Posts filed under “UnGuru”
How one discredited “mortgage expert” from the American Enterprise Institute launched an ongoing disinformation campaign to destroy a successful government program that helped stabilize the mortgage markets.
Much of the brouhaha concerning the fate of the Federal Housing Administration can be traced to the actions of one dishonest man, a crackpot who is treated with utmost deference by the current Chair of the House Financial Services Committee and by friends in the media.
Genesis of the Disinformation Campaign
As recently as last September, the House was capable of passing a piece of legislation, known as the FHA Emergency Fiscal Solvency Act of 2012, with a lopsided bipartisan vote of 402 to 7. The Senate version of the bill, sponsored by Pat Toomey, was co-sponsored by Richard Burr, Kay Hagan and Mark Warner. It seemed likely to pass in the Senate as well, until December 13, 2012, one day after The New York Times published a favorable story on the crackpot research of Edward Pinto of the American Enterprise Institute. On that date, the bill was sent back to Committee to die.
According to two knowledgeable sources, neither of whom are Democrats, Pinto was lobbying in the Senate to kill the bill, and he persuaded Sen. David Vitter and two other GOP senators to do just that.
Whether or not he had a hand in killing the legislation, one fact is indisputable. The only reason why anyone pays attention to Pinto’s disinformation campaign is because last year’s bipartisan bill died. And the only reason why anyone would take Pinto’s work seriously is if that person were ignorant of the subject matter, or shared Pinto’s contempt for the truth. His campaign went into overdrive on November 16, 2012, the day HUD released the latest annual actuarial study of FHA’s mortgage insurance portfolio. Right away, Pinto reveals his duplicity.
A Profound Misunderstanding of an NPV
FHA’s annual actuarial study is primarily a net present value calculation, prepared by an outside consultant, of the insurance in place as of July of the current year. The NPV, the 2012 portfolio had an NPV of negative $13.5 billion, a considerable downward slide from the 2011 portfolio, which was valued at $1.19 billion. The primary reasons for the slide were traceable to revised assumptions, which pertain to cash flows extending more than 30 years, and to a different methodology for calculating the NPV, used by a newly hired consultant.
The NPV number refers to a static portfolio in liquidation, as opposed to the economic value of an ongoing enterprise. Pinto demonstrates an inability to differentiate between the two concepts, which is a pretty big deal. Because, notwithstanding all the controversy surrounding the mortgage crisis, there remains one universally accepted truism: If you don’t understand the difference between a static loan portfolio and an ongoing lending enterprise, you don’t know WTF you are talking about.
So, upfront, excuse me for belaboring some obvious points, which seem to escape Pinto. An NPV is a way to count your chickens before they hatch; it involves a number of forward-looking assumptions. As any kid who ever took a course in finance knows, if you tweak the assumptions, you can change the NPV dramatically. Similarly, there are different methods for calculating an NPV. Change the method, and you change the outcome.
(Many, including myself, would take issue with the consultant’s change from a stochastic analysis to a Monte Carlo simulation for 30-year projections, but that’s beyond the scope of this piece.)
Also, given the way that discounted cash flows work, changes that occur sooner in time have a bigger impact than changes that occur further out in the future. So, when loans perform better or worse than expected in the first year, the updated NPV of the same portfolio can change dramatically.
I know, you’re thinking, “Duh.” But lot’s of people miss this point, which is the dirty little secret of credit ratings for private label mortgage-backed securitizations. A synonym for NPV is “credit enhancement,” which, for the rating agencies, represents the margin for error, or safety cushion. Credit ratings are supposed to be stable over time, whereas NPVs for RMBS can be wiped out very quickly.
Static Loan Portfolios Versus Ongoing Enterprises
The NPV of any static loan portfolio is an estimate the projected future income from performing loans, used to offset the projected future credit losses from defaulting loans. In FHA’s case, the static pool consists of insurance policies on mortgages, but the same concept still applies. If loans in a static portfolio prepay at a faster-than-expected rate, that shortfall in income is lost forever. The NPV goes down and the balance between good loans and bad loans irrevocably shifts for the worse. This is one of the key risks assumed by investors in any private label residential mortgage backed securitization.
And early prepayments are exactly what triggered the collapse of the subprime mortgage market in the late 1990s. A multitude of subprime RMBS portfolios were weakened when creditworthy borrowers refinanced at faster-than-expected rates beginning in 1998. Back in the 1990s, people had this quaint notion that an originator should have skin in the game. Many now-defunct subprime originators, like ContiFinancial and Southern Pacific Funding, acquired the equity tranches of deals securitizing the mortgages they originated. And with faster-than-expected prepayments, the NPVs of their bond holdings plummeted in value, which wiped out their capital, prompting banks to cut their credit lines and, viola, they went out of business rapidly.
This is really basic and really important: Rapid prepayment impacts the risk of principal recovery for private label deals in a way it does not for mortgage securities sold by Fannie Mae and Freddie Mac. Forget about any implicit or explicit government support, we’re talking about structure in structured finance deals. Private label RMBS are non-recourse, whereas the government sponsored enterprises guarantee their deals. Anyone who equates the credit risk diversification of private label deals with that of GSE securitizations is simply too ignorant or dishonest to be taken seriously.
Historically, the biggest trigger for rapid prepayments is falling interest rates. This is bad news for private label deals, but not for buy-and-hold lenders, which can easily replace early prepayments with new or refinanced loans. Similarly, if an investor in one GSE securitization sees the mortgage pool declining more rapidly than expected, he knows that the corporate guarantor is still generating new business, which enhances its ability to honor that guarantee. And since the GSEs extend credit during all stages of the real estate cycle, an individual investor is less concerned about credit losses from a mortgage pool that was booked at the wrong time.
The FHA, which insures mortgages, is like a balance sheet lender; it books new insurance policies on new mortgages when other loans prepay faster than expected. But the annual NPV of FHA’s portfolio, calculated by an outside consultant, Integrated Financial Engineering, Inc., assumes that FHA will never book a new insurance policy ever. Prepaid mortgages represent a permanent shortfall in cash flows. This fiction may be useful for analyzing the extant portfolio, but, again, the volatility in the different annual numbers is mostly traceable to revised assumptions and methodologies. And no one would confuse that valuation with GAAP accounting, which is based on the idea that you don’t book income or losses until the period when they actually occur.
The consultant calculated the annual NPV based on forecasts by Moody’s Analytics as of July 2012. The revised assumptions of lower interest rates, triggering faster prepayments, lowered the NPV by $8 billion. The revised assumptions of reduced home price appreciation lowered the NPV by another $10.5 billion.
As the consultant wrote, “We project that there is approximately a 5 percent chance that the Fund’s capital resources could turn negative during the next 7 years.” Such concerns were addressed in the FHA Emergency Fiscal Solvency Act of 2012.
Ed Pinto and His Cherry Picked Factoids
The same day that the actuarial study was released, Pinto rushed out his crackpot analysis to frame the media narrative. He said the FHA was masking its financial problems, because the latest interest rate forecasts, which were lower than those in July 2012, meant that the company was $31 billion in the hole. If you have no idea what he’s referring to, his words sound confusing, but not ridiculous.
Today the FHA released its FY 2012 actuarial study and as documented by FHA Watch, the FHA’s financial condition continues to deteriorate. This report should be cause for significant concern for Congress and taxpayers. As expected, the report shows that the FHA main single-family insurance program has a negative economic value of negative $13.5 billion. Even under generous accounting rules that no other financial entity gets to use, it is insolvent.
To make matters worse, this report is already obsolete and outlines a conservative estimate of the true losses incurred by the FHA. The projection of negative $13.5 billion is based on Moody’s July 2012 forecast projecting 10 Year Treasuries in CY Q3:12 to be over about 2.2% and climbing to 4.59% by 2014. Today the 10-year is at 1.57%. Under that same forecast, mortgage rates are projected to double to 6.58% by CY Q3:14.
The base case scenario ignores the Fed’s September QE 3 announcement. FHA has once again ignored intervening events that dramatically change the base case findings in their annual report. If the current low interest rate scenario were substituted, the FHAs FY 2012 is a negative $31 billion. Yet, FHA chose cherry pick a piece of “good news”–the study projects that FHA will generate $11 billion in new economic value in FY 2013 and seize on it as evidence the 2012 deficit will be largely wiped out and all will be fine. This ignores the of the real negative $31 billion hole in 2012. No matter how bad things get today, FHA continually paints a rosy picture. The SEC would be all over a public company that played by FHA’s rules.
“Yet FHA chose to cherry pick…”? Hey Ed, projecting much?
Let’s get to the big stuff first. Pinto says that the “economic value” of the ” FHA main single-family insurance program,” is not negative $13.5 billion, but negative $31 billion, based on an interest rate outlook that was even lower than that forecast in July.
Pinto conflates a static portfolio at a point in time with FHA’s ” single-family insurance program” which operates as a business. He says that FHA is dishonest in its presentation because the NPV, would change if it were based on updated projections from Moody’s Analytics, which show that interest rates are expected to be lower than previously forecast.
Again, under the methodology used by Integrated Financial Engineering, lower interest rates translate into faster prepayments, thereby reducing future income which is assumed to be lost forever. It’s sort of like assuming that every wage earner in his 30s who changes jobs or is temporarily laid off will never get another payroll check for the rest of his life.
Historically, about 60% of those loans that prepay because of lower rates end up refinancing with FHA.
And since interest rates have risen over the past few months, the outside consultant will need to reverse that year-old assumption that hammered the NPV. So, we can expect, at minimum, an $8 billion increase in the net amount.
Of course, Pinto ignores what he wants to ignore.
The same holds true for home price appreciation. The consultant assumed that housing prices would increase by 1% during 2012, which is why the NPV fell by $10.5 billion. As it wrote:
Moody’s July 2012 house price index forecast is very similar to the alternative scenario called “mild second recession in July 2011. Compared to its July 2011 forecast, Moody’s Analytics’ July 2012 local house price growth rate forecast is more pessimistic in the short run. In fact, The difference is that the 2011 “mild second recession” has a deeper short-term HPA drop in 2012, but rebounded back to exceed the July 2012 forecast by 2014 and stayed higher thereafter.
And once again, home price appreciation in the near term has a much bigger impact on the NPV than price appreciation further out in time. And the impact of price increases and decreases in huge, especially in terms of loss severity on defaulting loans. For instance, in California during in 2005, loss severity subprime defaults was under 2%; in 2008 it was 70%.
As we know, Moody’s Analytics was way off in its short term home price forecasts. Home price appreciation, especially in the bubble states, has been quite robust over the past year. As the firm stated in June, “Housing has gone from a major weight on the economy to an important source of growth.”
Consequently, if the NPV were calculated today, using the current FHA portfolio and the current projected prices increases from Moody’s Analytics, FHA’s NPV would be positive.
This is but one part of Pinto’s multi-layered smear campaign against a program that has never relied on government support for 78 years. Pinto also cherry picks to pervert history and malign the dead, by deceitfully conflating decades-old examples of poor FHA management and oversight with the agency’s underlying business model. More on this later.
In 2011, the head of Moody’s Analytics reminded us how the FHA stepped in to help the entire economy:
U.S. home prices have fallen by more than a third; without the FHA, the decline would have been substantially worse. Many more homes would have been foreclosed, and private financial institutions would have faced measurably greater losses. Aggressive intervention by the FHA saved the housing market and the economy from a much darker fate.
Why are Pinto and his AEI cohorts so vitriolic in their attacks on FHA? Because, over the past 18 years, we have seen how private financing of higher-risk mortgages, especially in private label deals, has proved to be an unmitigated failure, whereas FHA’s long-term track record, which shows a foreclosure rate less than one-half that of subprime securitizations, has proved to be a self-sustaining success.
“They’re in the business of flattering the prejudices of their base audience and they’re in the business of entertaining their base audience and accuracy is a side constraint.” -Philip Tetlock While researching this week’s Washington Post column (Everybody loves a good story), I came across Professor Tetlock’s quote above (we have previously referenced Tetlock…Read More
More on Munis, Detroit, Bloomberg, Whitney & Wilson David R. Kotok Cumberland Advisors, July 24, 2013 In our recent commentary on municipal bonds and Detroit, we argued in favor of buying the highest-grade AAA tax-free municipal bond It currently yields more than the corresponding taxable US Treasury obligation. Meredith Whitney, Muni Cassandra emeritus…Read More
Last week, I noted my preference for Fed Chief was Anyone But Larry Summers. So you can imagine my disappointment when Ezra Klein posted this today: Right now, Larry Summers is the front-runner for Fed chair. Oy. This nation faces too very large political problems related to economics: 1. The President of the United States…Read More
Take The Zero-Hedge Test
Being permanently bearish on equities definitely pays.
Just ask Zero-Hedge. Unfortunately, for wool-dyed pessimists and the other overly-skeptical black sheep of the thundering herd, it pays apocalyptic newsletter writers’ paychecks, and Zero-Hedge/Tyler Durden’s Manhattan bar tabs rather than those who permanently position against market priapism. And it’s worse than zero-sum because those who are optimistically-challenged often pay for the bad advice – whether directly in subscriptions, inflated margins on retail bullion products, or indirectly via page-views and click-throughs AND then they get hosed by the market.
The first step to improving behaviour toxic to one’s own self interest is admit one has a problem. As an aid to help those who have difficulty in distinguishing “a bearish trade” from “the lead boots of anger and pessimism”, I’ve devised a little something I call the Zero-Hedge Test to determine more precisely whether readers objective realities are sufficiently paranoid, pessimistic, anti-social and rantingly angry to warrant more serious help.
Instructions: Circle the letter that best describes the adjacent image:
a. a glass of water
b. glass of water, half-empty
c. glass of water, half-full
d. glass of errrr ummm , Grey Goose vodka? (NB: ed. choice)
e. The US Government must have stolen half of a glass of water.
a. First black elected (and first to be re-elected) President of the USA
b. Barack Hussein Obama
c. A Former Senator from Illinois
d. tall guy who used to like to sneak a cigarette now & then
e. Jezebel, dark Sith Lord Vader Emperor & Chief of the Plunge Protection Team. Odious non-American african muslim responsible for taking away our world-beating healthcare, encouraging the immigrants and foreigners who took our our jobs, and formulating a secret plan to put two-dads in every home .
a. Something that still buys a 12oz can of Coca-Cola
b. A greenback, worth a dollar, which, on average, an American is paid each 4 minutes of work
c. A US Federal Reserve Banknote almost universally accepted in exchange for goods and services the world over
d. A cocaine hoovering apparatus c.1978
e. Worthless fiat toiletpaper, so useless that bric-a-brac, watches, baseball cards or bitcoin should be more preferred than this P.o.S. that forms part of the elders of Zion grand plan to steal your labour savings before eating your babies.
a. six would-be wedding bands
b. 1oz novelty of pure gold smelted by JM
c. Au = element #79 on Periodic Table
d. Reward for a 9.59 sec 100m
e. The solution to all our financial problems…changer of men from liberal faggot zionist atheist swine into god-fearing hardworking people of fortitude and rectitude…curer of cancer, balancer of budgets….purifier of all our precious bodily fluids and divinely-given laws….come, my preciousssss…
“If you chained a thousand Boskins to a thousand keyboards for a thousand years, eventually one of them would make a correct prediction.” Over the years, I have been critical of economist Michael Boskin: I have critiqued his market forecasts (“Obama’s Radicalism is Killing the Dow“) that were made literally on the day…Read More
The Big Lie Annotated: An AEI History Of The Financial Crisis
February 26, 2013
“There was never any significant debate about the causes of the 2008 financial crisis,” argues Peter Wallison, who must believe that his stint on the Financial Crisis Inquiry Commission was a complete waste of time. Two years ago, he blamed the other nine FCIC commissioners, for “ignoring” the research of Edward Pinto, who proclaimed that the crisis was caused by Fannie, Freddie and affordable housing goals.
Now Wallison blames the media. ”Although there were two narratives about why it happened, only one of them was accepted and propagated by the media,” he says. “And in effect the necessary competition in ideas never occurred.” For $72 you can read all about it in his new book, Bad History, Worse Policy: How a False Narrative about the Financial Crisis Led to the Dodd-Frank Act.
The irony could not be more rich. Neither Peter Wallison nor Edward Pinto would ever subject themselves to a free and open competition of ideas, because their “research” cannot withstand a modicum of scrutiny. FCIC staffers carefully reviewed Pinto’s work, but neither they nor Pinto were ever able to reconcile his risk categories with actual loan performance, which seemed to nullify Pinto’s thesis. So Wallison simply lied to Congress, when he testified that the FCIC never reviewed Pinto’s work.
The schism described by Wallison is not between left and right, between Democrats and Republicans, or between regulation and laissez-faire. It is the divide between capitalists and crackpots. In the world of capitalism, everyone takes risks. Some pay off; some do not. Capitalists study the results in order to ascertain who was lucky and who was smart. Not crackpots like Wallison and Pinto. They declare that, “28 million mortgages, were subprime or otherwise low-quality,” of which, “three quarters were on the books of government agencies.” But they refuse to examine loan performance over time.
Wallison and Pinto maintain their media platforms because they are protected by a vast conspiracy of silence–an informal agreement among conservative think tanks, Republican politicians, academic shills, and friendly media outlets–which insulates the words of Wallison and Pinto to any kind of fact checking.
Consequently, there has never been an adequate takedown of the multifarious lies and deceptions embedded within the Wallison/Pinto “narrative.” So, what follows is a description of the elephant in the room, a brief explainer of some of Wallison’s more egregious whoppers. The list is by no means comprehensive. And it merely touches upon Pinto’s new disinformation campaign against FHA, which deserves a separate debunking. (Spoiler Alert: If you believe Pinto’s claim that, “FHA’s Estimated GAAP Net Worth Equals –$26.27 Billion,” you don’t know much about GAAP or finance.)
A Few Basic Metrics
But first, a few basic metrics.
Best Loan Performance: Over the past few decades, Fannie and Freddie’s loan performance has always been exponentially superior to that of any other segment in the mortgage market. The first chart covers the period of 1998 – 2010, the second from the beginning of the 2008 crisis until now.
$216 Billion versus $888 Billion: Similarly, the total credit losses incurred by the GSEs are about one-fourth those incurred about by private label mortgage securitizations, which are packaged and sold by Wall Street.
Laurie Goodman of Amherst Securities estimated that losses on private label securitizations issued between 2005 – 2007 total about $714 billion, a number fairly close to Moody’s current estimates. Add in another $133 billion in losses from synthetic subprime CDOs, which never financed a single mortgage, plus another $41 billion from CDOs issued before 2005, and the total approaches $888 billion.
If you hang around these parts for any length of time, you will occasionally run across one of my jeremiads complaining about the Financial Services Industry. I’ve been thinking about this more than usual lately. This has led to some correspondence with Helaine Olen, whose book Pound Foolish: Exposing the Dark Side of the Personal…Read More
My wife happened to mention hearing a financial guru on the radio a little while back. I am always interested in knowing what financial gurus are saying (and thinking maybe it was Ritholtz or Rosenberg or Levkovich or someone else I personally know). I asked her who it was.
“Dave Ramsey,” she said.
“Dave who?” was my reply.
So I asked around – colleagues, friends in the business, etc. etc. Couldn’t get a bid. I turned to The Google and in short order realized that Dave Ramsey is the male version of Suze Orman. He seems to be a self-promoter with little actual experience or knowledge of financial markets or economics. But what really struck me was the condescending, patronizing tone he directs toward his callers. This a site refers to him as a “Christian financial guru,” yet he doesn’t seem to preach in very Christ-like manner.
I could write a thesis about all that’s wrong with this ilk. But rather than take the 30,000 feet view (that’s BR’s province), let’s get granular:
Once again, investors are reacting to the uncertainty in the stock market by investing in gold. Since the third quarter of 2010, the price of gold has jumped 40%, peaking at just over $1,900 an ounce. The “experts” are touting gold as the only “safe” investment in a volatile market.
So is now the time to buy gold?
Think about it: Why would you buy something at its all-time high?
Before we move on to the idiocy of the final sentence, let’s consider another aspect of what’s going on here.
Later in that same post:
Gold Stash is a quality company that will gladly buy any of your unused gold and silver. They do business the right way, going above and beyond. Dave wouldn’t endorse them if they did any less. With Gold Stash, you can take advantage of the high gold prices in a safe and responsible way.
So, not only is Mr. Ramsey advising against gold under nearly all circumstances, he’s recommending selling it to a company he “endorses,” who coinicentally happens to be an advertiser?
Oct. 13, 2009: “He never has, and he never will [advise buying gold]. Companies like GoldStash.com offer an outlet for you to make some money on your unwanted or unneeded jewelry. Dave will only endorse companies that he trusts, and Gold Stash is reputable, honest and absolutely trustworthy.” Gold price then: About $1,050/oz.).
Who is Gold Stash? Hmm. Well, there’s a tab that allows us to see who “Dave Recommends.” There’s Gold Stash. Funny thing is that at the bottom of that drop down is a link for us to “View all Advertisers.”
Gold Stash is an advertiser of his, and Dave wholeheartedly endorses them (and only them, apparently) and, coincidentally, is always – 100 percent of the time – bearish gold. Dave is so concerned about your financial well-being that he’s going to let those suckers at Gold Stash take the hit on your soon-to-be-worthless gold. What a guy.
Paul Farrell responded to Wharton School prof Jeremy Siegel’s most recent predictions for the Dow by year-end 2013, who said: “My Dow 17,000 projection may turn out to be too timid.” He channels William Sherden, author of “The Fortune Sellers: The Big Business of Buying and Selling Predictions.” Sherden decided to test the accuracy of…Read More