The next US banking crisis?

Steve Saville
email: sas888_hk@yahoo.com
Oct 15, 2010

"Millions of U.S. mortgages have been shuttled around the global financial system -- sold and resold by firms -- without the documents that traditionally prove who legally owns the loans. Now, as many of these loans have fallen into default and banks have sought to seize homes, judges around the country have increasingly ruled that lenders had no right to foreclose, because they lacked clear title." (Washington Post, 7th October)

As we see it, here's the issue in a nutshell:

1. Banks made home loans.
2. Many of the loans were hurriedly packaged into Mortgage Backed Securities (MBS's) and sold to yield-hungry investors around the world.
3. The securitisation process blurred the mortgage ownership because titles weren't properly transferred as mortgages were shuttled around.
4. Consequently, in many cases it is no longer clear who owns the mortgage. At least, the correct paperwork to legally define ownership is not in place.
5. If the mortgage owner is not properly (legally) defined, property foreclosure cannot legally occur.
6. Banks tried to get around the lack-of-paperwork problem and thus proceed with foreclosures by creating new paperwork. In doing so they possibly broke the law.
7. Banks now have large potential liabilities to a) MBS owners due to problems with existing foreclosures and an inability to implement future foreclosures, and b) home owners who have had, or are in the process of having, their homes foreclosed with improper documentation.
8. Some banks have voluntarily suspended all foreclosure proceedings while the mess is sorted out, and the Federal Government is considering imposing a moratorium on foreclosures.

At this stage the market ramifications of what is becoming known as "Foreclosuregate" are unclear to us. What is clear is that the stock market currently views the issue as unimportant. We say this because although the Bank Index (BKX) has been weak in absolute and relative terms over the past 6 months, it has stabilised over the past 6 weeks. Refer to the following chart for details.

(Click on image to enlarge)

The fact that the stock market doesn't yet consider "Foreclosuregate" to be a serious problem doesn't mean it won't turn out to be a serious problem.

The stock market is generally not very good at discounting the future and is especially bad at anticipating financial crises.

According to the Fed, the cause of the problem is the solution

Artificially low interest rates combined with rapid monetary inflation (the result of the Fed's manipulation of interest rates and money supply) caused people to spend/borrow too much and prompted many investments that only appeared to make sense due to the unsustainable monetary backdrop. The 2007-2009 "bust" was the inevitable result. The remedy, according to the minutes of the latest FOMC Meeting, is to manipulate interest rates and money supply in a way that encourages more borrowing and spending.

The greater the amount of success achieved by the Fed in its efforts to promote more borrowing and spending, the greater the damage to the US economy because the less able the economy will be to make the necessary adjustments to return to a genuine growth path. It's as if the US economy has a destruct button and the Fed keeps unwittingly pushing it.

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Steve Saville
email: sas888_hk@yahoo.com
Hong Kong

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