Wednesday, March 24, 2010

BofA's Write-down Gambit

Bank of America, allegedly holding 1.5 million loans that are 60 days or more behind on mortgage payments, today announced a new plan designed to write down principal values on a variety of loans to their most troubled homeowners.

The most affected groups will be those who took loans that were largely responsible for the meltdown in the mortgage securities market and eventually, the larger economy, over the past two years: sub-prime, interest-only and other variable rate products.

Prompted by lawsuits which alleged that Bank of America "strung out, delayed and otherwise hindered" efforts to resolve mortgage issues on homeowners in the state of Washington, the nation's largest mortgage servicer outlined the new program, which at first glance appears to have some value, though the gamble is that by lowering principal on loans in which the property values are lower than the original purchase price - often called "underwater" - the bank will further depress real estate values amid a market that is already under considerable strain.

The bank's plan is somewhat crafty, in that it works down principal balances over a period of five years and is tied to homeowners continuing to make mortgage payments. While it sounds hopeful on the surface, the plan may only prove to drive home prices down further, especially if economic conditions remain subdued or worsen.

In practice, principal write-downs are usually a last resort for lenders, who routinely hold out for the original, agree-upon value at the time of purchase. However, such as are conditions across a wide swath of the US real estate landscape, the bank seemingly is agreeing to take a "haircut" on its investment. Under BofA's plan, investors in mortgages would not suffer actual principal losses, but they would not make as much as originally planned.

No matter what, a haircut is still a haircut, so the very next thing to expect are lawsuits by mortgage investors. Some have already commenced. The bank is in a box because of its lending practices back in the boom days from 200-2007, when regulators looked askance at all manner of exotic mortgage products and real estate prices skyrocketed because of the lax standards.

In effect, this just buys the zombie bank more leverage and time to sort through the incredible mortgage morass. Within weeks or months, expect to see more banks offering more exotic plans to remediate troubled mortgage loans. All of them will be met with skepticism, most of them won't go far enough, the end result being a further breakdown in prices for residential real estate.

Most of the major mortgage lenders - Citigroup, JP Morgan, Wells Fargo - in addition to BofA, are in an untenable situation between foreclosure and principal write-downs. Both solutions are wrought with conflict and offer no guarantee of a positive outcome. The best most of the banks can hope for now is that they aren't damaged too badly, though they have nobody but themselves to blame.

News of the bank's most recent maneuver was met with mostly positive reaction, though the real effects will not be known probably for years, if ever.

Adding to the real estate woes was a Commerce Department report on new home sales for February, which fell 2.2% to an annual pace of 308,000. That was the lowest figure since data has been monitored: 1963, when the price of a middle-class suburban home was close to $30,000. The number of new homes being built underscores the actual depth of the real estate collapse and augers for even further declines in home values. With median household incomes virtually stagnant since the 1980s, home values should not have appreciated as much as they did, nor as quickly.

A reversion to a level more in line with actual economic conditions now seems absolute. With household income struggling to keep pace with expenses, the correct path is toward lower prices, not just on real estate, but tangentially, on everything from garden gnomes to restaurant dinners.

The deflationary spiral the Fed, the government and Wall Street most want to avoid now seems to be what it always was: unavoidable. Efforts to stem the flow have only served to buy time, temporarily propping up prices on stocks, gold and assorted other assets, but now, as evidenced by the non-ending housing crisis and associated unemployment condition (at multi-year highs), the death dance can engage in earnest.

Truth be told, economists are grasping at straws when seeking solutions to stem deflation and depression. No good solution has ever been made available at any time, other than the traditional - and painful - exercise of writing down or writing off bad assets and bad debts. Be prepared for another three to four years of dismal conditions, though, as readers of this missive already know, there are a wide variety of ways to mitigate the damage and actually come away less-damaged than your neighbors.

Bank of America has now stepped over a critical line and will not be able to step back. Cries of "foul" from homeowners diligently paying on their mortgage obligations will be loud and resonant. In a relentless search for the bottom, prices will proceed downward at an accelerating pace over the next 18-36 months.

Governments and financial wizards can only distort the truth to varying degrees. eventually, Actions like Bank of America's and data like the February new home sales reveal the true condition and it is far from pretty.

As for Wall Street, reality may be setting in that the overall economy is being kept floating by bailout money, productivity gains and government debt purchases rather than real, productive enterprises. Stocks slipped early in the day and remained lower throughout the session.

Dow 10,836.15, -52.68 (0.48%)
NASDAQ 2,398.76, -16.48 (0.68%)
S&P 500 1,167.72, -6.45 (0.55%)
NYSE Composite 7,408.20, -70.56 (0.94%)

Declining issues outpaced advancers by a wide margin, 4471-2033. New highs came down precipitously, to 417, though there were still only 40 new lows. Volume was about normal, though slightly elevated off some of the low-volume days of gains lately.

NYSE Volume 5,284,420,000
NASDAQ Volume 2,309,833,750

Commodities were also feeling the sting of reality. Off a report of higher crude inventory, oil fell $1.30, to $80.61. Gold was whipsawed $14.90 lower, to $1,088.60. Silver plummeted 39 cents, to $16.63.

If any of this activity looks like selling, you may have it nailed. Stocks and commodities have been driven up by hope and market insiders, and their values are highly inflated. Another downturn in the economy is already underway. The media, government and especially YOUR BROKER - all co-conspirators in the worst deceit in the long history of finance - simply refuse to own up to the truth.

Be certain you fully understand the frail condition of not only the US economy, but the entire world to some degree, and weigh the implications as they relate to your specific conditions. Only then can you devise a workable plan of action that will save you from desperation and ruin.

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