A Liquidity Event Seems Imminent
Wednesday, 17. September 2008, 06:49:56
Introduction
There are a number of threats to financial stability that I have addressed in my blog. These include treasury repo fails in interbank lending, the failure of the insurance company AIG, the level two assets and level three assets at banks and investment bankers, the debt carried off balance sheets at a number of organizations, commercial lending gridlock where companies seeking to refinance debt as it comes due are unable to do so and go out of business, and the dearth of liquidity caused by the impact of FASB 141.
I am reporting that a liquidity vacuum has formed and is intensifying, and that as a result a liquidity event may occur where the world's financial system seizes up and break down.
A Liquidity Event appears imminent as liquidity has simply evaporated.
The Libor is a measure of liquidity, and it rose sharply today suggesting that liquidity has simply vanished. Gavin Finch of Bloomberg reports on September 16, 2008 in article Overnight Money-Market Rate for Dollars Doubles, BBA Says that the cost of borrowing in dollars overnight more than doubled to 6.44 percent, its biggest jump, according to the British Bankers' Association. The London interbank offered rate, or Libor, increased 333 basis points from yesterday, the BBA said today.
And today the Ted Spread, another metric of liquidity, closed at 2.17 up from just over 1% last week. Calculated Risk in September 15, 2008 article Credit Crisis: The Fourth Wave, relates that this is close to the highs reached in August 2007, late 2007 and in the spring of 2008, the three previous waves of the credit crisis. Note: the TED spread is the difference between the three month T-bill and the LIBOR interest rate.
Sam Mamudiin Market Watch article Money Market Giant Freezes Redemptions reports that "One of the first and largest money market funds has put a seven-day freeze on redemptions after the net asset value of its shares fell below $1. Primary Fund, RFIXX ... RFIXX, a $62 billion fund managed by money market fund inventor, The Reserve, said Tuesday afternoon that its $785 million holding of Lehman Brothers Holdings debt has been valued at zero. As of 4 p.m., the value of the fund's share is 97 cents. The Reserve said that redemption requests received before 3 p.m. Tuesday will be paid out at $1 a share.
Catherine Belton, Charles Clover, and Rachel Morarjee of FT. com report September 16, 2008 Russian Stock Market Crashes, Russia Halts Trading After 17% Share Price Fall.
Gavin Finch and Kim-Mai Cutler of Bloomberg in September 16, 2008 article Money-Market Rates Double Amid Global Credit Seizure relatesThe cost of borrowing in dollars overnight more than doubled to the highest since 2001 as the collapse of Lehman Brothers Holdings Inc. and credit downgrades of American International Group Inc. led banks to hoard cash.
The London interbank offered rate, or Libor, that financial institutions charge each other to borrow soared 3.33 percentage points to 6.44 percent today, its biggest jump in at least seven years, according to the British Bankers' Association. The rate was as low as 2.07 percent in June.
Banks are driving up short-term lending rates on concern that AIG, the biggest U.S. insurer, will follow Lehman into bankruptcy and leave financial institutions with losses on $441 billion of credit derivatives. Central banks around the world pumped more than $210 billion into the financial system as they sought to alleviate the credit-market seizure.
``It's fear,'' said Imke Jersch, a senior money-market trader in Hanover at Norddeutsche Landesbank Girozentrale AG, Germany's fourth-biggest state-owned bank. ``You don't know who has exposure and who might not be getting their money anymore. It's a domino effect. You never know who might fall next.''
The yield on the 10-year Treasury note fell to the lowest level in five years as investors sought the safety of government debt. Average yields on overnight U.S. commercial paper backed by assets such as credit cards and car loans jumped 54 basis points to 3.45 percent, the highest since March.
``I have never seen anything remotely like this. The money market was typically the one thing that always worked,'' said Luca Jellinek, head of interest-rate strategy in London at Royal Bank of Scotland Group Plc. ``It's the cardiovascular system of the financial body. When this happens, it's like a heart attack.''
The Fed added $50 billion in temporary reserves to the banking system today through overnight repurchase agreements, or repos. The European Central Bank offered 70 billion euros ($100 billion) in a one-day refinancing operation and the Bank of England injected 20 billion pounds ($36 billion). The Bank of Japan added 2.5 trillion yen ($24 billion) and the Reserve Bank of Australia injected A$1.85 billion ($1.5 billion)".
My analysis is that a Liquidity Event is very likely imminent, where the financial system, lacking liquidity simply freezes up and breaks down.
The Federal Reserve moved to prevent a disorderly failure of AIG, but has not addressed the risk to financial stability posed by Washington Mutual.
Associated Press reports on September 16, 2008, in Government Announces $85 Billion Loan To Save AIG that "In a bid to save financial markets and economy from further turmoil, the U.S. government agreed to provide an $85 billion emergency loan to rescue the huge insurer AIG. The Federal Reserve said in a statement it determined that a disorderly failure of AIG could hurt the already delicate financial markets and the economy."
While the Fed acted after market close, as referenced in their announcement, to prevent a disorderly failure of AIG, it has done nothing as of yet, to address the potential of a liquidity event, and financial system breakdown, associated with the counterparty risk associated with the credit default swaps and depletion of capital at Washington Mutual, WM.
Liquidity continued to evaporate today as the Counterparty Risk Index went critical
FT.com in September 16, 2008 article Counterparty Risk Goes Critical reports that counterparty risk in the market for credit default swaps, as measured by the CDR Counterparty Risk Index, CRI, hit an all-time high on Tuesday as traders reacted to Lehman Brothers’ bankruptcy and the unknown future of AIG.
The CRI hit 389.33bp this morning, compared with its previous record wide of 250bps during the Bear Stearns-induced market panic.
Washington Mutual, the home loan lender to the low income, sees share price fall and credit default swaps rise as the liquidity crisis unfolds
The MSN Finance chart of Washington Mutual from August 8, 2008 to September 16, 2008, shows that WaMu has lost 50% of its stock market value ... Chart of WM from 08-08-08 to 09-16-2008
A part of the force feeding the intensifying liquidity vacuum as well as WaMu's share price fall is the organization's portfolio of Option ARMs
Bob Ivry and Linda Shen in Bloomberg article Washington Mutual Hobbled By Increasing Defaults on Option ARMs reports on September 15, 2008 that Washington Mutual Inc., the thrift that lost 92 percent of market value in the past year, is being dragged down by a mortgage product once hailed by former Chief Executive Officer Kerry Killinger as a boost to profit.
As many as 45 percent of borrowers with payment-option adjustable-rate mortgages issued from 2004 to 2007 and bundled into securities may default, according to Fitch Ratings analysts Roelof Slump and Stefan Hilts. Washington Mutual held $52.9 billion of the mortgages, also called option ARMs or negative amortization loans, on its books in the second quarter, with defaults doubling to $3.2 billion from the end of 2007, according to a filing with the U.S. Securities and Exchange Commission.
``You look at all the major players in the option ARM market and they're all on their knees,'' said Andrew Laperriere, Washington-based managing director at the International Strategy & Investment Group research firm. ``These companies have changed their stance on these loans dramatically. They were defending them as late as a year ago. They said these loans would be fine.''
Two of the top five option ARM lenders, according to a ranking by industry newsletter Inside Mortgage Finance, are no longer in business and the other three have ousted their CEOs and seen their market value erode in the worst housing recession since the 1930s. Seattle-based Washington Mutual, the largest U.S. savings and loan, fired Killinger on Sept. 8 after 18 years as CEO, citing his failure to stem losses from home mortgages.
Payment Spikes
Option ARMs allow borrowers to skip part of their payment and add that sum to their principal. Monthly payments increase after five years or once the loan balance reaches a predetermined limit, usually 110 percent to 125 percent. Introductory interest rates can be as low as 1 percent.
For the average option ARM borrower, payments will rise 63 percent, or an additional $1,053 a month, when their rates reset, according to a Sept. 2 report by New York-based Fitch.
Because typical option ARM borrowers make less than the full payment each month, according to Fitch, they don't build equity in their homes. When house prices fall, they owe more than their home is worth. That leaves lenders facing losses if the loan defaults and they foreclose.
About 83 percent of the option ARMs issued from 2004 to 2007 were underwritten without full documentation of borrowers' incomes, Fitch said.
``For most borrowers, once their loan resets, there's no place for them to go,'' said Hilts of Fitch. ``A high percentage of them don't have equity, so they can't refinance, and they don't have the income to withstand the payment shock.''
Four percent of Washington Mutual's option ARM portfolio probably will reset in the second half of this year and 13 percent, or $7.1 billion, will reset in 2009, according to the SEC filing.
Home Price Declines
With home prices falling 18.8 percent nationally from their peak in 2006, according to the S&P/Case-Shiller Home Price Index, almost one-third of borrowers who bought their homes in the past five years now owe more on their mortgages than their properties are worth, real estate valuation Web site Zillow.com said.
Washington Mutual issued half its option ARMs in California, according to the thrift's second-quarter regulatory filing. One in 130 households there were in some stage of foreclosure in August, making it the state with the second-highest rate, data compiled by Irvine, California-based RealtyTrac Inc. show. Nevada is No. 1.
The thrift made 13 percent of its option ARMs in Florida, the state with the fourth-highest foreclosure rate, according to RealtyTrac.
``It's not the product, ultimately, it was how it was administered,'' said Gary Townsend, chief executive officer of Hill-Townsend Capital LLC in Chevy Chase, Maryland, referring to Washington Mutual.
`Nice Gains'
Killinger said in a July 22, 2004, conference call with analysts that option ARMs were a product that would boost Washington Mutual's profit margin.
``We will emphasize origination of higher margin product such as option ARMs and we will emphasize originations through our retail and wholesale channels,'' Killinger said.
Six months later, Chief Financial Officer Thomas Casey told analysts that the lender would ``push that option ARM as hard as we can.''
``We believe that the option ARM is a differentiating product for us, and we're continuing to see nice gains on that compared to some of the other products that are out on the market right now so that will be a continued focus for us,'' Casey said Jan. 20, 2005.
Killinger's departure from Washington Mutual came as the thrift signed a memorandum of understanding with its regulator requiring the bank to improve its risk management.
Washington Mutual was the second-biggest provider of option ARMs in the second quarter, behind Charlotte, North Carolina-based Wachovia Corp., which held $122 billion of the loans, according to a company filing.
Countrywide Financial Corp., formerly the biggest U.S. mortgage lender, had $25.4 billion of the loans on its books in the second quarter. Bank of America Corp. bought the company on July 1. The Calabasas, California-based lender had the third- highest amount of option ARMs.
Downey Financial Corp., a savings and loan based in Newport Beach, California, held $6.9 billion at the end of the second quarter, according to a filing, making it the fourth-largest U.S. option ARM lender, according to Bethesda, Maryland-based Inside Mortgage Finance.
Downey, with second-quarter assets of $12.6 billion, has lost 95 percent of its market value since the beginning of the year. It replaced its CEO, Daniel Rosenthal, on July 24.
Seized by Regulator
In July, IndyMac Bancorp Inc., the Pasadena, California-based lender that began as a spinoff from Countrywide, became the third- largest bank in U.S. history to be seized by its regulator, the Federal Deposit Insurance Corp., after depositors withdrew more than $1.3 billion in 11 business days. IndyMac held $3.5 billion of option ARMs, the fifth-largest amount.
Wachovia, the fourth-largest U.S. bank, lost 71 percent of market value in the past year. In July, the bank ousted CEO Kennedy Thompson, whose $24 billion purchase of Golden West Financial Corp. in 2006 came with a portfolio of option ARMS.
Robert Steel, the former Treasury official who replaced Thompson as Wachovia's CEO, said at a Sept. 9 investors conference in New York that he approached the option ARMs ``as if we were a distressed investment manager.''
Brock Davis, a broker with U.S. Express Mortgage Corp. in Las Vegas, calls option ARMs ``neutron loans'' because ``three years later the house is still there and the people are gone.''
Mike Mish Sheldon in recent article Thoughts On Credit Default Swaps relates that Credit Default Swaps, CDS, on Lehman, LEH, and Washington Mutual, WM, were soaring on Tuesday September 9, 2008. This should not be surprising given that both stocks were hammered today Wednesday September 10, 2008.
OptionArmageddon in article WaMu (& BKUNA, & DSL) On The Brink? reports on September 8, 2008 that "Basically, OTS just put WaMu on notice. Remember, WaMu has about $120 billion worth of toxic mortgage assets sitting on its balance sheet. Subprime, Option ARMs, Home Equity Loans, etc. Taken together, these securities are likely worth 50 cents on the dollar. It’s not easy deciphering their balance sheet, but WaMu probably has in the neighborhood of $40 billion of capital backstopping these losses. So if they actually write down their assets to reflect their current value, it could wipe them out.
Is it any wonder WaMu is desperate for capital?
With $140 billion in insured deposits, any prospect that WaMu might fail has to be stressing regulators, especially the FDIC. Remember, FDIC has only $45 billion in its reserve fund, meaning that a failure the size of WaMu could come close to wiping THEM out."
Just one of many causes for the liquidity vacuum, is the inability of banks and investment bankers, such as WaMu to obtain capital as documented by Jonathan Keehner and Linda Shen, in September 11, 20008, Bloomberg article, WaMu May Lose Suitors on Accounting Rule; Stock Plummets 30%: "At least three potential acquirers ended negotiations to buy either Seattle-based WaMu or Cleveland's National City Corp., the bankers said. One sticking point, they say: a rule change that will force acquirers to compute a target's assets at market prices instead of deriving values from measures including the purchase price. WaMu is in "a tough place," said Jaime Peters, an analyst at Morningstar Inc. in Chicago. "The revised rules will create additional hurdles for WaMu, and there are already plenty of hurdles."
Sara Lepo of the Associated Press and Orange County Register reports that Washington Mutual Removes CEO Kerry Killinger on September 8, 2008. Washington Mutual, the nation’s largest thrift, replaced Kerry Killinger as chief executive on Monday, as it continues to grapple with large losses from sour loans, reports the Associated Press. Killinger is being replaced by Alan H. Fishman, the former president and chief operating officer of Sovereign Bank and president and CEO of Independence Community Bank.
And WaMu said it has entered into a memorandum of understanding with its regulator, the Office of Thrift Supervision. WaMu has committed to provide the OTS with an updated, multiyear business plan, and does not have to raise capital or increase liquidity.
The New York Times, on May 20, 1999 in article Washington Mutual to Buy California Mortgage Lender reported that: "Washington Mutual, a financial services company, said yesterday that it had agreed to acquire the Long Beach Financial Corporation, a California mortgage lender, for $350.4 million, or $15.50 a share, expanding its presence in the residential mortgage market. Washington Mutual, based in Seattle, has 2,000 offices and assets of $174 billion. Long Beach Financial, known as a subprime lender, makes mortgage loans to customers with spotty credit records, usually at high interest rates, then packages its loans and sells them to institutional investors. Shares of Long Beach jumped 16.8 percent, gaining $2.0625, to $14.375. Shares of Washington Mutual climbed 75 cents, to $39.75."
Washington Mutual has been a consistent provider of home loans to the low income
Bakersfieldbubble on May 3, 2007 reported in article $14,000 Per Year Field Worker Buys $720,000 Home that: "Despite making only $14,000 a year, strawberry picker Alberto Ramirez managed to buy his own slice of the American Dream. But his Hollister home came with a hefty price tag - $720,000.
A year and a half later, Ramirez has defaulted on his loan, and he's hoping to sell the house before it's repossessed. And according to many housing advocates and civil rights groups, Ramirez is not alone. As mortgage foreclosures rise, many minorities are suffering.
Brown said the language barrier (Ramirez, a native Spanish speaker, is not fluent in English, and spoke to the Free Lance through a translator) can also play a big role.
"When you go into Washington Mutual ... you can't always get someone to speak your language," she said.
"The real estate boom covered a multitude of sins," Simmons said. "Once the market started depreciating, the rug was pulled back to show the rot underneath."
Investment Application
I have to relate that I am a blogger who holds forth the Liquidation Thesis and one who encourages investing in gold. I am not a licensed investment professional and do not take any compensation for things related in this blog. I am currently invested long in the ETF SKF and have a few small gold coins. I always suggest that one consult a licensed investment professional before making any investment decision.
Herb Greenberg in article How To Keep Your Investments Safe suggests the use of a trust account for investing.
I recommend that one buy gold immediately at GoldMoney and BullionVault as well as a limited number of Krugerands from Kitco.com.
Be advised that currently the price of gold, GLD, is a function of oil, USO. The gold ETF, GLD, traded yesterday at 77.56; it is currently trading at 76.62
The Yahoo Finance ongoing chart of oil, USO, relative to gold, GLD shows that oil has fallen twelve percent in the last two days to 74.19.
I fully expect gold to move lower in price; gold traded yesterday at $786: today it is trading at $780; strong support for gold is found lower at $750; 700 and $675.
The one year chart of Gold, GLD, compared to natural gas, GAZ, and silver, SLV, as well as Silver Standard Resources Inc, SSRI, and Barrick Gold, ABX, proves how speculative the latter four have been -- they got run up by the yen carry traders using the Bank of Japan lending window, and investors who went along believing these had real value got burned very badly. Their fall shows the absolute chaos that has come to the world from using the neoliberal Milton Friedman floating exchange currency system.
Keywords
mortgage backed securities, financialization, securitization, mortgage loans, cdo, cdos, liquidity crisis, liquidity evaporation, liquidity vacuum, evaporation of liquidity, counterparty risk, implosion, systemic risk event, financial system meltdown, financial system breakdown, ofheo, wamu, wm, real estate loans, financial stabililty threatened, means, meaning, implosion,
There are a number of threats to financial stability that I have addressed in my blog. These include treasury repo fails in interbank lending, the failure of the insurance company AIG, the level two assets and level three assets at banks and investment bankers, the debt carried off balance sheets at a number of organizations, commercial lending gridlock where companies seeking to refinance debt as it comes due are unable to do so and go out of business, and the dearth of liquidity caused by the impact of FASB 141.
I am reporting that a liquidity vacuum has formed and is intensifying, and that as a result a liquidity event may occur where the world's financial system seizes up and break down.
A Liquidity Event appears imminent as liquidity has simply evaporated.
The Libor is a measure of liquidity, and it rose sharply today suggesting that liquidity has simply vanished. Gavin Finch of Bloomberg reports on September 16, 2008 in article Overnight Money-Market Rate for Dollars Doubles, BBA Says that the cost of borrowing in dollars overnight more than doubled to 6.44 percent, its biggest jump, according to the British Bankers' Association. The London interbank offered rate, or Libor, increased 333 basis points from yesterday, the BBA said today.
And today the Ted Spread, another metric of liquidity, closed at 2.17 up from just over 1% last week. Calculated Risk in September 15, 2008 article Credit Crisis: The Fourth Wave, relates that this is close to the highs reached in August 2007, late 2007 and in the spring of 2008, the three previous waves of the credit crisis. Note: the TED spread is the difference between the three month T-bill and the LIBOR interest rate.
Sam Mamudiin Market Watch article Money Market Giant Freezes Redemptions reports that "One of the first and largest money market funds has put a seven-day freeze on redemptions after the net asset value of its shares fell below $1. Primary Fund, RFIXX ... RFIXX, a $62 billion fund managed by money market fund inventor, The Reserve, said Tuesday afternoon that its $785 million holding of Lehman Brothers Holdings debt has been valued at zero. As of 4 p.m., the value of the fund's share is 97 cents. The Reserve said that redemption requests received before 3 p.m. Tuesday will be paid out at $1 a share.
Catherine Belton, Charles Clover, and Rachel Morarjee of FT. com report September 16, 2008 Russian Stock Market Crashes, Russia Halts Trading After 17% Share Price Fall.
Gavin Finch and Kim-Mai Cutler of Bloomberg in September 16, 2008 article Money-Market Rates Double Amid Global Credit Seizure relatesThe cost of borrowing in dollars overnight more than doubled to the highest since 2001 as the collapse of Lehman Brothers Holdings Inc. and credit downgrades of American International Group Inc. led banks to hoard cash.
The London interbank offered rate, or Libor, that financial institutions charge each other to borrow soared 3.33 percentage points to 6.44 percent today, its biggest jump in at least seven years, according to the British Bankers' Association. The rate was as low as 2.07 percent in June.
Banks are driving up short-term lending rates on concern that AIG, the biggest U.S. insurer, will follow Lehman into bankruptcy and leave financial institutions with losses on $441 billion of credit derivatives. Central banks around the world pumped more than $210 billion into the financial system as they sought to alleviate the credit-market seizure.
``It's fear,'' said Imke Jersch, a senior money-market trader in Hanover at Norddeutsche Landesbank Girozentrale AG, Germany's fourth-biggest state-owned bank. ``You don't know who has exposure and who might not be getting their money anymore. It's a domino effect. You never know who might fall next.''
The yield on the 10-year Treasury note fell to the lowest level in five years as investors sought the safety of government debt. Average yields on overnight U.S. commercial paper backed by assets such as credit cards and car loans jumped 54 basis points to 3.45 percent, the highest since March.
``I have never seen anything remotely like this. The money market was typically the one thing that always worked,'' said Luca Jellinek, head of interest-rate strategy in London at Royal Bank of Scotland Group Plc. ``It's the cardiovascular system of the financial body. When this happens, it's like a heart attack.''
The Fed added $50 billion in temporary reserves to the banking system today through overnight repurchase agreements, or repos. The European Central Bank offered 70 billion euros ($100 billion) in a one-day refinancing operation and the Bank of England injected 20 billion pounds ($36 billion). The Bank of Japan added 2.5 trillion yen ($24 billion) and the Reserve Bank of Australia injected A$1.85 billion ($1.5 billion)".
My analysis is that a Liquidity Event is very likely imminent, where the financial system, lacking liquidity simply freezes up and breaks down.
The Federal Reserve moved to prevent a disorderly failure of AIG, but has not addressed the risk to financial stability posed by Washington Mutual.
Associated Press reports on September 16, 2008, in Government Announces $85 Billion Loan To Save AIG that "In a bid to save financial markets and economy from further turmoil, the U.S. government agreed to provide an $85 billion emergency loan to rescue the huge insurer AIG. The Federal Reserve said in a statement it determined that a disorderly failure of AIG could hurt the already delicate financial markets and the economy."
While the Fed acted after market close, as referenced in their announcement, to prevent a disorderly failure of AIG, it has done nothing as of yet, to address the potential of a liquidity event, and financial system breakdown, associated with the counterparty risk associated with the credit default swaps and depletion of capital at Washington Mutual, WM.
Liquidity continued to evaporate today as the Counterparty Risk Index went critical
FT.com in September 16, 2008 article Counterparty Risk Goes Critical reports that counterparty risk in the market for credit default swaps, as measured by the CDR Counterparty Risk Index, CRI, hit an all-time high on Tuesday as traders reacted to Lehman Brothers’ bankruptcy and the unknown future of AIG.
The CRI hit 389.33bp this morning, compared with its previous record wide of 250bps during the Bear Stearns-induced market panic.
Washington Mutual, the home loan lender to the low income, sees share price fall and credit default swaps rise as the liquidity crisis unfolds
The MSN Finance chart of Washington Mutual from August 8, 2008 to September 16, 2008, shows that WaMu has lost 50% of its stock market value ... Chart of WM from 08-08-08 to 09-16-2008
A part of the force feeding the intensifying liquidity vacuum as well as WaMu's share price fall is the organization's portfolio of Option ARMs
Bob Ivry and Linda Shen in Bloomberg article Washington Mutual Hobbled By Increasing Defaults on Option ARMs reports on September 15, 2008 that Washington Mutual Inc., the thrift that lost 92 percent of market value in the past year, is being dragged down by a mortgage product once hailed by former Chief Executive Officer Kerry Killinger as a boost to profit.
As many as 45 percent of borrowers with payment-option adjustable-rate mortgages issued from 2004 to 2007 and bundled into securities may default, according to Fitch Ratings analysts Roelof Slump and Stefan Hilts. Washington Mutual held $52.9 billion of the mortgages, also called option ARMs or negative amortization loans, on its books in the second quarter, with defaults doubling to $3.2 billion from the end of 2007, according to a filing with the U.S. Securities and Exchange Commission.
``You look at all the major players in the option ARM market and they're all on their knees,'' said Andrew Laperriere, Washington-based managing director at the International Strategy & Investment Group research firm. ``These companies have changed their stance on these loans dramatically. They were defending them as late as a year ago. They said these loans would be fine.''
Two of the top five option ARM lenders, according to a ranking by industry newsletter Inside Mortgage Finance, are no longer in business and the other three have ousted their CEOs and seen their market value erode in the worst housing recession since the 1930s. Seattle-based Washington Mutual, the largest U.S. savings and loan, fired Killinger on Sept. 8 after 18 years as CEO, citing his failure to stem losses from home mortgages.
Payment Spikes
Option ARMs allow borrowers to skip part of their payment and add that sum to their principal. Monthly payments increase after five years or once the loan balance reaches a predetermined limit, usually 110 percent to 125 percent. Introductory interest rates can be as low as 1 percent.
For the average option ARM borrower, payments will rise 63 percent, or an additional $1,053 a month, when their rates reset, according to a Sept. 2 report by New York-based Fitch.
Because typical option ARM borrowers make less than the full payment each month, according to Fitch, they don't build equity in their homes. When house prices fall, they owe more than their home is worth. That leaves lenders facing losses if the loan defaults and they foreclose.
About 83 percent of the option ARMs issued from 2004 to 2007 were underwritten without full documentation of borrowers' incomes, Fitch said.
``For most borrowers, once their loan resets, there's no place for them to go,'' said Hilts of Fitch. ``A high percentage of them don't have equity, so they can't refinance, and they don't have the income to withstand the payment shock.''
Four percent of Washington Mutual's option ARM portfolio probably will reset in the second half of this year and 13 percent, or $7.1 billion, will reset in 2009, according to the SEC filing.
Home Price Declines
With home prices falling 18.8 percent nationally from their peak in 2006, according to the S&P/Case-Shiller Home Price Index, almost one-third of borrowers who bought their homes in the past five years now owe more on their mortgages than their properties are worth, real estate valuation Web site Zillow.com said.
Washington Mutual issued half its option ARMs in California, according to the thrift's second-quarter regulatory filing. One in 130 households there were in some stage of foreclosure in August, making it the state with the second-highest rate, data compiled by Irvine, California-based RealtyTrac Inc. show. Nevada is No. 1.
The thrift made 13 percent of its option ARMs in Florida, the state with the fourth-highest foreclosure rate, according to RealtyTrac.
``It's not the product, ultimately, it was how it was administered,'' said Gary Townsend, chief executive officer of Hill-Townsend Capital LLC in Chevy Chase, Maryland, referring to Washington Mutual.
`Nice Gains'
Killinger said in a July 22, 2004, conference call with analysts that option ARMs were a product that would boost Washington Mutual's profit margin.
``We will emphasize origination of higher margin product such as option ARMs and we will emphasize originations through our retail and wholesale channels,'' Killinger said.
Six months later, Chief Financial Officer Thomas Casey told analysts that the lender would ``push that option ARM as hard as we can.''
``We believe that the option ARM is a differentiating product for us, and we're continuing to see nice gains on that compared to some of the other products that are out on the market right now so that will be a continued focus for us,'' Casey said Jan. 20, 2005.
Killinger's departure from Washington Mutual came as the thrift signed a memorandum of understanding with its regulator requiring the bank to improve its risk management.
Washington Mutual was the second-biggest provider of option ARMs in the second quarter, behind Charlotte, North Carolina-based Wachovia Corp., which held $122 billion of the loans, according to a company filing.
Countrywide Financial Corp., formerly the biggest U.S. mortgage lender, had $25.4 billion of the loans on its books in the second quarter. Bank of America Corp. bought the company on July 1. The Calabasas, California-based lender had the third- highest amount of option ARMs.
Downey Financial Corp., a savings and loan based in Newport Beach, California, held $6.9 billion at the end of the second quarter, according to a filing, making it the fourth-largest U.S. option ARM lender, according to Bethesda, Maryland-based Inside Mortgage Finance.
Downey, with second-quarter assets of $12.6 billion, has lost 95 percent of its market value since the beginning of the year. It replaced its CEO, Daniel Rosenthal, on July 24.
Seized by Regulator
In July, IndyMac Bancorp Inc., the Pasadena, California-based lender that began as a spinoff from Countrywide, became the third- largest bank in U.S. history to be seized by its regulator, the Federal Deposit Insurance Corp., after depositors withdrew more than $1.3 billion in 11 business days. IndyMac held $3.5 billion of option ARMs, the fifth-largest amount.
Wachovia, the fourth-largest U.S. bank, lost 71 percent of market value in the past year. In July, the bank ousted CEO Kennedy Thompson, whose $24 billion purchase of Golden West Financial Corp. in 2006 came with a portfolio of option ARMS.
Robert Steel, the former Treasury official who replaced Thompson as Wachovia's CEO, said at a Sept. 9 investors conference in New York that he approached the option ARMs ``as if we were a distressed investment manager.''
Brock Davis, a broker with U.S. Express Mortgage Corp. in Las Vegas, calls option ARMs ``neutron loans'' because ``three years later the house is still there and the people are gone.''
Mike Mish Sheldon in recent article Thoughts On Credit Default Swaps relates that Credit Default Swaps, CDS, on Lehman, LEH, and Washington Mutual, WM, were soaring on Tuesday September 9, 2008. This should not be surprising given that both stocks were hammered today Wednesday September 10, 2008.
OptionArmageddon in article WaMu (& BKUNA, & DSL) On The Brink? reports on September 8, 2008 that "Basically, OTS just put WaMu on notice. Remember, WaMu has about $120 billion worth of toxic mortgage assets sitting on its balance sheet. Subprime, Option ARMs, Home Equity Loans, etc. Taken together, these securities are likely worth 50 cents on the dollar. It’s not easy deciphering their balance sheet, but WaMu probably has in the neighborhood of $40 billion of capital backstopping these losses. So if they actually write down their assets to reflect their current value, it could wipe them out.
Is it any wonder WaMu is desperate for capital?
With $140 billion in insured deposits, any prospect that WaMu might fail has to be stressing regulators, especially the FDIC. Remember, FDIC has only $45 billion in its reserve fund, meaning that a failure the size of WaMu could come close to wiping THEM out."
Just one of many causes for the liquidity vacuum, is the inability of banks and investment bankers, such as WaMu to obtain capital as documented by Jonathan Keehner and Linda Shen, in September 11, 20008, Bloomberg article, WaMu May Lose Suitors on Accounting Rule; Stock Plummets 30%: "At least three potential acquirers ended negotiations to buy either Seattle-based WaMu or Cleveland's National City Corp., the bankers said. One sticking point, they say: a rule change that will force acquirers to compute a target's assets at market prices instead of deriving values from measures including the purchase price. WaMu is in "a tough place," said Jaime Peters, an analyst at Morningstar Inc. in Chicago. "The revised rules will create additional hurdles for WaMu, and there are already plenty of hurdles."
Sara Lepo of the Associated Press and Orange County Register reports that Washington Mutual Removes CEO Kerry Killinger on September 8, 2008. Washington Mutual, the nation’s largest thrift, replaced Kerry Killinger as chief executive on Monday, as it continues to grapple with large losses from sour loans, reports the Associated Press. Killinger is being replaced by Alan H. Fishman, the former president and chief operating officer of Sovereign Bank and president and CEO of Independence Community Bank.
And WaMu said it has entered into a memorandum of understanding with its regulator, the Office of Thrift Supervision. WaMu has committed to provide the OTS with an updated, multiyear business plan, and does not have to raise capital or increase liquidity.
The New York Times, on May 20, 1999 in article Washington Mutual to Buy California Mortgage Lender reported that: "Washington Mutual, a financial services company, said yesterday that it had agreed to acquire the Long Beach Financial Corporation, a California mortgage lender, for $350.4 million, or $15.50 a share, expanding its presence in the residential mortgage market. Washington Mutual, based in Seattle, has 2,000 offices and assets of $174 billion. Long Beach Financial, known as a subprime lender, makes mortgage loans to customers with spotty credit records, usually at high interest rates, then packages its loans and sells them to institutional investors. Shares of Long Beach jumped 16.8 percent, gaining $2.0625, to $14.375. Shares of Washington Mutual climbed 75 cents, to $39.75."
Washington Mutual has been a consistent provider of home loans to the low income
Bakersfieldbubble on May 3, 2007 reported in article $14,000 Per Year Field Worker Buys $720,000 Home that: "Despite making only $14,000 a year, strawberry picker Alberto Ramirez managed to buy his own slice of the American Dream. But his Hollister home came with a hefty price tag - $720,000.
A year and a half later, Ramirez has defaulted on his loan, and he's hoping to sell the house before it's repossessed. And according to many housing advocates and civil rights groups, Ramirez is not alone. As mortgage foreclosures rise, many minorities are suffering.
Brown said the language barrier (Ramirez, a native Spanish speaker, is not fluent in English, and spoke to the Free Lance through a translator) can also play a big role.
"When you go into Washington Mutual ... you can't always get someone to speak your language," she said.
"The real estate boom covered a multitude of sins," Simmons said. "Once the market started depreciating, the rug was pulled back to show the rot underneath."
Investment Application
I have to relate that I am a blogger who holds forth the Liquidation Thesis and one who encourages investing in gold. I am not a licensed investment professional and do not take any compensation for things related in this blog. I am currently invested long in the ETF SKF and have a few small gold coins. I always suggest that one consult a licensed investment professional before making any investment decision.
Herb Greenberg in article How To Keep Your Investments Safe suggests the use of a trust account for investing.
I recommend that one buy gold immediately at GoldMoney and BullionVault as well as a limited number of Krugerands from Kitco.com.
Be advised that currently the price of gold, GLD, is a function of oil, USO. The gold ETF, GLD, traded yesterday at 77.56; it is currently trading at 76.62
The Yahoo Finance ongoing chart of oil, USO, relative to gold, GLD shows that oil has fallen twelve percent in the last two days to 74.19.
I fully expect gold to move lower in price; gold traded yesterday at $786: today it is trading at $780; strong support for gold is found lower at $750; 700 and $675.
The one year chart of Gold, GLD, compared to natural gas, GAZ, and silver, SLV, as well as Silver Standard Resources Inc, SSRI, and Barrick Gold, ABX, proves how speculative the latter four have been -- they got run up by the yen carry traders using the Bank of Japan lending window, and investors who went along believing these had real value got burned very badly. Their fall shows the absolute chaos that has come to the world from using the neoliberal Milton Friedman floating exchange currency system.
Keywords
mortgage backed securities, financialization, securitization, mortgage loans, cdo, cdos, liquidity crisis, liquidity evaporation, liquidity vacuum, evaporation of liquidity, counterparty risk, implosion, systemic risk event, financial system meltdown, financial system breakdown, ofheo, wamu, wm, real estate loans, financial stabililty threatened, means, meaning, implosion,
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