Battle Royale: JPMC’s Dimon and Minneapolis Fed’s Kashkari Battle Over Bank Capital

Bloomberg has nice piece on the battle between JPMorganChase’s Jamie Dimon and the Minneapolis Fed’s Neel Kashkari.

(Bloomberg) Jamie Dimon is America’s most famous banker, and Neel Kashkari is its most outspoken bank regulator, so it’s not a shock that they would eventually come to blows. What’s interesting is that their contretemps is over an acronym that most Americans have never heard of, but one that may be central to preventing another recession.

TLAC, which is pronounced TEE-lack, is something you need to know about if you want to judge the sparring between Dimon, the well-coiffed chief executive of JPMorgan Chase & Co., and Kashkari, the very bald man who ran for governor of California on the Republican ticket and is now president of the Federal Reserve Bank of Minneapolis.

On April 6, Kashkari went after Dimon in a way that circumspect central bankers ordinarily don’t. In an essay published on Medium and republished on the Minneapolis Fed website, he challenged Dimon’s assertion in his annual letter to shareholders that 1) there’s no longer a risk that taxpayers will be stuck with the bill if a big bank fails, and 2) banks have too much capital (meaning an unnecessarily thick safety cushion). Wrote Kashkari: “Both of these assertions are demonstrably false.”

This is where TLAC comes in, so bear down for a bit of bank accounting. TLAC stands for total loss-absorbing capacity. The more capacity that a bank has to absorb losses, the smaller the risk that it will require a taxpayer-funded government bailout. So lots of TLAC is good. But not all TLAC is created equal. Kashkari argues that a lot of what Dimon calls TLAC on paper wouldn’t be available to absorb losses in a real-world crisis.

Imagine that a whale swims up the Thames River and beaches itself in the City of London, causing billions of dollars in losses to Bank X. If the loss is really big or Bank X is weak (unlike JPMorganChase, which most emphatically is not weak), then one such hit could push it into insolvency. The first thing that happens is that the price of the stock falls to zero. Shareholders, in other words, are the first to absorb losses. That’s fair: Shareholders get all the profit that a bank makes after paying its expenses, so they should have to take the hit when the bank’s profit is wiped out unexpectedly.

The fight between Dimon and Kashkari is over who absorbs the rest of the loss. According to Dimon, it’s the unsecured bondholders. (Unsecured meaning they don’t have a legal claim to any specific asset on the bank’s balance sheet.) Unsecured bondholders are informed that, sorry, there’s been a loss. They’re not going to get their interest payments anymore, and their bonds are being converted into common shares. Now they’re at the back of the line with the rest of the bank’s shareholders; they’ll get paid only if the bank starts making a profit again.

The beauty of the system outlined by Dimon is that taxpayers aren’t exposed to risk because if a bank gets in trouble it has a great, big escape hatch: It simply wipes out its bondholders, thus conserving its money.

“It sounds like an ideal solution,” Kashkari writes. “The problem is that it almost never actually works in real life.” In a financial crisis, regulators worry about contagion. If bondholders of one bank are defaulted on, those of other banks will worry they’re next and yank their support, causing a downward spiral of confidence that crashes the economy. So the regulators make sure bondholders keep getting paid.

“Indeed,” Kashkari writes, “the most recent crisis showed that even some debt holders who had been explicitly told that they would take losses during a crisis got bailed out.”

Kashkari argues that regulators and bankers should stop acting as if bonds are part of TLAC (which, remember, stand for total loss-absorbing capacity), because when push comes to shove, bondholders will absorb few if any losses. Taxpayers will be forced to step up and make sure they keep getting paid.

Kashkari also disses Dimon’s argument that banks’ safety cushions are needlessly thick. Dimon wrote to shareholders that if the Federal Reserve standards weren’t so tough, “banks probably would have been more aggressive in making some small business loans, lower-rated middle market loans, and near-prime mortgages.” Kashkari’s response? “Mr. Dimon argues that the current capital standards are restraining lending and impairing economic growth, yet he also points out that JPMorgan bought back $26 billion in stock over the past five years. If JPMorgan really had demand for additional loans from creditworthy borrowers, why did it turn those customers away and instead choose to buy back its stock?”

Mr. Kashkari has a valid point. Check out the bank capital to total assets during the housing bubble of the last decade. From 2004-2007, bank capital to total assets exceeded 10%, but fell under 10% for 2008. And we all remember TARP (the Troubled Asset Relief Program signed into law on October 3, 2008). Starting in 2o08, bank capital was strengthed to 12.74% of total bank assets by 2010, but has slipped to under 12% by 2013.

Of course, not all capital (and capital ratios) are equal. Take a look at Chase Bank’s Basel III standardized regulatory capital and advanced transitional regulatory capital. Chase Bank’s Tier 1 capital under Basel III Advanced Transition is now under 10% at 9%. JPMorgan_Chase_Co_4Q16_Basel_Pillar_3_Report

JPMorganChase has credit risk exposure to residential and commercial real estate, C&I loans, consumer auto loans and student loans.

Can any large bank survive if home prices and/or commercial real estate prices burst and fall 20%?

So while it seems that Dimon is correct (stiff the unsecured bondholders), Kashkari is also correct in that regulators may panic (again) and try to preserve the unsecured bondholders. That is, bail out the unsecured bond holders.

Maybe Dimon and  Kashkari can settle their “battle royale” by doing it “the Swanson Way.” 

MBA Residential Mortgage Application Index Hits Highest Level Since May 2010 .. And It Is Only April!!

As mortgage interest rates hit a new 2017 low, we now see mortgage purchase applications rising to its highest level since May 2010.

This new level is in spite of mortgage originations for borrowers with credit scores under 620 playing a lesser than during the financial crisis. Although mortgage originations for borrowers with credit scores under 620 are at their highest level since March 2010. So both mortgage purchase applications (SA) and under 620 credit score mortgage borrowers are at their highest levels since 2010.

With the worst wage recovery after a recession in modern history, expanding the “credit envelope” is about the only way to expand mortgage lending.

In other words, mortgage credit for borrowers under 620 FICO score is expanding at the fastest pace since Dodd-Frank and The Consumer Financial Protection Bureau were created in 2010.

Elizabeth Warren, architect of the Consumer Financial Protection Bureau.

 

Ratings Shopping Haunts Commercial Mortgage Bonds as Risks Rise

The retail slaughter caused by on-line shopping (Amazon effect) and sluggish wage growth since The Great Recession are taking a toll on large shopping mall stores and, as a consequence, commercial mortgage-backed securities (CMBS).

(Bloomberg) – Matt Scully and Adam Tempkin – Only a decade ago, global investors got a hard lesson about the dangers of relying on rosy bond ratings. Now they’re getting a reminder — this time in frothy corners of the $528 billion U.S. commercial-mortgage bondmarket.

As delinquencies on loans rise, some ratings firms are walking back their grades on bonds tied to properties like shopping malls and office towers, just a few years after assigning them. DBRS Inc. last month lowered the AAA ratings it had given 294 interest-only bonds after realizing it had been too lenient. Also in March, Kroll Bond Rating Agency Inc. cut some of its grades on a $1 billion bond issued in 2014, citing weakness in Texas loans exposed to energy prices.

The reversals underscore how forces that brought trouble to financial markets before are still percolating through Wall Street today. No one sees the dangers as being nearly as grave as they were during the home mortgage bust. But the same ratings business model used during that period still prevails — meaning that the banks that put together debt securities still pay for the credit grades, and they can shop around for the firm that will give them the highest ratings under the loosest criteria.

According to Trepp, retail delinquencies have risen to 6.12% as of March 17, 2016 (following only industrial loans).

And a foreclosure appeared in the WBCMT 2007-C32 CMBS deal (Rockvale Square in Lancaster, PA). Not to mention a non-performing property in teh BSCMS 2007-PW15 deal.

The WBCMT 2007-C32, a Wachovia deal, is now rated at CCC+ or lower for tranches B through D. Tranches E and F are rated as D by S&P. The H tranche, rated as C by Moody’s, has eaten $15.5 million in losses thus far. Tranches J and K are gone after sustaining losses of $56.6 million and $33,46 million, respectively. At least tranches A1, A2 and APB paid off with no losses.

And with delinquencies rising over the last year, the retail forecast is gloomy.

Parks and Recreation’s Tom Haverford may have to change his tune on “things are forever.” Particularly if shopping at Macy’s , Sears, JC Penney’s, The Limited, Abercrombie and Fitch, etc. 

Yes, Tom, you can buy things on-line. Unless your wages are slow to grow and you have accumulated significant debt. Particularly during the worst wage recovery after recession in modern history.

 

Bubble? Home Prices in 20 U.S. Cities Rise at Fastest Pace Since 2014 (But Wage Growth Is Terrible)

Bloomberg has an interesting article on rapidly rising home prices.  Despite the fact that US wage growth has been terrible since the Great Recession and is now (depending on how you measure it) 4 times lower than home price growth.

Home prices in 20 U.S. cities climbed in the 12 months through January at the fastest pace since July 2014, while nationwide the increase in property values also accelerated, according to S&P CoreLogic Case-Shiller data reported Tuesday.

Key Points

  • 20-city property values index rose 5.7 percent from January 2016 (forecast was 5.6 percent) after increasing 5.5 percent in the year through December
  • National home-price gauge increased 5.9 percent in the 12 months through January
  • Seasonally adjusted 20-city index advanced 0.9 percent from a month earlier (forecast was 0.7 percent)

Big Picture

Lean housing inventory helps explain why home prices are appreciating at more than twice the rate of inflation and wage growth, an impediment to an even bigger advance in housing demand. That’s making it difficult for some Americans to transition from renter to homeowner, a reason investors remain a big part of the market as they purchase properties and convert them to rental units.

Economist Takeaways

“Tight supplies and rising prices may be deterring some people from trading up to a larger house, further aggravating supplies because fewer people are selling their homes,” David Blitzer, chairman of the S&P index committee, said in a statement. “The prices also hurt affordability as higher prices and mortgage rates shrink the number of households that can afford to buy at current price levels.”

The Details

  • All 20 cities in the index showed year-over-year gains, led by an 11.3 percent advance in Seattle and a 9.7 percent increase in Portland, Oregon
  • After seasonal adjustment, Seattle had the biggest month-over-month rise at 1.7 percent, followed by a 1.3 percent increase in Chicago; home prices fell 0.1 percent in Cleveland

This Bloomberg chart shows that median home price growth is not quite 4x wage growth.

My “homebrewed” chart shows that it a similar effect except I show the decline in the volume of mortgage originations to borrowers with a credit score below 620.

Anyway you want it, home price growth is beating the tar out of wage growth .. but any metric.

Has the robot monster (aka, The Fed) helped create a home price bubble with its uber-accomodative monetary policies that did not help wage growth?

Yes, The Robot Monster (Federal Reserve and other Central Banks) stalks the earth.

 

Jurassic Banking: Shadow Banking Is Getting Bigger Without Getting Better

There is an interesting article on Bloomberg entitled “Shadow Banking Is Getting Bigger Without Getting Better” 

Taxi companies that compete with Uber and media companies that are up against Facebook know it: In a rivalry between regulated and unregulated firms, the latter have an unfair advantage. It also applies to banks, which spent the past ten years losing market share to companies that regulators ignored.

In a fresh working paper, Greg Buchak and Gregor Matvos of the University of Chicago, Tomasz Piskorski of Columbia Business School and Stanford’s Amit Seru calculated that between 2007 and 2015, so-called shadow banks have increased their share of the U.S. Federal Housing Administration mortgage market sevenfold to 75 percent. That’s the market where the less creditworthy borrowers get their loans. In the U.S. mortgage market as a whole, shadow banks held a 38 percent share in 2015, compared with 14 percent in 2007.

This is not really surprising since non-depository financial institutions have risen in force thanks in part to Washington DC’s penchant for trying to regulate anything that moves (Dodd-Frank, Consumer Financial Protection Bureau, etc.) But the growth of “shadow banks” is also linked to a growth in more risky FHA-insured loans.

And with FHA-insured loans having 4 times the serious delinquency rate than loans purchased by GSEs Fannie Mae and Freddie Mac, this is represents a dramatic shift in banking and risk taking.

As Gerald Hanweck and I showed in a recent paper, bank failures following the housing bubble and financial crisis boomed in  2009 and 2010. Most of these bank failures were small banks. This resulted in bank aggregation into progressively larger banks. These were failures of depository institutions and shadow banks (non-depository institutions like Quicken Loans) have stepped in with riskier loan profiles.

The result? The rise of the mega-banks.

As Professor Ian Malcolm said in the movie Jurassic Park, life will find a way. Including subprime lending. Welcome to Jurassic Park, where Senator Elizabeth Warren and CFPB Director Richard Cordray still believe that they can control the banking system.

 

New Home Sales Rise 6.1% MoM in February (Mostly In Midwest) Following -3.7% Decline in Existing Home Sales

New home sales rose by 6.1% in February, greater than expected.

The biggest winner? The Midwest! (Home of the Chicago Cubs, Cleveland Indians and … Pawnee Indiana!)

The growth in new home sales has lagged existing home sales since 2009.

But in terms of median price, median price for new home sales has been accelerating from median price for existing home sales since 2009.

Existing home sales? Down 3.7% MoM in February.

The Midwest includes Pawnee Indiana!

Housing Bubble? Homebuyers Face Bidding Wars on Scarcer-Than-Ever U.S. Listings

Is this the new, creditless home price bubble?

(Bloomberg) – Prashant Gopal – The winning bidder of a Grand Rapids, Michigan, house has been offered almost $20,000 to hand his purchase contract to another buyer. An agent in Nashville, Tennessee, got a property for his client by cold-calling local homeowners. Near Columbus, Ohio, it took a teacher five tries to secure a deal.

It’s the 2017 U.S. spring home-selling season, and listings are scarcer than they’ve ever been. Bidding wars common in perennially hot markets like the San Francisco Bay area, Denver and Boston are now also prevalent in the once slow-and-steady heartland, sending prices higher and sparking desperation among buyers across the country.

Buyers are clamoring as an improved job market and growing confidence in the economy collide with rising mortgage rates — yet there’s little new inventory for them to purchase. Housing starts remain well below levels before the last recession, and builders have focused on higher-end properties out of reach for many people. Homeowners have become even more reluctant to sell because, after all, where are they going to move?

The three months through January had the fewest homes on the market on record, according to an analysis by Trulia. Prices jumped 6.9 percent in January from a year earlier, the biggest increase for any month since May 2014, data from CoreLogic Inc. show. And homes sold faster in the first two months of 2017 — spending an average 58 days on the market — than at the start of any year since at least 2010, according to brokerage Redfin.

Low inventory of homes for sale and  bidding wars for homes? Existing home sales cratered in 2012 and have remained  at levels since before the financial (and housing) crisis. Yet the median price for existing home sales has skyrocketed to levels higher than the peak of the home price bubble.

But why is there so little inventory for sale? One reason is that the supply of mortgage credit to households with credit scores of less that 660 had drop precipitously by 2012.

Another reason is dreadful wage growth for the majority of the working US population.

There is a possibility of a home price bubble, but this time due to LACK OF AVAILABLE CREDIT. So, prices are being bid up but households are still not willing to put their properties up for sale.

For some buyers, patience and persistence can pay off. Jessica Streit, a 42-year-old teacher and mother of two, has been searching for months for a home in Sunbury, Ohio, north of Columbus. She lost three bidding wars and even went into contract on a home, only to back out after an inspection revealed some expensive problems. Last week, her fortunes changed — she signed a $136,000 deal for a two-bedroom condominium with a finished basement.

“We were absolutely shocked to get this one,” she said. “We had an appointment to see a rental house Saturday because we thought that would be our next direction.”

A $136,00o condo in Sunbury Ohio?????

This reminds me of Tom Haverford in Parks and Recreation expressing surprise over Jerry Gergich owning a time share condo in Muncie Indiana. “In Muncie??”