Loans aren’t better than securities

August 21, 2009
Floyd Norris in the NYT:

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A bad asset is a bad asset, whether it’s a loan or a security. And the distinction between the two isn’t particularly helpful, as is evidenced by equal-and-opposite newspaper stories today.

On the one hand, there’s Floyd Norris in the NYT:

Banks are now losing money and going broke the old-fashioned way: They made loans that will never be repaid.

As the number of banks closed by the Federal Deposit Insurance Corporation has grown rapidly this year, it has become clear that most of them had nothing to do with the strange financial products that seemed to dominate the news when the big banks were nearing collapse and being bailed out by the government.

There were no C.D.O’s, or S.I.V.’s or AAA-rated “supersenior tranches” that turned out to have little value. Certainly there were no “C.D.O.-squareds.”

Staying away from strange securities has not made things better.

On the other hand, there’s Robin Sidel in the WSJ:

U.S. banks have been dying at the fastest rate since 1992, mainly because of bad loans they made. Now the banking crisis is entering a new stage, as lenders succumb to large amounts of toxic loans and securities they bought from other banks.

Federal officials on Thursday were poised to seize Guaranty Financial Group Inc., in what would be the 10th-largest bank failure in U.S. history, and broker a sale of the Texas bank to Banco Bilbao Vizcaya Argentaria SA of Spain. Guaranty’s woes were caused by its investment portfolio, stuffed with deteriorating securities created from pools of mortgages originated by some of the nation’s worst lenders.

Guaranty owns roughly $3.5 billion of securities backed by adjustable-rate mortgages, with two-thirds of the loans in foreclosure-wracked California, Florida and Arizona, according to the company’s latest report. Delinquency rates on the holdings have soared as high as 40%, forcing write-downs last month that consumed all of the bank’s capital.

Guaranty is one of thousands of banks that invested in such securities, which were often highly rated but ultimately hinged on the health of the mortgage industry and financial institutions.

So, which is it? Was Phase 1 of the crisis based on securities while Phase 2 is based on loans, or was Phase 1 the souring loans and now Phase 2 is the securities? Frankly, it’s neither. Banks’ assets soured, and they failed. Some of those assets were loans, and others were securities. Some banks trusted the structured-finance wizards more than they trusted their own underwriters, and loaded up on highly-rated CDOs. Others trusted their own underwriting more than the structured-finance wizards, and lent out billions of dollars in housing loans which will never be repaid. Both were doomed: the only way to win was not to play.


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