Gaining insight from the banking crisis in Japan a decade ago, the United States should immediately remove troubled assets off bank balance sheets, the president of the Federal Reserve Bank of Boston said Monday.

"Banks with troubled assets focus on avoiding further losses and further depleting capital," Boston Fed chief Eric Rosengren told a conference of international bankers. "Troubled banks in Japan were often more supportive of problem borrowers than borrowers who had good prospects going forward.  Focusing on future growth requires removing the problem assets."

Furthermore, governments are not the best managers of bad assets, Rosengren said.

Japan's financial hardship in the 1990s — often referred to as the "lost decade" in which the government's hesitation to deal with troubled banks lead to "zombie banks" — has been a subject of focus for U.S. policy makers as they search for a solution to the nation's credit freeze, according to a Market Watch report.

When a bank is closed with FDIC support — the current protocol for troubled banks in the United States — the institution's bad assets are removed and quickly disposed of by the FDIC, and the good assets are sold to an acquirer.  The new acquirer does not spend time focusing on the problems of the past, but rather, focuses on maximizing future profitability — which is a good thing, according to Rosengren.

But the problems become more difficult when bad assets are present in troubled, but not insolvent, banks the Fed president said. And allowing these banks to struggle in hopes of a recovery isn't a good idea. Troubled banks tend to postpone reserving loans because it would further deplete capital.

"The evidence from Japan and previous problems in the U.S. indicates that allowing poorly capitalized banks to continue operations with insufficient capital is likely to exacerbate problems with credit availability," Rosengren said. And therefore, the government should move "quickly" to resolve banks that are "clearly insolvent."

While Rosengren didn't offer an outright solution to the issues he raised, he said the issues themselves "must remain in our sights."

Write to Kelly Curran at kelly.curran@housingwire.com.

Disclosure: The author held no relevant investment positions when this story was published. Indirect holdings may exist via mutual fund investments. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.

Top bond traders are not as worried about pending cramdown legislation as some might think — and some are now loading up on Alt-A MBS after what they see as a fear-based sell-off. According to top traders in asset-backed hedge funds who spoke with HousingWire, they're now loading up on certain subprime and Alt-A products while telling investors to expect big returns this year from distressed asset bets in the residential mortgage sector.

“Sure it’s spotty, not everything is moving, but we are definitely trading MBS and making a market," a trader with New York-based Guggenheim Partners, LLC said Friday on condition of anonymity. "What’s moving now is the last cash-flow senior tranche subprime bonds. At prices in the low 20s, it’s hit bottom and the top ABS traders in hedge funds are gobbling it up.”

With the junior debt whipped out of the bond, pro-rata loss-sharing can kick in, he said — meaning that when principal does get paid, it’s now shared throughout all senior tranches, and not just the super-senior bond classes. Since last cash-flow is cheaper to buy then the super-seniors, that’s where the trader at Guggenheim said "the smart money is running to."

“I think the good trades are last cash-flow subprime and super-senior option arms with 40 percent subordination," said Shad Quraishi, former co-head of mortgage backed securities at UBS AG (UBS: 14.05 +0.50%). "These two asset classes generate returns approaching 20 percent yields. I would stay away from prime.” Quraishi left UBS a few months ago, he said, because he saw an opportunity to trade distressed MBS on his own and is now investing his money in the sector, along with advising hedge funds on where the nuggets are.

“The 20 percent yields on the senior tranche of Alt-A and subprime is what I’m banking on," another trader at a large New York-based hedge fund said, on condition of anonymity. "The prices we are paying for these senior tranche Alt-A’s — mid 40 cent range — is a real deal now. Even if home prices fall a bit more, the yield on these bonds are still going pay.”

According to Hedgefund.net, the HFN Mortgages Average index that measures 22 funds active in MBS trading strategy, rose 2.45 percent in January, reflecting that sort of bullish sentiment.

Scott Minerd, a partner at Guggenheim Capital who runs the firm's ABS fund, called a bottom in much of the private party MBS market back in late November of last year. People familiar with his trading say he’s been loading up on senior Alt-A ever since. It's a move that made his fund look like he’d outsmarted former Treasury secretary Hank Paulson in this New York Post story.

Some bond traders and banks holding various MBS on their books are anxiously awaiting the outcome of ongoing Congressional negotiations over the latest homeowner assistance package, HR 1106, which would clearly have an effect on both investors and owners of securitized mortgage products. One RBS Greenwich Capital analyst, however, tried to inspire trading activity last week when he told his clients in a report that certain provisions in the pending cramdown legislation would actually give senior tranches in these MBS a chance to rise in price again.

While the bill appears to prohibit pro-rata loss allocation in deals with “carve-out” provisions, it does not provide guidance to servicers on how they should allocate the losses when principal is reduced in bankruptcy, he said in a research note last week. As a result, the analyst suggested that it's likely servicers would revert to applying bankruptcy losses in much the same way as they apply other losses, by first allocating them to the subordinate bonds before moving up the credit curve to more senior-rated bonds.

Of course, other analysts have been very vocal in suggesting that the proposed bankruptcy cramdown measure could send the secondary market for mortgages into its latest set of fits and starts, as well. But nonetheless, some hedgies are clearly willing to take a risk, betting that fear has oversold the real impact of the proposed legislation.

Desmond Macauley, managing director of asset-backed mortgage strategy at RBS, told HousingWire, “These bonds have already sold off when the chatter on cramdown legislation first began. But there should be a lift in price if the legislation passes as-is.” That means traders who bought on the sell-off could be looking a nice upward swing in price.

“As currently written, this legislation would therefore be beneficial to triple-As and other senior bonds in shifting-interest prime and Alt-A transactions that have bankruptcy carve-out provisions," Macauley told clients in a letter last week.

“I see traders selling not from a view of how cramdown legislation might wipe out MBS bond holders, but they're just reacting to fear," another trader told HousingWire on condition of anonymity. "I’m buying those MBS they're selling because I think the legislation, if it’s even passed, won’t have a great effect on the MBS market."

He expects to ring in double-digit returns for his near-billion-dollar ABS fund this year, he said. "Think about it this way: just because there is new language in a bill it doesn’t mean the bankruptcy judge is going use it. When the market trades on on news out of fear, I go right in for the buying opportunity."

Teri Buhl is an investigative journalist covering Wall Street who has written for the New York Post Sunday Business and Trader Monthly. Contact her at teribuhl@yahoo.com.

Disclosure: The author held no relevant investment positions when this story was published. Indirect holdings may exist via mutual fund investments. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.

The Federal Reserve Board on Friday announced it had issued a cease and desist order against Altus, Okla.-based FSB Bancorp Inc. According to the order, FSB Bancorp failed to timely file required regulatory reports and notices, including a report on changes in organizational structure, engaged in banking activities not compliant with regulatory requirements for financial holding companies, and violated section 23A of the Federal Reserve Act (12 U.S.C. § 371c) and Regulation W of the Board of Governors of the Federal Reserve System (12 C.F.R. Part 223).

FSB Bancorp has consented to the issuance of the order, according to the Fed, and is required within 60 days of the order to submit a written plan to strengthen oversight of the board of directors on the management and operations of FSB and its nonbank subsidiaries. The plan must include action to improve FSB's condition and maintain effective control over the senior management and operations. The plan must address the responsibility of the board of directors to ensure FSB's adherence to applicable laws and regulations. The written plan must also include a description of the information that will be included in periodic reports to be reviewed by the board of directors.

The order requires that FSB hire an independent accounting firm to conduct a company-wide audit all the way back to calendar year 2005, the results of which will be made available to the Fed at the same time they are released to FSB. The company will then be required to submit a written plan "to correct all deficiencies noted in the audit report" within 45 days of receiving the audit report. FSB will be required to submit written procedures to strengthen accounting controls and maintain accurate books and records within 60 days of the order.

Within 30 days of the order, FSB will be required to submit an acceptable repayment plan that addresses any funds received by FSB or its nonbank subsidiaries in connection with the bank's violations of the Federal Reserve Act and Regulation W of the Board of Governors, which deals with the establishment of the Asset-Backed Commercial Paper Money Market Mutual Fund Lending Facility (AMLF) "to reduce liquidity and other strains being experienced by money market mutual funds…." According to Regulation W, bank holding companies "are able to borrow from the Federal Reserve Bank of Boston…on condition that the organizations use the proceeds of the Federal Reserve credit to purchase, at amortized cost, certain highly rated" asset-backed commercial paper from money market mutual funds.

FSB is also required to submit within 90 days of the order a written code of ethics and conflicts of interest policy to "prohibit self-dealing by institution-affiliated parties and their related interests, and the advancing of personal, business, or other interests at the expense of FSB…."

Write to Diana Golobay at diana.golobay@housingwire.com.

Freddie Mac (FRE: 0.00 N/A) announced Monday morning that its chief executive officer, David Moffett, has notified the chairman of the board of directors of his resignation. Moffett was named to the position just six months ago, as the government placed the mortgage giant into conservatorship.

Moffett indicated, according to a statement by Freddie Mac, that he wants to return to a role in the financial services sector. In his letter of resignation, he said, "I have enjoyed my time as CEO of Freddie Mac and I wish all the great employees the very best in the days to come." Moffett worked in the financial services industry from 1993 to 2007 as vice chairman and chief financial officer of U.S. Bancorp. Prior to 1993, he worked at Security Pacific Corp. and BankAmerica Corp.

John Koskinen, chairman of the board, said the company expects to name an interim CEO before March 13, the date on which Moffett's resignation will be effective. John Lockhart, director of the Federal Housing Finance Agency, the company's regulator, said he would work closely with Freddie Mac in order to guarantee a smooth transition in leadership.

Management continues to estimate that FHFA, in its capacity as conservator of Freddie Mac, will submit a request to Treasury to draw an additional amount of approximately $30 billion to $35 billion under the Senior Preferred Stock Purchase Agreement between Freddie Mac and the Treasury.

Write to Kelly Curran at kelly.curran@housingwire.com.

Disclosure: The author held no relevant investment positions when this story was published. Indirect holdings may exist via mutual fund investments. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.

American International Group Inc. (AIG: 25.25 +0.44%) on Monday announced an agreement with the U.S. Treasury Department and the Federal Reserve to restructure and refocus its core business, potentially with the aid of additional government funds. The Treasury said it will exchange the existing $40 billion in preferred shares for new preferred shares under terms that will be revised "to more closely resemble common equity and thus improve the quality of AIG's equity…." The Treasury has also promised up to $30 billion in exchange for non-cumulative preferred stock through a new and upcoming equity capital facility.

"The company continues to face significant challenges, driven by the rapid deterioration in certain financial markets in the last two months of the year and continued turbulence in the markets generally," the Treasury said in a joint media statement with the Fed. "The additional resources will help stabilize the company, and in doing so help to stabilize the financial system."

The Fed said it would also participate in the restructuring effort, reducing the $60 billion revolving credit facility set up back in September for AIG in exchange for up to $26 billion in preferred stock interests — "based on valuations acceptable to the New York [Federal Reserve Bank]" — in the two special purpose vehicles AIG will create to hold outstanding stock of American Life Insurance Co. (ALICO) and American International Assurance Co. (AIA). The Fed said it would also make up to $8.5 billion in new loans to special purpose vehicles (SPVs) established by domestic life insurance subsidiaries of AIG. These loans would be repaid through net cash flows received by the SPVs from designated blocks of life insurance policies.

The Fed said after these steps, the revolving credit facility would be reduced from $60 billion to no less than $25 billion. The interest rate on the facility would also be altered, the Fed said, from the existing three-month LIBOR plus 300 basis points. The existing floor — 3.5 percent — on the LIBOR rate would be removed, and the facility would continue to be secured by a lien on "a substantial portion" of assets held by AIG, according to the Fed. The Treasury and the Fed have said AIG must comply with the executive compensation and corporate government restrictions set forth in the Emergency Economic Stabilization Act.

“AIG is executing one of the most extensive corporate restructuring programs in history at a time when the global economy and capital markets are in turmoil,” said chairman and CEO Edward Liddy in a media statement on the restructuring movement. “While we have made meaningful progress, we have concluded, along with Treasury and the Federal Reserve, that additional tools are needed to enable success. The measures announced today provide the necessary U.S. government support for a plan to establish separate capital structures, including outside ownership, for certain AIG companies."

AIG announced it was forming AIU Holdings Inc., a General Insurance holding company composed of its Commercial Insurance Group, Foreign General unit and other property and casualty operations. The company will boast a board of directors, management team and brand distinct from that of parent AIG. The company also announced it would position ALICO and AIA as independent operations, with their equity contributed into the SPVs that will allow for the repayment of additional government aid put into AIG. “Given the importance of ALICO and AIA to repaying our obligation to the U.S. government, we think this structure is the optimal solution to maintain the value of these businesses and best position them to enhance their franchises," Liddy said.

The restructuring announcement came within moments of the release of the company's fourth-quarter and year-end earnings statement. AIG posted a loss of $61.7 billion — $22.95 per share — in the fourth quarter, for a total net loss of $99.3 billion — $37.84 per share — for the full year 2008.
Write to Diana Golobay at diana.golobay@housingwire.com.

Disclosure: The author held no relevant investment positions when this story was published. Indirect holdings may exist via mutual fund investments. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.