005 the Bankruptcy Abuse Prevention and Consumer Protection Act made it harder to declare bankruptcy, and prior to it taking affect there was a spike in filings that hit over 2 million! In 2008 there were about 1 million filings, which mean that in the US one in three hundred people declared bankruptcy.

But a bankruptcy is still, for the most part, considered a last-ditch option for dealing with overwhelming debt. Most of your assets go away, and your credit rating takes a fall (a bankruptcy for ten years, whereas a foreclosure remains on it for seven). Most homeowners will avoid a Chapter 7 bankruptcy and instead file for Chapter 13 if they want to avoid a foreclosure. A Chapter 7 filing can wipe out unsecured debts, but secured debts are tied to a specific asset, such as a mortgage secured by a home and which reverts to the creditor. A Chapter 13 bankruptcy doesn’t actually wipe out the debt but can shield debtors from their creditors for several months during the forbearance period until a court-ordered repayment schedule can be worked out. During this time most homeowners try to work out a loan modification program.

FDIC’s Bank Takeover Strategy
What does the FDIC do with all those bad loans when they take over a bank? Yesterday they announced a deal to sell $1.3 billion of them (in this case, from Houston’s Franklin Bank, 30% of them are non-performing) to a joint venture created with Residential Credit Solutions, also based in Texas. RCS ponies up $64 million of its own money in order to hold and manage the portfolio, and the FDIC (who owns 50% of the venture) provides the loans and the financing. The New York Times reports that “Instead of taking cash for the loans, the F.D.I.C. will accept a government-guaranteed note for $727.8 million with an interest rate of 4.25 percent. Agency officials said the deal meant that investors would be paying about 70 cents on the dollar for the loan portfolio, which is a higher price than hedge funds and other private investors have been willing to pay for troubled mortgages. Had the government not provided Residential Credit with the ability to borrow most of the money it needed at low interest rates, agency officials said, the investors would have probably paid about 20 cents on the dollar less than they did.” But analysts wonder if it will push banks to sell nonperforming mortgages, which they’ve hesitated to do because of the discount to their original value and the losses they’d have to book.

Market Update
Gee, what more could we want from the market? Stocks are improving on signs of economic stabilization and growth, while interest rates are steady or perhaps even improving. In addition, relative to Treasury rates, mortgage rates have actually come down slightly, even with the nervousness out there about the continuation of the Fed’s mortgage purchase program. The Fed wants a stable housing and mortgage market, and at this time it is still a fact that private investors have not stepped up enough for the Fed to back away: the huge majority of loans being funded are those either directly or indirectly supported by the government.

Speaking of the Fed buying mortgage securities, most of their purchases have been in the 5-5.5% coupons, meaning that they are helping the 5.25-6.125% 30-yr mortgage prices. This is why the pricing which some investors are offering on lower rates (in the 4’s) is not quite so aggressive – or logical. At this point, Wall Street firms say that origination is outpacing demand for these lower rates, in spite of the prepayment risk on the higher coupons.

Arcane Housing Stat
Just when you’ve figured out all the economic releases, along comes one you’ve never heard of. Yesterday it was reported that the “Wells Fargo NAHB Housing Market Index” rose to 19 in September versus 18 in August. I didn’t even know it existed, but this is the highest reading for this index since March 2008. Readings below 50 are still poor.

Other Economic Stats
The Federal Open Market Committee (FOMC) meets next week and yesterday there was a rumor that the Fed will soon preparing the markets for higher rates due to the continued signs of economic growth (or at least leveling off). Yesterday’s Industrial Production and Capacity Utilization numbers reinforced this, and the bond market saw rates slide up. This morning we have Housing Starts and Building Permits, along with the Philly Fed survey and the usual Jobless Claims. Housing Starts and Building Permits rose in August to their highest level since November, lifted by a rebound in multifamily homes. Starts were +1.5% with an upward revision in July, and Permits were +2.7% (although they are -32% from a year ago). Multifamily Housing Starts were up over 25%. And Jobless Claims dropped by 12,000 to 545,000, the lowest reading since July. After the news the 10-yr is unchanged at 3.47% and mortgage prices are also roughly unchanged from Wednesday afternoon.

Daily Humor
(Reader warning: I try to stay away from political humor, but I found this funny enough, true or not, to post here. No complaints please.)

A noted psychiatrist was a guest speaker at an academic function where Nancy Pelosi happened to appear. Ms Pelosi took the opportunity to schmooze the good doctor a bit and asked him a question with which he was most at ease.
“Would you mind telling me, doctor,” she asked, “how you detect a mental deficiency in somebody who appears completely normal?”
“Nothing is easier,” he replied. “You ask a simple question which anyone should answer with no trouble. If the person hesitates, that puts you on the track.”
“What sort of question?” asked Pelosi.
“Well, you might ask, ‘Captain Cook made three trips around the world and died during one of them. Which one?'”
Pelosi thought a moment, and then said with a nervous laugh, “You wouldn’t happen to have another example would you? I must confess I don’t know much about history.”