[Continued from yesterday's Part 1.]

Yesterday’s post opened the topic of payday lending as exploitive microfinance, designed not to maximize the borrower’s well-being but rather to hold that borrower on the razor’s edge of permanent default, as illustrated by this article from the Washington Post:

Meanwhile, big companies are muscling into a sector that has been dominated by independent operators, lured by the promise of a largely untapped $13 billion market. Wal-Mart, the world’s largest retailer, stepped up the competition earlier this year by slashing prices on its most popular financial services, such as check cashing.

Three years ago, I wrote about these ‘industrial loan companies,’ or banks by any other name describing them in favorable terms, although with a caveat:

“That’s caveat, not Cavett, as you know full well”

Pursuit of CRA investment test credit is a principal driver in LIHTC equity investment, leading to very high prices and resulting highly efficient use of government tax expenditures. And however much banks may tout their CRA performance, there’s no question it’s a burden to them, so if banks are competing against non-banks without a CRA obligation, they will be at a competitive disadvantage.

Consider then an entity that:

1. Has an enormous market capitalization.

2. Is active from coast-to-coast.

3. Takes deposits.

4. Makes loans and provides financial services to its depositors.

Is that a bank by any other name?

“O Romeo, that which we call a time-deposit, by any equivalent interest rate would yield as much.”

If it is, should it be subject to the CRA?

Ask Wal-Mart, as shown in this Economist article:

When Wal-Mart rolls into town, small shopkeepers quake. Now that the world’s biggest retailer wants to enter the financial business, America’s bankers are trembling, too. On April 10th the Federal Deposit Insurance Corporation (FDIC), one of America’s bank regulators, held the first day of public hearings on Wal-Mart’s bid to open an industrial loan company (ILC).

Industrial loan companies are a symbiotic species advantage – the ILC symbiotically lives inside the retailer, and provides the retailer’s customers with credit to buy the retailer’s products.  That’s powerful competition, and we’re all for it – if it’s properly regulated (as to capital, transparency, and consumer protection) and provided it bears the same social responsibilities banks do – namely, CRA.

Beyond ILCs, we are seeing a rebirth of American microfinance (a business model that I believe was born in the USA just over a century ago:

Start-ups have emerged to offer lending to niche groups, such as Hispanic immigrants, at dramatically lower rates.

Niche lending is key to establishing a microfinance institution (MFI).  Focusing on the niche gives the lender better touch on the customers, which reduces probability of default.

Even as non-banks are making small American microfinance loans, banks too are finding their way into the space:

Some credit unions offer short-term loans as an alternative to payday lenders. North Side Community Federal Credit Union in Chicago, manager Ed Jacob said, introduced a six-month, $500 loan with 16.5% interest several years ago.

Microfinance, American style, coming to you from the streets of Chicago

Five hundred bucks for six months?  That’s the very definition of a normal microfinance loan worldwide.

Mohammad Yunus would be proud of you, NSCFCU

The credit union has since made 5,000 such loans, and it has become one of the most popular products.

Meanwhile, start-ups such as Progreso Financiero in California are targeting new niches. James Gutierrez founded Progreso in 2005 to make short-term unsecured loans of $250 to $2,500 to Hispanic families lacking credit scores and banking records. The company charges 36% interest, significantly less than other payday lenders charge but still more than double the average consumer credit card interest rate.

While we think of America as exporting financial innovation, here is Gutierrez importing innovation, proven in Mexico and Peru and Brazil, into El Norte. 

With Progreso’s main Web site in Spanish, he probably doesn’t even have to translate the forms.

Financiero has made about 25,000 loans to its customers in California but needs to make 100,000 before it can turn a profit because the loan amounts are so small and the cost of doing business is high, Gutierrez said.

Let’s take him at his word, and return to that ‘usurious’ 36% interest rate.  Convert that into 3% per month, apply it to a $500 loan and a six-month average duration, and you get a princely sum of $90 gross revenue per customer.  Out of that must be paid costs of money, costs of administration, loan loss reserves, cost of collection, cost of marketing and advertising …

Hence the challenge of microfinance, American style.  To make a profit from inception, you have to charge rates that seem very high expressed as a pure percentage.  Then, even if you charge a rate that will take many people aback, you make so little per loan you need 100,000 customers to turn a profit.

To get the rates down, get the customer volume up

Jacob said the credit union doesn’t make any profit from its payday-loan alternatives.

Motivation matters.  If you sell a drug to cure someone of addiction, that is very different from selling a drug to get someone hooked.

Too much payday borrowing

Instead, it hopes to boost members into good financial standing so they can then apply for profitable products such as auto loans.

Moving someone up the bankability pyramid makes the prospect profitable to you because you can lend them a larger sum for a longer interval.  Lending profitability isn’t about interest rate so much as it is about the total ‘loan area’: Amount x Term.

Motivation matters.  So does the lender’s use of profits, since that influences the lender’s orientation on rate compression – something to pursue, or to resist?

Some industry veterans are also moving into the sector. Just this year, Wal-Mart lowered the price of its prepaid debit card to $3 and its fee to cash checks to a maximum of $3.

The more nodes, the lower marginal cost

Finance scales.  Like other network-based businesses, it has a substantial establishment cost of intangible and intellectual infrastructure.  As those costs are shared across an expanding customer base, higher marginal profits ensue, allowing lower fees – which in turn expands the market further.

It also allows shoppers to pay many of their bills in stores. The giant retailer estimates that about 20% of its customers are unbanked.

20% of the people who buy there have no bank

Except on the historical context of microfinance born in the USA, I have yet to post structurally on how retailers are natural entrants into the business of financing.  They have interactions with the unbanked – Wal-Mart’s 20% figure is simply staggering.  They are motivated to extend credit so they can sell more products, and they have a hidden pricing advantage in that the profit component of each object sold is, in effect, marginal first-loss exposure for them.  They develop extensive credit histories on their customers and can use computer analysis to provide credit scoring.  Given these facts, the wonder is not that Wal-Mart is in the banking business, but that more such retailers aren’t.

“Our customers are living paycheck to paycheck and watching every penny,” said Jane Thompson, director of Wal-Mart’s financial services.

Wal-mart may be creating the Model T Bank.

The next global bank?

But perhaps the biggest hurdle the industry faces is improving customers’ financial literacy. Many are afraid of leaving their money in banks, do not have the documentation to open a bank account or have had accounts closed. They also may not understand how loans are structured.

There lies the regulatory and policy challenge – how do you distinguish between Bad and Good microfinanciers, when your prospective customer is unable to do so for himself?

D.C. resident Gregory Warf, 20, said he doesn’t want a bank account. He turns his savings over to people he trusts, like his brother, or hides it.

Familiarity dulls people’s risk sensitivity; we have many examples of unworthy siblings.

Oh, you can trust me, Simba

If he needs to cash a check, he goes to the nearest liquor store, which charges him a fee. And if he needs money – say, $10 to put on his SmarTrip card – he asks a friend.

Not trusting anyone dooms Mr. Warf to high transaction costs and cuts him out of the banking system.

“I’d rather have my money in my possession,” Warf said. “I don’t really trust anybody else.”

Except that those two statements are contradictory over time.

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In business, does motivation matter?  Or are markets sufficiently rational that our apologias are meaningless, and we should be judged exclusively by our actions?  This philosophical question lies submerged under every new lender and loan product, for every action – extending or denying credit, charging too high a rate – can be criticized. 

“In many ways, the job of a WaPo columnist is easy …”

After the fact, we can always criticize:

Lenders who refuse good credit.

Lenders who charge ‘excessive’ or usurious interest.

Lenders who extend ‘teaser’ credit to people who cannot repay.

While bad lenders make bad loans, some bad lenders also make good loans, at least in the sense that the loans are repaid, albeit at ruinous cost to the borrowers.  Who then lends to the unbanked – and what are their motivations for that lending?  This compound question runs through a lengthy profile in the Washington Post showing the perils and surtaxes of being unbanked:

For years, the country’s makeshift network of payday lenders and check cashers has operated with little competition or federal regulation.

If, like me, you’re part of our formal financial system, you need sharp eyes to spot the unbanked.  My downtown 7-11, for instance, in addition to doing a land-office business in Mass Lottery tickets and cigarettes, also sells a stream of money orders, typically at $2 or so apiece.

Check-cashing around the corner and around the world …

… and cheap refills on Grotesque Gulps!

While the marginal profitability of each such transaction cannot be terribly high, it’s a legitimate service – and a much more honorable profession than that of payday lending, about which I posted 2½ years ago in Payday lending: doing well …?

Ev’ry evening you will find him,

Around our neighborhood.

It’s the old dope peddler

Doing well by doing good.

“By do-oo-oo-ing good.”

The lenders’ interest is in the very simple question: can we get our loan repaid? By taking a postdated check, the lender jumps the payment queue, assuring itself Mr. Milford pays his loan first, leaving his Christmas presents for last.

A postdated check is not in and of itself a bad thing, but there is certainly something vampiric in the payday lender’s approach.

But I’m so innocent and small …

In many states, including New Mexico, lenders also make no effort to see if customers have borrowed elsewhere, which is how Mr. Milford could take out so many loans at once. If they repay on time, borrowers pay fees ranging from $15 per $100 borrowed in some states to, in New Mexico, often $20 or more per $100, which translates into an annualized interest rate, for a two-week loan, of 520% or more.

Who takes out a two-week loan? People who have difficulty envisioning the future. People living from paycheck to paycheck. People who lack financial literacy or the habit of saving. Such people are vulnerable:

In September, Congress, responding to complaints that military personnel were the targets of “predatory lenders,” imposed a limit of 36% annual interest on loans to military families.

As I made clear in that post’s second part, Part 2 … by doing good?, I found the whole notion of payday lending barely this side of despicable. 

It’s despic-ic-icable!

For decades we have tolerated the payday lenders, largely unregulated, on the reasonable theory that people are under no compulsion to seek them out.  That is changing now:

But as the financial crisis sparks a new wave of consumer protections, lawmakers and the private sector alike are training their sights on an industry that caters to the most vulnerable of populations: the estimated 40 million households on the margins of the nation’s financial system, with limited, if any, access to banks or credit.

Catastrophe being a precondition to fundamental financial reform, when once the groaning granite blocks of legislative inertia start to move, their grinding weight scrapes all before them.  Regulation advances, turn by turn.

You hope it comes out as sausage!

Congress is debating the creation of a Consumer Financial Protection Agency that would provide federal oversight of the industry for the first time.

If as government you think consumers are being bilked, you can do three things: shine a light on the bilking in hopes of making smarter consumers, cap charges, or ban the business altogether.  Yet lending – providing credit to people who need it – is not illegal per se, and most lending is desirable for everybody, particularly the borrowers.  Thus, throughout Congress’s approach will run two possible structural remedies: (1) greater disclosure/ transparency (as everyone becomes a Bank of Glass), and (2) usury limits.

In addition, several bills have been introduced to cap the often-triple-digit interest rates on payday loans, long considered by many one of the industry’s most abusive practices.

Just the phrase ‘triple-digit interest rates’ sounds usurious.  Framing it that way is easy, because payday lenders generate their revenue not through fees but through interest.  Yet at the same time, those payday lenders normally quote interest not in whirling-odometer percentages but in dollars per period, which brings in the second feature: the small sums advanced.  Introducing our protagonist:

If I could just get rid of these debts

Anthony Jeffers lives in North Carolina, where the unemployment rate is 10.7% –

Only on close reading did I catch that bit of urban-sophisticate snobbery.  North Carolina is a big state, and its unemployment rate varies dramatically between the coastal and rural areas versus (say) Charlotte or the Research Triangle.  But to the Washington Post’s editors, it’s all one big Tobacco Road blur.

Where the smokes are grown …

– and he travels to Washington every other month to hunt for construction work.

We don’t ask why Anthony feels compelled to live in North Carolina, instead of bunking with roommates in Washington. 

The costs are high – he pays for an apartment in both places.

Probably he has a wife/ girlfriend and child/ren.  His circumstances should be relevant to his story

The expenses overwhelmed him last year, so Jeffers turned to a payday lender to get $800 for his rent. When he repaid the loan two weeks later, he owed about $1,100, meaning he paid more than 30% interest, or 975% on an annualized basis.

Even making allowance for risk and processing fees, there’s no question $300 for a two-week loan of $800 is brutally expensive – but one does have to ask, Anthony, what are you doing maintaining two apartments?

It comes in handy, in a Mad Men sort of way

“All you’re thinking of is getting your money to take care of your situation,” said Jeffers, who was standing outside a check casher in the District on a recent afternoon after buying a money order to pay his rent back home. “It just seems like a lot of interest to pay back.”

It is – and Mr. Jeffers should find one of several possible solutions – move to Washington, find a roommate or bunking situation for when he is in Washington, find work in North Carolina (presumably harder), or borrower from family/ friends – but all these things are really easy for me to say.  I’ve spent a lifetime thinking about finance; Mr. Jeffers is just trying to keep body and soul together.

“People are always damaged by these products. . . . This can be the thing that pushes them over the brink,” said Rachel Schneider, innovation director of the nonprofit Center for Financial Services Innovation.

Schneider

“In a recessionary environment, the consequences of using predatory products are more apparent.”

Enter the question of motivation.  Mr. Jeffers and other payday-lending customers find themselves in these pickles because they’re not well capitalized, they’re not financially literate, and they lack the luxury of options.  They are desperate.  Encountering those who are desperate, we who are not have power and that makes our choice of action a moral one: do we help or hurt?

Industry representatives say they provide necessary services for households that have become alienated from traditional financial institutions. Many of their customers have poor credit and may not qualify for basic bank accounts [Meaning loans – Ed.].

Microfinance seeks to help.  Loan sharks and shysters seek to hurt. 

We’re all one big happy predator-prey ecosystem, aren’t we?

Though the number of unbanked is difficult to track, Schneider said anecdotal evidence suggests that their ranks increased as the recession deepened.

One thousand?  One hundred thousand?  Nobody knows. 

How many ice creams does it sell?

[We could probably dimension it by measuring the number of payday lenders; speculating as to how many payday-loan customers each one has; and multiplying out.  – Ed.]

Being unbanked does not necessarily mean falling into the clutches of a payday lender – but I’m sure it correlates.

The center estimates that median household income for the unbanked is $26,390 – about half of the national median – and many have little to no savings.

In other words, the median unbanked customer is Very Low Income as federally defined (50% of Area Median Income, AMI), and eligible for Housing Choice Vouchers – which are unfortunately in short supply.

Three bills in the House and one in the Senate that were submitted this spring seek to curb one of the industry’s most controversial practices: charging triple-digit interest rates for short-term loans to risky customers. The bills would impose caps as low as $15 for every $100 borrowed and, in some cases, require greater transparency of the lending terms.

Transparency absolutely.  Caps are more complex:

The cap’s too tight

The payday-lending industry has opposed capping interest rates, and its trade group, the Community Financial Services Association, is raising $1 million from its members to lobby against the bills. CFSA spokesman Steven Schlein said the group has reserved judgment on the proposed Consumer Financial Protection Agency.

Opposition is not necessarily proof of malevolence:

“It’s all in the details,” he said. “It would be a big change for us.”

Right.  The CFSA’s members’ business model is built around on-the-spot credit decision-making, high interest rates (to cover for default and costs of collection), minimal regulation and minimal paperwork.  Even if we grant them the noblest of motives, to overlay government disclosure and government regulation will drive up their unit costs of originating and servicing a loan.  That will disrupt their business model, and it’s certainly possible that the post-regulation, post-reform “better” loans might be more expensive and less available than the lend-first-collect-later model that the payday lenders now use.

The Financial Service Centers of America, which represents check cashers, said that it supports increasing transparency to customers but that additional federal regulation “is unnecessary and duplicative and will only increase the cost of financial services to consumers without any corresponding benefit.”

The FSCA could well be right.  Check cashing is also a form of credit decision, and if the check is bad, the cashier is out the money with no hope of recovery.  So there are transaction costs, and they can rapidly mount up as a percentage of a $20 or $50 check.  One could so burden the hummingbird that it could never fly.

The trade group for payday lenders said it began requiring members to display their fees on posters in their stores last year.

Good!  Why do I have the feeling the members are doing this only because they are running scared?

Industry advocates argue that innovation – not legislation – is the key to reform.

Why not both?

You may need both

Might the innovative response to payday lending be the emergence of 21st century American microfinance?

[Continued tomorrow in Part 2.]

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Last week in Washington, as part of the World Habitat Day activities, AHI – in partnership with the National Housing Conference as host and the Housing Partnership Network as a co-sponsor – issued and discussed the Extract of our report, Mission Entrepreneurial Entities: Essential Actors in Affordable Housing Delivery.

It’s all about MEE – Mission Entrepreneurial Entity, that is!

This is a major report that changes the way people will think about and interact with MEEs.  Download the Study’s Extract here, and for the full report, see the end of this post.

We held the event (click here for more background) at the National Housing Conference, which over its distinguished 75 years of existence, dating back to 1934, has been the best-respected convener of thought leadership, research, and bipartisan advocacy on affordable housing. 

Dubbed a Creative and Effective Institution by the MacArthur Foundation

NHC is led by its president and CEO, Conrad Egan.

Egan, creative and effective, and by now an institution?

To reach our conclusions, we recruited two authors, one from the US and one from the UK, each with deep experience in affordable housing in their respective countries:

Ray Christman, principal US author, with Gaynor Asquith, principal UK author

Gaynor Asquith, arc4 Consulting, Manchester UK

As far as we can tell – and our participants include virtually universal experience – no study like this has ever been done, a remarkable omission considering the hundreds of millions of dollars’ worth of funding these organizations annually handle.  So we approached our investigation like Victorian naturalists, examining the species and making careful notes:

What species is this?

We selected representative and distinctive MEEs (which we’ve decided should be pronounced to rhyme with ‘please’) in both countries, US and UK:

The 23 profiled MEEs

We chose them for diversification of geography; of experience; of business model; of scale; and of portfolio.

The US has a strong population of MEEs along the coasts; many fewer in the South and Southwest

For each one, we looked at their history, current portfolio, financial statements (balance sheet and income/ expense), business lines, activities, CEO, and board.  We also interviewed their leadership, developed a standardized profiling document and populated it with each one, invited them to submit representative properties for inclusion in the appendix, and had their leadership review their final profiles. 

Even though England has one-fifth the US population, their MEEs average more than twice the size of US MEEs

To that we added in-depth interviews with non-MEE thought leaders, and had our initial draft further reviewed by some constructively sadistic editors.  The results (download the Study’s Extract here), we believe, are potent, because they both derive policy conclusions and back them up with a small mountain of evidence.

Here are the highlights:

1.  MEE is the right term … because all other terms are wrong

It’s always infuriated me that outside the US, the term of art is Non-Government Organization – as if being governmental were the world’s default state for all objects and being non-governmental was an act of conscious refusal. 

We could have listed many more things MEEs are not

Even worse, it describes the entities by what they are not and hence gives no indication of what they are

I’m a non-governmental organism … how about you?

As the co-panelists were inadequately avid blog readers, MEE was a new term to them, but as the symposium developed, they naturally adopted it — and the term facilitated further discussion.

2.  MEEs are at the heart of US and UK ecosystemic evolution

Forty years ago, the US and UK housing finance ecosystems were widely divergent – pure public in the UK, and pure private in the US.  Over the ensuing four decades, the two have evolved entirely independently, yet similar forms and principles have emerged in both:

Forty years of convergent evolution can’t be wrong!

Public-private partnership has supplanted pure public and pure private both as the funding architecture of choice.  MEEs have emerged as increasingly important counterparties, commanding a steadily growing share of resources.  They have become essential actors in the ecosystem.

Representatives of the growing species: Mike Pitchford of CPDC, Tom Bledsoe of Housing Partnership Network

3.  What we had thought one species was really two; Neighborhood and Production.

When we started, we thought that isolating MEEs as a species would be both a testable classification and a useful advance.  As our study delved more deeply, we realized we had to divide them further, because though they came from the same genus, they were distinct species.

When we looked closely, we saw two schools

The difference between Neighborhood MEEs and Production MEEs proved more than just a matter of scale.  It went to issues of culture, business and funding model, effectiveness, governance.

The difference between Neighborhood and Production MEEs

The difference in culture mattered enormously.  As Deb Schwartz of MacArthur observed, when they looked at potential donees,

“Look at what reports the board sees, and what it does with the reports it sees”

4.  Implications for the global South

Although of less importance to this audience, our authors and AHI all concluded that our findings are equally applicable around the world.  Indeed, both HPN (via Tom Bledsoe) and NHC (via Conrad Egan) have facilitated international linkages between their organizations and their counterparts in the UK and Canada.  Our work with SDI and others demonstrates that the same growth, structure, and financing challenges confronting southern MEEs have been or are being experienced by US and UK MEEs now.

The Equator isn’t a barrier; ideas should flow both ways

It was an absorbing hour and three-quarters, with a large and thoroughly engaged crowd:

Over a century’s worth of experience represented in four folks following the discussion.

This is significant work that we want to have significant exposure.  Download the Study’s Extract here. 

We’ve completed the full report – with narrative, and four-page profiles of each of the 23 selected MEEs, running a total of over 220 pages.  We’re still determining the best and most effective way of distributing it; if you’re interested in a copy, email mee@affordablehousinginstitute.org.

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If no one wants your pile of booty, perhaps you should try shaking things up  At first blush, that appears to be the strategy behind the proposed remixing of Real Estate Mortgage Investment Conduits (REMICs), as presented in a recent Wall Street Journal article:

I’m gonna shake it up

Once upon a time, Wall Street invented a nifty means of centrifuging, separating, refining off, then packaging and selling the resulting slices.  It was called ‘securitization‘ and everyone everywhere lived happily ever after again.

I’ve invested all our money with Bernie Madoff, honey

Or something like that ….

Debacle, period

Certainly the Journal, which is always skeptical of money-making that doesn’t involve a smokestack industry producing manly products, brings appropriate skepticism to this one:

Some day, son, you too can read the Wall Street Journal.

Wall Street Wizardry Reworks Mortgages

Wizards, as we all know, are not manly men.

Oh no?  I can make your security that big

A new wave of financial alchemy is emerging on Wall Street as banks and insurers seek to make soured securities look better.

That’s full metal alchemy, you know

Regulators are pushing back, saying the transactions don’t have enough substance and stand to benefit bankers and ratings firms.

The popular deals are known as “re-remic,” which stands for resecuritization of real-estate mortgage investment conduits. The way it works is that insurers and banks that hold battered securities on their books have Wall Street firms separate the good from the bad. The good mortgages are bundled together and create a security designed to get a higher rating. The weaker securities get low ratings.

The Journal provides a handy graphic:

REMICs REMIX: How a bad bond is rebundled.

Doesn’t sound bad in the abstract; but we’ve seen this movie before, haven’t we? 

And the picture gets no better the second time

A hypothetical example cited in research by Barclays Capital said that a $100 million asset that required $2 million in capital at a triple-A rating may require $35 million if downgraded to double-B-minus. At triple-C, the capital requirement might rise to 100%, or $100 million.

Key to your understanding is that downgrades are not changes in the thing itself, but changes in the observation of the thing.  This is a Schrodinger’s Cat moment: the act of observing changes the thing’s value even if its essence remains unchanged. 

You observing me?  You think that changes me?

Though the essence is unchanged, the value is increased.

In a re-remic, three-fourths of the same asset may regain a triple-A rating, requiring just $1.5 million in capital, Barclays said. The remaining one-quarter may require 100% capital, but the total capital requirement would fall to $26.5 million.

Shake up your booty, and it becomes more tasty

The net result is financial firms’ books look better and they need to hold less capital against those assets, even though they are the same assets they held before the transaction.

Put simply, if value is added through the remixing, there are three possibilities:

1. The restructuring changed the risk profile. 

2. The old assessment was too pessimistic.

3. The new assessment is too optimistic.

Better when it’s green, isn’t it?

Of these three, Theory 1 is positive change, Theory 2 has positive impact, and Theory 3 will only make things worse.  So we’d really like Theory 3 to be false, but as we saw some months back, it’s all too easy for people to believe what they desperately hope should be true.

Hope is not good enough – we need expertise and integrity.  Where will we seek it?  Why, the supposedly independent rating agencies.  (I say supposedly because in a five-part series – Part 1, Part 2, Part 3, Part 4, and Part 5 – we saw the rating agencies cozily symbiotic with their ratees.) 

I can be disinterested if you pay me enough

Meanwhile, let’s examine the parol evidence:

American Equity Investment Life Holding Co. has told analysts that it is considering a re-remic. Recent downgrades of its mortgage bonds overstate their risk by a wide margin, its executives said.

That’s Theory 2 expressed in its quintessence.  And it might well be right – many folks, including me, have suggested that the capital markets’ liquidity shortage had led to a massive over-reserving on these assets. 

Some state insurance regulators worry that current ratings are flawed – perhaps even too harsh – for determining the capital that should back up residential-mortgage securities.

Arr, yer too low-rated, matey!

Another anonymous expression of Theory 2.

But they are chafing at the re-remic strategy. That’s partly because of the fees and partly because re-remics rely on ratings firms – faulted for failing early on to identify problems with mortgage-backed bonds – to rate the new securities.

We do know that a symbiote’s life is not a happy one.

At hearings Wednesday on Capitol Hill focused on the ratings firms, U.S. Rep. Dennis Kucinich (D-Ohio) raised concerns about the mounting number of re-remics, saying, “The credit-rating agencies could be setting us up for problems all over again.”

And I know about being set up for problems

Regulators would like “a lot fewer dollars” paid to Wall Street, as well as “less reliance on the ratings agencies,” said Kermitt Brooks, first deputy insurance superintendent in New York. The state is an important voice on financial matters at the National Association of Insurance Commissioners, or NAIC.

Fewer dollars paid is fine if the quality doesn’t suffer, and if you’re not going to rely on the discredited rating agencies, what not-yet-discredited referee are you going to rely on?

The alternative solution, proposed by trade group American Council of Life Insurers, calls for hiring an analytical firm with expertise in residential mortgage-backed securities to help regulators determine the value of deteriorated holdings on insurers’ books, bypassing the ratings providers.

There’s a place for experts who value complex interests.  What will make these postulated new ones any better than the current rating agencies?

It is unclear how big a concern this is for banking regulators. Alabama Deputy Banking Superintendent Trabo Reed said he has seen only a few examples of re-remics.

Is $11 billion ‘only a few examples’?

Wall Street bankers and analysts said a minority of re-remics, perhaps as little as 10% to 30%, are aimed at helping firms like insurers manage capital requirements. The general goal, as one banker put it, is to help “create buyers for orphan securities that otherwise would have languished.”

The issue isn’t why the booty’s being remixed; rather, the issue is whether the remixing is sound or unsound.

“There is $350 billion to $400 billion in market value of securities with no natural buyer due to their rating,” Barclays said in a June report. “The re-remic market provides a way out of this gridlock by creating new AAA securities, which are likely to be viewed as attractively priced.”

We’re only in it for the money

Remixing the booty has a valid regulatory purpose.  Institutions have capital requirements; low-rated securities consume very high capital reserves. 

And Protective Life Corp. said in August that its re-remics, totaling about $1.4 billion, improve the company’s capital standing “in the ballpark” of $75 million.

Getting the securities re-rated, or even re-rating a portion of the securities, adds meaningful value via Theory 1.

Insurance executives estimate that insurers pay 0.35% or so of a deal’s size in investment banking, ratings firm, legal and other costs.

Expressed as a percentage, that’s only 35 beeps.  Doesn’t sound like much, until you multiply it out and its $35 million in fees.

Thirty-five mil!

Pay $35 million, free up $75 million.  Worth it but not by a huge amount.

At an NAIC hearing last week, ratings firms described changes over the past year to improve their analytical, compliance and corporate-governance processes. But they also generally agreed that their ratings weren’t ideal as a sole basis for determining insurers’ capital levels.

In other words, discredited though the rating agencies be, nobody’s offered real competition.

The alternative is to go overseas and get your money from Sheik Yerbouti

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[Continued from yesterday's Part 1.]

As we saw in yesterday’s post, policing is more effective and more civilized if it is preventive, a role played by the cop on the beat since first sentries walked their posts.

Twirling a jaunty billy club

In earlier times, policing was preventive (discouraging crime) or even pre-emptive (rounding up ’suspicious characters’), both of which enforce order at the cost of liberty and often justice.  In today’s developed world, in our yearning for auditable justice we have migrated to a rights-based and rules-based approach to law enforcement, with heavy emphasis on post-facto procedure, and have forgotten how to be creatively preventive – except for Peoria, Illinois, as featured in a story from the Wall Street Journal:

In yesterday’s post, innovative police chief Steven Settingsgaard parked a retired police car conspicuously in front of a suspected drug dealer’s house.  Overnight it was demolished, but then something striking happened:

The dealer left the neighborhood soon after the incident –

Flush a predator from cover and the animal becomes unsettled and nervous; easier to capture.

– he was later arrested and convicted on a gun charge.

Evidently the emotional disruption played a powerful role in the physical disruption.

Find me worrisome?

Still, that’s an expensive trade.  Something reusable was needed.

One summer night, Chief Settingsgaard was pulling out of police headquarters when he did a double take. Rusting in a corner of the police parking lot was a hulking Brink’s truck. It had been purchased — for a dollar — to use in emergencies but had yet to be pressed into service. The chief thought it could be the perfect nuisance-deterrence vehicle, seemingly indestructible and inarguably an eyesore.

Is it an eyesore?  Seems rather fetching to me, a mechanical Saint Bernard standing guard.

I’ve got a rough-hewn manly style

Over the next year, the 12,000 pounds of heavy metal got an extensive makeover, including about $10,000 in new equipment and repairs. It was outfitted with five infrared surveillance cameras, a padlocked hood, a locked gas cap, and protective screens over the head and tail lights.

In short, it became a siege tower in the war on crime – movable, durable, intimidating.  An invulnerable platform for electronic eyes.

Bombard all you want; I’ll still be there

A Peoria tire company installed foam-filled tires that can’t go flat. Decals that say “PEORIA POLICE Nuisance Property Surveillance Vehicle” were pasted on all four sides of the white truck.

By its presence, the Armadillo thus several messages:

We are serious about crime.

We’re not going away.

You are being watched.

I am aware of your activities, citizen

Remarkably, its very stolidity evoked fear in those it sought to frighten:

There were some bumps along the road. When Officer Elizabeth Hermacinski, 39, the force’s nuisance-abatement officer and Armadillo driver, took the behemoth out for its first deployment in July 2008, the targeted troublemakers seemed to have gotten wind of the plan.  In any case, they had parked cars in every available spot in front of the house.

A traditional defense to siege warfare – ringing the castle with a moat.

No parking next to the building

However, in any siege, there is always an outer perimeter.

So Ms. Hermacinski parked across the street, close enough to get the message across. “It’s psychological warfare,” she says.

The besiegers also have another asymmetric advantage: time on their side.

What makes the Armadillo so interesting, in a housing and community safety sense, is that its effect is not judicial but psychological.

Do I make you nervous?

The Armadillo is the opposite of an undercover operation. Its goal isn’t making arrests, but alerting suspects that police are on to them, police say.

In this, the Peoria Armadillo applies the principles of Jeremy Bentham’s Panopticon:

The Panopticon is a type of prison building designed by English philosopher and social theorist Jeremy Bentham in 1785.

A child of the English Enlightenment, Bentham propounded a political doctrine of utilitarianism: “the greatest good of the greatest number.” 

Enlightened, if grim

Government and force were justified if they moved humanity toward greater happiness.  Instead of punishment, prisons were to be social laboratories, where the penitents turned themselves toward civility, overseen by the benevolent gaze of an omniscient if not omnipotent jailer:

The concept of the design is to allow an observer to observe (-opticon) all (pan-) prisoners without the prisoners being able to tell whether they are being watched, thereby conveying what one architect has called the “sentiment of an invisible omniscience.”

In 1984, George Orwell turned the panopticon into a force for totalitarianism via the telescreen.

It was partly the unusual geography of the room that had suggested to him the thing that he was now about to do. 

In his corner, Winston may do the most erotic thing George Orwell could imagine:

But it had also been suggested by the book that he had just taken out of the drawer.  It was a particularly beautiful book.  Its smooth creamy paper, a little yellowed by age, was of a kind that had not been manufactured for at least forty years past.  He could guess, however that the book was much older than that.  Page 9.

With that, he begins to write his own words in this luscious book.

The potential link between official observation and repressive government is so evident that it was obvious even to its inventer:

Bentham himself described the Panopticon as “a new mode of obtaining power of mind over mind, in a quantity hitherto without example.”

Bentham’s Panopticon: Guards at the center of a spider web of sight lines

Behind the power of seeing lies the power of enforcing, and so powerful is that possibility it seldom needs to be deployed.

The surveillance footage is rarely reviewed by the police and is saved for just a short time before it is erased.

After all, if nothing has happened, there is no need for evidence.  The beat cop has prevented crime, which is much cheaper than having to apprehend the criminal.

Short sleeves, visible face – accessible but observing

Still, the unit can have a significant impact.

I love that its value is in being seen much more than seeing.

I don’t want you seeing mea

This past July, Maggie Wren, 50, requested that the Armadillo pay a visit to her home. Police say her adult children and grandchildren were loitering on her front porch and leaving empty beer bottles in her yard. “Every time I wake up, there’s something broken on my fence,” she says.

Police parked the truck outside her house while she went away on vacation. Police say the porch remained quiet and empty while she was gone.

One recent afternoon, Officer Hermacinski was moving the Armadillo to a new spot. “It drives like a tractor,” she said, yelling in order to be heard over the engine’s roar.

The ‘Armadillo,’ a former Brink’s truck with video cameras patrolling Peoria (Elizabeth Hermacinski).

It does drive like a tractor.  Check out this video link.

She pulled the Armadillo to the curb of a white, one-story house with red siding suspected of being a drug house. She flipped on the surveillance cameras, hopped down from the truck and knocked on the door of the house. No one answered. Then she walked over to a waiting police cruiser, got in and drove away, leaving the Armadillo to do its job.

The Robocop on the beat.

Eyes on the street

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