Federal bank bailout may not be that big during this downturn?

[FormerOwner]

It’s looking like most of the bad news coming out about loans relates to sub-prime lenders. I think most sub-prime loans are not made by banks and are NOT federally insured in any way.

Could it be that the big banks were actually pretty responsible with their underwriting and may end up not getting hurt that bad? Of course, house values dropping 50% would not be good for their collateral but maybe the banks’ exposure is not as high as we have been thinking.

Maybe the Fed had this all figured out when the lowered the interest rates and the Treasury dept ran the printing presses 24×7. Fed member banks are NOT the ones holding most of the bad loans, it would seem. Why would the government care if a bunch of non-bank subprime lenders goes under? There will be a credit contraction since sub-prime borrowers have been a big portion of the market but why would the banks or the Fed care? Anyone have any thoughts on this?

[Anonymous]

You’re likely right that FDIC insured banks have for the most part isolated themselves from the majority on direct subprime risk. That said, I’m still convinced that eventually this becomes an issue that forces some type of federal intervention. Why?

Subprime foreclosures are currently out of control… with the problem in every way likely to get *much* worse. Moreover, most subprime borrowers are minorities. I’m convinced that the political ramifications of minority borrowers being kicked out of their homes in record numbers will be too much for the government to bear. They’re going to have to come up with some “solution”.

The other side, is that while this is happening, there is a big push to legislate that borrowers should be qualified “at the fully indexed rate”. Well, we’re 8-12 months from the biggest subprime ARM reset in history. All these borrowers are going to hit their resets and are no longer going to be able to afford their loans. How are they going to be able to qualify for new loans when they, by definition, aren’t able to afford the fully indexed payment?

The government is going to step in with the largest borrower bailout in history. There won’t be a “direct” cost to this, but debt forgivness of this magnitude can’t be done in a vacuum… a lot of people are going to lose a lot of money.

[anxvariety]

Tax payers! Yay!

[Bugs]

Some of the FDIC lenders have a lot of subprime loans on their books. Washington Mutual, just as an example. It’s already cutting into their viability. Lots of people are speculating they have become buyout bait.

Even those lenders with conventional loans have some exposure to an RE market in significant decline. Their borrowers tend to be stronger, but few borrowers are completely isolated from the effects of an extreme RE downturn. No matter what, a borrower can get sick, a spouse can pass on, a divorce can occur; and when something like that happens and the borrower finds they owe more than the current value problems can ensue.

[bigtrouble]

Industry insider perspective, FWIW.

All of the banks have these toxic loans on board. And they all knew that they were crap. But real estate works in cycles, and the first rule is you never leave money on the table during a boom market–you’ll need it when things go bust, as they always do.

But the big banks and mortgage financial giants are not going out of business and will not need a bailout. During down times they just prune their operations, and if its really bad they will prune away everything except an information hub. Because they are not in the home business, they are in the number tracking business. That’s all they need to do, track these records until they reach some sort of decision point (foreclosure, pooling for MBS, etc), capture the releveant information and route it to processors and decision makers. It makes no difference if they are routing info inhouse, or if they are outsourcing. They just track the records.

The only difference with this cycle is that the boom was very big, so the inevitable correction will be big as well. As will the scale of the layoffs and pruning.

[anxvariety]

doesn’t the front loaded interest on loans = banks gap insurance for foreclosure sale? Sure money still lost.. but at a high level isn’t it more distributed and hedged in a way that dampens the effects on any one institutions condition?

[bigtrouble]

Definitely. And think about it this way: a foreclosure sale is still a sale. They isolate the business unit responsible for the losses (subprime), if the ltv is out of whack, foreclose, sell it to someone else (market price not loan value) and offer a discount if they finance through your company. With the tightening of lending standards, your buyer will have to have better credit. You have just recycled bad paper into good paper, and the losses are isolated to a separate expendable unit.

And these clauses are in almost all payment option ARMS. IF the LTV gets above 110% or 125%, they can automatically readjust. And they will if it makes financial sense to them to do so.

[Author]

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