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Money Morning Mailbag: The Capital Wave That Could Blunt the U.S. Recovery

[Editor's Note: If you missed Shah Gilani's recent essay on "capital-wave investing," you might want to go back and take a look. We've been deluged with upbeat comments from readers wanting to learn more - including this reader query asking if the banking sector's reluctance to lend will blunt the U.S. rebound. Read Gilani's response ... and make sure you don't miss Gilani's free video report on capital-wave investing, which will be released to readers at 2 p.m. EDT today (Thursday).]

Question: How can banks justify not giving out mortgage money in light of the fact that they can now qualify their applicants to a level not previously seen? I am talking about literally millions of people applying for loans with 800-plus FICO scores and Loan-to-Value (LTV) Ratios that are better than ever before.

How can banks and lending institutions take our money and then turn around and shut nearly everyone out – which simply prolongs this recession? Can anyone explain why the present administration and regulatory bodies are not forcing the banks to loan monies to qualified applicants?

At this rate, we will be dead soon.  Without borrowing, we will die.  

•  (Signed) Living in Costa Rica

Answer: Dear Living in Costa Rica:

You pose an excellent question – one that is being asked by smart-and-frustrated investors everywhere. Fortunately, there is a simple answer. But I fear it's an answer that you won't like.

Banks don't want to write mortgages because they may have to hold all or part of those mortgages on their books if they cannot pool large quantities of them (quantities they don't presently possess because … as you point out … they're not making enough loans), and if they can't then "securitize" them and sell them off to investors.

Banks are also playing a waiting game. They are waiting to see how potential regulatory reforms will affect how they originate, package, securitize, label, rate and account for mortgages and mortgage-backed securities.

And, finally, banks know that rates are eventually going to rise. They don't want to get caught making low-interest loans in a rising-rate environment. Banks borrow short and lend long. If a bank makes you a 30-year mortgage and it gets the money it loaned to you by borrowing it for only a year, when that year is up, the bank will have to go out and borrow that money again.

But there's a problem: A year later, if it costs the bank more to borrow and if the rate on the loan it made to you doesn't change, the institution starts to lose the profit margin that it had hoped to book on your loan.

Indeed, if rates rise high enough, the bank could actually lose money on the loan or mortgage it made. The U.S. Federal Reserve is very worried about the future health of banks if rates do, indeed, start to rise … and precisely because of the scenario I just explained.

The Fed flooded the banks with money – both directly, and by cutting the benchmark Federal Funds target rate to zero.

U.S. lenders know that they have to fix their balance sheets and build up capital. The U.S. Treasury Department and the Obama administration may talk tough and demand that banks make more loans – but why haven't they forced them to do so? Because it's more important for banks to not fail than it is for them to be making loans that might get them in hot water later when interest rates ultimately rise.

It's an ugly reality – especially because banks are making good money by not making loans, but by instead leveraging and buying Treasuries with the free money the Fed affords them, which enables the "lenders" to pocket risk-free gains.

What makes this situation even worse – positively angering U.S. taxpayers – is the fact that the banks then turn around and pay out their ill-gotten, taxpayer-financed profits as bonuses to the same crew that drove us all over the cliff at the start of this credit-spawned financial crisis.

[Editor's Note: As the response to his "capital-wave-investing" essay underscores, Money Morning Contributing Editor R. Shah Gilani always has something to say. So it's no surprise that his columns and analyses have been read by millions.

A retired hedge-fund manager and gifted analyst, Gilani has literally seen it all on the world of finance. That enables him to take readers behind Wall Street's "velvet rope" – and into the world he knows so well – exposing the pitfalls that can inoculate investors against ruinous losses even as he highlights profit opportunities that most other experts never even recognize.

With his new advisory service – The Capital Wave Forecast – Gilani shows investors the monster "capital waves" now forming, will demonstrate how to profit from every one, and will make sure to highlight the market pitfalls that all too often sweep investors away.

Take a moment to check out Gilani's capital-wave-investing strategy – as well as the profit opportunities that he's watching as a result. And, like the reader above, please feel free to submit questions, comments and contributions to the " Money Morning Mailbag " feature to Then watch Money Morning each week for readers' letters and our published responses.]

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About the Author

Shah Gilani is the Event Trading Specialist for Money Map Press. He provides specific trading recommendations in Capital Wave Forecast, where he predicts gigantic "waves" of money forming and shows you how to play them for the biggest gains. In Zenith Trading Circle Shah reveals the worst companies in the markets - right from his coveted Bankruptcy Almanac - and how readers can trade them over and over again for huge gains. He also writes our most talked-about publication, Wall Street Insights & Indictments, where he reveals how Wall Street's high-stakes game is really played.

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  1. Bruce L. Davies | March 25, 2010

    Mr. Gilani is certainly correct explaining the causes of the current lending woes. However, the reasons for the lending industries follies are not only on the failed industry business practices Mr Gilani correctly points out but by the government's political power to incentivize lending to those who would not otherwise qualify. Since the Fannie & family could not support anymore bad loans, Wall-street created essentially new junk bonds called derivatives and packaged under different names to be distributed world-wide to reduce exposure to risk and then insured them with AIG. All of this was to accommodate the failed ideas emanating from politicians who threatened the markets with the full force of statist power. After the collapse, the FED transfered the toxic assets to its sheet while creating currency out of thin air and placing it on the banks balance sheets. Since the creation of currency needs a source, the FED created bonds that no one wanted to buy. So, the banks paid 0 & .025% for FED money while getting about 4% for buying the FED debt. Why would they lend money at risk to you? To make matters worse, the FED decides to lower interest rates to encourage investing. The unintended consequences are the mess we find ourselves in. Banks cannot risk current loan profitability if the eventual high interest rates caused by the inflation plus standard rates produce losses. The failure rate would cause the politicians to blame capitalism and a call for socializing the banks & their debt; ending liberty as we know it. The less government intervention in the pricing mechanism the truer values are. Government's intervention can only lead to distortions of value based not on economic reality but the purchase of political power. If we are looking at being investors for the LONG term, we need to know our true risks by analyzing true values. As a trader for the immediate term, there is no tomorrow to consider. As the communist nations embrace free markets & snub big government with astounding success, we are turning away from free markets to big government. As China in a Global Meltdown grows at 8% embracing freer markets, we are at a very low growth with a fear of a double dip recession while embracing larger government. Where do you wish to live in 10 years? The Peoples Republic of China or the Unites Socialist States? What we need Mr. Gilani is good information; timely, accurate & COMPLETE.

  2. mr briggs | March 25, 2010

    The person from Costa Rica is correct. I recently helped my Daughter buy a house. It was a fight all the way even after proving I had the cash to buy it many times over. Settlement had to be posponed because at the last minute BAC was concerned over a "large" deposit in my account. $5,000 from selling an article. Can you imagine? That's not a large deposit in todays inflated world. It was an excuse to try and stop the loan even with a 820 credit score.

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