A memo written by BofA home loans sales executive Matt Vernon notes that:

While we regret the inconvenience this will cause to some of our customers in the short term, we are making the responsible choice that is in the best interest of our long-term capabilities to provide a predictable customer experience.

The memo was provided to National Mortgage News by a confidential source.

In spite of arguments that this is some of the cleanest product ever to be originated, and profit margins being solid for many in the business, BofA seems to be backing off a bit. They produced just over $22 billion in mortgages during 4Q2011, a 75% decline from 4Q2010.
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Source:
Another Mortgage Shoe Drops At BofA – National Mortgage News
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Related:
Mortgage Banker View: BofA Cuts Off Mortgage Bankers

Normally I just link, but today I’m leading with an excerpt from former FDIC head Sheila Bair’s recent Fortune article on the topic. The current Volcker Rule proposal is 300 pages, and she simplifies it down to this:

Regulators should scrap the mind-boggling complexity in the proposed rule and focus instead on the underlying economics of a transaction. If the transaction makes money the old-fashioned way — the customer paying the institution for a service through interest, fees, and commissions — then it passes the test. If profitability (or loss) is driven by the direction of markets, then it fails. Inevitable gray areas, such as marketmaking, need to be done outside of the insured bank and be supported by a truckload of capital. Securities firms should be allowed to maintain adequate inventory to make liquid markets.

Most important, regulators should tell executives and boards that they will be held personally accountable for monitoring and compliance. Bank leadership must make clear to employees that they are supposed to make money by offering good customer service, not by speculating with the firm’s funds.

Complex rules are easy to game and hard to enforce. If regulators can’t make this work, then maybe we should return to Glass-Steagall in all of its 32-page simplicity.

And now the must-read Volcker Rule links…

-We Need A New Volcker Rule For Banks (Sheila Bair, Fortune)

-Where Is The Volcker Rule? (Baseline Scenario)

-The 2012 Market & Regulatory Landscape (WSJ)

-Volcker Rule Definition (New York Times)

-Incisive hate mail to JP Morgan Chase CEO Jamie Dimon (Josh Brown)

-Catchup reading: Europe Will Stumble Until Banks Face Reality (Sheila Bair)

-Bill Gross’ Argument Against Low Interest Rates (CNBC’s John Carney)

-Lenders Ignore Zillow Mortgage’s AOL Deal At Your Own Peril (NationalMortgagePro)

-Today’s rate market recap: Biggest 10yr Yield Selloff In 2 Months (MortgageNewsDaily)

It appears today as a debt crisis. More than that, it is a growth crisis. Behind the growth crisis is a leadership crisis.

Strauss-Kahn resigned as head of the IMF after charges, later dropped, that he raped a hotel maid in May.

More of his comments in full story on Financial Times via BusinessInsider.

Like him or not, Strauss-Kahn’s view is hard to disagree with as Europe’s slog continues.

Markets were optimistic Friday 12/9 following an EU summit that promised more centralized budget controls and more pressure on member nations to balance budgets.

But sentiment reversed last week as the IMF said Greece was shirking its promises to reform economic policy and cut government spending.

Also IMF managing director Christine Lagarde said Europe’s crisis is escalating, and deputy assistant Treasury secretary Mark Sobel told congress about U.S. economic risks stemming from Europe.

Then Fitch became the third major ratings agency to downgrade several large banks on European contagion concerns, plus they issued a negative outlook on France.

And today markets were rattled when European Central Bank president Mario Draghi implied a Euro breakup costs way more than staying together, and said that the ECB can’t step up bond buying.

It all led investors toward safe bets like U.S. mortgage bonds and Treasuries, which helps U.S. rates.

But seriously, the H.8 report released by the Federal Reserve recently showed that domestic bank holdings of agency MBS have increased by $27b over the two week period ending on November 30, which brings the YTD growth in bank holdings of MBS to $148b, a significant pickup since the August announcement from the Fed that it is likely to keep overnight Fed Funds near 0% through mid-2013. Add to this volume the recent monthly purchases of around $25b agency MBS by the Fed and it is easy to see why mortgage rates are doing well: supply and demand.

And as for different facet of the relationship between banks and mortgage backed securities, where does the discussion over QRM (Qualified Residential Mortgage) stand?

First, a reminder of what QRM even means…

Under Finreg, banks must retain some risk when selling mortgage loans. These risk retention rules require banks to keep 5% or more of mortgages they sell so they have skin in the game. Earlier this year, regulators started defining which loans constitute “Qualified Residential Mortgages” (QRMs) that are exempt from these risk retention rules.

Since then, the debate is mired in a sea of government agencies. But recently the MBA created a stir by saying the proposed QRM rule may be “fatally flawed.” (The last time I heard that term was from a long-time-ago girlfriend describing our relationship, but that’s another story.)

In written testimony prepared for delivery before a House Financial Services subcommittee, MBA President and CEO David Stevens said that although it is still premature to call for repealing the QRM, “that day may not be far away. Regrettably, the proposed rule, with its QRM definition and creation of a premium capture cash reserve account, is so deeply flawed that we seriously question whether it reflects congressional intent or can ever be successfully implemented,” Stevens wrote ahead of the hearing. The committee is holding the hearing to assess the Private Mortgage Market Investment Act authored by Rep. Scott Garrett, R-N.J. The bill calls for abolishing Dodd-Frank’s risk-retention provisions, among other reforms for the secondary mortgage market.
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Further Reference:
-FT: Banks face €350bn Basel III shortfall
-Banks Must Have Skin In The Game When Selling Mortgages

(1) stockholders

(2) customers who (a) place deposits in the bank—these are liabilities to the bank, and (b) borrow money from the bank—these are the assets

(3) the employees.

Keep this in mind: a bank’s assets consist of the loans that it owns and whatever physical assets it may own (real estate, for example.) A bank’s liabilities consist of shareholder equity and its deposit liabilities. There are rules which regulate the relative size of the two classes of liabilities. A bank can only take in deposit liabilities which are a certain multiple of its shareholder equity. These rules are international and are set by the Bank for International Settlements.

On September 15, 2008 Lehman Brothers filed for Chapter 11 bankruptcy protection. Lehman had made large investments in mortgage backed securities. Worse yet, there were highly leveraged. Lehman was not a bank but an investment bank and was allowed by SEC to leverage itself almost 31:1. A 3.5% loss in the value of its mortgage assets could wipe out all of the equity in the company.

The Lehman BK let out of the bag the fact that all the large investment banks and many large commercial banks were holding a ton of mortgage debt which was going to see a much higher default rate than anticipated. The mortgage mess/liquidity crisis was launched. Potential retail buyers of these mortgage backed securities made up of crappy loans stopped buying them and the folks who held them—the investment banks and large commercial banks—were stuck. This created a massive liquidity problem on top of the capital problem created by the losses.

Let’s go back to the statement “A bank liabilities consist of shareholder equity and its deposit liabilities.”

Deposit liabilities consist of the deposits of the regular customers (individuals and businesses) and also interbank lending. Interbank lending is short term (one day to one week) lending from one bank to another. The need for this can arise at the end of any bank’s business day. It may find that it has insufficient cash to cover its reserves. Banks with excess cash lend it to banks which are cash short every day. In general, banks face the task of funding long term loans with short term deposits. Some of these loans are things such as HELOC’s, commercial lines of credit and credit cards where the borrowers have control over the balances.

Post-Lehman what happened is that no one trusted anyone else and interbank lending dried up. Since interbank lending was the normal solution to any bank’s liquidity problem, business as usual was not an option. Banks were not concerned about making money. They were concerned about not suffering contagion from another bank’s ills.

At that point there were two serious problems with banks: (1) because the real value of their mortgage assets was a lot less that they thought they suffered a capital shortfall problem, and (2) the mutual distrust created a liquidity problem.

The risk at this point was enormous. Two thing were done to help. One was TARP which address bank capital and the other was the liquidity programs put together by the Federal Reserve. TARP (Troubled Assets Relief Program) was passed by Congress and signed by Bush II. It authorized the expense of up to $700 billion of which $432 billion was ever disbursed. This was originally intended to shore up bank capital but banks rather quickly got their own capital and paid back TARP loans. Then TARP morphed into a bailout for AIG, FNMA, FHLMC, Chrysler and GM – none of which were banks.

Treasury has collected about $13.7 billion in interest or dividend on TARP and the eventual loss is estimated to be less than $20 billion.

Banks were bailed out but quickly repaid Treasury. But the populist myth misses the point.

Bank stockholders were massive losers. Some such as Washington Mutual were totally wiped out while others were merely heavy losers. The bailout benefited the public in general. Absent a bailout, if banks had become insolvent then either depositors would have lost money or the FDIC (the public) would have made up the difference.

The most significant support when the liquidity crisis occurred came from the Federal Reserve in the form of a number of programs which provided a gigantic amount of money to a massive array of entities. These were broker dealers, banks, credit unions, and corporations.

This is a detailed blog piece I wrote explaining the various Fed liquidity programs.

The liquidity providing provisions of the Federal Reserve saved the economy from much larger disaster. They costs the taxpayers nothing and, in fact, earned a profit 95% of which went to Treasury. The bailout was more to everyone who had a bank account and lost zero than it was to banks per se. Some bank shareholders lost all the value of their equity. Other merely took large hits.

Preservation of the banking system benefited everyone. Letting almost the entire banking system fail was not an option. If these interventions had not occurred the losses to Treasury (the taxpayers) would have been much more massive and many businesses and jobs would have been destroyed.

The message that somehow only banks were bailed out and the public was ignored misses the point as to what the functions of a bank are. It is the taxpayers and the depositors who were bailed out. The bank equity owners took large losses.

“the agencies’ market risk capital rules for banking organizations with significant trading activities. The amended NPR includes alternative standards of creditworthiness to be used in place of credit ratings to determine the capital requirements for certain debt and securitization positions covered by the market risk capital rules. The proposed creditworthiness standards include the use of country risk classifications published by the Organization for Economic Cooperation and Development for sovereign positions, company-specific financial information and stock market volatility for corporate debt positions, and a supervisory formula for securitization positions.”

Any time one combines Basel III with Dodd-Frank and several government agencies, it can become a little muddled. Here’s the full notice.

Agencies are indeed trying to clarify their supervisory and enforcement responsibilities for Federal Consumer Financial Laws. Remember (who can forget) that Dodd-Frank provides the CFPB with exclusive supervisory and primary enforcement authority over “Large Institutions,” defined as institutions with total assets exceeding $10 billion. The prudential regulators retain supervisory and enforcement authority over their respective institutions falling under that threshold. But the devil is in the details: the Dodd-Frank Act does not specify how or when to calculate total assets for purposes of applying the threshold. Here’s the joint statement.

“Ongoing distress in real estate markets and slow growth in jobs and incomes continue to pose risks to credit quality,” Acting Chairman Gruenberg said. “The U.S. economic outlook is also clouded by uncertainties in the global economy and by volatility in financial markets. So even as the banking industry recovers, the FDIC remains vigilant for new economic challenges that could lie ahead.” As was the case in each of the last eight quarters, lower provisions for loan losses were responsible for most of the year-over-year improvement in earnings.

For the geographically challenged, Basel, Switzerland is in Europe. The Basel Committee on Banking Supervision is a committee of banking supervisory authorities that was established by the central bank governors of several large countries in 1975. It provides a forum for regular cooperation on banking supervisory matters. Its objective is to enhance understanding of key supervisory issues and improve the quality of banking supervision worldwide. The Committee also frames guidelines and standards in different areas. As the FT says:

Under the global Basel III rules, which will be phased in between now and 2019, banks have to hold top quality capital equal to 7% of their assets, adjusted for risk. The biggest banks will also be hit with an additional surcharge of up to 2.5%. Banks in the European Union will also have to hit a temporary 9% ratio next year after discounting their risky sovereign debt holdings.

But US banks are asking for weakened Basel III rules (FT excerpts and link below).

Basel III’s capital requirements, of course, is one of the reasons servicers (like GMAC) are either shifting servicing values, selling servicing, or deciding they don’t want it anymore period.

US lenders are urging financial regulators to ease new international bank liquidity rules as the industry faces a collective shortfall of $1.4 trillion for complying with the new regulations.

…American banks are at a disadvantage to their foreign peers because the regulatory response to the financial crisis limits the kind of assets US companies can use to show they could withstand a 30-day bank run … The package of reforms, known as Basel III, includes a provision that requires banks to hold enough cash-like assets to survive a month-long crisis. Lenders in the US and in Europe have argued that the “liquidity coverage ratio” is too stringent and would limit lending.

…The Clearing House urged US regulators to relax implementation of the Basel standards because they unfavorably treat debt and mortgage securities issued by Fannie & Freddie.

…While cash and sovereign debt can be used to meet the entire liquidity requirement, Fannie and Freddie securities, covered bonds and high-quality non-financial corporate bonds can only count towards 40 per cent of it.

…Fannie and Freddie securities are generally regarded as more liquid instruments than covered bonds. We have a little time: the liquidity rule will not go into effect until 2015. In response to complaints from lenders, financial regulators agreed to fine-tune the liquidity standards, where needed, by 2013.

Bill R. wrote to me, “When Basel III took over it rigged/leaned the banking systems rules and regulations toward the larger banks awash in global CDS and CDO’s. Left swinging in the wind were smaller banks forced to stand on their own feet, their own balance/income statements without the support of Government bailouts. This is what the unknowing useful idiots on WS are jumping up and down about.”

Across the Pacific, Australia’s major banks are preparing to issue covered bonds to enhance liquidity-risk positions as Basel III rules loom. “The two major benefits for Australian banks issuing covered bonds are access to lower costs of funding and a move to a more stable longer-term source of funding,” said William Mak, credit-desk analyst at Nomura. “Covered bonds will also have implications for the net stable funding ratio as banks shift to longer-term stable funding required under Basel III liquidity reforms.”
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Reference:
-FT: Fed Sets US Banks Toughest Stress Tests
-FT: US Banks Ask For Weakened Basel III Rules
-TheBasisPoint: Time To Dump Basel Bank Capital Rules?

The bank is disputing Fannie Mae’s demand that lenders repurchase mortgages or cover any losses themselves if an insurer drops coverage, Bank of America said this month in a regulatory filing. BofA said it ‘does not intend to repurchase loans’ under what it deems to be new rules, and the refusal may trigger penalties or other sanctions, according to Fannie Mae. At stake is Bank of America’s ability to contain costs from faulty mortgages, which have reached about $40 billion for refunds, lawsuits and foreclosures…Fannie Mae didn’t enforce this policy before because “it was a different economic time,” said David Felt, a former deputy general counsel at the FHFA. Defaults were fewer and the firm didn’t want to harm relations with lenders by being too picky, he said. “They’d overlook the small things. Well, they’re no longer small things, and they’re no longer the old Fannie Mae.”

And in other Bank of America news, The Financial Times reports that the states of New York and Delaware…

…won the right to intervene in a proposed $8.5bn settlement agreement over soured mortgage bonds between Bank of America and a group of aggrieved investors. New York attorney-general Eric Schneiderman and Delaware’s Beau Biden say the deal is inadequate to investors and that the trustee for the investors, Bank of New York Mellon, broke state laws. Mr. Schneiderman asked the judge overseeing the agreement to reject it. Bank of America struck the June accord with 22 institutional investors, including the Federal Reserve Bank of New York and bond group Pimco, to settle claims that the bank repurchase home loans bundled into 530 securities with an original loan balance of $424bn. BNY Mellon agreed to the deal on behalf of all investors in the securities.” “This could complicate efforts by BofA to limit its exposure to allegedly faulty mortgage practices. The company’s shares have plunged 59 per cent this year in part on concern the bank faces unresolved and unknown mortgage liabilities. Its shares closed at $5.49 on Monday, the lowest since March 2009.

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Sources:
-BusinewwWeek: BofA Won’t Cooperate Fannie’s Loan Buyback Policy
-FT: States Win Right To Block $8.5b BofA Settlement