Using Veritas to Construct the "Per…

29-04-2017 Hits:93396 BoomBustBlog Reggie Middleton

Using Veritas to Construct the "Perfect" Digital Investment Portfolio" & How to Value "Hard to Value" tokens, Pt 1

The golden grail of investing is to find that investable asset that provides the greatest reward with the least risk. Alas, despite how commonsensical that precept seems to be, many...

Read more

The Veritas 2017 Token Offering Summary …

15-04-2017 Hits:84615 BoomBustBlog Reggie Middleton

The Veritas 2017 Token Offering Summary Available For Download and Sharing

The Veritas Offering Summary is now available for download, which packs all the information about Veritas in a single page. A step by step guide to purchasing Veritas can be downloaded here.

Read more

What Happens When the Fund Fee Fight Hit…

10-04-2017 Hits:84532 BoomBustBlog Reggie Middleton

What Happens When the Fund Fee Fight Hits the Blockchain

A hedge fund recently made news by securitizing its LP units as Ethereum-based tokens and selling them as tradeable (thereby liquid) assets. This brings technology to the VC industry that...

Read more

Veritaseum: The ICO That's Ushering in t…

07-04-2017 Hits:89091 BoomBustBlog Reggie Middleton

Veritaseum: The ICO That's Ushering in the Era of P2P Capital Markets

Veritaseum is in the process of building peer-to-peer capital markets that enable financial and value market participants to deal directly with each other on a counterparty risk-free basis in lieu...

Read more

This Is Ground Zero for the 2017 Veritas…

03-04-2017 Hits:87568 BoomBustBlog Reggie Middleton

This Is Ground Zero for the 2017 Veritas Offering. Are You Ready to Get Your Key to the P2P Capital Markets?

This is the link to the Veritas Crowdsale landing page. Here is where you will be able to buy the Veritas ICO when it is launched in mid-April. Below, please...

Read more

What is the Value Proposition For Verita…

01-04-2017 Hits:87379 BoomBustBlog Reggie Middleton

What is the Value Proposition For Veritas, Veritaseum's Software Token?

 A YouTube commenter asked a very good question that we will like to take some time to answer. The question was, verbatim: I've watched your video and gone through the slides. The exchange...

Read more

This Real Estate Bubble, Like Some Relat…

28-03-2017 Hits:58546 BoomBustBlog Reggie Middleton

This Real Estate Bubble, Like Some Relationships, Is Complicated...

CNBC reports US home prices rise 5.9 percent to 31-month high in January according to S&P CoreLogic Case-Shiller. This puts the 20 city index close to an all time high, including...

Read more

Bloomberg Chimes In With My Warnings As …

28-03-2017 Hits:86911 BoomBustBlog Reggie Middleton

Bloomberg Chimes In With My Warnings As Landlords Offer First Time Ever Concessions to Retail Renters

Over the last quarter I've been warning about the significant weakness in retailers and the retail real estate that most occupy (links supplied below). Now, Bloomberg reports: Manhattan Landlords Are Offering...

Read more

Our Apple Analysis This Week - This Comp…

27-03-2017 Hits:86528 BoomBustBlog Reggie Middleton

Our Apple Analysis This Week - This Company Is Not What Most Think It IS

We will releasing our Apple forensic analysis and valuation this week for subscribers (click here to subscribe - lowest tier is the same as a Netflix subscription). As can be...

Read more

The Country's First Newly Elected Lame D…

27-03-2017 Hits:86871 BoomBustBlog Reggie Middleton

The Country's First Newly Elected Lame Duck President Will Cause Massive Reversal Of Speculative Gains

Note: Subscribers should reference  the paywall material here for stocks that should give a good risk/reward scenario for bearish trades. The Trump administration's legislative outlook is effectively a political desert, with...

Read more

Sears Finally Throws In The Towel Exactl…

22-03-2017 Hits:93187 BoomBustBlog Reggie Middleton

Sears Finally Throws In The Towel Exactly When I Predicted "has ‘substantial doubt’ about its future"

My prediction of Sears collapsing once interest rates started ticking upwards was absolutely on point.

Read more

The Transformation of Television in Amer…

21-03-2017 Hits:90514 BoomBustBlog Reggie Middleton

The Transformation of Television in America and Worldwide

TV has changed more in the past 10 years than it has since it's inception nearly 100 years ago This change is profound, and the primary benefactors look and act...

Read more

This is a DRAFT of part 4 of Reggie Middleton on the Asset Securitization Crisis – Why using other people’s money has wrecked the banking system: a comparison to the S&L crisis of 80s and 90s. As was stated in the earlier parts, I periodically have third parties fact check my investment thesis to make sure I am on the right track. This prevents the "hubris" scenario that is prone to cause me to lose my hard earned money. I have decided to release these "fact checks" as periodic reports. This installment covers consumer finance, an aspect at risk in the banking system that is both overlooked and underestimated, in my opinion.

I urge discourse, conversation and debate on this post and the entire series. To me, it is necessary to make sure the world is as I percieve it.

The Current US Credit Crisis: What went wrong?

  1. Intro: The great housing bull run – creation of asset bubble, Declining lending standards, lax underwriting activities increased the bubble – A comparison with the same during the S&L crisis
  2. Securitization – dissimilarity between the S&L and the Subprime Mortgage crises, The bursting of housing bubble – declining home prices and rising foreclosure
  3. Counterparty risk analyses – counterparty failure will open up another Pandora’s box
  4. You are here => The consumer finance sector risk is woefully unrecognized, and the US Federal reserve to the rescue
  5. To be Published: Credit rating agencies – an overhaul of the rating mechanisms
  6. To be Published: An oveview of my personal Regional Bank short prospects


And now, on to the report...

Reggie Middleton on the Asset Securitization Crisis and Consumer Finance

As with the mortgage market, the consumer lending market reported significant growth since the beginning of this decade largely due to lax lending standards of financial institutions, imprudent lending and poor assessment of payback abilities of customers and more importantly, securitization!!!

Consumer credit is generally classified as revolving and non-revolving. Revolving consumer credit includes credit card lending, lines of credit, home equity line of credit (HELOC) and similar products. These types of lending products do not have a fixed number of payments; there is a limit assigned to the borrower up to which he can borrow and pay the principal and interest within a certain period. The method of functioning in this case is very similar to that of a credit card.

On the other hand, non revolving consumer credit includes loans such as automobile loans, loans for mobile homes, education, boats, trailers, vacations, etc. Unlike revolving credit, these require fixed number of payment over a period of time. Over the last 27 years, non revolving credit on an average has constituted 68.8% of the total consumer credit market.

Consumer credit outstanding (US$ bn)


Source: Statistical Releases of the US Federal Reserve

Growth in consumer credit registered its peak during the S&L crisis, as it grew 18.4% y-o-y to US$517.2 billion at the end of 1984. Over the last 20 years (1988 to 2007), total consumer credit outstanding in the US economy has grown at a CAGR of 6.7%, making it a US$2.57 trillion industry at the end of 2007.

The growth proceedings were dominated by revolving consumer credit (CAGR of 9.0%) due to the rising demand for HELOCs over the years, a result of the booming housing market. Moreover, with low interest rates in the earlier years, borrowers found it easy to get their credit limits enhanced. As opposed to this, non revolving credit grew at a lower CAGR of 5.7% over the same period simply due to the dominance of mortgage lending over other lending forms. The faster growth in revolving credit led to a change in the composition of the market. Revolving consumer credit constituted 37.3% of total consumer credit outstanding in 2007, from 25.2% in 1988.

However, since the growth in the consumer credit market was based on extremely fragile assumptions – which cracked as soon as interest rates went up – increasing number of defaults hindered the performance of the consumer credit industry.

Source: The American Bankruptcy Institute

Rising interest rates led to higher loan payments, which most borrowers could not afford as they were never truly ineligible to bear such heavy burdens of loan paybacks in the first place when they were granted these loans. As a result, the number of individual bankruptcy filings in the US has grown at a CAGR of 2.1% in the last 20 years, from 549,612 in 1988 to 822,590 in 2007. The total bankruptcies in the US totaled 850,912 at the end of 2007, registering a CAGR of 1.7% over the last 20 years.


Source: The American Bankruptcy Institute

The significant rise in bankruptcies came in 2005, after the US Federal Reserve increased the Funds Rate from 2.25% in 2004 to 4.25% at the end of 2005. Total bankruptcy filings rose 30.1% in 2005 to 2.07 million, with a 30.5% growth in individual filings to 2.03 million in the same period. However, in 2006, although Federal Funds Rate was 5.25%, healthy economic growth and improved disposable incomes led to a decline in total bankruptcies (-70.3% y-o-y to 617,660). The year 2007 saw the biggest yearly increase in bankruptcies filed, up 37.8% from the previous year to 850,912 filings. We expect this to number to post another record increase as the effects of the Asset Securitization Crisis bears its prickly fruit.

The percentage of consumer bankruptcy filings as a percentage of total filings has gone up from 89.6% in 1988 to 96.7% in 2007, after peaking at 98.1% in 2005 due to the interest rate rise. While it may seem prudent to expect the 2005 peak to be revisited or surpassed, we believe that corporate bankruptcies are due to spike as the debt of marginal companies overwhelm them in the upcoming quarters due to their inability to refinance out of their cash flow problems. The recent past has seen a lull in bankruptcies due to the happy availability of easy credit. With this “get out of jail free” card revoked, the corporate sector will truly compete with individuals for the bankruptcy record over the next 4 to 10 quarters. The corporate sector will be lead by leveraged loan and high yield bond defaults, while the individuals will be hit by the trifecta of revolving debt - mortgage, HELOC and non-revolving (auto, boat, etc.) loans amid a rapidly stagnating residential real estate and economic environment.

Soaring loan-to-value (LTV) ratios

Another important reason for the downfall, or “one more” indicator of imprudent lending being followed - is the prevalence of high loan-to-value ratios for both revolving and non-revolving debt over the years. The housing issue has been beat to death, so I will highlight the lesser followed consumer finance markets. Considering the LTV ratios for auto loans since 1980, the average LTV ratio from 1980–2007 is 90.4%. In fact, in September 2006, the LTV ratio actually reached a level of 100.4%. Moreover, only in 10 out of the 27 years under consideration was the LTV ratio below 90%.

With loans already issued at such a high LTV, any decline in the value of the underlying asset would further push up the LTV ratio, which increases the risk associated with such loans. Such loans written on traditionally depreciating assets, such as motor vehicles, are guaranteed to inherently increase in risk as a result of merely being written!

Loan-to-Value ratios for auto loans in the US


Source: Statistical Releases of the US Federal Reserve

Commercial Real Estate follows Residential – let’s go down together!

Commercial real estate also followed a similar trend, and declined for reasons almost similar to the residential real estate market. Over optimistic expectations from cash flows of underlying properties, sloppy lending and highly leveraged buying of property. Now, after interest rates went up, most of the excessively leveraged deals suffered massively due to irregularities in loan/lease payments of those who had rented office space. Obviously, the cash inflow of these CRE owners also got affected, which, in turn impacted their loan servicing. Overall, this weakened the market and led to increased vacancies in the US office markets. This, coupled with the influx of fresh supply, shortened the demand supply gap over time and led to weakening of commercial real estate prices, deteriorating the value of the commercial properties. Vacancy rates have risen in US office markets, from 12.6% in 3Q 07 to 12.8% in 4Q 07.

Considering the erosion in value of commercial property, rising vacancy rates and slowing demand in a sluggish economy, the outlook appears extremely bleak.

The consequences – bankruptcies, sell-offs and writedowns

Not surprisingly, speculation in real estate, poor discretion at the time of lending and lax overall lending standards did what they were supposed to – they triggered a series of write-downs as soon as payback (dis)abilities of the borrowers started to coalesce.

The first to suffer were obviously the mortgage lenders. The race to the bottom began in early 2007, when mortgage lenders began to report bankruptcies, close lending operations or simply sell themselves off. According to “Subprime Shakeout”, a compilation by the Wall Street Journal, a total of 42 mortgage lenders – led by subprime mortgage lenders – either filed for bankruptcy, closed all or part of its lending operations, or were sold off in 1Q 07. This marked the collapse of the subprime lending market in the US and shivers are still being felt across the world.

New Century Financial Corporation – the nation’s then biggest subprime lender – was one of the first casualties of this crisis which filed for bankruptcy on 02 April 2007. In the period from January 2007 - September 2007, there were 100 mortgage lending institutions which had either filed for bankruptcy, stopped all or part of its lending operations, or were sold off!

These developments had a negative impact on the MBS/ABS markets as liquidity contracted and the reduced demand for investment led to a significant drop in the fresh issuance of MBS in 2006 and 2007. With an average annual growth rate of 28.0% for MBS issuance in the 1997-2005 period, total MBS issued grew by a mere 1.1% in 2006 and 3.1% in 2007.

The next to be affected were financial institutions like commercial banks, who had recklessly lent in the mortgage market; investment banks, who had underwritten some of the riskiest MBS issues and allegedly invented the exotic products; and hedge funds, who had hefty investments in the securitized assets market. This led to a series of write-downs across major global banks. This not only worsened the impact of the crisis, but also gave a major indication of the depth to which the crisis was enrooted in the US financial system.

Hedge funds too, had to bear the brunt of the decline. In mid-2007, Bear Stearns was looking to raise US$3.2 billion to bail out the High-Grade Structured Credit Fund and the High-Grade Structured Credit Enhanced Leveraged Fund. Later in July 2007, Bear Stearns declared the funds to be almost valueless. It was at this juncture that the Subprime Crisis had hit Wall Street in earnest, leading to the eventual demise of Bear Stearns, the nations 5th largest investment bank. Bear Stearns collapsed in mid-March of 2008. Side note: Although I was short Bear Stearns in 2007, I issued a research note declaring the “Breaking of the Bear” in January, which – in no unequivocal terms – made clear these events were about to happen.

This is just one instance. Various funds owned by major institutions such as BNP Paribas, Goldman Sachs and Sentinel Management Group suffered significant value depletion in the same period.

Write-down statistics – where do we stand

Although the impact of the crisis were witnessed first on the financial statements of the mortgage lenders, it was (and still is) the major commercial banks, investment banks and hedge funds who bore the maximum brunt of the fiasco.

The total value of global writedowns at the end of April 2008 was US$265.4 billion reported by 42 institutions, with most of these based in the US (we feel that Europe and Asia will see their native institutions write down significantly more assets in the next few quarters).

15 biggest write-downs since the beginning of 2007 (April 2008)


Source: Asset-Backed Alert

Note that this table shows only the top 15 write-downs of the available list of 42. Moreover, the 42 institutions considered are only those who have reported a cumulative pre-tax write-down greater than or equal to US$0.5 billion since the beginning of 2007. This list can, and probably will, expand dramatically as banks are forced to become more realistic in their approach to writing down impaired assets.

Rising layoffs in financial institutions

In a quest to reduce their losses incurred as an impact of the crisis, many financial institutions in the US have resorted to streamlining their operations and consequently slimming down their workforce. According to statistics reported by Bloomberg on 24 March 2008, major job cuts were witnessed in the crisis-hit banks after the subprime mortgage market collapsed in July 2007. The total job cuts totaled 34,463 in this period.

Crisis-hit banks and job cuts since July 2007


Source: Bloomberg

This graphic does not take into account the failure of Bear Stearns, which will most likely result in the bulk of their employees being laid off as a result of the purchase and pruning by JP Morgan Chase. We expect between 8,000 to  14,000 additional layoffs. UBS, after posting a net loss of US$10.9 billion in 1Q 08, has planned to further cut 5,500 more jobs, which would reduce its current workforce by almost 7%.

According to the WSJ:

The global financial crisis is increasingly claiming jobs as the stock market struggles, financial firms retreat from risky businesses and deal-making remains slow. More than 23,000 financial-related U.S. job cuts were announced last month, according to outplacement firm Challenger, Gray & Christmas Inc. That increased the total to 49,825 in the first four months of this year -- nearly as many job cuts as were announced for all of 2007.

The US economy managed to grow by only 0.6% y-o-y in 1Q 08, according to advance estimates provided by the Bureau of Economic Analysis. Moreover, unemployment rate has jumped from 4.5% in April 2007 to 5.0% in April 2008. This is due, in no small part, to the contributions made by the construction, real estate and banking industries.


The US Federal Reserve – Moral hazard is for others!!!

The bailout of homeowners

On 31 August 2007, President Bush announced bailout plans for homeowners unable to bear the burden of high interest costs of their debts. After this announcement, various measures were taken to bailout the homeowners.

First, the launch of FHASecure initiative at the Federal Housing Administration (FHA) was completed, to offer refinancing to creditworthy homeowners who are unable to service their debts. By 2008, this is expected to help 0.3 million families.

Second, the HOPE NOW alliance consisting of credit and homeowners’ counselors, mortgage servicers, and mortgage market participants was formed in October 2007. This alliance aims to “reach families early, before their mortgage problem becomes overwhelming”.

Third, the Department of Housing and Urban Development and the US Federal Reserve have decided to tighten the requirements to improve disclosures. This would help homeowners receive accurate and complete information about their mortgages.

In addition, the Foreclosure Prevention Act was passed on 10 April 2008 by the Senate, which also provides various relieves for homeowners. Some of the important measures, amongst others, include:

  • Modernization of the FHA permitting it to insure home loans worth as much as US$550,000 after 2008. In 2008, the loan limit granted to it is US$729,500
  • Tax credit of US$7,000 for buyers who purchase a foreclosed property within the next 12 months
  • Temporary tax deduction of US$500 for single filers and US$1,000 for joint filers

Bailout of financial institutions

The steps taken by the US Federal Reserve in this regard encompass a variety of measures and easily undermine the initiatives taken to help other parties involved in the crisis. Some of the most significant measures taken to help the US financial system, apart from the famed Bear Stearns bailout included:

Interest rate cuts

The most important monetary measure from the US Federal Reserve was the consistent cuts in its benchmark Federal Funds Rate. In order to ease liquidity pressures and foster lending in the economy, the US Federal Reserve reduced the benchmark interest rate from 5.25% in June 2007 to 2.00% in April 2008.

Federal Funds Rate


Source: US Federal Reserve

Apart from this, the US Federal Reserve also facilitated lending through its discount window by slashing the discount rate to lessen the interest rate pressure on commercial banks, thereby improving the overall liquidity position. Moreover, beginning 17 August 2007, the primary credit program under the discount window was changed to allow primary credit loans up to 30 days as compared to overnight or for very short term.

Discount rate (primary credit)


Source: US Federal Reserve

Increased availability of funds

In August 2007, the US Federal Reserve injected US$38 billion in the form of repurchase agreements for MBS, and a further US$2 billion later. These were followed by various other policy measures including the interest rate cuts mentioned above, and later US$41 billion was further injected into the system in November 2007.

The US Federal Reserve also took significant decisions under its Term Auction Facility as well as Term Securities Lending Facility. On 07 March 2008, the US Federal Reserve announced the amounts outstanding in the Term Auction Facility (TAF) to be increased to US$100 billion, an increase of US$20 billion from earlier the limit. Moreover, it announced that it would implement a series of term repurchase transactions worth US$100 billion, accepting various types of collateral such as treasury securities, agency debt securities, or even agency MBS.

Generally, under the Term Securities Lending Facility, the US Federal Reserve used to lend to primary dealers only overnight. However, it took a big step, after it extended the period from overnight to 28 days, beginning 27 March 2008. On 11 March 2008, the US Federal Reserve also announced it would lend US$200 bn of treasury securities to primary dealers for a period of 28 days.

The bailout of homebuilders

Although the “Foreclosure Prevention Act” passed by the Senate is primarily publicized to help homeowners, there is an arguably important move in favor of the home builders. The center of attraction of the Foreclosure Prevention Act passed is a tax break worth US$25 billion for home builders over the next three years. This measure permits such companies to adjust the losses they would witness in 2008 and 2009 against taxes paid as far back as 2004 (the boom times of imprudence and bad judgment in the real estate bubble) and claim immediate cash refunds. However, this is being viewed as a deliberately designed measure for the benefit of the home builders, who enjoyed the boom as much as any other entity involved and were also partially responsible for aggravating the crisis through aggressively creating and marketing homes and “by any means necessary” mortgages through their financing subsidiaries. In addition, their imprudent buying drove up land prices to unsustainable levels through leveraged fueled, off balance sheet joint ventures.



Please show your support. Digg this article!