“Those who ignore history are doomed to repeat it.” Adapted from quote by George Santayana (1863-1952)
Well, well, well. According to a recent article in Bloomberg.com, it appears that JPMorgan Chase is going to try skating across the frozen private label pond once again. For those with any recollection of what caused the collapse of the credit markets and resulting implosion of the housing market, this may or may not come as a surprise. After all, it’s been over five years since the 3Q tipping point was reached in 2007. Memories fade; especially for traders who thrive on risk using other people’s money.
For those unfamiliar with the causes of the collapse that led to the Great Recession, please see my posts here and here. The Readers Digest version is this: The big investment banks, e.g. Goldman Sachs, JPMorgan, and others that are still standing – plus several that are not, e.g. Bear Stearns and Lehman Bros. most notably – decided to mass-market a relatively new product for investors to buy, instead of the boring “conforming loan”products sold by Fannie Mae and Freddie Mac in the secondary mortgage market. So they created a “private label” secondary market that consisted of higher yielding securities, primarily risky residential mortgages that were made to almost anyone who could fog a mirror. Lender underwriting for many of these mortgages was virtually non-existent and they became known as “sub-prime loans”, which were packaged as securities, rated by their shills Moody’s and S&P, and handed out to hungry investors like party favors. The fact that many of these packaged loans failed within months of their making was generally ignored, until it was too late.
By 2007, the big investment houses saw the handwriting on the wall, and although that didn’t stop them from selling their toxic brew to investors [who believed that “investment grade” ratings actually meant something], they began betting against them at the same time. The resulting crash of the credit markets dried up the private label secondary market and decimated the residential construction and housing industries.
So, after spending the next five years walking through the Valley of the Shadow of Debt, it appears that at least one investment bank, JPMorgan Chase, is, according to the February 20 Bloomberg article, “…seeking to sell securities tied to new U.S. home loans without government backing[1] in its first offering since the financial crisis that the debt helped trigger.”
Why is JPMorgan doing this now? Investor demand. According to the article, “[t]he market for so-called non-agency[2] mortgage securities is reviving as the Federal Reserve’s $85 billion a month of bond purchases help push investors to seek potentially higher returns.”
So what is the bank doing differently this time, just to make sure they aren’t named in put-back suits from angry investors saying that the mortgage securities were poorly underwritten and over-hyped junk? One thing is that they will likely impose 36 and/or 60-month limitations on the reps and warranties they make to their investors. This means that the bank’s promises of high grade securities will expire after three or five years. If they fail after that, the investors are on their own.
Time will tell whether JPMorgan’s move will be repeated elsewhere. Certainly, with the banks’ tighter underwriting standards [some might say too tight], there is every reason to believe that the loan products being securitized this time will be much safer. But remember, underwriting was good in the early 2000s, too. It was the easy money that could be quickly made by securitizing, selling, and servicing millions of loans that fueled the last crisis. Standards and safeguards were in place then, as well. Granted, today, with Dodd-Frank, there are new regulations under consideration, such as the Qualified Mortgage/Ability to Repay and risk retention[3] rules. But, as we know, banks being banks, there are always ways to game the system. I can’t wait….
[1] “Government backing” refers to Fannie and Freddie, who, because they were government sponsored enterprises (or “GSEs”) had the implicit guarantee of the federal government. That “backing” became explicit when Fannie and Freddie failed in September 2008, and were placed into conservatorship by the federal government.
[3] Risk retention simply means the investment banks selling their product will have to retain a percentage of them in their own portfolio. It is like basing quality assurance in a restaurant on a rule that the chef must eat what he serves.
