This outspoken expert on the financial services industry shares his thoughts on current bank regulation and hot topics like Basel III.
Mortgage Banking
November 2012
By Robert Stowe England
Richard (Dick) X. Bove, senior vice president of equity research at Rochdale Securities LLC, Lutz, Florida, is a prominent banking and brokerage analyst. A 1962 liberal arts graduate of Columbia University, New York, he began his Wall Street career in 1965.
Bove has worked as a salesman, analyst and director of research at a number of companies, including Wertheim & Co., New York; Shearson Lehman Hutton (merged with Smith Barney); Dean Witter Reynolds (later merged with Morgan Stanley); Raymond James Financial of St. Petersburg, Florida; and Hoefer & Arnett Inc., San Francisco. In 2004, he joined Punk, Ziegel & Co., New York; and was there when Ladenburg Thalmann & Co., New York, acquired the firm in 2008. He left Ladenburg Thalmann for Rochdale in 2009.
Bove is frequently interviewed on financial news television channels such as CNBC, Bloomberg Television and Nightly Business Report, whose programs are distributed by American Public Television, as well as in major daily newspapers and business magazines.
Mortgage Banking caught up with Bove at his Florida office recently to ask about his outlook for the banking industry and for mortgage banking.
Q: What is the current state of the banking industry?
A: Well it’s very good. It’s very strong. If you pull out the Fortune 500 data for 2011, you’ll see that that Wells Fargo [& Co. at $15.869 billion in 2011 profits] makes more money than IBM [$15.855 billion] or Walmart [$15.699 billion].
You’ll find that Citigroup [$11.067 billion] is one of only 15 companies in the United States that makes over $10 billion a year. They make more money than Coke [$8.572 billion], Pfizer [$10.009 billion] and Google [$9.737 billion]. JPMorgan [Chase at $18.976 billion] makes more money than all those companies mentioned. I believe it’s banks that make the most money. From that perspective, these banks are making a huge amount of money.
If you look at FDIC [Federal Deposit Insurance Corporation] data--and the FDIC-insured portion of banking industry is just about the whole industry--in [every one of] the last 12 quarters, [from the third quarter of 2009 to the second quarter of 2012], bank earnings have been up every quarter on a year-over year basis.
Q: I have the FDIC data handy, and I see that the FDIC reports that all the banks it insures earned $34 billion in the second quarter of 2012, compared with $29 billion for the second quarter of 2011. Going back to the third quarter of 2009, industry profits totaled only $2 billion--but that was higher than the $1 billion in profits in the third quarter of 2008.
A: That’s right. And, if you look at the balance sheet, banks have more common equity as a percent of equity than at any point since 1938. If 75 years of experience in the banking industry has any relevance, American banks are overcapitalized. From a liquidity standpoint, you never go back to the 1930s and 1940s for a comparison, because they didn’t make loans in that period. During most of the last 30 to 40 years, liquidity was not as high as it is today.
The loan-to-deposit ratio of the FDIC-insured banks is 71 percent--the lowest it’s been since the FDIC started publishing data in 1974.
So, from an earnings standpoint, they are doing really well. From a balance-sheet perspective, the industry is in a position to fund significant growth in the U.S. economy. The industry’s balance sheet is unusually liquid and strong in terms of its capital base.
Q: Has the onslaught of new laws and banking regulations had any negative fallout on the economy?
A: Yes.
Q: Could you give an example?
A: Take the capital rules. Take a look at a company like Comerica [Inc., Dallas, which is required to have] capital risk weighting at 104 percent of assets. This company is being forced to come up with more capital than would be normal if it was a dollar-for-dollar valuation of their assets. Then there’s BNY Mellon [Bank of New York Mellon Corporation, New York], which has a capital risk weighting of 31 percent.
Why is BNY Mellon at 31 percent and Comerica at 104 percent? Because Comerica lends money to business and BNY Mellon lends money to the United States government--it buys U.S. securities. What the capital rules do is that they dramatically incent, if you will, the banker to stop lending money to the private sector and to give it to the government.
And if you take a look at the aggregate bank balance sheet of the United States of the FDIC-insured industry from 2008 to the present, you will find that’s exactly what banks have done. If I’ve got it right, they’ve loaned something like $500 billion to the U.S. Treasury or to buy agencies [Fannie Mae, Freddie Mac, the Federal Home Loan Bank system and Ginnie Mae securities], and they’ve reduced by about $600 billion their loans to the private sector.
Q: How have new federal laws and regulations affected the mortgage industry?
A: We’ve had 75 years of legislation in the United States, oriented to two goals. Goal No. 1 is get more money into the housing industry and goal No. 2 is to reduce the monthly cost of housing to broaden the ownership base of houses in this country.
Why does the United States government want to do that? If you go back to the Great Depression--that was a period in which people lost their houses in sizable numbers, and it created this massive migration to California. If you read The Grapes of Wrath in high school, you know that that whole phenomenon was a result of the fact that people lost their houses. It was not good to destabilize the system.
Then, in the 1960s, neighborhoods were burning. [New York City Mayor] John Lindsay was walking through the city of New York every night to try and convince kids not to burn down their neighborhoods. The Douglas Commission and the Kaiser Commission both came to the same conclusion: that people do not burn down neighborhoods if they own houses in those neighborhoods.
[The President’s Committee on Urban Housing was chaired by financier Edgar F. Kaiser and issued a 264-page report titled A Decent Home in December 1968. The National Commission on Urban Problems, headed by Paul H. Douglas, the former Democratic senator from Illinois, issued a 31-page report, Housing America’s Low- and Moderate-Income Families in September 1968.]
In other words, the United States government decided it was good for the social stability of the nation to have people own their own homes. And, therefore, they passed all this legislation.
So, now what’s happened in the last four years? They’ve thrown all this legislation right out the window because they have created capital rules that penalize banks if they make loans to low-income people. If you put down 10 percent on a house instead of 20 percent, the capital requirement on that mortgage is higher and therefore the interest rate on that mortgage must be higher. If you have a piggyback loan, you are going to get hit, again, with a higher capital requirement at the bank and a higher interest rate. And who has all these high-LTV [high loan-to-value ratio] mortgages or piggyback loans, etc.? It’s the minorities. The U.S. government is redlining. It’s against the law, but they’re doing it.
Q: Proposed Basel III capital standards limit holdings of mortgage servicing rights at banks, which might reduce the availability of credit unless somebody else would hold those servicing rights.
A: Well, that becomes the next issue. From 1968 to 1972, you had all these people working like the devil to figure out how to get money into the housing industry. The United States government passed a law in 1968 that said you had to build 26 million housing units by 1978, which they did. They invented the mortgage-backed security [MBS]; they invented Ginnie Mae; and they invented Freddie Mac.
[They tried] to stop the contra-cyclicality of the mortgage business in this country by opening up access to the broader capital markets--not just savings-and-loans--and to give the mortgage industry a competitive product in those broader capital markets so that when interest rates went up, there would not be a considerable decline in housing activity.
Now, without Congress doing a thing, the Basel III people and the regulators have shut down those programs. This whole theory that housing should be made available to everyone who can somehow afford it, has just been dumped by people in Basel, Switzerland--which includes Americans, too--and the people who created this newly proposed [Basel III] . . . rule that has been placed on the head of the industry. It’s 750 pages put into three documents by the Federal Reserve, the FDIC and the Office of the Comptroller of the Currency to comply with the Basel III requirements. But what it does is, it contradicts 75 years of legislation by the Congress, driven to the effect of stabilizing the social system in the United States by having people live in houses that they own. We’ve made a decision that [the goal of social stability through homeownership] doesn’t matter anymore.
Q: So, what you are saying is that regardless of what people in Washington say about their commitment to homeownership for Americans, their actions speak louder than words?
A: That’s exactly right. I don’t care what people say in Congress. No.1, they have no clue about the impact of what they do. They write all this legislation about credit cards. They write the Dodd-Frank [Wall Street Reform and Consumer Protection Act] rules, the Volcker Rule. They write legislation about the Durbin Amendment [limiting transaction fees on debit cards]. They do this song and dance at the Fed on Reg E [on electronic fund transfers.]
The one thing they do not do is ask, “What is the impact of what we’re doing?” At some point, you are going to have social minority groups around the United States suing the United States government right across the board for redlining--because the United States government is redlining.
Q: What about the impact on the housing market of the Federal Reserve’s latest QE or Quantitative Easing III--or, as some call it, QE Infinity, since it is open-ended? Under QE III, the Fed is supposed to purchase mortgage-backed securities to boost the housing market and the economy.
A: Well, think about it. The United States government owes $15 trillion. The GSEs [government-sponsored enterprises] owe $6.5 trillion. So, the United States government effectively owes $22.5 trillion. The United States government has [now through its policies] cut off funding in the private sector for housing, as I indicated. There’s a big argument as to whether the GSEs are going to shrink or stay the same size. No one’s arguing that they are going to grow. For the first time, the Democrats have agreed with the Republicans that the GSEs constitute a problem. And the problem is clear: The federal government is borrowing too much money.
Now the Federal Reserve comes along--an entity that is operated by the United States government but it is not the government. And what does the Federal Reserve do? It steps up and says we’re going to buy, who knows what, $40 billion of mortgage-backed securities a month for as long as it takes to get unemployment down to some unknown level.
What have QE I and QE II done? They have funded the United States government. They have not funded the economy. There’s $1.5 trillion in what are called net free reserves in the Federal Reserve, which is essentially bank deposits that are being utilized by the Federal Reserve to buy Treasuries.
So, the federal government has this problem. It can’t grow Fannie and Freddie. And it wants to assist the housing market. What does the Federal Reserve do? It comes along and it decides to buy mortgages. Now, people are looking at whether QE III is stimulating the economy. But [if you think the way I do] you say, what is happening here is that they are taking the pressure off Fannie and Freddie. They’re taking the pressure off Treasury. They’re printing the money to buy mortgages to stimulate economic activity. I hope the hell it works, because that’s what they are doing.
Q: So, how do you see the private sector coming back?
A: Very strongly, because basically, you know, the housing industry is in my view has turned around.
Q: How so?
A: We add 3 million people to the population every year, right? That’s 18 million people since the peak of the housing boom. That’s close to equaling the population of Greece and Portugal put together. That’s how small those countries are that we’re freaking out about. So, the net effect is real demand for housing. Secondly, [we assume that] three-fourths of 1 percent of the housing stock becomes unusable each year.
Plus, for three years, housing starts have not been as great as the [decommissioning] of existing housing units. So, the net effect is we’ve got this demographic demand, which is building, and we’re removing units from the system faster than we’re building units. Now the vacant houses are being bought by the distressed housing buyers. [Plus,] housing affordability is the best I’ve ever seen it since I started collecting these figures over 40 years ago. [On top of this,] you’ve got a system that is preventing people from getting at those affordable houses.
Q: That system would be the new regulations curtailing the availability of credit?
A: Right. That’s why the resurgence of the mortgage banking industry is going to be phenomenally positive.
Q: Over what time period do you see this happening?
A: Five, six or seven years. You’ll get a normal housing cycle. Then the housing cycle will go bust again. Every time the housing industry goes bust, as you know, you wipe out all the mortgage brokers and the mortgage bankers out there. Then they all come back. But this time there’s greater incentive for them to come back than in prior periods, because you’ve throttled, if you will, the regulated channels for getting [mortgage] money into the market.
Fannie and Freddie are not going to grow. The banks are unwilling to hold 30-year and 20-year paper on their books, which have yields of 3.5 [percent] to 4 percent. People who have a 3.5 percent mortgage for 30 years, they will die in that house before they give up that mortgage. So the point is the banks know that and they are not going to put that paper on their books. So someone else has to do it. And who’s going to do it? The mortgage bankers are going to do it.
Q: So, a new, stronger army of mortgage bankers will sell the loans to securitizers and then the Federal Reserve will buy the securities--
A: --from them.
Q: Who’s going to hold the servicing?
A: The mortgage banker.
Q: There is already a trend for some correspondents to keep the servicing. Some correspondents are starting to see that as a great move for them.
A: It is--because basically, unless you run into a one-in-a-hundred-year situation like we did in the last few years, the fact is, all you’re talking about is a computer program [to handle the servicing assets and pass along the payments].
Q: So, the Federal Reserve would not be the only buyer of the new private-label mortgage-backed securities. You would also have institutional investors who would want to snap them up?
A: Yes, particularly if they are mortgages outside the conforming guidelines [for Fannie and Freddie] or, if you will, low-income borrower mortgages and jumbo mortgages. [Investors would buy these mortgages] because they have higher yields, and higher yields are more attractive.
Remember, the money out there has not diminished. The funds chasing a return have not gone away--they’ve gone up. The matter of fact is, there is a need for yield. If the Federal Reserve is going to say, “We’re going to keep interest rates down close to zero, and we’re going to buy mortgage-backed securities,” the enterprising mortgage banker is going to go out there and say, “Well, I’m going to make jumbo mortgages with 200 basis point premiums over the conforming mortgage and I’m going to sell them to a hedge fund or a pension fund or the Federal Reserve.” Or they can say, “We’re going to go out there and we’re going to create subprime mortgages and sell them to these same people.”
Q: If we are going to bring back private-label securitization, won’t we need to improve transparency about the mortgages in the pool that is being securitized?
A: Yes. The buyer who is buying them is going to have to take a look and know what’s he’s buying.
Q: And they may need loan-level detail on the mortgages in pool.
A: Yes--but quite frankly, as time goes by, you’re going to find that the rating agencies will come back in some form and do it for them. The rating agencies will just be a lot more rigorous than they were the first time around. MB
Robert Stowe England is a freelance writer based in Arlington, Virginia, and author of Black Box Casino: How Wall Street’s Risky Shadow Banking Crashed Global Finance, published by Praeger and available at Amazon.com. He can be reached at
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