GLG News by Raymond Natter

Implications: Congress is in the process of re-acting to the problems caused by subprime lending and securitization of subprime debt.  As the extent of the problem grows, Congress will respond with legislation to "reform" the marketplace and "punish" the guilty.  Wall Street firms will be a clear target, and one can expect new laws and rules to be forthcoming in 2008,

Analysis: When millions of constituents are hurt by foreclosures, and significant negative impact is felt across the economy, Congress will feel compelled to address the "problem."  It will be a political necessity to enact "reforms" and to "punish" the wrongdoers.  Wall Street firms and credit rating agencies are two obvious targets.  In 2008 one can expect a number of legislative and regulatory proposals to make sure this problem does not re-occur.  The unintended consequences of such action may be a problem in themselves (remember Sarbanes-Oxley).  For example, its becoming more and more likely that securitization vehicles will have on going liability to the borrower for loans that do not meet some form of subjective lending standard, such as "in the borrower's best interests."  The increased risk caused by this liability will make securitization more expensive and more difficult.

Implications: The mortgage rate freeze announced on December 6 will be harder to implement than one might think.  Many questions remain and the answers will have to be negotiated among the parties.  But even after it is implemented, it will not be enough and additional measures will be necessary.

Analysis: The Administration's plan to freeze interest rates for certain subprime borrowers will need to be fleshed out.  The details are lacking, and the answers will require hard negotiations among the parties.  Questions remain on such important matters as how to account for frozen loans, how to report the status of the loan, and  how to determine if the borrower is qualified.  However, even under a best case scenario, this plan will only affect a fraction of the loans that are in danger of defaulting, and additional action by the Administration, the Congress, the Federal agencies and the financial services industry will be necessary in 2008.

Implications: The 18 month moratorium on approvals of commercial firms acquiring industrial banks will not be extended past January.  The FDIC may not have the legal ability to block the acquisition of banks by Wal-Mart and Blackstone (Alliance).  This could open the flood gates for other deals as well.

Analysis: For 18 months the FDIC has refused to process applications by commercial companies to acquire industrial banks.  Today, the FDIC Chairman announced that this "moratorium" will end on January 31, 2008.  Unless Congress intervenes before then, the FDIC will have to start issuing decisions by early Spring.  Immediate benefits will flow to Blackstone, in that its acquisition of Alliance will be able to be approved, and to Wal-Mart which is seeding to acquire an industrial bank.  Other acquisition will follow after that.

Implications: Many of the larger financial services firms have been hurt by the subprime mortgage downturn, with most of the damage resulteding from the loss of confidence in the credit markets for MBS, CDOs and other instruments that would be tainted by subprime collateral.  However, the industry is also heavily exposed to commercial real estate (CRE), and the percentage of capital tied up in CRE loans is greatest for smaller banks.  If the market turns south, as now seems a real possibility, there will be big problems for community banks.

Analysis: The financial services industry is reeling from problems caused by subprime mortgages, but not because the banks hold these loans.  Rather, the problem for the banks is that they hold, or are managing funds that hold securities that may be tainted by subprime assets.  This is a problem for the big banks. 

For years, regional and smaller banks have been aggressively making commercial real estate loans.  The concentration of commercial real estate loans in smaller institutions grew so large that the banking agencies issued guidance in December of 2006 warning of the risks in this asset class.  Now we are getting the first indications that the CRE market may go south, and if this comes to fruition, the pain will be felt especially by regional and smaller banks.  The California market may be the bell weather, but I would also look carefully at Florida and Nevada.  Iff the economy slides into a recession, the CRE turmoil could be just as drastic as the subprime mess. M

Implications: Blackstrone Group (BX) acquisition of Alliance Data (ADS)may be held up by the FDIC due to controversy over industrial loan companies?  Approval is likely to be delayed at least until the end of January.  It all hinges on whether Blackstone is viewed as a commercial or financial company.

Analysis: The Blackstone Group (BX) acquisition of Alliance Data (ADS) requires the approval of the FDIC because Alliance Data controls an FDIC insured industrial loan company (ILC).  These industrial banks have become the source of controversy in Washington because of a recent attempt by Wal-Mart to acquire one.  As a result, Congress has taken a keen interest in this type of bank, and the FDIC announced a one year moratorium on approving companies that engage in "commerce" from acquiring an ILC.  If the FDIC views Backstone as engaging in direct or even indirect commercial activiites, such as managing a chain of hotels, the approval will be subject to the moratorium.  Even after the expiration of the moratorium, the FDIC may not rush to approve an application that may be controversial.

Implications: Good news for Fannie Mae and Freddie Mac.  Fed Chairman Bernanke supports increasing the size of mortgage loans that these GSEs can buy, from $417,000 to $1 million.  Bernanke also wants the U.S. Government to back securities issued by the GSEs.  It could help the financial industry unload some of these mortgages, but it will certainly help increase Fannie and Freddie's profits.

Analysis: During Congressional testimony today before the Joint Econmic Committee, Fed Chairman Ben Bernanke told Sen. Jeff Bingaman (D-MN) that a good way to fix the broken down mortgage system would be to raise the limits on loans that could be purchased by Fannie and Freddie, and then sold to the secondary market in the form of securities.  Bernanke also thought that it would be important for the U.S. Government to explicitly back these securities.  The Fed Chairman later told Senator Schumer (D-NY) that the new limit should be $1 million.  Schumer announced that he would introduce legislation to effectuate this suggestion, and hinted that he might even go as far as authorizing the purchase of $3 million mortgage loans. 

The Fed's opposition to raising the GSE conforming loan amount, and limiting the GSE's portfolio of mortgage loans has been a key factor in Congress till now.  The fact that the Fed is apparently switching positions may mean that legislation along these lines will pass.

Implications: The mortgage industry can expect significant new regulatory restrictions as a result of the subprime melt down. These regulations and possible legislation will govern the mortgage industry and MBS long after the current subprime situation is resolved.  Companies that might feel the pinch in include regulated lenders like Washington Mutual and Countrywide, investment banks like Merrill Lynch and Goldman, and home builders such as Toll Brothers and Bleazer and KB Homes.  The Admistration has to be careful not to over-regulate in this area or the long term consequences will be harmful to the economy and housing industry. 

Analysis: Beginning last year the banking regulators issued guidance to regulated banks and savings associations regarding low-doc and no-doc loans, teaser ARMS, and other practices deemed unsafe or predatory.  This was followed by additional guidance this year that has pushed regulated banks toward the prime customer.  The Federal Reserve is about to issue a new proposal that would affect all mortgage lenders, not just regulated banks.  The Fed is likely to impose a subjective standard on lenders, so that loans can only be made if the lender has a documented basis to believe that the borrower can repay.  Congress is also considering new legislation that would, in certain cases, impose liability on assignees.  If this passes, it will have a dramatic affect on the securitization of all mortgage loans.  Now the Treasury Department has joined the chorus regarding the need for new rules.  The Congress and the Administration must act carefully, or the mortgage industry will be saddled with new regulatory requirements that could have an adverse impact on housing and housing finance.

Implications: The credit rating agencies, Moody's, Standard and Poors, and Fitch, have become the focus of Congress ire over the subprime mortgage problems.  If Congress enacts remedial legislation, it will no doubt affect the bottom line for these companies.  A more likely outcome will be that the SEC will feel the pressure to take regulatory action, and their rules could also require the credit rating agencies to alter their current business model.

Analysis: Congress continues to pound the credit rating agencies, and powerful Members have suggested in public hearings that the agencies have an inherent conflict of interest.  Some have gone so far as to accuse the agencies of colluding with the issuers in selling securities knowing that they will default.  This extreme position just illustrates that current environment on the Hill.  Prominent members have suggested such remedies as requiring the CRAs to become non-profit organizations, requiring rotation of CRAs so that the same agency cannot rate an issuer twice in a particular period, enhanced disclosures, requiring the SEC to publish performance statistics, and even exposing the agencies to liability for errors.  The SEC announced that it is examining the agencies and will likely revisit its regulations over the agencies as part of this process.

Implications: Congress is expressing concern that the rating agencies have an inherent conflict of interest clouds the objectivity of their ratings. Hearings and Congressional attacks on the rating agencies will be forthcoming. However, the likelihood of substantive Congressional legislative is less than the propect of new and tougher regulations by the SEC. These regulations may have a significant impact on the profitability and business models used by the rating agencies.

Analysis: When potentially hundreds of thousands of homeowners facing foreclosure and the financial markets in turmoil, the political demands require Congress to take action. Congress has to show their constituents that they are doing something, and part of that process is to identify a culprit. In this case, the rating agencies appear to be a prime candidate. However, aside from hearings and public statements, there is little that Congress can actually do directly. Rather, it is more likely that the SEC will be pressured to take action, and exactly what the SEC will do will be the significant development for this industry.The most important factor to watch is the SEC and the statements of its senior staff.

Implications: Legislation moving in the House and Senate may have significant adverse impact on the mortgage markets, hurting both mortgage lenders such as Washington Mutual, Countrywide, Wells, HSBC.  Companies holding MBS portfolios will also be hurt, including Goldman Sachs, Bear Stearns and Merrill Lynch.  The bill would apply retroactively to upset settled understandings of the rights of mortgage holders in bankruptcy proceedings.  As a result, mortgage rates will have to reflect the additional risks and outstanding mortgage-backed securities will lose value.

Analysis: Bills in both the House and Senate would amend the Bankruptcy Code to permit a debtor in Chapter 13 to submit a plan to restructure mortgage debt.  The new provisions would authorize the court to declare the amount of the debt in excess of the market value of the home as unsecured, would allow the debt to be paid off over an additional 30 years, and would permit the court to set the interest rate over this period.  The debt would not have to be amortized over the life of the loan, thus permitting the plan to provide for 30 years of small payments followed by a balloon.  The performance of MBS will be adversely affected as the debt backing these securities will be re-structured with new payment streams and new interest rates.  Mortgage originators will have to price mortgages to reflect the added risk.  While it is not certain which version of these bills will ultimately pass, some legislation in this area is likely, especially as foreclosures begin to increase next year.

Implications: Bankruptcy reform proposals appear to be moving in Congress, but these bills will create additional risks for mortgages and MBS.  Holders of MBS may see if further decline in value if the legislation passes.  Mortgage costs would likely go up to reflect new risks.

Analysis: Congress is actively considering Bankruptcy amendments that would, at a minimum, permit a bankruptcy court to restructure mortgage loans.  The Senate bill would permit the court to "cram down" the amount of the claim to the market value of the home, and extend the payment period on the mortgage for up to an additional 30 years.  The court would be able to re-set the interest rate during the 30 year repayment period.  The House bill is more limited, but is likely to adopt some of the Senate provisions as it makes it way through the legislative process.  If this legislation passes, it would apply retroactively to existing mortgages and would thus further impair the value of MBS.  In addition, new mortgages would have to be priced to reflect the added risks.  The bills could have the unintended consequence of making the current problems in the mortgage area worse.

Implications: Holders of mortgage-backed securities and subprime mortgage lenders, such as Countrywide, holding loans in portfolio are likely to benefit from Government "solutions" to the subprime mess. 

Analysis: Political pressure is growing on the Administration and Congress to "do something" to help subprime homeowners who are facing possible foreclosure as mortgage loans re-set.  However, the likely solutions will also, by necessity, also bail out holders of subprime mortgage backed securities.  Countrywide and other mortgage lenders who hold significant loans in portfolio will also benefit.  The proposed FHA legislation already demonstates that the Congress is prepared to shift the credit risks to the Government in the name of helping homeowners.

Implications: Recently introduced legislation on overdraft protection would impose significant burdens on financial institutions, and would impair the use of ATM networks and require changes in current business models.  The banking lobby is making a strong case that the bill needs to be modified.

Analysis: Legislation introduced by Congresswoman Maloney, Chair of the House Subcommittee on Financial Institutions, would create administrative burdens on financial services companies and would require significant changes in current business models.  The banking industry, and significantly, the credit union industry, is making a strong push to have the legislation revised before it is reported to the full House.  Chief concerns relate to the impact of the bill on the use of ATM machines, especially those located in another State.  If these changes are not accepted, financial institutions will experience significant costs and business inefficiencies.

Implications: The Federal Reserve Board and Treasury issued a joint proposed regulation to implement the Unlawful Internet Gambling Act.  The Act potentially could have imposed expensive and burdensome requirements on the financial services industry.  However, the proposal is quite limited, and provides flexibility for members of the payment system.  It also includes broad exemptions design to ensure that the payments system is not burdened by the new law.

Analysis: The proposed regulations indicate that both the Treasury and the Federal Reserve are not interested in establishing new burdens and costs for the payments systems or for the financial institution members of that system.  Unless a bank has a direct customer relationship with an internet gambling concern, compliance will be a non-event.  As a result, the burdens on the financial services industry will be minimal.  Further, through the use of intermediaries, internet gambling companies may be able to have continued access to U.S. markets.  The Justice Department may continue to  prosecute off-shore internet gambling owners under the theory that they are violating other laws.

Implications: The Credit Rating Agencies came under fire in two Congressional hearings this week. While it is still unlikely that Congress will pass substantive legislation affecting S&P, Moody's or Fitch, pressure on the SEC is mounting. One can expect the SEC to modify its regulations to require increased transparency, at the very least.

Analysis: The Credit Ratings Agencies, S&P, Moody's and Fitch, were subject to intense scrutiny during two Congressional hearings this week.  In the House hearing, one senior Democratic alleged collusion with issuers and illegal conduct.  Chairman Cox of the SEC stated that the agency was examining the Credit Rating Agencies for conformance with the rules issued under the 2006 Reform Act.  It is likely that the SEC will ultimately amend its regulations to require increased disclosures (transparency) and more detailed information on performance of rated issuances.  Other regulatory changes may well add to the administrative costs of the Credit Rating Agencies and increase competition by easing the entry of new players.

Implications: The House passed comprehensive FHA reform legislation on Sept. 18 and the Senate is likely to act later this year.  The House bill lowers underwriting standards and will enable subprime borrowers to refinance into FHA insured mortgages.  But some could argue that the legislation simply shifts risks from investors to the Government.

Analysis: The House of Representatives passed far ranging FHA Reform legislation on September 18, 2007.  The bill was amended to open FHA insurance for subprime borrowers with FICO scores as low as 560, and will allow refinancing for borrowers that are delinquent on their current mortgage.  LTV limits are raised to 100 percent, the the current requirement for a cash down payment may is waived.  This reform legislation may wind up exposing the U.S. Treasury to significant future liability, and could itself become the subject of future reform proposals.  The real question is whether this version is likely to pass the Senate, or if a more moderate bill will eventually emerge.

Implications: Credit card issuers will face additional pressure as the OCC urges the Fed to allow consumers to refuse to accept interest rate changes pay of balance at old rate.  This will have a negative impact on credit card issuers that raise rates for customers that have a credit score downgrade.

Analysis: John Dugan, the Comptroller of the Currency, is urging the Federal Reserve to change its regulations to permit greater ability of credit card customers to avoid interest rate increases.  Dugan proposed that before an increase goes into affect, customers be given advance notice and the option to stop using the card and pay off existing balances at the old rate for an extended period of time.  The Fed may find it hard not to accept this suggestion from a fellow banking regulator.  The ability of the credit card issuers to increase rates based on a credit score downgrade will certainly be affected.

Implications: Congress is looking for the "villians" in the subprime mortgage meltdown, and the credit rating agencies are prime suspects.  S&P, Moody's and Fitch will have to play a defensive game, but in the end substantive legislation is unlikely.

Analysis: Congressional hearings are likely to target S&P, Moody's, Fitch and the credit ratings industry for the problems in the subprime mortgage market.  Legislation might be introduced that could affect their profitability by increasing regulatory oversight, or creating new potential civil liabilities.  However, it is more likely that Congress will back away from substantive legislation and ask the SEC to increase scrutiny instead.

Implications: There is no question that the Fed will use its regulatory authority to prohibit practices it deems to be unfair or deceptive.  It is under tremendous political pressure to act and to act soon.  Its regulations will affect all mortgage lenders, not just banks.  The real question is whether the market has already moved away from these so-called unfair or predatory practices. The rules will further limit market for mortgages, andcould interfre with those consumers who need to refinance.

Analysis: Every mortgage lender should be concerned that the regulations are not overboard.  The task of defining abusive practices is not easy, and prohibiting loan terms will have unintended consequences.

Implications: Although Congress passed legislation designed to prevent Internet Gambling sites from operating in the U.S., the law is probably ineffective  and will not achieve its goals.

Analysis: The law passed by Congress is attempting to use the payment system to police internet gambling.  The credit card industry had voluntarily stopped processing payments for gambling sites prior to the enactment.  So the legislation will not change the role played by credit cards.  Attempting to control other payment methods, such as ACH transfers or paper checks  is far more difficult, and there is good reason to believe that the Internet Gambling bill will be ineffective in its attempt to do so.