How much trouble are U.S. Banks in?

So just exactly how much trouble are our banks in?  THAT is the question that is growing like a strangling vine in America.  And of course if it’s the question there, it’s the question here.

And as always there are two answers, because there are, and have been for two and a half years, two increasingly out of joint, realities.  There is the official, bank sponsored reality presented to us every day in a noisome, viscous flow of oleaginous, plastic faced bankers, politicians and financial apologists.  And then there is the dissenting mob.

The strength of the official version is that it is able to dominate our every moment with its chorus of loud and strident voices. Its weakness is that so little of what it has assured us is true, (sub prime is contained. Over by Christmas) has been borne out by events.  I have the growing impression that like Hitler in his bunker, our leader’s official version is increasingly based on moving phantom divisions around on a make believe map, which bears less and less relation to the shattered landscape outside.

The weakness of the dissenters is that they are studiously ignored by those in power and are therefore hard to hear.  Their strength is that what they are pointing to, everyone around them can see with their own eyes.

In the banker’s bunker, the banks are making profits, paying bonuses, paying back the government with shares which have risen in value and all is good.

Outside, the official fiction, has no more substance than paper money whose value has been lost.  It just blows around us as so many greasy lies.

So let’s look at what we know of the trouble the banks are now facing.

America’s regional banks have been and currently are collapsing at twice last years rate.  So far 129.  A large part of that debacle is due to the collapse in commercial property prices.  Which is in turn a result of the collapse in consumer spending.  Commercial property has, according to Moody’s,  lost 35.9% of its value in just the last two years.

America’s big banks have several hundred billion in second lien, heloc loans.  That is loans which took equity out of houses on the basis that the houses had appreciated above the value of the mortgage.  Those loans are now a serious problem because the house prices are now LESS than the total amount owed (mortgage plus heloc loan). In fact for very many, possibly most, the value of the house is now less than the amount of the original mortgage on its own.

Second lien loans are NOT entitled to any of the proceeds of a house sale until after the  mortgage has been paid off.  Thus for hundreds of billions of dollar’s worth of helocs loans held by the big banks, (most at mark to model myth values) there will be ZERO money to be re-couped. Those ‘assets’ are  in fact worth nothing whatsoever.  That fact has not been accounted for or written down by any of the big banks.

Those same banks are currently already holding a very large stock of already foreclosed houses.  I have seen those houses.  They are wreaks. In just weeks after foreclosure they are ransacked and become eyesores. But the banks claim they are worth full price.

Estimates are that in total the unsold housing stock already waiting to be put on the market plus those destined to default and join them over the next 12 months, is about 7 million homes. Up till now various ‘loan modification’  wheezes have helped to make the rate of default look better than it is and has helped the banks pretend, on paper at least, that non-performing loans are still current, when they aren’t.

Accounting tricks cannot however, change the fact that the current overhang of unsold housing stock held by the banks, or in default, must be cleared and will, at current rate of sales, take a year to do so. A year’s backlog on top of properties coming to market. House prices will decline further.

While this is happening the banks are not getting any income from the defaulted, bank owned or non-performing loans.   According to a talk by Christopher Whalen, (he’s an investment banker and co-founder of Institutional Risk Analytics)  at the American Enterprise Institute, two days ago,

“Mounting cash flow stress on all lenders is reaching crisis levels. Non payment by borrowers and mounting foreclosure backlogs are creating the conditions for the collapse of some of the largest U.S. banks in 2011.”

Basically, rising costs of restructuring and foreclosing as well as other operating expenses are going to force a new stage in the bank crisis.  As well as rising costs, the same banks are facing huge decreases in income.  The low rates which are, on the one hand, helping to stop mortgages dying as quickly as they would otherwise, are, on the other hand, also keeping returns from bank assets equally low.  Thus the banks are getting no income from their other investments.  At the same time income from trading fees has also  fallen off the proverbial cliff because there are no investors left in what they evidently regard as a rigged market.  That they think this, is evident from the continuing outflow of their money.  For 22, now 23 weeks they have simply taken their money and gone home.  Actually I think they have been crossing the street and investing it in the bond and currency markets. But that is another story.

Then we come to the new killer on the loose.  The U.S. banks are now embroiled in a thickening quagmire of law suits. As I have mentioned recently the law suits accuse them of systemic fraud and racketeering.  So serious and systemic are the accusations that the big banks have voluntarily stopped foreclosing.

If you want to get to the details you need to read Karl Denninger at Tickerforum.org.

I am not a lawyer, so what I will give you is the general synopsis of things as they stand now. The crux of the matter is that in transferring mortgages from the bank or broker who originated the loan to the Mortgage backed security into which it was eventually packaged and sold-on as an investment, a trail of legally required paperwork, transferring ownership of the mortgage DID NOT HAPPEN.

The banks have been trying to say this was clerical oversight or simple error.  It is already evident that the practice was systemic, endemic even, and so WAS NOT an error.  It was how it was being done as a matter of course.

“So what’.”you might think. ” Let’s just catch up on the missing paperwork now.”  Sadly, for the banks, that won’t do, unless the law is set aside, which may end up being what the banks lobby for.

The problem with the missing paperwork is two fold.  First, it means that when a bank says it is the ultimate owner of a mortgage  it now wants to foreclose uopn, you, the owner, only have the bank’s word that it is the mortgage owner and has legal right to your house.  Worse, if you want to contest the foreclosure or force the bank to work out a payment scheme with you, or stop the bank forcing a quick and low valued sale, for example, you will not be able to. Because YOU will not be able to show which bank owns your house and therefore which bank you want to call to court.  No court will accept any appeal from you, the house ‘owner’ if you don’t know who you are filing suit against.

For the banks, the lack of legal proof is halting the whole foreclosure process. Which is a real problem, because the banks are now running out of cash flow, they are very keen to ramp up foreclosures simply to get their hands on some cash. The banks are, however,  now in the position of not getting payments in from the loan AND not being able to sell the asset either.

And it gets worse.  Many, many of these securitized loans were put into trusts.  The purpose of the trusts was to minimize tax. Particularly state tax.  But under the law being used to minimize taxes, several things MUST be true and in place.  The main one is that the paper work must be there at creation, to show that the loans have been signed off by a responsible bank person to guarantee that the bank is satisfied that the loans going in to the securities and the trust, are above a certain standard – That very few will end up being defaulted.

THAT is the paper work which is NOT there. So EITHER no one inspected them and that is why there is no paperwork, OR they were signed and ‘lost’ and in their place we are finding thousands and thousands of post dated legally fraudulent documents. An example being investigated in Ohio showed, 8 notaries were ‘signing’ 8000 documents a month every month.  There COULD NOT have been any due diligence being done.  The signer was a smurf.  That action is fraud.

As Karl Denninger said recently in an interview, if you have original documents you don’t present fraudulent ones.  You only present fake one if you have reasons why you don’t want an original to be seen.  The evident reason is that those originating and those packaging the loans BOTH knew that the loans were NOT of the required standard. They knew, that a high proportion of the loans would default.  This had to be hidden from those who were being sold the securities. The buyers had to believe the securities and the mortgages from which they get their income, were AAA quality.

It is further alleged, that in some of the cases, the banks creating and selling the securities not only knew the securities sold as AAA were not, but subsequently bought CDS that would pay out to the banks, if and when the mortgages they were selling, would default and fail.

You build a car that you know WILL fall apart. But you badge it as a Ferrarri and sell it at a Ferrarri price. You knowingly defraud the person you sell it to. You steal his money.  But then you also take out insurance on HIS car that will pay YOU ‘if’ his car falls apart.  When it does fall apart, as you knew it would, you get paid a second time. this time defrauding the insurer and the insureres share holders. Two paydays for you. Two people you have stolen from.

Those ‘intentionally’ fraudulent securities were sold to US pension schemes, who traditionally buy AAA rated MBS because it is so safe, and more recently were also sold  to Freddie mac and Fannie Mae – IE sold to the tax payer and also sold to German Landesbanks and probably RBS here in the UK.

The fraud was endemic. I have seen some of the paper work from Ohio.  I have seen smurf buyers – the same person applying for mortgage after mortgage, and that person was at the time barely solvent, I have seen the name of the same lawyer over and over, acting between the buyer and the loan originator.  And they in turn dealing with the same  banks over and over. Thus either they were all of very limited mental capacity or they all knew and were thus all party to an organized fraud – otherwise known as racketeering.

What happens now?  Well one argument is that the fraudulent loans can be forced back to the originator of the loan/fraud.  That business/bank would have to pay back the money to the people who bought the securities.  There are about $6 trillion in such securities out there.  Between a quarter and a half may be involved. That would detonate most, if not all, of the banks involved. Or, somehow, you leave those currently holding the bag to continue holding it.  THEY take a couple of trillion in losses.  Pensions disappear and so do Fannie and Freddie and all those holding their IOU’s – That would be the Chinese.

This is now a massive problem. which got EVEN worse this week.  Remember the tax minimizing I mentioned earlier?  If the Trusts were not legally constituted, THEN they become liable for tax on 100% of their holdings.  Which means, the trusts may owe billions in back tax to US States.  Those States are currently, 35 at last count, I think, facing bankruptcy themselves. The Secretary of State for Ohio, Jennifer Bunner has already started talking to the Justice department about action. Count on the States wanting those taxes.

So, THAT is the view from OUTSIDE the Bank bunker.  That is how much trouble US banks are in.

And if you are not inclined to believe me, and why should you, let me give the last word back to Mr Whalen. Remember he IS a banker and an insider, and is in the market.  This is how he concluded his talk to the AEI (which, if I remeber rightly, used to advise Gengis Kahn on his welfare policy).  Mr Whalen concludes,

“The US banking industry is entering a new period of crisis where operating costs are rising dramatically due to foreclosures and defaults…. Rising operating costs in banks…could force the U.S. government to restructure some large lenders as expenses overwhelm revenue.”