Yield Spread Premiums Revealed as Interest Rates Rise

Editor’s Note: This article might help you understand the workings of a yield spread premium. For every 1% difference in interest rate the “cost” of the loan to you goes up 19%. Now if you look at it from the point of view of the “lender” that means the “value” goes up by 19%. That means, on a $100,000 loan an increase of $19,000.

So if you have a $100,000 loan and you qualified for a 5% loan, then a smooth-talking mortgage broker or mortgage originator might get you confused enough to get into a loan that looks better but ends being worse.

The result might be that you pay a 10% rate when the loan re-sets. This increases the “cost” of the loan (oversimplifying here for the purpose of education) to the borrower and the “value” of the loan to the “lender.” How much? 19% for every 1% increase, so in our example here, to keep it simple, the cost to you on a $100,000 loan is increased by 19%x5=95%. So you will pay $95,000 more for that increase. And the lender will get $95,000 more for their “investment.”

The mortgage broker gets a “share” of that increase as a reward for having talked you into a worse loan product even if it means that the viability of the loan (the likelihood that you will pay it off) has been diminished. This “share” is called a premium and it is caused by the spread between the original 5% that you could have had and the 10% loan they you bought. Hence yield spread premium, and I call that “tier 1.”

Tier 2 occurs because the source of funds is not the bank, it is an investor who is kept in the dark much as you are. They think they are getting 5% on a $200,000 loan. But what Wall Street did was they actually funded your $100,000 loan, valued it at 10%, and then kept the balance of the $200,000 investment for themselves. To the investor the numbers look the same — they expected 5% on their $200,000 purchase of mortgage backed securities which is $10,000 per year. Wall Street gave them what looked like an investment that yielded $10,000 per year simply by creating toxic loans and used it against the borrowers who would have otherwise paid on the loans because they could.

It is the same yield spread between 5% and 10%, but used in reverse against the investor.
In my opinion this gives rise to recovery of the undisclosed tier 2 yield spread premium payable to the borrower. It might also give rise to a cause of action for securities fraud that the investor could claim. At the moment, few people are pursuing this. Eventually as the mystery unravels, there will be competing claims for this money, and the first one to the finish line is probably going to be the winner.
April 10, 2010

Interest Rates Have Nowhere to Go but Up


Even as prospects for the American economy brighten, consumers are about to face a new financial burden: a sustained period of rising interest rates.

That, economists say, is the inevitable outcome of the nation’s ballooning debt and the renewed prospect of inflation as the economy recovers from the depths of the recent recession.

The shift is sure to come as a shock to consumers whose spending habits were shaped by a historic 30-year decline in the cost of borrowing.

“Americans have assumed the roller coaster goes one way,” said Bill Gross, whose investment firm, Pimco, has taken part in a broad sell-off of government debt, which has pushed up interest rates. “It’s been a great thrill as rates descended, but now we face an extended climb.”

The impact of higher rates is likely to be felt first in the housing market, which has only recently begun to rebound from a deep slump. The rate for a 30-year fixed rate mortgage has risen half a point since December, hitting 5.31 last week, the highest level since last summer.

Along with the sell-off in bonds, the Federal Reserve has halted its emergency $1.25 trillion program to buy mortgage debt, placing even more upward pressure on rates.

“Mortgage rates are unlikely to go lower than they are now, and if they go higher, we’re likely to see a reversal of the gains in the housing market,” said Christopher J. Mayer, a professor of finance and economics at Columbia Business School. “It’s a really big risk.”

Each increase of 1 percentage point in rates adds as much as 19 percent to the total cost of a home, according to Mr. Mayer.

The Mortgage Bankers Association expects the rise to continue, with the 30-year mortgage rate going to 5.5 percent by late summer and as high as 6 percent by the end of the year.

Another area in which higher rates are likely to affect consumers is credit card use. And last week, the Federal Reserve reported that the average interest rate on credit cards reached 14.26 percent in February, the highest since 2001. That is up from 12.03 percent when rates bottomed in the fourth quarter of 2008 — a jump that amounts to about $200 a year in additional interest payments for the typical American household.

With losses from credit card defaults rising and with capital to back credit cards harder to come by, issuers are likely to increase rates to 16 or 17 percent by the fall, according to Dennis Moroney, a research director at the TowerGroup, a financial research company.

“The banks don’t have a lot of pricing options,” Mr. Moroney said. “They’re targeting people who carry a balance from month to month.”

Similarly, many car loans have already become significantly more expensive, with rates at auto finance companies rising to 4.72 percent in February from 3.26 percent in December, according to the Federal Reserve.

Washington, too, is expecting to have to pay more to borrow the money it needs for programs. The Office of Management and Budget expects the rate on the benchmark 10-year United States Treasury note to remain close to 3.9 percent for the rest of the year, but then rise to 4.5 percent in 2011 and 5 percent in 2012.

The run-up in rates is quickening as investors steer more of their money away from bonds and as Washington unplugs the economic life support programs that kept rates low through the financial crisis. Mortgage rates and car loans are linked to the yield on long-term bonds.

Besides the inflation fears set off by the strengthening economy, Mr. Gross said he was also wary of Treasury bonds because he feared the burgeoning supply of new debt issued to finance the government’s huge budget deficits would overwhelm demand, driving interest rates higher.

Nine months ago, United States government debt accounted for half of the assets in Mr. Gross’s flagship fund, Pimco Total Return. That has shrunk to 30 percent now — the lowest ever in the fund’s 23-year history — as Mr. Gross has sold American bonds in favor of debt from Europe, particularly Germany, as well as from developing countries like Brazil.

Last week, the yield on the benchmark 10-year Treasury note briefly crossed the psychologically important threshold of 4 percent, as the Treasury auctioned off $82 billion in new debt. That is nearly twice as much as the government paid in the fall of 2008, when investors sought out ultrasafe assets like Treasury securities after the collapse of Lehman Brothers and the beginning of the credit crisis.

Though still very low by historical standards, the rise of bond yields since then is reversing a decline that began in 1981, when 10-year note yields reached nearly 16 percent.

From that peak, steadily dropping interest rates have fed a three-decade lending boom, during which American consumers borrowed more and more but managed to hold down the portion of their income devoted to paying off loans.

Indeed, total household debt is now nine times what it was in 1981 — rising twice as fast as disposable income over the same period — yet the portion of disposable income that goes toward covering that debt has budged only slightly, increasing to 12.6 percent from 10.7 percent.

Household debt has been dropping for the last two years as recession-battered consumers cut back on borrowing, but at $13.5 trillion, it still exceeds disposable income by $2.5 trillion.

The long decline in rates also helped prop up the stock market; lower rates for investments like bonds make stocks more attractive.

That tailwind, which prevented even worse economic pain during the recession, has ceased, according to interviews with economists, analysts and money managers.

“We’ve had almost a 30-year rally,” said David Wyss, chief economist for Standard & Poor’s. “That’s come to an end.”

Just as significant as the bottom-line impact will be the psychological fallout from not being able to buy more while paying less — an unusual state of affairs that made consumer spending the most important measure of economic health.

“We’ve gotten spoiled by the idea that interest rates will stay in the low single-digits forever,” said Jim Caron, an interest rate strategist with Morgan Stanley. “We’ve also had a generation of consumers and investors get used to low rates.”

For young home buyers today considering 30-year mortgages with a rate of just over 5 percent, it might be hard to conceive of a time like October 1981, when mortgage rates peaked at 18.2 percent. That meant monthly payments of $1,523 then compared with $556 now for a $100,000 loan.

No one expects rates to return to anything resembling 1981 levels. Still, for much of Wall Street, the question is not whether rates will go up, but rather by how much.

Some firms, like Morgan Stanley, are predicting that rates could rise by a percentage point and a half by the end of the year. Others, like JPMorgan Chase are forecasting a more modest half-point jump.

But the consensus is clear, according to Terrence M. Belton, global head of fixed-income strategy for J. P. Morgan Securities. “Everyone knows that rates will eventually go higher,” he said.

How to Buy a Foreclosed House: It’s a business — it’s an opportunity— it’s a risk

The way the media tells it, there are million of bargains out there that will be the house of your dreams and will make you rich. If it seems too good to be true, that would because it IS too good to be true. As a backdrop to this discussion remember that there are over 2 million homes that could be on the market but for the fact that the “owners” don’t want to flood the market. 2 million homes means there are too many homes for any foreseeable demand from buyers. That means that bargain prices are simply early predictors of where the market is heading. Those statistics, taken from over 500,000 homes reported and sampled, shows that the average “discount” is 15%-20%. In a normal market the discount would be real and relatively stable. In this market where we have 2 million homes already in the pipeline and around 3-4 million MORE homes coming it is not merely possible but rather likely that prices will continue to be depressed.

Add to that the credit crunch and the current environment where banks are reinstating underwriting standards where they verify the appraisal, verify your ability to pay, verify your history, verify other conditions affecting the value or future value of the home, and you have a seller’s glut with very little demand. Analysts from companies that maintain divisions employing economists now are estimating that it will take 6-12 years to clean up this mess. I think these estimates will change monthly until they give recognition to the fact that 10 years is about the best we could ever hope for, 30 years in about the worst case, and that the probable time will be something close to 20 years. That is 2 decades of confused downward price pressure, title errors, defects and defects, and figuring out how to undo the the chaos created by Wall Street.

That said, there are many reasons why you SHOULD buy a foreclosed home. First you SHOULD buy a home if you want to live in it — but beware that most people THINK they will live there a long time but frequently move within 3-5 years due to unforeseen circumstances. Financially, the likelihood that you will financially benefit from such circumstances is extremely low. Renting the same house or one just like it will probably cost no more than 60% of the monthly payment you would have even if you put 20% down payment. And you don’t get stuck trying to sell a house in a market that will basically be unchanged or worse than it is now.

Second you should buy a home on a short sale or otherwise, if you have capital and a good credit score and want to do something good. Let’s assume the house was originally bought for $450,000 and the buyer made a 20% down payment. So the buyer paid $90,000 PLUS all the improvements that are made, especially to a new developer tract house. So the sake of our example, the buyer now finds himself with a house that is currently “appraised” at $275,000. The “lender” refuses (actually lacks the authority because they are not really the lender) to modify the mortgage with a principal reduction, the terms are resetting so that the buyer’s payments are about to triple or have already done so. Assume they had no problem making the original teaser payments and could even pay more but not the absurd amounts called for under his current mortgage or deed of trust.

Let’s further assume the foreclosure has already taken place and the buyer is still in the home, awaiting eviction. With a little help from you and this post you get the homeowner to fight the eviction and start a confrontation where the homeowner is demanding discovery and is alleging a fraudulent foreclosure. Using average “discounts” you buy the house for $55,000 less than appraisal from the “bank” (actually a separate entity with dubious authority to have taken or retained title to the property since neither the forecloser nor the REO (Real Estate Owned) entity had one dime in funding the mortgage). So you have purchased the home for $220,000. Don’t get all excited. The original $450,000 price was false and even fraudulent. The next time that house sees $450,000 will be somewhere around the year 2040.

So now you make a down payment of 20% or $44,000. You have $44,000 into the deal plus whatever assistance you have the original buyer/homeowner. Your mortgage is $176,000. Using an amortization of 15 years fixed rate for 5%, your payments for principal, interest, taxes, utilities and insurance are probably going to be around $1250-$1350 per month. You give the original buyer/homeowner a lease requiring payments of $1600-$1700 per month plus a CPI (Consumer price index no less than 2% with no maximum) AND a pass through of increases in utilities, taxes etc. The lease is at least 5 years long. If you don’t have a homeowner willing to lease for 5 years, you are going to have trouble.

The lease is a net lease requiring the tenant to maintain the house. It renews automatically for additional terms of 5 years unless canceled with at no more than 9 months notice and no less than 6 months notice. Beginning with the end of the third year, the homeowners may have a two year option to buy the house at either the price you paid for the house, plus CPI or the current fair market value, whichever is higher. This option is good only in years 4 and 5.

You start negotiating with the “bank” or the REO with a demand for proof of title. See how-to-negotiate-a-modification

They will offer you indemnification, hold harmless and release. None of that means anything because most of them have either gone out of business or are about to go out of business. You ask “Who is the actual creditor here?” That will make them uncomfortable. You get rough and tough. And then you soften a little and use the procedure set forth below. Meanwhile the original buyer/homeowner starts threatening them because they obviously don’t have physical possession of the note or they have no rightful claim to ownership of it. The original buyer/homeowner makes demand and maybe even files suit demanding to know who the creditor is or was. This will soften up the game of the bank/REO.

Now let’s talk about how you are going to do this without being in the same mess that the banks, homeowners, title companies and others are in.

The attributes of a good solid purchase of a foreclosed home are:

  1. Warranty Deed
  2. Title Policy from large company without any exclusion relating to securitization of the prior owner’s loan. It would be best if the policy specifically mentioned securitization and stated affirmatively that there is no exception relating thereto.
  3. Friendly Quiet Title Action, in which the REO, the forecloser and all other known parties, at their expense bring a quiet title action naming the former buyer/homeowner and you, and naming John Does 1-1000 being the holder of mortgage backed securities who could have or who could claim an interest in the mortgage being extinguished by this deal. As long as the relief sought is ratification of the above deal and ordering the clerk of the County to remove the old mortgage and accept the new filings without any encumbrance other than your new mortgage and without any owner other than you.
  5. Indemnification from the forecloser
  6. Indemnification from the REO
  7. Hold Harmless from the Forecloser
  8. Hold Harmless from the REO
  9. General release from original buyer/homeowner
  10. Acknowledgment from your new lender that they were advised of the above and they agree that they will not make any claims against you for misrepresentation or misstatement based upon the securitization of the loan.

Bank Fee Disclosures Deficient — same as Mortgages

By Gail Liberman and Alan Lavine

Last update: 7:33 p.m. EST March 5, 2008

PALM BEACH GARDENS, Fla. (MarketWatch) — Get out an extra-powerful magnifying glass if you’re trying to learn what fees you’ll be charged once you open a checking or savings account.

A U.S. Government Accountability Office report released this week says getting this information could prove tough. Reason: Consumers are not consistently getting required disclosures on fees and account terms and conditions prior to opening an account. GAO reps, posing as customers, visited 185 branches of 154 depository institutions.


They were unable to obtain detailed fee information at more than one-fifth of branches visited. Nor could the GAO find the information on the Web sites of many institutions. Bank regulators, the GAO says, need to do a better job getting depository institutions to give consumers these mandated disclosures.

Our Decaying Educational SYstem: An Answer from Cyberspace

Several pilots around the country involving tens of thousands of students point strongly to a solution for education that is fiscally possible and could catapult this nation back into the forefront of innovation and education. It also presents a major opportunity for local American businesses to get involved in their communities, expand their revenues, increase their profits and boost employee productivity.

On-line education is being tested in several states with some interesting and very positive results. Criticism seems to come mostly on ideological grounds. But the home-schoolers already know that our education system as it stands is broken. Now comes a high tech solution to a low tech problem — parent – child involvement and bonding.

This is a possible way of sidestepping the high cost of renewing parts of our infrastructure while at the same time leaping ahead of where we currently stand in education, relative to our own past and relative to other countries. U.S. HIstory points to several seminal turns like this and I suspect that this is going to catch on BIG time.

Older facilities can be retrofitted cheaply to accommodate occasional classes and extracurricular activities, sports and social events while most of the schooling is done on line. Under the right direction, if the child is doing well, then the system is working. If the child is not doing well, tutoring can be offered at some local facility.

This leads to an interesting phenomenon. Only parents whose children are NOT doing well will suffer the inconvenience of taking their child for tutoring. 

For the first time, parents whose approach is based upon their own satisfaction and convenience and laziness, would have an active reason to make certain that the child is learning their lessons well at home. This in turn could lead to more parent-child interaction and thus the ultimate high tech solution to a low-tech problem — parent-child involvement and bonding. 

The financial savings would easily cover the re-introduction of arts, physical fitness, and all the things we were accustomed to seeing at school a few decades ago.  

It could also lead to high productivity of students, enhanced by greater knowledge, more highly developed analytical skills, more nourished creative impulses, and more rounded and complete understanding of world history, geography, culture, arts, sciences and of course the basics of science, math and communication. 

In turn, this means that baby boomers, like myself, would have a better chance of getting treated by a physician who is better trained and educated when we really need it, if we are still around, in 20-30 years. And it means that our children and grandchildren stand a much better chance in a highly competitive world to create entrepreneurial opportunities for themselves and get jobs that offer better lives than the generation before them. 

And here is a tip for the marketing savvy geniuses. If you assume that this IS going to catch on, you have a huge marketing channel for many services and products. So for example, community banks and credit unions who offer on-line banking could include tutorials on basic personal finance and let students manage virtual bank accounts. Hardware and software providers would have easy access into each of the homes of the students if they offered basic systems to the schools for nothing or next to nothing. Companies wishing to make a name for themselves and ingratiate themselves with a community could make donations that they know will result in better candidates for employment.

Borrowers/Investors Fight Back!—SubPrime Bailout Blowout

The big boys were all about stepping up to the plate to hand back some of their hard-earned (make that unearned) profits with a bailout fund. First it was $75 billion, then it was $100 billion, today it is $80 billion and going down because in the final analysis it is once again about smoke and mirrors. They wanted to create the appearance of reassurance rather than the actuality. Front page of Wall Street Journal today gives a sketch of one of the feeding frenzies and that ensuing crashes that are happening all over the place. It isn’t pretty and it will get a lot worse. In the end, the people who made all the money are  going to be looking for the tax papers to bail them out of a liability that is really all theirs. Donald Trump said it right on Larry King two nights ago. People should start kicking ass — the borrowers who stand the lsoe their homes and everything in it, the banks that cannot survive the massive write-downs that will restate huge earnings into huge losses, and the investors and fund managers who have watched their wealth spiral up and then spiral down (all on paper, nothing real) as the world turns upside down and sideways.Borrowers: Stop playing the game. Renegotiate your loans.Banks: Be creative. Let the talks begin with your borrowers and be ready to fight with the people who got you into this mess. Your borrowers and their good faith are the only hope for many banks to survive this mess. Take your head out of the sand.  Investors: Stop playing the game: Demand compensation for being mislead. No surprise here. Concentrations are in Black and Hispanic communities where it was all the more likely they wouldn’t know, understand or absorb the details they were signing away their lives on. The FUND that was being negotiated between the Treasury department of a lame duck unpopular president and a greedy bunch of predatory bastards who after 10 years of doing this crap think they can get away with anything — it just might fall apart. Some players are back-pedaling. The vacuum in leadership is going to magnify the effects of black October, 2007. There are only two people in the right position to force a massive change in business methods and a bailout in proportion to the requirements of this disaster — GW and Bernanke. Neither one has the muscle or credibility to do it. The only other two people who could do it are Bill Clinton and Alan Greenspan — and neither of them has been or will be invited to try. This is going to be very messy. 

%d bloggers like this: