Aug312016

Homeowner bailouts benefited lenders far more than homeowners

While some underwater homeowners were saved by federal reserve policy, the main beneficiaries of this stealth bailout were the banks.

The populace was sold on quantitative easing and mortgage interest rate stimulus as a measure to save “Main Street.” It was said this money pumped into the economy would create jobs, and the combination of jobs, increased incomes, and low mortgage rates would cause a boom in housing which would elevate loanowners above water. What was sold as a big benefit to Main Street devolved into another massive bailout of the banking industry with few tangible benefits to the people the programs were ostensibly designed to help out.

Proponents of these policies can point to the rapid increase in house prices since 2012 as a sign of success. While it’s true that many loanowners have emerged from beneath their debts, this policy wasn’t designed to keep them in their homes. The interest rate stimulus has merely elevated prices so when the terms of loan modifications increase borrower costs and push them out, the lender losses less money.

(See: Lenders cash in on the success of their housing market manipulation)

The policy of mortgage interest rate stimulus is a success from the perspective of a banker because higher house prices are helping them recover more money from their bad bubble-era loans. However, wouldn’t the real measure of success from the perspective of Main Street have people remain in their homes rather than simply improve the bank’s bad debt recovery?

And what about future buyers? They are being forced to pay bubble-era peak prices and endure a much higher cost of ownership. Is that a success for Main Street? It looks much more like a success for lenders. Not just do they recover more on their bad loans, they also get more interest income because they are making large loans to today’s homebuyers. It’s a win-win for the banks.

However, the biggest back-door bailout of them all is the quantitative easing policies of the federal reserve. Basically, the central bank is printing money, some of it has flowed into mortgage bonds to drive down mortgage rates, but much of it has made it’s way onto bank balance sheets and into deposits at the federal reserve who pays those banks interest on the money the federal reserve prints. Not a bad deal — for the banks.

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The federal reserve can only create money by loaning money. It can’t merely print dollars and put them into circulation. It generally buys US Treasury notes (Government debt) to print money, but it now also buys mortgage-backed securities (private debt).

How much of this money has made it’s way to Main Street? Does the average American feel the benefits at this point?

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Availability of money to lend wasn’t a problem for the banks — which is unfortunate since that’s the only problem the federal reserve can do anything about. The real problem for banks was the lack of good prospects for loans to give the money to.

The problem was insolvency. Nobody had the income to support the debts they already had. Insolvency is a much more serious problem than liquidity, and the federal reserve has only one tool to deal with it — ultra-low interest rates. They can make the marginally insolvent borrower solvent again by lowering their cost of debt, but that’s about it. Adding liquidity does nothing to improve the problem of insolvency. Potential borrowers need stable and expanding incomes, and they need to pay down the debts they already have. That takes time — a long time.

Wall Street needed to make more money to make up for the massive loan write-downs they were making. The above chart showing declining loan balances didn’t happen because people took money out of their savings and paid down debt. Those reductions were caused by bank write downs, mostly on mortgage debt.

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As the federal reserve lowered interest rates, particularly using QE to buy 10-year treasuries, it served as a direct bailout to lenders, though this is often overlooked and misunderstood by most people. I want to make sure you understand how this part of the bailout worked.

Mortgage bond prices are inversely related to interest rates. Interest rates go down when bond prices go up. Since the federal reserve was buying a lot of bonds to drive down rates, the prices of bonds rose a great deal. The banks knew this was coming, so they loaded up on 10-year Treasuries and other bonds, held them while the federal reserve bid up prices, then sold these bonds to the federal reserve at nosebleed prices.

In that way, banks made billions in capital gains by taking the money given to them by the federal reserve, buying bonds, then selling them back to the federal reserve. It was free money given to the banks by manipulating bond prices — and they made transaction fees on these deals to boot.

That’s a pretty good deal for the banks, wouldn’t you say?

And it was no small bailout. Over five years, its bond purchases have come to more than $4 trillion. Not all of this was profit to the banks, but a significant amount of it was.

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I made the argument that the housing market bottomed due to decisions made in the boardrooms of the major banks. It’s a cartel arrangement. Those 0.2% of institutions that control 70% of the assets made a conscious decision not to foreclose on delinquent mortgage squatters, deny short sale approval to those who do want out, and cut deals with the rest until house prices get back to the peak.

It’s been argued that these banks are just doing what they’re told by the government. Well, the government told them to modify instead of foreclose from 2008-2011, and it didn’t dry up the MLS inventory of foreclosures.

Something changed in mid to late 2011 that caused the number of foreclosures processed to decline significantly — and it wasn’t that they ran out of people to foreclose on. Was it a secret meeting in a smoky room? That’s how JP Morgan did it in 1907. We may never know, but what we can see from the evidence is that policies changed, and the distressed inventory was removed from the MLS causing house prices to bottom.

Do you still believe quantitative easing and mortgage interest rate stimulus was designed to help you? I think it was designed to help the banks, and the evidence supports that view.

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