Sunday, October 25, 2009

Where are All the Bad Loans Hiding?

Pee-Yew! Something sure smells rottenly ripe around the banking industry...

To piggyback on the previous article, let’s review how the securitization process IGNORED risk and thus created over leverage… The Seattle Times just wrote a piece about Wa Mu and how their practices destroyed risk assessment, ultimately leading to their demise:

Reckless strategies doomed WaMu

Execs say WaMu fell victim to the economy & employment; but WaMu caused its demise by embracing risky loans and dismantling safeguards

By Drew DeSilver

On Sept. 10, 2007, Washington Mutual CEO Kerry Killinger stood before an audience of analysts and money managers and assured them the Seattle-based thrift would come out of the housing slump stronger than ever.

WaMu, Killinger told the Lehman Brothers conference, had tightened its lending standards, could access plenty of cash, and was "picking and choosing carefully" when it came to making new loans.

"This frankly may be one of the best times I have ever seen for taking on new loans into our portfolio," he said.

But even as he spoke, WaMu was a dead bank walking. The company had plunged headlong into the business of making exotic, high-risk home loans, selling many of them to investors but holding onto others; now defaults on those loans were rising, and big investors had lost their taste for them.

Almost a year to the day after the Lehman conference, Killinger was fired. Two and a half weeks after that, federal regulators seized WaMu's banking units, effectively euthanizing a 119-year-old institution that had survived the Great Depression and the S&L crisis.

After its collapse, Killinger and other leading WaMu executives repeatedly deflected responsibility, saying the company fell victim to a housing slump turned global credit crisis that they foresaw but couldn't outrun.

But interviews with former WaMu executives and employees, along with government and internal company documents, reveal a far different picture, one of executives charting a reckless course that doomed the bank:

• In its headlong pursuit of growth, WaMu systematically dismantled or weakened the internal controls meant to prevent the bank from taking on too much risk — the very standards and practices that had helped it grow in the first place.

• WaMu's riskiest loans raked in money from high fees, but because the bank skimped on making sure borrowers could repay them, they eventually failed at disastrously high rates. As loans went bad, they sucked massive amounts of cash that WaMu needed to stay in business.

• WaMu's subprime home loans failed at the highest rates in nation. Foreclosure rates for subprime loans made from 2005 to 2007 — the peak of the boom — were calamitous. In the 10 hardest-hit cities, more than a third of WaMu subprime loans went into foreclosure.

By the summer of 2004, nearly 60 percent of the loans WaMu was making were the riskiest sort — option ARMs, subprime mortgages and home-equity loans.

The demise of Wa Mu was easy to see coming. Mish, me, and others tracked their mortgage pools and watched as delinquencies soared. In fact, it was so easy to see coming that I stated well over a year before it happened that they would fail. They did, but we still have a not-so-little problem…

You see, they made a huge number of JUMBO Option-Arm loans that are just now hitting their reset periods and they do not peak until the middle of the year 2011. A very high percentage of loans are going bad. The questions I ask now are; where are they, who holds them, how many times were the same loans sold in differing tranches, and how much risk are the holders of this toxic waste exposed to?

Instead of letting Wa Mu go completely down the toilet, the government (remember the central banks are now the government) decided that JPMorgan would take over Wa Mu. Thus, all of Wa Mu’s “assets” (bad loans) are now owned by JPM, unless they have been able to dump them on hapless “investors” or the U.S. Taxpayer. I sincerely doubt that they have managed to get rid of the bulk of it, but regardless, those time bombs are sitting out in our financial system just ticking away, backed by homes worth a fraction of what they once were. JPM holds more than $80 TRILLION worth of derivatives. While I can’t see exactly what’s going on with the securitization process (who can?), what I can see is the swamp, and the swamp is beginning to smell worse and worse.

Those who think that the financial crisis is over are simply living with their noses buried in the sand. The large banks and the government are complicit in trying to hide the rotting smell. Their fraud and deception are going to be the end of both, just as Wa Mu’s recklessness was the end of them.