gmoApproaching the Eraser

Two months ago, I noted that the surprise resignation of Wells Fargo’s Chief Financial Officer had caught the eye of a number of shareholders, who noted my comment several quarters ago that we could observe a wave of fresh risk aversion “at the point where the first bank CFO resigns out of refusal to sharpen his pencil any further.” My impression is that the underlying state of mortgage debt is no better than it was quarters ago, and indeed may be worse in the sense that there has been no meaningful decline in the backlog of delinquent and unforeclosed homes. While foreclosure filings certainly fell significantly in the first quarter, the decline was driven by record-keeping problems and legal moratoriums.

As Realty Trac observed, “Weak demand, declining home prices and the lack of credit availability are weighing heavily on the market, which is still facing the dual threat of a looming shadow inventory of distressed properties and the probability that foreclosure activity will begin to increase again as lenders and servicers gradually work their way through the backlog of thousands of foreclosures that have been delayed due to improperly processed paperwork.”

It’s fascinating to hear JP Morgan’s Jamie Dimon complaining “We have homes sitting there for 500 days rotting that we can’t do anything about” while at the same time reducing loan loss reserves on those assets. But of course, that’s precisely what the FASB has allowed banks to do. Specifically, there is no longer any need to mark to market, and the FASB appears to have dropped any plan to restore it. The standard instead is “amortized cost” (on which basis you can continuously make the mortgages whole simply by tacking the delinquent payments on to the back of the loan). Little wonder half of all mortgage modifications re-default. The modifications themselves don’t materially change the present value of the payment stream, and frequently don’t reduce the payments themselves beyond the first year. Meanwhile, it’s equally fascinating to observe how much bank earnings for the first quarter (thus far) have been driven by trading profits from commodities and fixed income (thanks Ben).

 

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