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Liquidity crises in the mortgage market

By Patrick following x   2018 Mar 31, 1:22pm 1,484 views   6 comments   watch   nsfw   quote     share    

Of particular importance, these liquidity vulnerabilities are still present in 2018, and arguably the potential for liquidity issues associated with mortgage servicing is even greater than pre-financial crisis. These liquidity issues have become more pressing because the nonbank sector is a larger part of the market than it was pre-crisis, especially for loans securitized in pools with guarantees by Ginnie Mae. As noted in 2015 by the Honorable Ted Tozer, President of Ginnie Mae from 2010 to 2017, there is now considerable stress on Ginnie Mae operations from their nonbank counterparties


I shouldn't point this out, but one of the authors is You Suk Kim of the Federal Reserve Board. No doubt named in Korea.

I've also met Chinese guys named Johnson Wang and Jim Shu, who did not seem to know that their names could be interpreted humorously in English.
1   anonymous   ignore (null)   2018 Mar 31, 5:39pm   ↑ like (0)   ↓ dislike (0)   quote   flag        

I know a guy named Huong (pronounced "hung") Dong
2   APOCALYPSEFUCKisShostikovitch   ignore (38)   2018 Mar 31, 7:12pm   ↑ like (0)   ↓ dislike (0)   quote   flag        

If you can't pay for a house in cash, you should not be living indoors.

3   everything   ignore (1)   2018 Apr 1, 7:32am   ↑ like (0)   ↓ dislike (0)   quote   flag        

Most creditworthy get loans now, as in yesterdays loans, anyone with some money and half a brain mopped up after the last crisis, and even up until 2014 prices were pretty soft. By the summer of 2017 mortgage rates were as low as they can go. If you had a job, a decent income, a down payment, you wanted to buy, you bought. Prices have gone up since then, and rates. Now, if you want to sell RE the element of risk or repayment is higher now. But, so is the reward, higher prices mean better commissions, higher interest rates.

I can only suspect .. Whoever is collecting these commissions and servicing the loans they don't care if the owners on the title have more risk, Realtor gets paid if they can close the deal, bank makes it's money on the front end of the loans. Banksters are influenced by CEO's who push targets or projections down to the peons, Wells Fargo is known for this kind of behavior although I'm sure they all do it to some extent.

Although the complexity here of how these loans are sold or serviced (nonbanks???), maybe it's just creative banking, it's still the same on the buyers end, they make payments, which on the front end most all of which are just interest payments. Do they care if the buyer is getting into something they can truly handle.
4   justme   ignore (0)   2018 Apr 1, 9:08am   ↑ like (0)   ↓ dislike (0)   quote   flag        

I read some of the paper and found some good information. One of the questions I had after just reading the thread intro was how being a "mortgage servicer" (=the entitiy that collects mortgage payments and distributes them to bondholders) could be subject to "liquidity pressures", meaning lack of ability to sell or buy some product without materially affecting prices.

p.2: The Ginnie Mae servicing model, for example, assumes that nonbank servicers will have the resources to absorb a substantial share of credit losses before the government steps in, yet it is not clear that the sector has the capacity to absorb those losses, or that the existing prudential standards are sufficient to ensure the nonbanks’ viability in a stress scenario.

In addition to the losses that the government is explicitly on the hook for, the experience of the financial crisis suggests that the government will be pressured to backstop the sector in a time of stress, even if such a backstop is not part of the government’s mandate ex-ante. We end by observing that this aspect of mortgage-market fragility is almost entirely missing from the housing-finance reform debate.

In other words, so-called "mortgage servicers" need to have CAPITAL, to handle financial stress, and they don't have (enough of) it.
5   justme   ignore (0)   2018 Apr 1, 9:21am   ↑ like (0)   ↓ dislike (0)   quote   flag        

While I'm at it, some more info about the mortgage industry that people may not be aware of:

1. Only GNM (Ginnie Mae) is a true government AGENCY and sell mortgage bonds that have an explicit explicitly government guarantee

2. FRE and FNM (Freddie Mac and Fannie Mae) are not repeat not government agencies and do not have an explicit government guarantee of their loans. Wall St will fudge and misrepresent and call FRE/FNM bonds "agency bonds", but they are not agencies, they are Government Sponsored Enterprises (GSEs). Wall St does this for their own profit motives.

And now some deconstruction of the often intentionally confusing lingo:

1. "Mortgage Loan Originator" (and variations thereof) really means "Mortgage Debt Originator", that is, the broker that arranged the mortgage. You would think that an MLO was the entity or person that provided the loan, but, no, it is the entity that provided the DEBT for someone else to provide the loan.

2. "mortgage servicer" in turn takes on the meaning of debt originator.

3. "(Government) Agency" gets bandied about as a moniker for entities that are NOT Government agencies, but rather Government Sponsored Enterprises.

(more to be added ...?)
6   anonymous   ignore (null)   2019 Feb 13, 4:58am   ↑ like (0)   ↓ dislike (0)   quote   flag        

Bond Funds Are “Potential Source of Financial Instability,” after Years of Global QE and Low Interest Rates: Fitch

“Liquidity issues at bond mutual funds could result in wider contagion and affect other parts of the financial system and the macro economy.”

Bond investors go for different risks and returns. There is buy-low-sell-high, unless things don’t work out and it’s buy-high-sell-low. Buy-and-holders buy bonds when issued and hold till maturity, collecting coupon payments and then getting their money back – unless things don’t work out.

Other investors buy a bond when a company or an entire sector gets in trouble, such as the shale-oil space in 2015 and 2016. They might buy a distressed junk bond for 40 cents on the dollar, at a yield of 20%, that then does not blow up, allowing them to collect coupon payment representing a 20% yield from cost, year-after-year until maturity, when the bond is redeemed at face value for a capital gain of 150% (cost 40 cents on the dollar, redeemed at 100 cents). Sweet deals, if it works out.

There are many ways of taking calculated risks with bonds. And that is cool.

What is not cool is when you invest in a conservative sounding open-end bond mutual fund that holds mostly corporate bonds, and it experiences a “run on the fund” and blows up and takes a large part of your principal down with it — making it far riskier than the actual bonds it holds. This happened to a number of open-end bond mutual funds during the Financial Crisis, including Schwab’s family of “YieldPlus” funds.

Investors never knew of those risks and were never paid to take those risks. They thought it was a low-risk investment. Instead it was an open-end mutual fund that experienced a run-on-the-fund and collapsed.

I’ve been lambasting open-end bond mutual funds for years, including when the Focused Credit Fund by Third Avenue experienced a run-on-the-fund in late 2015 and was ultimately liquidated. There are two fundamental dynamics at work:

“Liquidity mismatch”: The risk from open-end bond mutual funds when they mostly hold corporate bonds, mortgage-backed securities, and the like, comes from a structural problem: investors can sell the shares of those funds on a daily basis; but the underlying assets such as corporate bonds, including junk-rated bonds, are not liquid and can take days to sell at reasonable prices, even in a good market. This is the liquidity mismatch.

“First-mover advantage”: When redemptions requests are piling up as investors are trying to get out the door, the bond fund will meet the first redemptions by using up its cash balance. Then it will sell the liquid Treasury securities it has for this purpose. Then it will sell the most liquid corporate bonds. All along net asset value (NAV) will remain stable, and the first investors out the door will be fine. This is the infamous “first mover advantage” at open-end bond mutual funds.

The remaining investors are then stuck with the most illiquid bonds, and also with the higher trading costs incurred during the prior asset sales but not yet fully accounted for. When the fund has to dump the remaining illiquid bonds at cents on the dollar to some hedge fund, the NAV suddenly plunges and panic breaks out among the remaining investors in the fund, and they all try to stampede through the narrow door.

I was just focused on individual investors. But there is a broader problem.

Fitch warns these bond funds could trigger a financial crisis.

If enough open-end bond mutual funds experience runs-on-the-fund simultaneously, and collapse together, investor fears could spread to other funds. Wide-spread forced selling would set in as bond prices crash, freezing up credit markets and possibly triggering a financial crisis.

The risk of a widespread contagion-driven bond mutual fund meltdown triggering a financial crisis is not huge. But it’s apparently big enough for Fitch to warn in a new report — “The Coming Storm: Bond Funds’ Potential Impacts on Financial Stability” (behind paywall, here’s a summary) — that open-end bond funds are “a potential source of financial instability.”

This has always been the issue, but now the setup is bigger and riskier than it was during the Financial Crisis, as according to Fitch, “global QE, prolonged low yields, technology, and a wave of regulation” have contributed to the surge in open-end mutual funds and exchange-traded funds (ETFs).

“These market dynamics increase the number of unknowns in the financial markets, even if the underlying fund assets are still performing, especially since weaker liquidity can contribute to valuation volatility,” Fitch says.

“Interconnectedness among funds, non-bank financial institutions (NBFIs), banks, and the rest of the financial market adds to the complexity of understanding whether this could be severe enough to affect financial stability.”

Here are some of the specific risks Fitch points out

“Gating,” designed to stop a run-on-the-fund, might ironically trigger more financial instability:

“High redemption activity could test relatively newly implemented extraordinary liquidity management tools, such as suspending redemptions or ‘gating.’ These tools have helped to contain open-end fund stress to individual funds or fund sub-sectors in the past, but there is a risk that gating could spark contagion in other funds as it could be disruptive to market confidence. Changes in market dynamics or a combination of idiosyncratic and macro stresses could increase the spillover effects.”

Leveraged bond funds – especially with derivatives being used to create higher effective leverage – “are more likely to be forced to deleverage as a result of margin calls in a market downturn, with potential for adverse spillover effects, including for its counterparties.”

Ironically, “dry powder” adds risk. “Dry powder” – private equity firms’ “uncalled investment capital” – across the industry has risen to toward $2 trillion in January 2019, according to Fitch, which cited Preqin data. This is money that specialized funds want to deploy at times of severe financial market stress, to buy assets for cents on the dollar. This would help provide liquidity and ease pressure on market prices. But, Fitch says, there are financial stability implications because that “dry powder” doesn’t actually just sit there waiting; it’s invested in something – often open-end mutual funds because of their convenience – that has to be sold to get that “dry powder”:

“As alternative investment managers call committed capital from their limited partners (LPs), these investors are likely to need to switch from other investments, at least partially open-end funds, to raise cash to meet the calls. LPs’ abilities to meet capital calls could be more challenged in a market stress. A large shift of LP capital away from mutual funds to alternative investment funds during a crisis could also contribute to forced sale risks at open-end funds.”

90% of bond funds lack a primary defense against a run-on-the-fund. Regulations allow funds to impose terms on redemptions to where they’re more in line with the liquidity of the underlying assets, such as slower redemptions, rather than allowing daily liquidity. But in Fitch’s sample of 1,832 US credit funds, 90% offered daily liquidity – which makes them sensitive to a run-on-the-fund.

Trying to hoard cash is good, until it isn’t. Bond mutual fund managers, particularly those of less liquid bond funds, tend to hoard cash to soften the liquidity issues, Fitch says, citing a working paper based on global bond mutual fund data by the Bank for International Settlements. Alas, this would “amplify forced asset sales and the post-redemption NAV decline as the manager would sell underlying assets to boost cash buffers in anticipation of redemptions.”

Contagion is real. When Third Avenue’s bond fund collapsed in late 2015, it was just a small-ish fund and it didn’t trigger cascading runs. However, the market did react, Fitch says: “Bonds of higher-quality liquid issuers traded down a percentage point or two, whereas lower quality, less-liquid names dropped three to five points….” It also triggered a 16% outflow from junk-bond mutual funds over the three-month period, and the CCC-and below rated average yield jumped to over 20%, indicating that the collapse of just one small-ish fund caused additional stress in the sector.

The known unknown risks created by QE. “The ‘known unknown’ is what combination of problems in terms of credit and market conditions could cause runs in multiple structurally vulnerable credit funds, where extraordinary liquidity measures by fund managers would not be sufficient to contain the problems,” Fitch explains.

“While previous periods of micro-level stress in the bond fund universe did not threaten financial stability, the rapid growth in open-end credit funds and the significant distortions to credit markets caused by QE mean that market conditions look very different now.”

“Liquidity issues at mutual funds could result in wider contagion and affect other parts of the financial system and the macro economy, especially as mutual fund holdings of US corporate bonds increased significantly since the last crisis….”


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