Published by clickbroker.blogspot.com
A new form of restraint is evolving on future residential real estate bubbles that goes way beyond more stringent lending standards and better due diligence on borrowers. The Wall Street Journal’s “A Short Sale May Not Mean You're Home Free” reports that banks, mortgage servicers and mortgage investors are becoming more aggressive in recovering the remaining loan balances after a short sales and foreclosures. The inclusion of a promissory note might not be directly obvious in the short sale agreement, as the clause might be hidden in the small print.
States vary in their laws for allowing additional recovery after foreclosures, and forcing the borrowers into bankruptcy might or might not benefit the lender. But short of foreclosure and bankruptcy, the lender has complete discretion on the amount of forgiveness to bestow on the borrower. Dept forgiveness by the primary mortgage holder does not imply forgiveness of any secondary leans. The Journal pointed to a former WaMu borrower granted a short sale with forgiveness on the first mortgage only to have JP Morgan (JPM) demand payment on the second mortgage.
Walk away borrowers are starting to be actively pursued if they have a job and any assets. At this point it’s an economic decision based on cost and expected recovery. But as the courts and bankruptcy laws continue to be tested, more standardized out of court settlements should evolve.
The important question is how will an active pursuit of deficiencies effect real estate buyer behavior and their appetite for risk? Will future buyers fully understand that their obligation to repay their loan is independent of the collateral they post? In this case, I hope the states move to a legal framework that obligates borrowers beyond the value of their collateral.
Educating mortgage borrowers to their repayment obligation might put a drag on home sales and lenders might once again become complacent about the value of residential real estate as sufficient collateral. But adding risk to the borrowers, beyond their down payments, would create a more even real estate market. This should fit in well with President Obama’s call for the end of severe bull and bust cycles.
Think about how many times Federal Reserve Chairmen Greenspan and Bernanke adjusted interest rates in the last two decades to try to fine tune the economy. Neither being successful, but in desperation Greenspan proclaimed booms and busts were necessary to promote innovation.
The President is trying to focus consumers on understanding and intelligently using credit, from mortgages to credit cards, and being treated fairly in the process. We cannot depend on a consumer economy to the detriment of the consumers themselves. The new thinking goes against everything both Greenspan and Bernanke stand for. But the pursuit of mortgage deficiencies is certainly one of the primary steps in whipping the consumer back into shape.
Fair lending practices must include consumer responsibility for all their debts and being fully knowledgeable of their obligations before signing. As difficult as it is for the banks to digest, consumers must be told that they may never get out from under a credit card debt with a 30% interest rate.
The consumer economy has relied far too long on disguising the traps of consumer debt. The financial system must first end usury interest rates, and then aggressively pursue all obligations, so that consumers are scared straight. The Fed be damned.
No disclosures.
Banks Seeking Short Sale Deficiencies
Dendreon’s Provenge: Scientifically Intriguing, Commercially Nonsensical
Published by clickbroker.blogspot.com
I know that Dendreon’s (DNDN) groupies are an enthusiastic bunch. Now Wall Street has joined the party, at least until they get the fees from Dendreon’s inevitable secondary stock offering needed to fund Provenge’s launch. Dendreon doesn’t plan on filing for FDA marketing approval until sometime in Q4, and then the FDA could take up to an additional 6 months to contemplate the amazing data. The company refused to be any more specific as to when in Q4 or why the delay in filing.
Opportunism is the hallmark of the company’s CEO, so between now and year-end the FDA cannot say that the supplemental NDA filing is insufficient. That’s right; this is an add-on to the prior rejected NDA. Dendreon cannot chance the FDA rejecting its paperwork early. This provides the company with a risk free window to raise cash. They plan to commercialize Provenge in the U.S. themselves.
Adam Feuerstein in TheStreet.com “Dendreon's Provenge: A Behind-the-Scenes Look” and Catherine Arnst in BusinessWeek “Dendreon's Prostate Vaccine Validated with Drama” give us some background into the medical and economic benefits of Provenge.
Provenge was tested against placebo, not the standard of treatment Taxotere. Provenge’s survival benefit over placebo was about a median 4 months (25.8 vs. 21.7), but it had only about a median 1 month survival benefit over Taxotere. The company’s management tried to convince analysts that while Provenge was not measured against Taxotere, patients would find Provenge less invasive to administer. But they also told us that both have side effects over placebo.
Three urologists interviewed by Feurstein doubted “Provenge’s survival benefit in relation to the drug’s high price.” Dendreon refused to comment on price, except to say that it should be judged equivalent to other advanced cancer treatments. The urologists further stated that Provenge showed no measurable positive effect on time to progression.
Feurstein said Dendreon bears had to cover their shorts and some have turned around and gone long. Analysts are predicting certain FDA approval and a $1B to $2B annual sales base on $60K to $80K for a course of treatment. Feurstein says that a $30K price is ridiculous compared to Avastin and Erbitux.
While Wall Street is preparing for the road show, their logic is simply nonsensical. First, Provenge won’t be launched for at least another 18 months, if at all. The manufacturing and processing operation for this patient customized medicine will face intense FDA scrutiny. More importantly, all of these sales estimates are based on the American drug marketing and reimbursement model remaining static. With the current momentum in President Obama’s healthcare reform, that’s like sticking your head in the sand.
The U.K. has restricted Avastin (Roche) based on limited benefit for the cost and required that the government be rebated for patients not benefiting from Velcade (Takeda). The National Institute for Clinical Excellence (NICE) advises the NHS on the cost-benefit of drugs. Despite the industries disbelief that the cost-benefit of pharmaceuticals will come to America, it is a key plank in the President’s healthcare platform.
It is unlikely that a 1 month survival benefit with no additional quality of life benefit will ever be worth $60K under American healthcare reform. Beyond that is the ethical issues related to the distribution of care. If you go with the premise that most of Provenge’s target audience will be government subsidized through Medicare, how can you justify taxing a working person struggling to pay a $100 doctor bill to give a senior 1 month of life?
Some try to argue that healthcare reform will bring rationing of care for the first time to America. Anyone with high deductible insurance plans knows it already exists. The reality is that America actively rations care in favor of those with high priced insurance and seniors. Provenge expects to take advantage of the current system of rationing.
The swine flu scare is teaching America that it is only as healthy as its entire people. The healthcare have-nots can easily infect the healthcare haves. Potential epidemics from SARS to bird flu are happening as often as financial black swans. Likewise the once in one hundred year storms seem to appear every few years.
Dendreon CEO Mitch Gold wants his stock to steady long enough for major mutual funds to take interest. But he is selling the same fantasy that healthcare reform will not affect business as usual as Merck (MRK), Pfizer (PFE), Humana (HUM) and UnitedHealth Group (UNH) tried to do on their Q1 conference calls.
What the healthcare industry needs to learn from the banks is that companies that depend on the government can get TARPed and feathered. Humana depends on Medicare Advantage for 40% of its members. Just like the defense industry, government is their biggest customer. And Obama has not been afraid to shakeup the defense contractors.
The clear lesson to Dendreon bulls is to model Provenge under the stress of full blown healthcare reform based on the U.K. cost benefit model. If Provenge cannot pass the Federal Reserve’s bank stress test, sell Dendreon now before the hype subsides.
In my previous Dendreon article “Dendreon’s Troubles Beyond Provenge’s Potential FDA Approval”, I was concerned with whether their form of customized medicine was commercially viable. With the data release on April 28, my new concern is drug price realization. Clearly the expectations are overblown.
If Gold gets his wish and the stock steadies, puts might get cheap enough to bet on the downside. I think we may have to wait a few months. Hang on tight for a wild ride.
Disclosure: Author is long PFE.
Merck’s Position on Healthcare Reform
Published by clickbroker.blogspot.com
Merck’s media relations representative Ronald Rodgers sent Click Broker a form letter objecting to the article “Merck and UnitedHealth Group Unprepared for Obama’s Healthcare Reform”. The purpose of my article was to highlight that Merck (MRK) and UnitedHealth Group (UNH) did not really believe significant change would happen and were unprepared if it did. Rodgers recommend that I read Merck’s Public Policy Position and Merck’s President of Global Human Health Kenneth C. Frazier’s speech before the FDA-CMS Summit for Biopharm Executives (12/04/2008) to correct the record.
Rodgers’ form letter contends: “We believe your significant misstatements of fact are based on a lack of awareness of Merck's positions on health care reform. The fact is Merck supports comprehensive healthcare reform in the U.S. While much work remains to be done, we believe healthcare reform is the right path forward for the patients we serve, our company and our industry.”
The documents make it clear that Merck and their trade group PhRMA wanted a seat at the healthcare reform table. The Wall Street Journal’s “Business Spends Less, Unions More on Lobbying” reports the Pharmaceutical Research and Manufacturers of America increased lobbying 12% in Q1 2009 to $6.9M. But the majority of their effort is focused on health insurance rather than reforming the practices of the pharmaceutical industry.
Merck’s recommendations center on maintaining the current public-private system with the following insurance reforms: play or pay for employers, mandated catastrophic coverage for individuals, guaranteed issue, community rating by age, eliminating pre-existing conditions with continuous coverage, and equal tax treatment for individuals and businesses. Merck is against any “Medicare for All” options. But Medicaid should be available for individuals up to 100% of the federal poverty level. Subsidies should be provided for private plan participants with incomes up to 300% of the federal poverty level.
Merck claims they support The Comparative Effectiveness Research Act of 2008, along with “more research and public dissemination of cost and quality”, and more transparent pricing. But Frazier really is not interested in the government determining cost effectiveness of drugs, only “comparative effectiveness” (efficacy). Merck does not want the government to say that the slight benefit of one drug over another is not worth the cost difference, or a drug is not worth its cost at all. This is a critical area were consumers need help.
Merck chooses not to address any of the pharmaceutical industries practices that drive up the cost of healthcare: direct to consumer advertising, life cycle management, and the ever expanding use of cholesterol and other lifestyle drugs. Direct to consumer advertising has created diseases and consumer fears where often no treatment is required. The idea is to create awareness that a slight pain or ache is really a serious problem. The advertisements say one disappointing evening leads to dependency on ED medications, or too many trips to the bathroom can spoil your day. Fortunately, the recession has stunted the effectiveness of direct to consumer advertising.
Life cycle management is a far more sinister version of the new and improved Tide syndrome. First, once a drug is approved, price increases one or more times a year are common. After the R&D and manufacturing startup costs are fully amortized, there is no free market explanation for price increases. The pharmaceutical market lacks any free market discipline; it functions more like an oligopoly. Merck is staunchly against the re-importation of drugs and Medicare Part D directly negotiating drug prices. Merck must believe that Americans should pay the highest price in the world for drugs.
Life cycle management part two is even more difficult to defend. The year before a drug’s patent is due to expire and be subject to generic competition its price is raised significantly. The new and improved version is much cheaper to attract all of the new prescriptions. Patients on the new and improved drug cannot easily be switched back to the generic form of the old drug. This transitioning severely weakens generic competition. A true free market would never support the volume of branded statins with so many generics available.
Lifestyle drugs for cholesterol, high blood pressure, asthma inhalers and others have been the lifeblood of the traditional pharmaceutical industry for the last two decades. Each year the disease delineation line for cholesterol and blood pressure are systematically lowered so more Americans fall into the group that needs treatment. Merck does not want the government to challenge the cost effectiveness of constantly expanding the target audience for lifestyle drugs. Pfizer (PFE) sees this ending and is dropping out of the cholesterol business once the patents for Lipitor expire.
Drug pricing has become much like the due diligence of corporate compensation committees. Drugs are priced to equal their peers, not compete against their peers on price. Competition is the roles of sales and marketing, in a world where cost is of no object.
In conclusion, Merck has not told us specifically how they are preparing to be a more cost effective participant in healthcare reform. Can Merck maintain its profitability as a low cost drug producer? Can Merck withstand world pricing coming to the American market? What changes in marketing and distribution would be required for Merck to compete under President Obama’s vision of healthcare?
Disclosure: Author is long PFE.
Merck and UnitedHealth Group Unprepared for Obama’s Healthcare Reform
Published by clickbroker.blogspot.com
In two Tuesday Q1 earnings conference calls, one at 8:30 AM and one at 11:00 AM, I got the notions of Alice in Wonderland and an ostrich with its head in the sand. Neither Merck (MRK) nor UnitedHealth Group (UNH) really believes that President Obama and the Democrats can actually pull off a healthcare revolution. Both half heartedly said that some type of reform is coming, but neither showed any deviations from business as usual as they continue to deteriorate.
Let’s look at Merck first. Overall sales dropped 8% and sales of Gardasil dropped 39%, Vytorin dropped 28%, and Fosimax went generic. And Merck still believes that the Schering-Plough (SGP) merger still makes sense. According to Merck, it’s just the economy and distributors running down inventory. Consumer behavior has not really changed and their lobbyists will never allow Congress to pass funding for efficacy and cost effectiveness drug comparisons.
As soon as the distributors start restocking, Merck will be fine their thinking goes. Merck did admit that consumers appeared to be delaying doctor visits, but they intend to ramp up direct to consumer advertising to remedy that. Apparently, Merck was not listening to Larry Summers this Sunday when he said that comparative analysis of medical procedures and pharmaceuticals could save the nation up to $700B over a decade.
Gardasil is on the way to becoming a flop, and Vytorin is just another me-too statin. If Merck cannot provide true cost effective value during the healthcare revolution, it will become a generic of itself. Maybe that’s the idea behind Merck BioVentures.
Here I go again ranting that UnitedHealth just does not get it. Membership dropped by 1.5M due to job losses, but government programs (Medicare and Medicaid) were steady. UnitedHealth has not seen any evidence of adverse selection through COBRA, however analysts were concerned.
The economy has not caused their 3M high-deductible plan members to cut back on usage so far. So UnitedHealth will start feeling the impact once the deductibles are broke. UnitedHealth tried to make sure analysts understood the seasonality of deductibles. UnitedHealth touted these plans as private sector initiatives to save money, but did not recognize that the political climate has changed and President Obama wants everyone to be covered by comprehensive health insurance.
In defending their Medicare Advantage plans, UnitedHealth stated that their selection of superior doctors and hospitals prevented far more readmissions than standard Medicare. Again, President Obama doesn’t see any statistical evidence of better outcomes from Medicare Advantage. Although Medicare Advantage reimbursements were reduced 5% this year, UnitedHealth believes they will be able to negotiate a better deal. This is further evidence that UnitedHealth will be buried next year.
UnitedHealth provided mixed answers when questioned on their preparation for the government plan option for consumers. They said the “Medicare for All” plan is just a concept so they could not analyze the impact. UnitedHealth might benefit as an administrator was the initial response. Then their political hack lambasted a government plan saying Medicare-like price controls would mean a 29% reduction in hospital reimbursements and a 19% drop in doctor reimbursements. Sorry UnitedHealth, sharp cost reductions is exactly what President Obama wants.
Both Merck and UnitedHealth are inefficient Goliaths of the statin pumping generation. Think of the wrenching changes IBM (IBM) went through to evolve from the mainframe generation and you’ll understand what Merck and UnitedHealth must do to survive and become economically viable in the healthcare revolution.
No disclosures.
Fed’s Backdoor to Negative Interest Rates
Published by clickbroker.blogspot.com
By now, every living cable viewing being has seen the P90X infomercial touting the fitness benefits of “muscle confusion.” Their theory is that bulk building plateaus when your muscles get used to the same movements. The secret goes, mix up your routine and you’ll get extraordinary results. Faster results than you ever dreamed possible.
From the YouTube videos of the P90X cult followers, we get the real life before and after pictures by week for the first 90 days. You may want to hide your eyes. While the laptop cam reality players haven’t lost their enthusiasm, they admitted they are having trouble keeping up with the program. And confused or not the reality players don’t match the muscle tone or bulk of the infomercial actors.
The confusion that Federal Reserve Chairman Ben Bernanke has created over the last two years has not done anything to improve the nation’s brain tissue bulk or toning either. Even a man of substantial physical and mental bulk, former Federal Reserve Chairman Paul Volcker has verbally challenged Bernanke’s 2% inflation target. If Volcker doesn’t get it, than there is little hope for the rest of us.
That is until The New York Times’ “It May Be Time for the Fed to Go Negative” explains Bernanke’s logic. The Fed has already lowered short-term interests to zero, and the numerous other credit creation programs are doing little to motivate consumers to actually spend. Increasing the supply of credit is like leading the horse to water, but as the say goes, getting the horse to drink is another matter.
Asking consumers to accept the bank charging them for their savings account or CD is as fortuitous as borrowing $100 from the bank and only having to pay back $97. Bank of America (BAC) CEO Ken Lewis said in the Q1 conference call that deposit interest rates needed to attract savers have reached their cycle low, so the NYT example of a negative 3% interest rate will never happen. Savers would keep their money in a safe deposit box and lenders just wouldn’t lend. Just like the behavior of gold.
Helicopter Ben is not one to be stopped by the constraints of mere mortal behavior. The Fed has historically lowered interest rates below inflation to motivate spending. And we have had negative real interest in many periods of our financial history. What is different this time is that nominal short-term interest rates are already at zero, so even Bernanke has to admit that they cannot be lowered any more.
So if Bernanke cannot lower nominal interest rates, but still wants to cut real interest rates further what does he do? The NYT hit the jackpot; create the belief of sustained inflation for the foreseeable future. Higher perceived future inflation implies greater negative real interest rates and greater enticement for businesses and consumers to spend now. So you see my dear Watson, interest rates really can go below zero.
In order for Bernanke to motivate spending, the inflation fear has to be large enough and sustained enough to overcome the hoarding instinct in times of economic fear. Sorting through the confusion of Bernanke’s mixed messages cannot be any clearer. Sustained and increasingly negative real interest rates for the next decade is the message to the finically astute. And excess liquidity will be removed before inflation starts is the message for the politicians and the general public. Trouble is Volcker caught Bernanke and his cohorts with their shoes untied.
Bernanke’s P90X program is perfectly clear: The Fed is bulking up on inflation, whether its muscles are confused or not.
Disclosure: Author is long BAC.
Fed Running Out of Credit Worthy Consumers
Published by clickbroker.blogspot.com
The Federal Reserve has stated unambiguously that it wants to boost the economy by putting more money into the strongest hands. The Fed only wants to extend credit to consumers who can handle it, giving the best borrowers lower mortgage rates and freer unsecured credit. Even without cash-out refinancing, the Fed believes that consumers will spend more by lowering their mortgage payments. But what happens when the Fed runs out of strong hands? How will they boost consumer spending?
On Tuesday President Obama showed some enlightenment. During his midday economic speech, the President said that we have to move from a nation of consumers to a nation of producers, implying the strong hands have to move from spending to saving and investing. Aside from the alchemy of converting the financial “masters of the universe” to scientists and engineers, we were given little guidance.
Trouble is the President was speaking of the future and in the present no policies are shifting away from a consumer dominated economy. All incentives, including the eminent hyper inflation are leading to the continuation of the same economic model of the last 60 years. This model that has become more consumer oriented with each passing decade. Despite the President’s rhetoric, “it is never the right time” to change the economic model.
Getting back to the Fed, all guns are pointed to the shadow banking system to boost consumer spending. Amongst the incomprehensible multitude of Fed and Treasury programs there exists the purchase of GSE MBS and securitizations of auto and credit card loans. Wells Fargo (WFC) and Bank of America (BAC) have created a temporary jubilation with their Fed driven profits from mortgage refinancing.
Like all Ponzi schemes this too will come to an end when the pool of qualified borrowers is exhausted. Retail spending is also likely to continue to fall along with housing prices. People buying houses with artificially low interest rates are likely to lose money unless they receive a substantial discount on their purchase price.
The Wall Street Journal’s “Banks Ramp Up Foreclosures” reports that Bank of America, Citigroup (C), JP Morgan (JPM) and Wells Fargo have ended their mortgage foreclosure moratoriums and are once again separating the weak from the strong. President Obama’s foreclosure mitigation initiatives will only benefit homeowners strong enough to actually pay their mortgages. Foreclosure avalanche two is just beginning.
Let’s hope the Fed’s next move is not to actually lower lending standards to increase its pool of consumers. Or better yet let’s believe that President Obama really wants to turn America into a country that makes stuff. In "US Needs to Convert from a Consumer to an Industrial Economy", I must have had a premonition of the President’s intent. Unfortunately, we just might have to waste a few more trillion dollars on the way to get there.
Disclosure: Author is long BAC, C and WFC.
Dendreon’s Troubles Beyond Provenge’s Potential FDA Approval
Published by clickbroker.blogspot.com
Dendreon (DNDN) is a company not unknown for hype. Today’s hype was that the Provenge prostate cancer immunotherapy met the Phase 3 survival goals of reducing death by 22% and extending life by 4.5 months for men with advanced prostate cancer who no longer responded to hormone therapy. While the company claims the results are consistent with previous studies, detailed results will not be presented until the American Urological Association's Annual Meeting in Chicago on Tuesday, April 28 at 2:20 pm CT.
I won’t pass judgment as to whether the product is clinically effective. The investor risk is greater with the clinical procedure. The procedure involves three cycles of blood extraction, antigen loading and reinfusion over four weeks. The extraction and reinfusion take place in the doctor’s office, while the customized antigen loading is done for each patient in Dendreon’s manufacturing facilities.
Given the difficulty of this procedure for patients and physicians, the actual clinical results will have to be significantly better and more cost effective than oral or infusion-only products. I had a bad stock investment experience with Trimeris’ (TRMS). Trimeris' Fuzeon HIV treatment showed clinical superiority, but the twice daily injections proved too cumbersome and painful for its target audience. Fuzeon showed only limited commercial success. Likewise, I believe that Provenge’s cumbersome procedure will inhibit its success, even if you believe management on the trial results.
In addition to patient and physician acceptance, Dendreon has a series of manufacturing and logistical problems to overcome. In its unique process, it has to become both the Intel (INTC) and Federal Express (FDX) of the pharmaceutical industry.
Shorting this stock carries a lot of risk and the puts are priced for very high volatility. If you believe the product will be approved by the FDA, but have limited commercial success, wait for the implied volatility to wane. This should happen after the detailed results are on April 28 are released. Betting on the urological conference is too expensive, whereas betting against the long-term success of Provenge should be quite inexpensive.
Disclosure: Author is long TRMS.
Fed Crowding Out Banks as Portfolio Mortgage Lenders
Recently I wrote "The Death of Mortgage Banking and the Shadow Banking System" describing Geithner and Bernanke’s futile attempts at resurrecting the banking system that led to the current worldwide financial meltdown. Now I would like to explain the facilitators of the shadow banking system and how the government is forcing banks away from portfolio mortgage lending.
The shadow banking system proliferated because investors in structured products viewed them as risk free. MBS, CDO, and various CLO were considered virtually risk free based on two factors: statistical modeling and insurance through CDS. I believe that investors were fully aware of the high level of fraud in mortgage origination, but thought that the history of a continuing rising real estate market would mitigate the financial impact of fraud.
In order for Geithner and Bernanke to resurrect the shadow banking system, they would have to convince investors that it is once again risk free. After the Long Term Capital Management collapse and the current crisis, it will be a long time before statistical models are trusted again. And the cost of insuring structured products has increased dramatically since the real estate bust. Now the government is trying to recreate the risk free structured products environment through the Public-Private Investment Program, but investors are worried that the program is not politically risk free.
Prying legacy portfolio whole loans and securities from banks has proved difficult for the government for a multitude of reasons. So the Federal Reserve is attacking the new loan market. The policy of printing almost $1.5T to buy Fannie Mae (FNM) and Freddie Mac (FRE) MBS and debt has mortgage interest rates recently below 5%. At this level the interest rate risk is too difficult to hedge economically for banks to do portfolio lending. And no private investor could compete with the Fed given the outlook for much higher inflation and interest rates.
The political cry to prop up real estate prices is being extended to commercial properties. Given that commercial mortgages are medium term and need to be rolled over, this would provide some relief to the banks. But here again, the Fed would be crowding out banks that want to lend at tougher terms. The banks have no leverage once the Fed enters the game.
The banks might be smart enough to avoid the interest rate risk in the current environment, but it seems as though Fannie and Freddie have no choice. The government should be doing everything possible to shrink the GSEs’ portfolios, instead of expanding. The GSEs cannot possibly hedge close to a combined $2T of interest rate risk. Dealing with future interest rate exposure will make the GSEs credit exposure seem like child’s play.
The Fed’s effort to crowd out everyone else in the market for new mortgages comes at no risk to itself being its cost of funds is free. Bernanke is shouting from the rafters that he will raise interest rates in time to stop inflation. So it does not matter whether banks are worried about higher interest rates or inflation, they cannot compete with a desperate Fed.
Disclosure: Author is long FNM and FRE.
The Death of Mortgage Banking and the Shadow Banking System
The Los Angeles Times’ “Bill would fundamentally reform home mortgage industry” reports that House Financial Services Committee Chairman Barney Frank and friends introduced the Mortgage Reform and Anti-Predatory Lending Act of 2009 (H.R. 1728) on March 26. The most chilling provision of the bill for the shadow banking system is the extension of liability for underwriting violations to third party securitizers. Together with the 5% capital requirement for originators of all production except 30-year fixed rate loans, this will lead to the end of most mortgage bankers.
My understanding of the players is mortgage brokers originate loans for commercial, savings and mortgage banks as correspondents or independent agents. They do not warehouse or maintain their own capital for production. Mortgage bankers both originate and warehouse loans prior to sale or securitization and are therefore dependent on the almost nonexistent warehouse financing. Even loans originated for sale to Fannie Mae and Freddie Mac must be financed for a short period of time.
Banks no longer trust mortgage brokers and are now relying on their own retail networks for originations. And if mortgage bankers cannot even get adequate warehouse financing where are they going to come up with the 5% capital requirement for ARMs and other exotics? This will limit the few surviving mortgage brokers and bankers to only writing the safest 30-year fixed rate production.
Consumer protections include: forbidding payments to loan originators based on interest rate and type of loan, minimum mortgage quality standards, loan officer “duty of care” related to home buyers’ income and ability to pay, and the “net tangible benefit” test for refinancing.
Mortgage originators are so scared that The Dallas Morning News’ “Mortgage rates are great – if you can qualify” reports that they are being even more strict than Fannie (FNM) and Freddie (FRE) require to insure their loans get purchased.
Mortgage banks are not depository institutions, so beyond the 5% of ARMs and exotics they do not have capital requirements to be impaired by maintaining liability on securitizations. The GSEs do require a minimum of capital, but the capital requirement is not based on production. The real issue in the new liability is whether mortgage bankers will be reliable counterparties for investors in their whole loans and securitization.
Banks on the other hand have little to gain capital wise in securitizations if they cannot remove the risk from their balance sheet. This will seal the fate of the 20-year old shadow banking system that Bernanke and Geithner are desperately trying to resuscitate. It does not matter that investors and the actual trusts are excluded from liability; capital relief was the primary motivation of banks feeding the shadow banking system.
Eventually the government will realize that promoting basic savings through a basic banking system is the route to long term financial recovery. The Federal Reserve should be charged with balancing interest rates paid on savings with interest rates charged on lending. The needs of savers for income should not be sacrificed for the needs of borrowers. Increased incentives to savers will make more money available to lend, thus promoting long-term economic growth and eliminating any need for a shadow banking system.
Monopolizing the banking system and creating disincentives for savings provides only short term economic relief. Having the FDIC penalize banks for offering higher savings rates is just one example. The shadow banking system was a black swan in the history of banking and should never be resurrected.
Disclosure: Author is long FNM and FRE.
Business Trends: Coke, Pepsi, Genzyme, Mortgage Bankers, Autos and Health Insurance
Coke and Pepsi
The Wall Street Journal’s “Soda-Pop Sales Fall at Faster Rate” reports that Coca-Cola’s (KO) soft-drink volume dropped 3.1% and PepsiCo’s (PEP) dropped 4%. I don’t think it’s a shifting of tastes because these products are addicting, since even the high energy segment is losing its strong momentum.
It is simply that name brand soft-drinks are priced as luxury items. Price creep has pushed 2 liter bottles close to $2 and it’s been a few years since you could buy a 12 pack of 12 oz. cans on sale for $2. People are not trying to get any healthier; they just cannot afford to drink soft-drinks like water any more.
Genzyme
The Wall Street Journal’s “Genzyme Buys Rights To MS Drug” reports that Genzyme (GENZ) is straying from its successful game plan of selling drugs that can cost up to $200K per year to small patient populations. Genzyme’s first move to large patient populations was to team up with Isis Pharmaceutical (ISIS) for the potential blockbuster cholesterol drug Mipomersen. Now they are buying the cancer drug Campath from Bayer. Could it be that Genzyme realizes that there is no future for very high priced drugs in President Obama’s healthcare reform?
Mortgage Bankers
The New York Times’ “Why You Should, or Shouldn’t, Use a Mortgage Broker” reports that mortgage bankers are being attacked from every direction. The major banks (BAC, C, JPM and WFC) have either reduced or completely eliminated warehouse lending and decided it is safer to originate real estate loans in their own vast retail networks. Congress is contemplating requiring all mortgage originators to retain at least 5% of the risk. Most mortgage bankers don’t have enough capital to maintain any risk on an ongoing basis. And now the mortgage bankers are crying to the FHFA to force Fannie Mae (FNM) and Freddie Mac (FRE) to provide warehouse funding.
Bloomberg’s “Bernanke Easing Mortgage Rates for Consumer-Driven Rebound” reports that the Federal Reserve’s purpose in lowering mortgage rates is not to keep marginal borrowers in their homes. The real purpose is to free up cash for strong borrowers to spend now. That’s Bernanke’s almost $1.5T stimulus. I find this disturbing, along with all of the other Geithner and Bernanke programs to revive the shadow banking system. US Bancorp (USB) saw the possibility of increased profits with the collapsing of the shadow banking system, but unfortunately the government won’t let that happen.
Auto Stimulus
The Wall Street Journal’s “Cash-for-Clunkers Plan Gains Speed” reports a lot of chatter from both Congress and the Administration about copying the German’s cash for clunkers programs to stimulate demand for the big three domestic automobile manufacturers. Actually, one former big one (GM) and little one that never came out of diapers since Ricardo Montalban sang the praise of the 1970’s Chrysler Cordova’s fine Corinthian leather.
The American auto cash for trash proposals target the replacement of 8 year old “gas guzzlers” with new fuel efficient cars. The guzzlers will be scrapped and the owners paid between $2500 and $5000 to use toward the purchase of a new fuel efficient vehicle or public transportation. While waxing my 8 year old non-prestigious Japanese 4 door sedan I had time to contemplate.
The internet told me my plebian vehicle was worth between $6000 and $7000 as a trade in. Assuming that I don’t get the scrap value of the car, I can expect to lose $1000 or more on this deal. The only redeeming factor is that President Obama wants to use money from the green energy portion of the Titanic stimulus package to send some of our Titanic size SUVs to an early sinking.
Health Insurance
Just when you thought you passed medical underwriting, The New York Times’ “Getting a Health Policy When You’re Already Sick” reminds us about insurance companies rescinding policies. In the individual health insurance market, the insurers look for any reason not pay large claims. If the policy holders failed to disclose any medical conditions during the application process or were not prudent in pursuing medical treatment that would have identified preexisting conditions, the insurer will cancel the policies retroactively back to the start date. The insurer will reimburse all premiums; policy holders must reimburse all medical losses.
Even individuals in the few guarantied issue states need to be careful. Insurers will look to classify a condition as preexisting during the preexisting waiting period. They are ready to starting investigating as soon as the red flag rises. Beware of asking your doctor for a complete physical, even if you are on an employer’s plan. You will never know what that fishing expedition will tell future health insurers.
Disclosures: Author is long BAC, C, FNM, FRE, ISIS and WFC.
Posts
