The last financial crisis can be blamed in large part on runaway securitization. Wall Street giants sliced and diced mortgage loans into bonds that they sold around the world. They claimed that they diversified the mortgage pools so that even a few defaults would not undermine the value of the securities, and they offered tranches of the bonds at a decent yield. As global demand increased for the securities, Wall Street pressured originators to close more and more loans, regardless of creditworthiness. This caused a bubble in prices. Moreover, financial innovators took the lower-tranche loans and cut them up into once-removed securities, making bets on bets on the housing market that were allegedly “safe”. We all know how this ended, and how the securitization bubble took a crash in housing prices and made it exponentially worse.
So now we’re poised to do that all over again.
As I’ve been chronicling, the housing market has been boosted by two events over the past several months, both of which have brought down supply and subsequently nudged up prices. First, banks and REO (real estate owned) holders have deliberately kept their properties off the market, restricting supply. Second and more important for the purposes of this post, institutional investors, including private equity firms and hedge funds, have begun to buy up foreclosed properties in large quantities at a discount. Over 40% of the foreclosed properties in Oakland have been purchased by investors of this type. In the near term, they plan to rent them out, creating what they believe is a fool-proof profit stream of rental payments. Eventually, I believe the plan is to flip the houses once prices rise more.
This has already raised fears about absentee slumlords, and massive redevelopment pushing out residents in these high-foreclosure areas. Now we’re learning about a second-order innovation to this process that looks curiously familiar. The investors want to package up these REO-to-rental properties and create securities out of them.
I first wrote about this a month ago.
The private securitization market for homes has been broken since 2008, and virtually no deals have gone through. But I could see the same alchemy used to prove to investors that they couldn’t lose on a mortgage-backed security put to work to prove the same thing on a rental-revenue-backed-security. They could slice the pools of rental units up into tranches to cushion the blow of missed monthly payments or vacancies, with more risk for higher return. And who knows, maybe they’ll just securitize that junior tranche into a CDO, just like during the housing bubble, and magically turn a high-risk security into a AAA-rated lock.
In other words, this is just a rerun, and the first movie ended rather badly. It was already going to be a problem for the management companies of these REO-to-rental units to have no community involvement; if they can securitize the payments and get sure revenue no matter what happens at their properties, they have even more of a reason to abandon them and act as absentee slumlords. This could also lead to all sorts of strong-arm tactics to force tenants to pay their rent that we have previously never seen before, well beyond a simple eviction after a grace period. The potential for abuse is high, because now there will be massive amounts of money on the line. And who will service the rental units for the investors? Servicers for loans haven’t exactly covered themselves in glory of late.
At the time, I thought the key would be if the rating agencies played along with this gamble, and handed out AAA ratings on these rental revenue securitizations. Reuters reports that many of the bonds are coming to market without ratings at all.
The first so-called real estate owned (REO)-to-rental securitizations in the United States may go ahead without credit ratings, as agencies ponder how to assign grades to the new and potentially risky products [...]
“There are unrated deals in the works,” said Suzanne Mistretta, a senior director at Fitch.
“Right now investor demand is focused on short-term [two years or less] unrated offerings, but by next year, we could be presented with a new rated transaction. Beyond a two-year average life, investors may want a rating.”
Over the past three months, Fitch, S&P, DBRS and Morningstar have each published initial assessments of the potential risks of the new asset class. But no agency has yet published official criteria for the product.
Fitch said that such transactions are unlikely to merit a rating above Single A — and even that would require sufficient historical rental-payment data or a solid record from the property’s operator/manager.
It’s simply incredible that, even with so many variables involved, Fitch would give these deals something even as high as single-A. You need data on default rates, vacancy periods, the impact of local economic forces on rentals, the various property managers and operators who would be handling the rental units in the deal, etc., etc.
Nonetheless, Wells Fargo and other banks are moving forward with unrated products that will probably attract some investors. And that’s just a horrifying prospect, especially if they catch on. There’s just no reason to believe that hedge funds and PE firms with no history of being landlords will be able to ensure a steady stream of revenue out of this. Moreover, one economic shock could blow up this market as easily as the housing bubble popped. We already know that the US economy is due to take a step back in 2013 at best, if not a full-blown recession as a result of the fiscal cliff. Add that into the mix with 9% unemployment or above (the expected range in the event of a recession), and suddenly hundreds of thousands if not millions of Americans fall behind on their rent. The securities start to sour. And this could become a full-blown financial crisis just like in 2007-2008.
This of course depends on whether rental-revenue securitizations become a big market. And so far the rating agencies aren’t playing ball, showing sufficient wariness. But considering how REO-to-rental has the potential to boost the housing market; considering all the stakeholders wanting to see that housing market rise; and considering the global economic slowdown, the associated low interest rates, and the need for large investors to get a yield on their fortunes, it’s not out of the realm of possibility that these REO-to-rental bonds catch on. And that just adds a whole other layer of risk to the system, in completely predictable ways.




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Who is going to buy this cr*p? After the last decade of financial innovation, are there any muppets left
who haven’t already had their faces ripped off?
In my neighborhood, two houses. One has been on the market for several months. It is a REO/foreclosure and over-priced, according to people who have seen it at $199K. The other house was on the market exactly a week, listed for $275K and sold for just under $260K, according to the sellers. Both houses are around 90 years old.
I have seen a lot of sold signs in the general area where I live in ABQ. This seems recent, and I don’t know that the houses are mostly foreclosed, I would guess probably mostly not, but I really do not know, this was not a big area where speculation happened.
But there are areas of ABQ where this sort of rental production could be happening, in the newest areas where people were romanced into the housing market and where the foreclosure rate is high.
Thanks for the info, will be looking for more on this.
So there are to be unrated portfolios full of rented proprties.
What is the likely ability of any particular renter to pay or alternatively, simply pick up and move? Also, how difficult and lengthy is it for a landlord in any particular locale to evict for non-payment?
Are there perverse incentives lurking here, or not? How will local gov’t respond?
This is an absolutely can’t lose investment idea. If something goes wrong, the Obama/Geithner/Bernanke regime will be there to help.
I think the banks want to invent a new game to entice the idiots back to the casino. Rental Income seems to me a very risky game to play.
The same thing is happening in Vallejo. You can buy a house there for $100,000. In the forkin’ Bay Area!
Duh, haven’t we seen this before?
That’s really the only logical explanation, isn’t it? Obama and Geithner will bail out this bullshit 100% when it blows up. How can the banks lose?
The American public, played like suckers once again.
That goes without saying.
I would not call it the worst idea in the world. As soon as you say that the MOTU will come up with an even more insane and destructive scheme to extract rents from the system.
Securitizing rental income is a great idea if you hate Capitalism.
Let’s look at causes. Capitalism can’t find returns. There’s too much “job-creating” money (LOL) chasing too few returns. The whole system has degenerated into a Grifter Economy.
I am enjoying it. And preparing for its crash.
Without the Credit agencies who will buy this junk only other banks a we will buy your junk debt if you buy our junk debt and then we will both have removed our junk debt from our balance sheets and then we can loan out more money.
This sounds like a quicker way to bankrupt America than Housing debt was.
What is Mitt’s take on this issue or is Bain already involved?
Does anyone know what Bain’s exposure to Home loan debt was last banking crisis?
Some possible acronyms for these financial instruments:
Real Estate Annuity Modules
Securitized Collateral Repossessed Earning Widgets
Shock doctrine Housing Investment Turds
Obama if he had some stones could easily say Mitt was bailed out by the banks and now he wants to keep gambling just as long as he is sure we tax payers pick up the tab again.
Banks financed Corporate take overs by having Hedgefunds like Bain buy their home loan debt then the hedgefunds used that money as collateral to borrow money to buy companies.
If Obama did not bail out the banks Mitt would be very poor right now since Bain rarely used their own money to finance the buying of a company.
How about calling it the worse deal you are aware of so far:)
The only way that I can see anyone buying these steaming piles of shit is if someone like Goldman Sachs over states the profit/income and then convinces some unlucky bastard to buy them OR someone like Goldman Sachs bribes a pension plan administrator to include this shit in their portfolio.
If the rate-es are paying the rate-rs for ratings, I don’t see how the ratings agencies can resist. Anyone? Hey, eCAHN, jump in, here.
I first heard about this a couple of weeks ago, David.
And from what I was told, you’re spot on about this idea getting bigger and starting the next crisis !
The American public are not suckers. They don’t know how to stop this. What would you suggest that might have an immediate, measurable effect? Every suggestion I’ve seen is longer term, and for good reason. Given the constitution and scope of the problem, systemic corruption and consequent criminality, short term solutions in a system the size of America aren’t feasible.
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Even insofar as we don’t need the revenue to finance govt services, we would still need to set the top marginal rate at about 99% to Hoover up all the income that will otherwise have no outlet but feeding more bubbles.
Whatever conditions may have been in Adam Smith’s day, the reality now is that industrial enterprises are now so incredibly productive that capital formation just isn’t much of a rate-limiting step anymore. There’s too much loose cash floating around at the top, at income levels so high that the money will never be used to buy goods and services. There simply aren’t enough actual investment opportunities available to soak up that excess cash, so it turns to bubbles and pyramids, ever more opaque and thus dangerous bubbles and pyramids, so that the “investors” can continue to con themselves that they aren’t invested in a pyramid.
If we don’t end the hayride soon, and start separating these people from their unreal profits, we will condemn the economy to an ever-escalating series of financial crises, each leadng to further retrenchment of the real driver and rate-limiting step under modern conditions, demand. How far do we go into contraction before the peasants react to the latest bubble burst by sending the aristos to the guillotine?
That works. I just hate to incentivize them to find new and more destructive ways to screw us over.
That may be so, but we’ve got an election this year, and odds are that Obama or Romney will be elected. Neither of these guys will do anything to reform Wall St or stop this type of BS (which is why I will not vote for them).
Although it’s not the main point in your post, I’m so glad to see you mention this, David.
I am SO tired of the RW Republican meme that it was “Democrats forcing the banks to lend to people who shouldn’t own houses” that caused the crash.
Naw, couldn’t have been those greedy bankers and hedge fund guys.
We all understand this bankster scam ,especially with them admitting they are insolvent but have “flow”,but we will still be underwriting the pump and dump as taxpayers and austerity victims .
The missing piece of the fraud is the landlord .Here in the Bay Area residentials are being purchased by large investment firms ,even in the Hood .I can imagine these are the new Mozelli-style Countrywides .There must be retail complicity to buy money for high-risk rentals .
Nor I. But given the ruling cliques’ sensibilities, there are no immediate solutions. Because the ruling cliques are the problem.
Jesus H. Christ! Pardon me, but this deserves extreme language.
I am incredulous…and also not surprised, contradictory though those are.
At first I thought you were saying this was merely being proposed, but then you say they “are coming to market unrated,” so I presume it’s already in operation.
How could anyone be so stupid? So greedy? So utterly reckless?
I’m sputtering with rage and frustration here. wish I could think of a way to put a stop to this now…
Again?
Wall Street and the banksters never stopped doing what led many nations in the world into economic collaspse and are now poised to do it in a slightly different way as well.
Greedy ? yes. Reckless ? yes .However.nobody is stupid .If criminals can perpetrate multi-trillion theft with no fear of prosecution,have us pay via debt peonage .and then steal every hard asset we own ,fleece us of our safety net via austerity ,sell our public utilities via privatization ,then offshore our productive wealth and make us work for pennies while further shackling us into debt enslavement.pretty much makes our Wall.St. masters the smartest criminals in world history .As with all great swindles ,the chumps don’t even know ,or don’t want to know ,they have been played for suckers .Such denial prevents resistance ,and that’s stupid .
Thanks for the heads-up on this latest of many schemes being cooked up to keep the worldwide ponzi scheme running. It is better to be informed of this free market stunt before it turns into a disaster and ruins thousands of more lives, rather than after the fact as was the case in 2008. Wonder if our cops on the financial beat are asleep again.