Did US banks dig their own grave by hiking mortgage rates?

[MichaelR]

DISCLAIMER: this may be a silly question, but I still want to know...

Apparently the mortgage crisis in the US did not just come because banks gave "risky" mortgages to people who were after some years unable to pay them. Instead, the banks hiked the rates sharply, leading to things like quadruplying payments - and then people defaulted en masse. Example source: http://www.telegraph.co.uk/finance/econ ... tline.html

Would it not be better for the banks, in the situation of rising inter-bank rates, to take some moderate losses by keeping rates lower, instead of taking massive losses by triggering a wave of defaults?

Also, is it true that Ireland has avoided massive mortgage hikes, and fire sales are mostly due to negative equity or falling income as opposed to a rising mortgage? If so, would be interesting to know why such a massive difference. A bubble, after all, was in place in both cases.

[QuestionsQuigley]

DISCLAIMER: this may be a silly question, but I still want to know...

Apparently the mortgage crisis in the US did not just come because banks gave "risky" mortgages to people who were after some years unable to pay them. Instead, the banks hiked the rates sharply, leading to things like quadruplying payments - and then people defaulted en masse. Example source: http://www.telegraph.co.uk/finance/econ ... tline.html

Would it not be better for the banks, in the situation of rising inter-bank rates, to take some moderate losses by keeping rates lower, instead of taking massive losses by triggering a wave of defaults?

Also, is it true that Ireland has avoided massive mortgage hikes, and fire sales are mostly due to negative equity or falling income as opposed to a rising mortgage? If so, would be interesting to know why such a massive difference. A bubble, after all, was in place in both cases.

I think the Law of unintended consequence might explain it

The law of unintended consequences

The "law of unintended consequences" (also called the "law of unforeseen consequences") states that any purposeful action will produce some unintended consequences. A classic example is a bypass — a road built to relieve traffic congestion on a congested road — that attracts new development and with it more traffic, resulting in two congested streets instead of one.

This maxim is not a scientific law; it is more in line with Murphy's law as a warning against the hubristic belief that humans can fully control the world around them. Stated in other words, each cause has more than one effect, and these effects will invariably include at least one unforeseen side effect. The unintended side effect can potentially be more significant than any of the intended effects.
http://en.wikipedia.org/wiki/Unintended_consequence

[expat girl]

DISCLAIMER: this may be a silly question, but I still want to know...

Apparently the mortgage crisis in the US did not just come because banks gave "risky" mortgages to people who were after some years unable to pay them. Instead, the banks hiked the rates sharply, leading to things like quadruplying payments - and then people defaulted en masse. Example source: http://www.telegraph.co.uk/finance/econ ... tline.html

Would it not be better for the banks, in the situation of rising inter-bank rates, to take some moderate losses by keeping rates lower, instead of taking massive losses by triggering a wave of defaults?

Also, is it true that Ireland has avoided massive mortgage hikes, and fire sales are mostly due to negative equity or falling income as opposed to a rising mortgage? If so, would be interesting to know why such a massive difference. A bubble, after all, was in place in both cases.

You're absolutely correct, they had no choice though. The Fed lowered rates after 911, so people bought property very cheaply, at large multiples. Then inflation rose, because oil prices went from $10 per barrel in 1999, to almost $150 in July this year. Everything we buy is oil dependent (farming, transport, heating, plastics, you name it). So raising the price raises inflation. So the central bankers noticed that, and raised rates en masse. Pile that on top of dodgy lending, and you have the meltdown that is upon us. No, this isn't 1929, it's worse than that. It's 1929 rolled into the 1970's oilshocks. And there will be no recovery, not unless someone finds an easily exploitable source of cheap energy soon. However, given the likely depth and breadth of this recession, the chances are demand may plummet, giving us maybe 2-5 years of stable or falling energy prices. We need to use that time to develop alternatives, because every time the oil price spikes again, asset prices will spike DOWNWARDS, and we will wave byebye to a few more banks.

Radical rethink required on how we run our societies, folks. Anglo-American capitalism is dead, and the bloated corpse is giving the rest of us the plague

[Sidewinder]

A huge number of US mortgages in recent years had all sorts of crazy toxic schemes: negative amortization and the like. Basically the banks would give out a mortgage with a 2,3 or 5 year "introductory" interest rate of near zero, in order to keep monthly repayments low and "affordable". The interest that wasn't being paid for those first few years was rolled up and added to the principle. When the introductory period ended, all of a sudden the mortgagee started having to pay standard variable rate interest on an amount of principal which was now much larger than the original mortgage. All these Alt-A, Option-ARM etc. mortgage products that you hear about were up to similar madness.

Crazy stuff, yes. But that's what happens in a FIRE economy. "Property only goes up, so do wages, it's a one way bet, fill your boots!"

But firing out billions in unpayable dodgy loans wasn't enough for the financial system, oh no. Some bright spark had the genius wheeze of packaging up all these dud loans into securities, and selling them on. The securatised funds came with all sorts of fantastically exciting names like "Structured Investment Vehicles" and "Collatoralised Mortgage Obligations", and banks all over the world filled their boots with this crap, and claimed that these "assets" were worth something and hence counted towards their capital reserve ratios.

Now it's not only the original mortgages which are going sour. Banks everywhere are now discovering that their bad loans are rising, their losses on trading income are increasing, the cost of funding on the inter-bank markets has soared (true interest rates are much higher than the headline Fed/BoE/ECB base rates) and all these toxic securities they bought, and which they were claiming counted towards their capital reserves, are now essentially completely worthless. And hence bank after bank is having to declare that they are in fact insolvent.

All this was easily forseeable. Many people predicted exactly what would happen when the music stopped, none of what was going on for the last decade was remotely sustainable or even remotely sane. IMO all these banks should be allowed to fail, and their management jailed for massive fraud.

[wombat]

IMO all these banks should be allowed to fail, and their management jailed for massive fraud.

Can't say I disagree with the sentiment. Unfortunately as I heard a Yank explain last week, its the ultimate terrorist threat, we'll blow ourselves up & take you all with us if you don't meet our demands. Unlike the movies, Bruce Willis can't save us.

[Sidewinder]

But it is just a threat.

Not all the banks were reckless gamblers. Quite a few were still reasonably well-run. Not every bank will collapse. Tis simple, in an ideal world not run by morons: the regulator (ha!) should be keeping an eye, and if a bank is nearing insolvency should immediately move in and place the bank under State control, for a limited period of say 2,3 months.

In that time everyone with deposit & savings accounts with the failed bank can move all their accounts, direct debits, blah blah to another institution. The other institutions would be obliged to take in the refugees.

The loans of the failed bank can be placed into the care of a State Recovery Agency which will do its best to get at least some of the money back, and/or sell on the good-quality performing loans to the other institutions. Then the failed bank can be stripped, all remaining assets sold off, as many creditors as possible paid off, and the rest will just have to wait and see what if anything comes out of the Recovery Agency.

In other words, a minor modification to standard receivership procedures for any other company, and the only modified for the purely practical consideration of allowing ordinary punters time to move their accounts to prevent panic and chaos.

Why should the banks be special?

[droghedasouth]

But it is just a threat.

Not all the banks were reckless gamblers. Quite a few were still reasonably well-run. Not every bank will collapse. Tis simple, in an ideal world not run by morons: the regulator (ha!) should be keeping an eye, and if a bank is nearing insolvency should immediately move in and place the bank under State control, for a limited period of say 2,3 months.

In that time everyone with deposit & savings accounts with the failed bank can move all their accounts, direct debits, blah blah to another institution. The other institutions would be obliged to take in the refugees.

The loans of the failed bank can be placed into the care of a State Recovery Agency which will do its best to get at least some of the money back, and/or sell on the good-quality performing loans to the other institutions. Then the failed bank can be stripped, all remaining assets sold off, as many creditors as possible paid off, and the rest will just have to wait and see what if anything comes out of the Recovery Agency.

In other words, a minor modification to standard receivership procedures for any other company, and the only modified for the purely practical consideration of allowing ordinary punters time to move their accounts to prevent panic and chaos.

Why should the banks be special?

What you described is more or less what happened to WaMu.
Regulator (FDIC) decided early last week that WaMu could not survive because of a run on the bank.
Put the deposits and branches of WaMu up for secret aution.
JP Morgan won the auction and all deposits (including uninsured deposits) were saved.

But all of this happened because banks are special.
That is why the FDIC has the special powers to tell the management and shareholders; STOP - THE GAME IS OVER - YOU LOST.
These powers are not a minor modification of standard insolvency/bankruptcy procedure - they are draconian.

Given that Goldman Sachs and Morgan Stanley have reconstituted themselves as banks, and are subject to the regulation that goes with it, the day of the highly leveraged (30:1) masters of the universe is over [at least for now].