Reverse Mortgage good or BadBackward mortgage good or bad
A good bank
Since today, the mechanism of the Bad Bank is hidden, rumours and speculations about how the Bad Bank programme will work. Obama and his Treasury Department had already scheduled to reveal provisional detail of a bailout package next Wednesday, but both outstanding questions and the amount of elapsed working hours needed to review the package with major members of Congress have slowed the revelation.
According to the proposal, a government-created bad bench would consist of a pool that would buy a certain amount of the most poisonous asset currently kept on banking books, such as depreciated mortgage loans and derivative financial instruments, and keep them "fenced". "This would allow them to clear their balances of distressed debt and allow these institutions to recover their loans.
In the ideal case, the reduction of problematic asset values provides a sound financial basis for them. Banking control can concentrate on new business. By selling unprofitable asset values and releasing cash, the institutions will improve their results. Simultaneously, the markets can start valuing distressed debt as soon as the Bad Estate starts selling distressed debt in the open markets.
Latest demands for a "Good Bank/Bad Bank" resolution to the present bank turmoil include a call for an update of the Resolution Trust Corporation (the "RTC") to wind up bankers' poison bank accounts. RTC was established under the Financial Institutions Reform Recovery and Enforcement Act of 1989 as a State-owned US investment fund manager entrusted during the 1980s with the liquidation of wealth (mainly property-related wealth, primarily mortgage loans) of defaulted saving and credit unions ("S&Ls").
Nevertheless, as the buyers strongly avoided "unknowns" about the asset values and the general insecurity about the property markets at that point in times, the prices for certain kinds of asset often turned out to be a disappointment for the State. Accordingly, the RTC launched the programme "Equity Partnership" to assist in the liquidation of property and investments it has taken over from bankrupt savings banks.
RTC's venture capital companies had different structure but were all characterised by a privately owned venturer who (i) purchased a share in a fund, (ii) managed and sold the fund's asset base and (iii) made dividends to RTC in accordance with RTC's held interest.
The RTC 747 completed or redeemed S&Ls between 1989 and mid-1995 with aggregate net worth of USD 394 billion. The Good Bank/Bad Bank approach has achieved significant successes in the retail and smaller business sectors, such as the Mellon Bank/Grant Street National Bank ("Mellon"; now part of the Bank of New York Mellon) deal.
In 1988, due to declining property valuations and the slump in the price of petroleum, Mellon Bank set up a subsidary, Grant Street National Bank ("Grant Street"), to accommodate 191 of Mellon's problematic business and industry lending and lease agreements, as well as property interest. Property was $1.4 billion in value, but was divested to Grant Street at a 47 per cent rebate (about $640 million).
On the other hand, a non-bank Mellon entity administered Grant Street's asset base and quickly wound it up. UBS AG ("UBS") used a good bank/bad banking facility in October 2008 when the Confederation intervened to save the business. To acquire $60 billion of UBS's distressed asset, UBS established a SPV.
Switzerland's National Bank granted the SNI credits of up to 54 billion dollars to finance poisonous investments. Citigroup on 16 January 2009 announces that it has started a revised Good Bank/Bad Banking Plans release by dividing the banks in two in order to reduce its problem asset base.
Even though the detail is not yet definitive, Citigroup's Good bank, Citicorp, would be threatened globally in its key areas of business, namely trading, retailing and investing banks. Bad bank, Citi Holdings, will comprise the bank's private label portfolio, as well as private equity and a high-risk portfolio. Citi Holdings' fortunes as an investee have not yet been decided as Citigroup is considering whether to sell or ripen the investments.
Originally, the TARP was conceived to behave basically like a bad bank buying and accumulating poisonous asset from participant bankers. TARP, with an original $350 billion, would act as a revving buyer credit line to buy problematic mortgage-related securities and other problematic portfolios from finance companies.
Governments would then either (i) either resell these problematic asset values to retail and/or corporate buyers or (ii) own the asset values and redeem the commission. "The proceeds from these disposals and from the vouchers retained would flow back into the fund to make it easier to buy further problematic asset.
Once it became apparent that the economies were weakening much faster than initial expectations, TARP's initial TARP arrangement, as a bad bank, was abandoned. Today, the Bad Bank concept under TARP seems to be taking shape on the basis of recent declarations by the Obama administration's business group.
The above Senator Chuck Schumer explanation shows that the overall costs of the Bad Bank programme remain spectacular, with some estimations ranging from 3 to 4 trillion US dollars. In September 2008, the Federal Deposit Insurance Corporation ("FDIC") insurance companies owned approximately $13.8 trillion in asset holdings with $7.7 trillion in credit and $1.3 trillion in shareholders' funds.
Obviously, the $350 billion of the TARP funding left would not help the amount of bad asset in the system. Exchequer and the present government must find imaginative ways to meet the objectives of eliminating bad asset values from the bank's balance sheet, relieving borrowers and recovering some of the monies spent on buying them.
Unresolved are the main questions: how will the Bad Bank be organised; who will run and administer it; which banks will be allowed to offer their bad bank asset sales; how will these poisonous asset selections be made; how will these asset valuations be made either at fair value or nominal value; and most of all, how much will the Bad Bank programme be costing the taxpayer?
An updated review of the suggested Bad Bank architecture indicates that FDIC may lead the Bad Bank. Sheila Bair, FDIC Chairwoman, is aware that FDIC is in the best possible situation to operate and fund the Bad Bank programme, as it could be issuing loans supported by FDIC.
What competitive argument the Obama government is presenting to either the Treasury, the OCC or the Federal Reserve in a battle for Bad Bank leadership is yet to be seen. Bad Bank would most likely take the form of the RTC and act on the model of the RTC, which was the tool used to deal with the 1930s and early 1990s subprime mortgage lending crises.
Whilst shareholding could be reintroduced to maximise and amortise taxpayers' investment, a major distinction is that the bad bank would not supervise failed FIs with the intention of liquidating bad asset and dissolving the bankrupt. Rather, it is a matter of absorbing the poisonous asset values from the accounts of the banking sector, while the banking sector is recovering.
A further crucial question is what kind of regulation system would be put in place to address the poor asset sales of those bad bankers. The Phoenix Programme was used in the eighties by the Federal Savings and Loan Insurance Corporation ("FSLIC") to bring together one or more troubled SMEs into a unified operational entity, which could then be redeemed or amalgamated, with FSLIC injecting funds into the Phoenixitution.
S&L' s reorganisation as part of the Phoenix programme saw the replacement of the Phoenix Executive Committee and the appointment of a new manager to lead the Phoenix enhanced team. When a Phoenix Bank was set up, it was less expensive for the FSLIC and less political than the payment of insurances to account holders and the liquidation of the FSLIC.
Bad Bank's initiatives are designed to partially open the doors for regulatory authorities to change problematic mortgage issues that are at the roots of the financial turmoil and increasing home enforcement. It is about how the banks rescue and the Bad Banks regimes would help the battered house owners. Probably the Bad Bank's acquisition of problematic investments would also involve problematic mortgage loans.
Being such, many disturbed house owners could contact the German Government in an effort to rescue their houses from foreclosure. IndyMac's banking collapse and the FDIC's reaction may set a precedent for a nation-wide suspension of executions by the state. Part of the Indy Mac confiscation, FDIC chairman Bair implemented a 38 per cent resolution setting a ceiling of 38 per cent of a borrower's earnings that can be used for mortgage, taxpayer and insurer payment.
This involved a step-by-step evaluation procedure of mortgage values and the reduction of mortgage payment below the 38 per cent mark, thus preventing foreclosure. The question remains, however, whether FDIC, FannieMae or FreddieMac could outperform other credit insurers in changing problematic mortgage types. While advocating another FDIC-funded credit bailout programme in November 2008, FDIC Chairman Bair quoted the fact that more than 5,000 of the approximately 40,000 potential beneficiaries had obtained credit modification under the IndyMac credit bailout scheme, a number of sector analysts questioned this.
Generally, the success rate of market-wide credit modification is not particularly high. Latest announcements by the Obama administration's business leadership suggest that a reverse bidding is being conducted to buy the banks' poisonous asset. In general, in a reverse auctions, a purchaser will announce an amount he wishes to buy and a maximal amount he will be paying.
As an example here the purchaser is the Bad Bank and the amount to buy is a certain amount of mortgage-backed bonds ("MBS") with a face value of 100 million dollars. One of the keys issues that would impact any reverse auctions, as already noted, is the valuation of certain specific poison asset held by them.
A kind of poisonous property, the mortgage bond (MBS), poses particular problems in that it is a matter of having fixed income whose income stream is linked to the reimbursement of the mortgage on which it is made. If two MBSs with the same due date and interest rates appear to be the same, they can be rated very differently according to the solvent nature of the mortgage.
It is only the custodian which holds the mortgage in its portfolios that can really value the mortgage, as only it knows the borrowers' credit standing and thus the likely generation of liquidity from underlyings. Probably it would be the case that bankers would decide to divest those parts of their existing investment property that they know have a lower probability of repayment, usually those less than 50 per cent high.
This means that if the programme is meant to be a grant, then the selling prices are at a certain rate above the actual fair value. Otherwise, the bank could not incur the losses without becoming insolvent. A further problem that makes the assessment of MBS more difficult is that there is currently no commercial outlet for this indebtedness, otherwise the bank would have already divested it.
It is therefore hard to determine the value on the basis of what the markets will be paying. The Bad Bank will probably be paying well above the actual fair value for these MBSs. Probably the unparalleled fiscal position has destroyed all credible economic data. Indeed, the role of the Bad Bank is to create the markets.
In the absence of recapitalisation of the bank, the Bad Bank can only buy these asset values if the Bad Bank acquires them with a bonus at actual commercial rates. The bad bank would overpay for the bonds it expected and at the same amount make a great present to the bankers' stockholders if the poisonous bankers' estates were bought at the value at which they were reported in the sales banks' accounts.
One possible remedy would be to oblige the participant institutions to participate in the Bad Banka in order to cover part of the costs of the overpayments. The Confederation, as already noted, compelled UBS to invest $6 billion to fund its bad banking operations in order to at least partially offset the UBS bad banking operations.
A further possibility under consideration is to keep a significant part of the asset on the bank's accounts as long as they are providing their service, but to offer a bad bank guaranty against payment. It would also apply to other asset categories if those asset categories were depreciated within a specific measurement framework.
Every federal programme that has ever been tackled will be outdone in its magnitude, even the RFC of the time of the depression.