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.
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Capital Wave Investing: Is it Time to Profit From the Cash-Rich Technology Sector?
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- Money Morning Mailbag Feature:
Money Morning Mailbag: How the Demise of Glass-Steagall Helped Spawn the Credit Crisis
How Your FICO Score is Calculated
Loan-to-Value (LTV) Ratios
About the Author
Shah Gilani is Chief Financial Strategist for Money Map Press and boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker. He helped develop what has become known as the Volatility Index (VIX) - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk and established that company's "listed" and OTC trading desks. Shah founded a second hedge fund in 1999, which he ran until 2003. Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see. On top of the free newsletter, as editor of The 10X Trader, Money Map Report and Straight Line Profits, Shah presents his legion of subscribers with the chance to earn ten times their money on trade after trade using a little-known strategy. Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on FOX Business' "Varney & Co."