I spent much of this weekend on a letter writing campaign to congress, over an issue that has deeply disturbed me as of late surrounding the US financial markets and has a huge impact on the real estate industry. My most recent letter is below...
Dear Sir,
I've written previously about very disturbing events currently taking place in the US banking and financial system. Articles published in the last two days in both the Wall Street Journal and the New York Times point to a new and even more disturbing development. First to give some background...
During the previous five years banks provided trillions of dollars in high risk loans primarily in the residential mortgage space. While the media has frequently labeled it as the "sub-prime crisis" the largest amount of high risk loans lie outside of the sub-prime sector. Recent studies have shown that high LTV, no-doc and exotic loan products such as Option ARMs have much more impact on defaults than credit score. In fact we are now begining to see higher default levels on high LTV prime loans than many sub-prime loans.
Many of the large financial institutions and banks are currently holding hundreds of billions of dollars of these loans "off balance sheet" in SIVs (Special Investment Vehicles) and conduits. These off balance sheet vehicles create an intentionally false view of a firm's financial conditions making banking regulation impossible. A primary factor in the implosion of Enron was the fact that they were able to hide liabilities and losses in conduits until losses became realized all at once and they had to take them back onto their balance sheet.
Earlier this year the assets held by these banks off balance sheet began to take heavy losses due to the underlying loan defaults. Many large banks faced having to take these loans back on balance sheet, an action which would have caused the banks themselves to take large write downs. At this time The Federal Reserve took an unprecedented step in issuing "23A Exemption Letters" letters to six of the largest banks including Bank of America, JP Morgan and Wachovia.
These letters exempted them from "safety valve" regulation (Regulation W) that had been on the books since the great depression and prohibited more than 10% of bank's regulatory capital being allocated to a single affiliate. This exemption allowed these banks to pump more money into their distressed off balance sheet vehicles and avoid realizing losses on balance sheet. It did nothing to solve the real problem and simply allowed banks to put three times as much of their capital (bank deposits) at risk. In essence it bailed out bank investors from taking significant losses while significantly increasing the risk of a bank failure. A single bank failure of this magnitude would easily wipe of the $50B FDIC fund, mean congress would be forced to step in and use tax payer money to cover the rest.
In a turn of events reported by both the Wall Street Journal and The New York Times, the Treasury Department is in confidential talks with heads of many of these large banks to create a "Super Conduit" that would be used to buy assets from the individual banks SIVs and conduits. The claim is that there is nothing wrong with the underlying assets (yeah right) but since no one will buy them at (I wonder why) it is stalling the financial markets. All this will do is further delay losses for investors in a few large financial institutions that took inappropriate risks, while further spreading the risk throughout the banking system. This is the exact same type of deception that lead to the S&L crisis in the ‘80s, hundreds of bank failures and a $250b tax payer funded bailout.
Link to article:
http://www.nytimes.com/2007/10/14/business/14bank.html?_r=2&oref=slogin&oref=slogin
Congress must act to exert its constitutional authority to regulate the banking system before it becomes too late to avert another crisis.
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Congress MUST act to ban off balance sheet vehicles (SIVs and conduits) as they have no legitimate use other than to obscure the true state of company's finances and evade taxes.
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Congress MUST exert its constitutional authority to regulate the banking system and demand that The Federal Reserve immediately revoke these six "23A Exemption Letters" before more depositors are put at risk.
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Congress MUST NOT bail out mortgage companies and investors who voluntarily entered into risky mortgage and derivative contracts due to lax lending standards, poor due diligence or as a matter of business policy.
;)
;)
